978-1259723223 Chapter 23

Chapter 23 – Income Inequality, Poverty, and Discrimination

McConnell Brue Flynn 21e

DISCUSSION QUESTIONS

1. Use quintiles to briefly summarize the degree of income inequality in the United States. How

and to what extent does government reduce income inequality? LO1

2. Assume that Al, Beth, Carol, David, and Ed receive incomes of $500, $250, $125, $75, and

$50, respectively. Construct and interpret a Lorenz curve for this five-person economy. What

percentage of total income is received by the richest quintile and by the poorest quintile? LO1

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3. How does the Gini ratio relate to the Lorenz curve? Why can’t the Gini ratio exceed 1? What is

implied about the direction of income inequality if the Gini ratio declines from 0.42 to 0.35? How

would one show that change of inequality in the Lorenz diagram? LO1

4. Why is the lifetime distribution of income more equal than the distribution in any specific

year? LO1

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5. Briefly discuss the major causes of income inequality. With respect to income inequality, is

there any difference between inheriting property and inheriting a high IQ? Explain. LO2

6. What factors have contributed to increased income inequality since 1975? LO3

7. Should a nation’s income be distributed to its members according to their contributions to the

production of that total income or according to the members’ needs? Should society attempt to

equalize income or economic opportunities? Are the issues of equity and equality in the

distribution of income synonymous? To what degree, if any, is income inequality equitable? LO4

Chapter 23 – Income Inequality, Poverty, and Discrimination

8. Do you agree or disagree? Explain your reasoning. “There need be no trade-off between

equality and efficiency. An ‘efficient’ economy that yields an income distribution that many

regard as unfair may cause those with meager incomes to become discouraged and stop trying. So

efficiency may be undermined. A fairer distribution of rewards may generate a higher average

productive effort on the part of the population, thereby enhancing efficiency. If people think they

are playing a fair economic game and this belief causes them to try harder, an economy with an

equitable income distribution may be efficient as well. LO4

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9. Comment on or explain: LO4

a. Endowing everyone with equal income will make for very unequal enjoyment and satisfaction.

b. Equality is a “superior good”; the richer we become, the more of it we can afford.

c. The mob goes in search of bread, and the means it employs is generally to wreck the bakeries.

d. Some freedoms may be more important in the long run than freedom from want on the part of

every individual.

e. Capitalism and democracy are really a most improbable mixture. Maybe that is why they need

each other—to put some rationality into equality and some humanity into efficiency.

f. The incentives created by the attempt to bring about a more equal distribution of income are in

conflict with the incentives needed to generate increased income.

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e. The principles underlying the two systems can be summarized as follows: Each dollar

has a vote in the marketplace, and each person has a vote at the ballot box. These

principles are similar enough that the presence of one often leads to the other. They are

dissimilar enough so that the type of society that arises from a combination of the two

represents a workable social compromise.

f. Incentives created in the attempt to bring about more equal distribution of income may

cause a tradeoff in decreased economic efficiency. Higher marginal taxes may reduce the

efforts of those at the top to work harder and produce more. Greater benefits to those at

the bottom may reduce their incentive to do the same as they receive benefits without the

productive effort. In so far as this tradeoff occurs, there will be a reduction in economic

growth and therefore, damage to incentives leading to increased incomes.

10. How do government statisticians determine the poverty rate? How could the poverty rate fall

while the number of people in poverty rises? Which group in each of the following pairs has the

higher poverty rate: (a) children or people age 65 or over? (b) African Americans or foreign-

born noncitizens? (c) Asians or Hispanics? LO5

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11. What are the essential differences between social insurance and public assistance programs?

Why is Medicare a social insurance program whereas Medicaid is a public assistance program?

Why is the earned-income tax credit considered to be a public assistance program? LO6

12. The labor demand and supply data in the following table relate to a single occupation. Use

them to answer the questions that follow. Base your answers on the taste-for-discrimination

model. LO7

a. Plot the labor demand and supply curves for Hispanic workers in this occupation.

b. What are the equilibrium Hispanic wage rate and quantity of Hispanic employment?

c. Suppose the white wage rate in this occupation is $16. What is the Hispanic–to-white wage

ratio?

d. Suppose a particular employer has a discrimination coefficient d of $5 per hour. Will that

employer hire Hispanic or white workers at the Hispanic–white wage ratio indicated in part c?

Explain.

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e. Suppose employers as a group become less prejudiced against Hispanics and demand 14 more

units of Hispanic labor at each Hispanic wage rate in the table. What are the new equilibrium

Hispanic wage rate and level of Hispanic employment? Does the Hispanic–white wage ratio rise

or fall? Explain.

f. Suppose Hispanics as a group increase their labor services in that occupation, collectively

offering 14 more units of labor at each Hispanic wage rate. Disregarding the changes indicated in

part e, what are the new equilibrium Hispanic wage rate and level of Hispanic employment? Does

the Hispanic–white wage ratio rise, or does it fall?

13. Males under the age of 25 must pay far higher auto insurance premiums than females in this

age group. How does this fact relate to statistical discrimination? Statistical discrimination

implies that discrimination can persist indefinitely, while the taste–for–discrimination model

suggests that competition might reduce discrimination in the long run. Explain the difference.

LO7

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14. Use a demand and supply model to explain the impact of occupational segregation or

“crowding” on the relative wage rates and earnings of men and women. Who gains and who loses

from the elimination of occupational segregation? Is there a net gain or a net loss to society?

Explain. LO7

15. LAST WORD Go to Table 1 in the Last Word and compute the ratio of average wealth to

median wealth for each of the 7 years. What trend do you find? What is your explanation for the

trend? The Federal estate tax redistributes wealth in two ways: by encouraging charitable giving,

which reduces the taxable estate, and by heavily taxing extraordinarily large estates and using the

proceeds to fund government programs. Do you favor repealing the estate tax? Explain.

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REVIEW QUESTIONS

1. Suppose that the United States has a Gini ratio of 0.41 while Sweden has a Gini ratio of 0.31.

Which country has a more equal distribution of income? LO1

a. The United States.

b. Sweden.

c. They are actually equal.

2. Some part of income inequality is likely to be the result of discrimination. But other factors

responsible for inequality include (select as many as apply): LO2

a. Differences in abilities and talents.

b. Differences in education and training.

c. Different preferences for work versus leisure.

d. Different preferences for low-paying but safe jobs relative to high-paying but dangerous jobs.

3. Suppose that a society contains only two members, a lawyer named Monique and a handyman

named James. Five years ago, Monique made $100,000 while James made $50,000. This year,

Monique will make $300,000 while James will make $100,000. Which of the following

statements about this society’s income distribution are true? LO3

Select one or more answers from the choices shown.

a. In absolute dollar amounts, the entire distribution of income has been moving upward.

b. In absolute dollar amounts, the entire distribution of income has been stagnant.

c. The relative distribution of income has become more equal.

d. The relative distribution of income has become less equal.

e. The relative distribution of income has remained constant.

f. The rich are getting richer while the poor are getting poorer.

g. The rich are getting richer faster than the poor are getting richer.

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Answer:

a. In absolute dollar amounts, the entire distribution of income has been moving

upward.

d. The relative distribution of income has become less equal.

g. The rich are getting richer faster than the poor are getting richer.

The following three statements about this society’s income distribution are true. In

absolute dollar amounts, the entire distribution of income has been moving upward. We

know this to be true because each person in this society has seen his or her income rise

over the past five years.

The relative distribution of income has become less equal. This is true because

Monique’s share of total income has been rising. Five years ago, Monique’s $100,000 of

income represented 2/3 of the society’s total income of $150,000 (= Monique’s $100,000

+ James’ $50,000). But this year, Monique’s $300,000 of income will represent ¾ of the

society’s total income of $400,000 (= Monique’s $300,000 + James’ $100,000). Thus,

income inequality has risen because the share of income earned by the richest member of

this society has increased.

The rich are getting richer faster than the poor are getting richer. This is true because

while James and Monique have both gotten richer, Monique’s increase in income is

larger than James’ increase in income. In particular, Monique’s income has tripled from

$100,000 to $300,000 while James’ income has only doubled from $50,000 to $100,000.

So the rich are getting richer faster than the poor are getting richer.

4. Suppose that the last dollar that Victoria receives as income brings her a marginal utility of 10

utils while the last dollar that Fredrick receives as income brings him a marginal utility of 15

utils. If our goal is to maximize the combined total utility of Victoria and Fredrick, we should:

LO4

a. Redistribute income from Victoria to Fredrick.

b. Redistribute income from Fredrick to Victoria.

c. Not engage in any redistribution because the current situation already maximizes total utility.

d. None of the above.

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5. If women are crowded into elementary education and away from fire fighting, wages in fire

fighting will tend to be than if women weren’t crowded into elementary education. LO7

a. Higher.

b. Lower.

6. In the taste-for-discrimination model, an increase in employer prejudice against African–

American workers would cause the discrimination coefficient to and the demand curve for

African-American labor to shift. LO7

a. Decrease; right.

b. Decrease; left.

c. Increase; right.

d. Increase; left.

PROBLEMS

1. In 2015, Forbes magazine listed Bill Gates, the founder of Microsoft, as the richest person in

the United States. His personal wealth was estimated to be $76 billion. Given that there were

about 322 million people living in the United States that year, how much could each person have

received if Gates’s wealth had been divided equally among the population of the United States?

(Hint: A billion is a 1 followed by 9 zeros while a million is a 1 followed by six zeros.) LO1

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Feedback: Simply divide Bill Gates’ wealth, $76 billion, by the number of people in the

United States, 322 million. The answer is $236.02 (= $76,000,000,000/322,000,000).

2. Imagine an economy with only two people. Larry earns $20,000 per year while Roger earns

$80,000 per year. As shown in the following figure, the Lorenz curve for this two-person

economy consists of two line segments. The first runs from the origin to point a while the second

runs from point a to point b. LO1

a. Calculate the Gini ratio for this two–person economy using the geometric formulas for the area

of a triangle (= ½ x base x height) and the area of a rectangle (= base x height). Hint: The area

under the line segment from point a to point b can be thought of as the sum of the area of a

particular triangle and the area of a particular rectangle.

b. What would the Gini ratio be if the government taxed $20,000 away from Roger and gave it to

Larry? (Hint: The figure will change.)

c. Start again with Larry earning $20,000 per year and Roger earning $80,000 per year. What

would the Gini ratio be if both their incomes doubled? How much has the Gini ratio changed

from before the doubling in incomes to after the doubling in incomes?

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Answers: a. The Gini ratio is 0.300.

b. The Gini ratio here is 0.100.

c. The Gini ratio will remain as it was in part (a) at 0.300; the ratio has not changed.

Feedback:

Part a: First, we find the area under the equality line. Using our formula for the area of a

right triangle we have an area of 5,000 (= (1/2) x 100 (base or x-axis) x 100 (height or y-

axis).

Second, we find the area between the two curves. To do this we start by finding the area

UNDER the Lorenz curve (we have easy to use formulas for triangles and rectangles).

See the graph below.

Part b:

100%

Equality Line

100%

Lorenz Curve

50%

20%

A

B

C

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After the tax and redistribution program Larry’s new income is $40,000 and Roger’s new

income is $60,000. This implies that Larry (50% of the population) now controls 40% of

society’s income rather than the 20% before the program.

To calculate the new Gini ratio we use the same procedure as above. However, we use

40% rather than the 20% shown in the diagram.

Part c:

3In 2015, many unskilled workers in the United States earned the federal minimum wage of

$7.25 per hour. By contrast, average earnings in 2015 were about $23 per hour, and certain highly

skilled professionals, such as doctors and lawyers, earned $100 or more per hour. LO6

a. If we assume that wage differences are caused solely by differences in productivity, how many

times more productive was the average worker than a worker being paid the Federal minimum

wage? How many times more productive was a $100-per-hour lawyer compared to a worker

earning minimum wage?

b. Assume that there are 20 minimum-wage workers in the economy for each $100-per-hour

lawyer. Also assume that both lawyers and minimum-wage workers work the same number of

hours per week. If everyone works 40 hours per week, how much does a $100-per hour lawyer

earn a week? How much does a minimum-wage worker earn a week?

c. Suppose that the government pairs each $100-per-hour lawyer with 20 nearby minimum-wage

workers. If the government taxes 25 percent of each lawyer’s income each week and distributes it

equally among the 20 minimum-wage workers with whom each lawyer is paired, how much will

each of those minimum-wage workers receive each week? If we divide by the number of hours

worked each week, how much does each minimum-wage worker’s weekly transfer amount to on

an hourly basis?

d. What if instead the government taxed each lawyer 100 percent before dividing the money

equally among the 20 minimum-wage workers with whom each lawyer is paired—how much per

week will each minimum wage worker receive (assuming the lawyer continues to work)? And

how much is that on an hourly basis?

Chapter 23 – Income Inequality, Poverty, and Discrimination

Feedback:

Part a:

Since wage differences are solely due to differences in productivity in the current

example we can determine how many times more productive one group is relative to

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4. The desire to maximize profits can work against racial and other types of discrimination. To

see this, consider two equally productive accountants named Ted and Jared. Ted is black, and

Jared is white. Both can complete 10 audits per month. LO7

a. Suppose that for any accounting firm that hires either Ted or Jared, all the other costs of

performing an audit (besides paying either Ted or Jared) come to $1,000 per audit. If the going

rate that must be paid to hire an accountant is $7,000 per month, how much will it cost an

accounting firm to produce one audit if it hires either Ted or Jared to do the work?

b. If the market price that accounting firms charge their clients for an audit is $1,800, what would

the accounting profit per audit be for a firm that hired either Ted or Jared? What is the profit rate

as a percentage?

c. Suppose that firm A dislikes hiring black accountants while firm B is happy to hire them. So

Ted ends up working at firm B rather than firm A. If Ted works 11 months per year, how many

audits will he complete for firm B each year? How much in accounting profits will firm B earn

each year from those audits?

d. Since firm A passed on hiring Ted because he was black, firm A is forgoing the profits it could

have earned if it had hired Ted. If the firm is willing to forgo up to $5,000 per year in profit to

avoid hiring blacks, by how many dollars will firm A regret its decision not to hire Ted?