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WHAT’S NEW IN THE EIGHTH EDITION:
There is a new
In the News
feature on “A Worldwide View of the Income Distribution.” The term “food
stamps” has been updated to Supplemental Nutritional Assistance Program (SNAP) and tables and values
have been updated.
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
➢ the degree of economic inequality in our society.
➢ some problems that arise when measuring economic inequality.
CONTEXT AND PURPOSE:
Chapter 20 is the third chapter in a three-chapter sequence that addresses the economics of labor
markets. Chapter 18 developed the markets for the factors of production. Chapter 19 extended the basic
supply-and-demand model to help explain the wide variation in wages we find in the economy. Chapter
20 addresses the measurement of the distribution of income and looks at the role the government plays
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:
• Data on the distribution of income show wide disparity in our society. The richest fifth of families
earns more than twelve times as much income as the poorest fifth.
• 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
INCOME INEQUALITY AND
POVERTY
20
Table 2
Chapter 20/Income Distribution and Poverty ❖ 335
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
CHAPTER OUTLINE:
I. The Measurement of Inequality
A. To understand the distribution of income, we want to address four questions.
1. How much inequality is there in our society?
2. How many people live in poverty?
3. What problems arise in measuring the amount of inequality?
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.
Table 1
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.
336 ❖ Chapter 20/Income Distribution and Poverty
C. Inequality around the World
1. Figure 1 compares the income distribution in twenty major countries.
2. The U.S. has substantially greater income disparity than most other economically advanced
countries (such as Japan and Germany), but a more equal income distribution than some
developing countries (such as South Africa and Brazil).
3.
In the News:
A Worldwide View of the Income Distribution
a. While income inequality is worsening in some individual countries, the global distribution
of income is becoming more equal.
b. This article from
The New York Times
distinguishes between nationalistic concerns and
global income inequality.
D. The Poverty Rate
1. Definition of poverty rate: the percentage of the population whose family income
falls below an absolute level called the poverty line.
a. The poverty rate fell from 22.4 percent in 1959 to a low of 11.1 percent in 1973.
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.
Figure 1
Figure 2
Table 3
Chapter 20/Income Distribution and Poverty ❖ 337
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.
2. The Economic Life Cycle
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.
3. Transitory versus Permanent Income
a. Definition of permanent income: a person’s normal income.
4.
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.
E. Economic Mobility
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2. Because economic mobility is great, many of those below the poverty line are there only
temporarily.
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
4. The utilitarian case for redistributing income is based on the assumption of diminishing
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.
5. However, utilitarians do not believe that all incomes should be equal.
a. Principle #3: People respond to incentives.
B. Liberalism
1. Definition of liberalism: the political philosophy according to which the government
should choose policies deemed to be just, as evaluated by an impartial observer
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
not know whether he or she would end up at the top, bottom, or in between.
a. Rawls believed that a person would be most concerned about being at the bottom of the
income distribution.
Chapter 20/Income Distribution and Poverty ❖ 339
b. Thus, public policy should aim to raise the welfare of the worst-off person in society.
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.
C. Libertarianism
3. Libertarians also believe that the government should not take income from some individuals
and give it to others to achieve any particular distribution of income.
4. Libertarians conclude that equality of opportunities is more important than equality of
III. Policies to Reduce Poverty
A. Minimum-Wage Laws
1. For workers with low levels of skill and experience, a high minimum wage forces the wage
above equilibrium.
a. This leads to higher unemployment among those groups of workers affected by the
minimum wage.
b. Although those workers who remain employed benefit from a higher wage, those who
might have been employed at a lower wage are worse off.
2. The magnitude of the effect depends on the elasticity of labor demand.
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B. Welfare
1. Definition of welfare: government programs that supplement the incomes of the
needy.
2. Temporary Assistance for Needy Families (TANF) and Supplemental Security Income (SSI)
are two welfare programs.
3. A common criticism of these programs is that they create incentives for people to become
needy.
4. Proponents argue that being a poor, single mother on welfare is not a life that someone
would choose. Trends also indicate that, while the amount of welfare benefits (adjusted for
inflation) has fallen since the 1970s, the percentage of children living with a single parent has
risen.
C. Negative Income Tax
2. The only qualification required to receive assistance would be a low income.
a. A negative income tax does not encourage illegitimate births and the breakup of families.
b. A negative income tax would subsidize not only the unfortunate but also those who are
simply lazy.
3. The Earned Income Tax Credit (EITC) works much like a negative income tax, but it applies
only to the working poor.
D. In-Kind Transfers
Chapter 20/Income Distribution and Poverty ❖ 341
3. Advocates of cash payments argue that the government cannot know what goods and
services the poor need the most.
E. Anti-Poverty Programs and Work Incentives
1. Many policies for the poor have the unintended effect of discouraging work.
2. Welfare, Medicaid, SNAP, and the EITC all have eligibility requirements that are tied to
income level.
3. One possible solution would be to gradually phase out the benefits gradually as the family’s
income level rises. However, this would raise the costs of these programs substantially.
4. In 1996, the government passed a welfare-reform law that limits the amount of time that any
person can collect welfare.
E.
In the News: International Differences in Income Redistribution
1. Many countries have more generous government programs to support the poor, but they
also have very different tax systems.
SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
1. The poverty rate measures the percentage of the population whose family income falls below
2. Based on the assumption of diminishing marginal utility of income, a utilitarian would favor
some redistribution of income from Petra to Paula because it would increase the total utility
342 ❖ Chapter 20/Income Distribution and Poverty
3. Policies aimed at helping the poor include minimum-wage laws, welfare, a negative income
tax, and in-kind transfers. Minimum-wage laws can help the working poor without any cost to
Chapter Quick Quiz
1. b
Questions for Review
1. The richest fifth of the U.S. population earns about twelve times as much income as the
Chapter 20/Income Distribution and Poverty ❖ 343
Problems and Applications
1. The factors contributing to the increase in income inequality in the United States during the
2. The percentage of children in families with income below the poverty line is almost twice the
3. a. To increase economic mobility within a generation, the government could support
4. Community 1 has ten families with income of $100,000 each and ten families with income of
$20,000 each. Community 2 has ten families with income of $200,000 each and ten families
with income of $22,000 each.
a. Community 2 has more unequal income than Community 1. In Community 2 the rich
5. a. Leaks in the bucket are caused by the administrative costs of redistributing income,
344 ❖ Chapter 20/Income Distribution and Poverty
6. a. A utilitarian would argue that the marginal utility of income for the person with an
8. a. Since the woman receives a smaller TANF benefit when she earns a dollar more, she will