978-1285165905 Chapter 20 Part 1

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352

WHAT’S NEW IN THE SEVENTH EDITION:

There is a new

In the News

feature on “International Differences in Income Redistribution.” The

introductory section has been updated and tables and values have been updated.

LEARNING OBJECTIVES:

the degree of economic inequality in our society.

some problems that arise when measuring economic inequality.

the various policies aimed at helping poor families escape poverty.

CONTEXT AND PURPOSE:

in altering the distribution of income.

The purpose of Chapter 20 is to address income distribution. The discussion proceeds by answering

three questions. First, how much inequality is there? Second, what do different political philosophies have

to say about the proper role of government in altering the distribution of income? And third, what are the

various government policies that are used to help the poor?

KEY POINTS:

INCOME INEQUALITY AND

POVERTY

Chapter 20/Income Distribution and Poverty ❖ 353

 Because in-kind transfers, the economic life cycle, transitory income, and economic mobility are so

important for understanding variation in income, it is difficult to gauge the degree of inequality in our

society using data on the distribution of income in a single year. When these factors are taken into

account, they tend to suggest that economic well-being is more equally distributed than is annual

income.

 Political philosophers differ in their views about the role of government in altering the distribution of

income. Utilitarians (such as John Stuart Mill) would choose the distribution of income to maximize

the sum of utility of everyone in society. Liberals (such as John Rawls) would determine the

of income.

 Various policies aim to help the poor—minimum-wage laws, welfare, negative income taxes, and in–

kind transfers. While these policies help some families escape poverty, they also have unintended

side effects. Because financial assistance declines as income rises, the poor often face very high

CHAPTER OUTLINE:

I. The Measurement of Inequality

2. How many people live in poverty?

4. How often do people move among income classes?

B. U.S. Income Inequality

1. Table 1 shows the distribution of income in the United States by quintile.

2. Table 2 shows the distribution of income in the U.S. over time.

Table 1

Table 2

Encourage students to bring their textbooks to class on the day that you cover this

chapter so they can see these tables and charts up close while you are discussing

them. An alternative would be to provide handouts or use overheads or PowerPoint

slides of the tables and charts. You may also want to check current events for any

new legislation that modifies the rules under which government assistance programs

operate.

354 ❖ Chapter 20/Income Distribution and Poverty

a. Throughout the past several decades, the bottom fifth of families has received about 4 to

5 percent of income, while the top fifth has received 40 to 50 percent of income.

b. From 1935 to 1970, the distribution gradually became more equal. Since 1970, this

trend has reversed itself.

C. Inequality around the World

1. Figure 1 compares the income distribution in the twenty-five most populous countries.

2. The U.S. has greater income disparity than most other economically advanced countries

D. The Poverty Rate

1. Definition of poverty rate: the percentage of the population whose family income

2. Definition of poverty line: an absolute level of income set by the federal

a. In 2011, the poverty line for a family of four was $23,021.

3. Figure 2 shows the poverty rate in the United States since 1959.

b. Since 1973, the increase in income inequality in the United States has prevented the

poverty rate from declining further.

4. Table 3 lists the poverty rates from 2011 for different groups of people in the United States.

than are whites.

b. Poverty is correlated with age. Children are more likely to live in poverty and the elderly

are less likely to live in poverty.

couple.

Figure 1

Figure 2

Table 3

Chapter 20/Income Distribution and Poverty ❖ 355

E. Problems in Measuring Inequality

1. In-Kind Transfers

a. Definition of in–kind transfers: transfers to the poor given in the form of goods

and services rather than cash.

c. A study by the Census Bureau showed that, if in-kind transfers were included in money

income at their market value, the number of families living in poverty would decline by

about 10 percent.

2. The Economic Life Cycle

life.

b. Young workers typically have low incomes. Income rises as the worker matures and

gains experience, peaks around age 50, and then declines until the worker retires at age

65.

c. People borrow and save to smooth out life-cycle changes in income. Borrowing often

occurs when the individual is young, and most individuals save during middle age.

3. Transitory versus Permanent Income

a. Definition of permanent income: a person’s normal income.

b. To gauge inequality of living standards, the distribution of permanent income is more

relevant than the distribution of annual income.

c. Because permanent income excludes transitory changes in income, permanent income is

more equally distributed than is current income.

Case Study: Alternative Measures of Inequality

a. A 2008 study by economists at the Federal Reserve Bank of Dallas shows how different

measures of inequality lead to dramatically different results.

b. Taking tax payments into account or examining consumption rather than income shows

that inequality in the material standards of living is much smaller than inequality in

annual income.

E. Economic Mobility

1. Economic mobility is the movement of people between income classes and occurs often in

the U.S. economy.

2. Because economic mobility is great, many of those below the poverty line are there only

temporarily.

356 ❖ Chapter 20/Income Distribution and Poverty

3. Economists have found substantial mobility in terms of economic success from generation to

generation.

4. The U.S. economy is filled with self-made millionaires. Approximately 80 percent of the

millionaires in the United States made their money on their own as opposed to inheriting it.

II. The Political Philosophy of Redistributing Income

A. Utilitarianism

society.

2. Definition of utility: a measure of happiness or satisfaction.

3. The founders of utilitarianism are Jeremy Bentham and John Stuart Mill.

marginal utility.

a. An extra dollar of income provides a poor person with more additional utility than an

extra dollar would provide to a rich person.

declines.

5. However, utilitarians do not believe that all incomes should be equal.

a. Principle #3: People respond to incentives.

c. Thus, in a utilitarian’s opinion, the government must balance the gains from greater

equality against the losses caused by the distorted incentives.

B. Liberalism

behind a “veil of ignorance.”

2. This is a political philosophy developed by John Rawls.

3. Rawls considered what income distribution a person would consider just if that person did

a. Rawls believed that a person would be most concerned about being at the bottom of the

income distribution.

b. Thus, public policy should aim to raise the welfare of the worst-off person in society.

Chapter 20/Income Distribution and Poverty ❖ 357

c. Definition of the maximin criterion: the claim that the government should aim to

maximize the well-being of the worst-off person in society.

d. This idea suggests that we should consider income redistribution as a form of social

insurance.

e. Definition of social insurance: government policy aimed at protecting people

against the risk of adverse events.

utilitarianism).

C. Libertarianism

1. Definition of libertarianism: the political philosophy according to which the

redistribute income.

2. Libertarians believe that society itself earns no income; only individual members of society

earn income.

4. Libertarians conclude that equality of opportunities is more important than equality of

incomes. Thus, they believe that the government should enforce individual rights to ensure

that everyone has an equal opportunity to make the most of his or her talents and achieve

success.

III. Policies to Reduce Poverty

A. Minimum-Wage Laws

above equilibrium.

a. This leads to higher unemployment among those groups of workers affected by the

minimum wage.

2. The magnitude of the effect depends on the elasticity of labor demand.

a. If the demand for labor is elastic, firms will lower employment more than if the demand

is inelastic.

fully.