Unformatted text preview: 9160335_CH16_p351-372.qxd 6/22/09 9:08 AM Page 351 PA RT S I X Factor Markets, Inequality, and Uncertainty 16 Economic Inequality After studying this chapter,
y ou will be able to:
■ Describe the inequality in income and wealth in the
United States in 2007 and the trends in inequality ■ Explain the features of the labor market that contribute to
economic inequality ■ Describe the scale of income redistribution by
governments Six percent of adults in Los Angeles County, some What causes inequality in the distribution of economic 375,000 people, experienced homelessness during the past five well-being? How much redistribution does the government years. In this same part of the nation is Beverly Hills, with its man- do to limit extreme poverty? sions that are home to some fabulously wealthy movie stars. Los In this chapter, we study economic inequality—its extent, Angeles is not unusual. In New York City, where Donald Trump its sources, and the things governments do to make it less has built a luxury apartment tower with a penthouse priced at extreme. We begin by looking at some facts about eco- $13 million, more than 20,000 people, 9,000 of whom are chil- nomic inequality in the United States. We end, in Reading dren, seek a bed every night in a shelter for the homeless. Between the Lines, by looking at the changing gap between Extreme poverty and extreme wealth exist side by side in every the highest and lowest incomes over the past twenty years. major city in the United States and in most parts of the world.
How many rich and poor people are there in the United
States? How are income and wealth distributed? Are the rich
getting richer and the poor getting poorer? 351 9160335_CH16_p351-372.qxd 352 6/22/09 9:08 AM Page 352 CHAPTER 16 Economic Inequality ◆ Measuring Economic Inequality
Percentage of households The most commonly used measure of economic
inequality is the distribution of annual income. The
Census Bureau defines income as money income,
which equals market income plus cash payments to
households by government. Market income equals
wages, interest, rent, and profit earned in factor
markets, before paying income taxes. FIGURE 16.1 7 Mode (most common)
income: $50,233 6
5 The Distribution of Income Mean (average)
income: $67,609 4 Figure 16.1 shows the distribution of annual
income across the 117 million households in the
United States in 2007. Note that the x-axis measures household income and the y-axis is percentage
The most common household income, called the
mode income, was received by the 6 percent of the
households whose incomes fell between $10,000 and
$15,000. The value of $13,000 marked on the figure
is an estimate.
The middle level of household income in 2007,
called the median income, was $50,233. Fifty percent
of households have an income that exceeds the
median and fifty percent have an income below the
The average household money income in 2007,
called the mean income, was $67,609. This number
equals total household income, about $7.9 trillion,
divided by the 117 million households.
You can see in Fig. 16.1 that the mode income is
less than the median income and that the median
income is less than the mean income. This feature of
the distribution of income tells us that there are more
households with low incomes than with high incomes.
It also tells us that some of the high incomes are very
The income distribution in Fig. 16.1 is called a
positively skewed distribution, which means that it
has a long tail of high values. This distribution contrasts with the bell that describes the distribution of
people’s heights. In a bell-shaped distribution, the
mean, median, and mode are all equal.
Another way of looking at the distribution of
income is to measure the percentage of total income
received by each given percentage of households.
Data are reported for five groups—called quintiles
or fifth shares—each consisting of 20 percent of
households. The Distribution of Income
in the United States in 2007 3
1 0 13 50 67 100 150 200 250 Income (thousands of dollars per year) The distribution of income is positively skewed. The mode
(most common) income is less than the median (middle)
income, which in turn is less than the mean (average)
income. The shape of the distribution above $100,000 is
an indication rather than a precise measure, and the distribution goes up to several million dollars a year.
Source of data: U.S. Bureau of the Census, “Income, Poverty, and Health
Insurance Coverage in the United States: 2007,” Current Population
Reports, P-60-235 (Washington, DC: U.S. Government Printing Office,
2008). animation Figure 16.2 shows the distribution based on these
shares in 2007. The poorest 20 percent of households
received 3.4 percent of total income; the second poorest 20 percent received 8.7 percent of total income;
the middle 20 percent received 14.8 percent of total
income; the next highest 20 percent received 23.4
percent of total income; and the highest 20 percent
received 49.7 percent of total income.
The distribution of income in Fig. 16.1 and the
quintile shares in Fig. 16.2 tell us that income is
distributed unequally. But we need a way of comparing the distribution of income in different periods
and using different measures. A clever graphical
tool called the Lorenz curve enables us to make such
comparisons. 9160335_CH16_p351-372.qxd 6/22/09 9:08 AM Page 353 Measuring Economic Inequality FIGURE 16.2 U.S. Quintile Shares in 2007
Cumulative percentage of income Percentage of
households FIGURE 16.3 Lowest fifth
Next highest fifth The Income Lorenz Curve
in 2007 100 Highest fifth E 80 60 D Line of
40 0 10 20 30 40 353 50 Income
curve C Percentage of total income
20 B Households Income (percentage) (percentage of total income) Lowest 20 14.8 Next highest 20 23.4 Highest 20 49.7 40
Cumulative percentage of households 8.7 Middle 20 20 0 3.4 Second 20 A Households Income Cumulative
Percentage percentage Cumulative
Percentagepercentage A In 2007, the poorest 20 percent of households received
3.4 percent of total income; the second poorest 20 percent
received 8.7 percent; the middle 20 percent received 14.8
percent; the next highest 20 percent received 23.4 percent;
and the highest 20 percent received 49.7 percent.
Source of data: U.S. Bureau of the Census, “Income, Poverty, and Health
Insurance Coverage in the United States: 2007,” Current Population
Reports, P-60-235 (Washington, DC: U.S. Government Printing Office,
2008). animation The Income Lorenz Curve
The income Lorenz curve graphs the cumulative percentage of income against the cumulative percentage
of households. Figure 16.3 shows the income Lorenz
curve using the quintile shares from Fig. 16.2. The
table shows the percentage of income of each quintile
group. For example, row A tells us that the lowest
quintile of households receives 3.4 percent of total
income. The table also shows the cumulative percentages of households and income. For example, row B
tells us that the lowest two quintiles (lowest 40 percent) Lowest 20 20 3.4 3.4 B Second 20 40 8.7 12.1 C Middle 20 60 14.8 26.9 D Next highest 20 80 23.4 50.3 E Highest 20 100 49.7 100.0 The cumulative percentage of income is graphed against the
cumulative percentage of households. Points A through E on
the Lorenz curve correspond to the rows of the table. If
incomes were distributed equally, each 20 percent of households would receive 20 percent of total income and the
Lorenz curve would fall along the line of equality. The Lorenz
curve shows that income is unequally distributed.
Source of data: U.S. Bureau of the Census, “Income, Poverty, and Health
Insurance Coverage in the United States: 2007,” Current Population Reports,
P-60-235 (Washington, DC: U.S. Government Printing Office, 2008). animation of households receive 12.1 percent of total income
(3.4 percent for the lowest quintile and 8.7 percent
for the next lowest). The Lorenz curve graphs the 9160335_CH16_p351-372.qxd 9:08 AM Page 354 CHAPTER 16 Economic Inequality cumulative income shares against the cumulative
If income were distributed equally across all the
households, each quintile would receive 20 percent
of total income and the cumulative percentages of
income received by the cumulative percentages of
households would fall along the straight line labeled
“Line of equality.” The actual distribution of income
is shown by the curve labeled “Income Lorenz curve.”
The closer the Lorenz curve is to the line of equality,
the more equal is the distribution of income. The Distribution of Wealth
The distribution of wealth provides another way of
measuring economic inequality. A household’s wealth is
the value of the things that it owns at a point in time. In
contrast, income is the amount that the household
receives over a given period of time.
Figure 16.4 shows the Lorenz curve for wealth in
the United States in 1998 (the most recent year for
which we have wealth distribution data). The median
household wealth in 1998 was $60,700. Wealth is
extremely unequally distributed, and for this reason,
the data are grouped by seven unequal groups of
households. The poorest 40 percent of households
own only 0.2 percent of total wealth (row A' in the
table in Fig. 16.4). The richest 20 percent of households own 83.4 percent of total wealth. Because this
group owns almost all the wealth, we need to break
the group into smaller parts. That is what rows D'
through G ' do. You can see that the richest 1 percent
of households own 38.1 percent of total wealth.
Figure 16.4 shows the income Lorenz curve (from
Fig. 16.3) alongside the wealth Lorenz curve. You can
see that the Lorenz curve for wealth is much farther
away from the line of equality than is the Lorenz
curve for income, which means that the distribution
of wealth is much more unequal than the distribution
of income. Wealth or Income?
We’ve seen that wealth is much more unequally distributed than is income. Which distribution provides
the better description of the degree of inequality? To
answer this question, we need to think about the
connection between wealth and income.
Wealth is a stock of assets, and income is the
flow of earnings that results from the stock of
wealth. Suppose that a person owns assets worth FIGURE 16.4 Cumulative percentage of income and wealth 354 6/22/09 Lorenz Curves for Income
and Wealth 100 E
G' 80 F' 60 D Line of
equality E' Income 40 D' C
20 C' B
A A' 20 0 Wealth B' 40
Cumulative percentage of households Households Wealth Cumulative
Percentage percentage Cumulative
Percentage percentage A' Lowest 40 40 0.2 0.2 B' Next 20 60 4.5 4.7 C' Next 20 80 11.9 16.6 D' Next 10 90 12.5 29.1 E' Next 5 95 11.5 40.6 F' Next 4 G' Highest 1 99 21.3 61.9 100 38.1 100.0 The cumulative percentage of wealth is graphed against the
cumulative percentage of households. Points A' through G '
on the Lorenz curve for wealth correspond to the rows of the
table. By comparing the Lorenz curves for income and
wealth, we can see that wealth is distributed much more
unequally than is income.
Sources of data: U.S. Bureau of the Census, “Income, Poverty, and
Health Insurance Coverage in the United States: 2007,” Current
Population Reports, P-60-235 (Washington, DC: U.S. Government
Printing Office, 2008); and Edward N. Wolff, “Recent Trends in Wealth
Ownership, 1938–1998,” Jerome Levy Economics Institute Working
Paper No. 300, April 2000. animation 9160335_CH16_p351-372.qxd 6/22/09 9:08 AM Page 355 Measuring Economic Inequality $1 million—has a wealth of $1 million. If the rate of
return on assets is 5 percent a year, then this person
receives an income of $50,000 a year from those
assets. We can describe this person’s economic condition by using either the wealth of $1 million or the
income of $50,000. When the rate of return is 5 percent a year, $1 million of wealth equals $50,000 of
income in perpetuity. Wealth and income are just different ways of looking at the same thing.
But in Fig. 16.4, the distribution of wealth is more
unequal than the distribution of income. Why? It is
because the wealth data do not include the value of
human capital, while the income data measure
income from all wealth, including human capital.
Think about Lee and Peter, two people with equal
income and equal wealth. Lee’s wealth is human capital and his entire income is from employment. Peter’s
wealth is in the form of investments in stocks and
bonds and his entire income is from these investments.
When a Census Bureau agent interviews Lee and
Peter in a national income and wealth survey, their
incomes are recorded as being equal, but Lee’s wealth
is recorded as zero, while Peter’s wealth is recorded as
the value of his investments. Peter looks vastly more
wealthy than Lee in the survey data.
Because the national survey of wealth excludes
human capital, the income distribution is a more
accurate measure of economic inequality than the
wealth distribution. Trends in Inequality
To see trends in the income distribution, we need a
measure that enables us to rank distributions on the
scale of more equal and less equal. No perfect scale
exists, but one that is much used is called the Gini
ratio. The Gini ratio is based on the Lorenz curve and
equals the ratio of the area between the line of equality and the Lorenz curve to the entire area beneath the
line of equality. If income is equally distributed, the
Lorenz curve is the same as the line of equality, so the
Gini ratio is zero. If one person has all the income and
everyone else has none, the Gini ratio is 1. The Share of the Richest One Percent
The Rich Get Richer
The percentage of Americans who tell the Gallup
poll that wealth should be distributed more evenly
has been rising and in 2008, it reached 70 percent.
A reason might be the trend in the incomes of the
richest one percent of Americans. Emmanuel Saez,
an economics professor at the University of
California, Berkeley, has used tax returns data to get
the numbers graphed below.
After decades of a falling share, starting in 1981,
the share of income received by the richest one percent began a steady climb. By 2006 (the latest year in
Professor Saez’s database), the richest one percent
were earning 14.6 percent of the nation’s income. Annual or Lifetime Income and Wealth? 18
World War II
and the "Great
rising inequality 15 Income of top 1 percent
(percentage of total income) A typical household’s income changes over its life
cycle. Income starts out low, grows to a peak when the
household’s workers reach retirement age, and then
falls after retirement. Also, a typical household’s wealth
changes over time. Like income, it starts out low,
grows to a peak at the point of retirement, and falls
Think about three households with identical lifetime incomes, one young, one middle-aged, and one
retired. The middle-aged household has the highest
income and wealth, the retired household has the
lowest, and the young household falls in the middle.
The distributions of annual income and wealth in a
given year are unequal, but the distributions of lifetime income and wealth are equal.
The data on inequality share the bias that you’ve
just seen. Inequality in annual income and wealth
data overstates lifetime inequality because households
are at different stages in their life cycles. 355 12 9 6
1928 1948 1968 1988 2008 Year
The Income Share of the Top One Percent Source of data: Emmanuel Saez, University of California, Berkeley,
http://elsa.berkeley.edu/~saez/. 9160335_CH16_p351-372.qxd 6/22/09 9:08 AM Page 356 CHAPTER 16 Economic Inequality 356 Figure 16.5 shows the U.S. Gini ratio from 1970
to 2007. The figure shows breaks in the data in 1992
and 2000 because in those years, the Census Bureau
changed its method of collecting the data and definitions, so the numbers before and after the breaks can’t
be compared. Despite the breaks in the series, the
Gini ratio has clearly increased, which means that on
this measure, incomes have become less equal.
The major change is that the share of income
received by the richest households has increased. You
saw on the previous page how the income of the richest one percent has increased. No one knows for sure
why this trend has occurred, but a possibility that we’ll
explore in the next section is that technological change
has increased the value of marginal product of highskilled workers and decreased the value of marginal
product of low-skilled workers.
FIGURE 16.5 The U.S. Gini Ratio:
1970–2007 0.48 0.46 Changes in
break series Who Are the Rich and the Poor?
More Evidence that Schooling Pays
Movie stars, sports stars, and the CEOs of large corporations earn the highest incomes. People who scratch
out a living doing seasonal work on farms earn the
lowest incomes. Aside from these extremes, what are
the characteristics of people who earn high incomes
and people who earn low incomes? The figure answers
this question. (The data are for 2007 but the patterns are persistent).
Education A postgraduate education is the main source of a high income. A person with a professional
degree (such as a medical or law degree), earns (on
the average) more than $100,000—more than double
the median income. Just completing high school
raises a person’s income by more than $16,000 a year;
and getting a bachelor’s degree adds another $20,000
a year. The average income of people who have not
completed 9th grade is $21,000—less than half the
Type of Household Married couples earn more, on
the average, than people who live alone. A married
couple earns about $73,000. In contrast, men who
live alone earn about $37,000, and women who live
alone earn only $24,000. 0.44 Age of Householder Households with the oldest and youngest householders have lower incomes than do
those with middle-aged householders. When the householder is aged between 45 and 54, household income
averages $65,000. And when the householder is aged 0.42
Gini ratio 0.40 0.38
1972 1977 1982 1987 1992 1997 2002 2007 Year Measured by the Gini ratio, the distribution of income in the
United States became more unequal between 1970 and
2007. The percentage of income earned by the richest
households increased through these years. Changes in definitions make the numbers before and after 1992 and
before and after 2000 not comparable. Despite the breaks
in the data, the trends are still visible.
Source of data: U.S. Bureau of the Census, “Income, Poverty, and Health
Insurance Coverage in the United States: 2007,” Current Population Reports,
P-60-235 (Washington, DC: U.S. Government Printing Office, 2008). animation Poverty
Households at the low end of the income distribution
are so poor that they are considered to be living in
poverty. Poverty is a situation in which a household’s
income is too low to be able to buy the quantities of
food, shelter, and clothing that are deemed necessary.
Poverty is a relative concept. Millions of people living
in Africa and Asia survive on incomes of less than
$400 a year. In the United States, the poverty level is
calculated each year by the Social Security Administration. In 2007, the poverty level for a four-person
household was an income of $21,203. In that year, 37
million Americans—12.5 percent of the population—
lived in households that had incomes below the 9160335_CH16_p351-372.qxd 6/22/09 9:08 AM Page 357 Measuring Economic Inequality 357 Education of
householder 100,000 Professional degree Income (dollars per household per year) Doctorate degree
Master's degree 80,000 Bachelor's degree Type of
Married couple 60,000 45 to 54 years
35 to 44 years
55 to 64 years Associate degree
no degree 40,000 Male householder,
no wife present High school
graduate less than 9th grade Female householder,
no husband present
Female living alone Race
White 25 to 34 years Male living alone Grades 9–12,
no diploma 20,000 Age of
South Median income Hispanic
15 to 24 years Black 65 years
and over The Distribution of Income by Selected Household Characteristics Source of data: U.S. Bureau of the Census, “Income, Poverty, and Health Insurance Coverage in the United States: 2007,” Current Population Reports,
P-60-235 (Washington, DC: U.S. Government Printing Office, 2008). between 35 and 44, household income averages
$62,000. When the householder is aged between 15
and 24, average household income is $31,000. And for
householders over 65, the average household income is
Race and Ethnicity White Americans have an average
income of $55,000, while black Americans have an
average income of $34,000. People of Hispanic origin are a bit better off, with an average income of poverty level. Many of these households benefited
from Medicare and Medicaid, two government programs that aid the poorest households and lift some of
them above the poverty level.
The distribution of poverty by race is unequal:
8.2 percent of white Americans live in poor households compared to 22 percent of Hispanic-origin
Americans and 25 percent of black Americans.
Poverty is also influenced by household status. More
than 28 percent of households in which the householder is a female with no husband present had
incomes below the poverty level.
Despite the widening of the income distribution,
poverty rates are falling. $39,000. Best off of all are Asian people; their average income is $66,000.
Region People who live in the West and Northeast
earn more, on average, than people who live in the
Midwest and the South. While the region does make
a difference, its magnitude is small compared to the
dominating effect of education. The bottom line: schooling pays. So does marriage. Review Quiz ◆
2 3 4 Which is distributed more unequally, income
or wealth? Why? Which is the better measure?
Has the distribution of income become more
equal or more unequal? Which quintile share
has changed most?
What are the main characteristics of people
who earn large incomes and who earn small
What is poverty and how does its incidence
vary across the races?
Work Study Plan 16.1
and get instant feedback. 9160335_CH16_p351-372.qxd 358 6/22/09 9:08 AM Page 358 CHAPTER 16 Economic Inequality ◆ The Sources of Economic
We’ve described economic inequality in the United
States. Our task now is to explain it. We began this
task by learning about the forces that influence
demand and supply in the markets for labor, capital,
and land. We’re now going to deepen our understanding of these forces.
Inequality arises from unequal labor market outcomes and from unequal ownership of capital. We’ll
begin by looking at labor markets and two features of
them that contribute to differences in income:
■ Human capital
Discrimination Human Capital
A clerk in a law firm earns less than a tenth of the
amount earned by the attorney he assists. An operating room assistant earns less than a tenth of the
amount earned by the surgeon with whom she
works. A bank teller earns less than a tenth of the
amount earned by the bank’s CEO. These differences in earnings arise from differences in human
Suppose there are just two levels of human capital,
which we’ll call high-skilled labor and low-skilled
labor. The low-skilled labor might represent the law
clerk, the operating room assistant, or the bank teller,
and the high-skilled labor might represent the attorney, the surgeon, or the bank’s CEO. We’ll first look
at the market demand for these two types of labor.
The Demand for High-Skilled and Low-Skilled Labor High-skilled workers can perform tasks that lowskilled labor would perform badly or perhaps could
not perform at all. Imagine an untrained person
doing open-heart surgery. High-skilled labor has a
higher value of marginal product than does lowskilled labor. As we learned in Chapter 18, a firm’s
demand for labor curve is the same as the value of
marginal product of labor curve.
Figure 16.6(a) shows the demand curves for highskilled and low-skilled labor. The demand curve for
high-skilled labor is DH, and that for low-skilled labor
is DL. At any given level of employment, firms are willing to pay a higher wage rate to a high-skilled worker
than to a low-skilled worker. The gap between the two wage rates measures the value of marginal product of
skill; for example, at an employment level of 2,000
hours, firms are willing to pay $12.50 an hour for a
high-skilled worker and only $5 an hour for a lowskilled worker, a difference of $7.50 an hour. So the
value of marginal product of skill is $7.50 an hour.
The Supply of High-Skilled and Low-Skilled Labor High-skilled labor contains more human capital than
does low-skilled labor, and human capital is costly to
acquire. The opportunity cost of acquiring human
capital includes expenditures on tuition and textbooks and also forgone or reduced earnings while the
skill is being acquired. When a person goes to school
full time, that cost is the total earnings forgone. But
some people acquire skills on the job—on-the-job
training. Usually, a worker undergoing on-the-job
training is paid a lower wage than one doing a comparable job but not undergoing training. In such a
case, the cost of acquiring the skill is the difference
between the wage paid to a person not being trained
and that paid to a person being trained.
The position of the supply curve of high-skilled
labor reflects the cost of acquiring human capital.
Figure 16.6(b) shows two supply curves: one for
high-skilled labor and the other for low-skilled labor.
The supply curve for high-skilled labor is SH, and
that for low-skilled labor is SL.
The high-skilled labor supply curve lies above the
low-skilled labor supply curve. The vertical distance
between the two supply curves is the compensation
that high-skilled labor requires for the cost of
acquiring the skill. For example, suppose that the
quantity of low-skilled labor supplied is 2,000 hours
at a wage rate of $5 an hour. This wage rate compensates the low-skilled workers mainly for their
time on the job. To induce high-skilled workers to
supply 2,000 hours of labor, firms must pay a wage
rate of $8.50 an hour.
Wage Rates of High-Skilled and Low-Skilled Labor The demand for and supply of high-skilled and lowskilled labor determine the two wage rates. Figure
16.6(c) brings together the demand curves and the
supply curves for high-skilled and low-skilled labor.
Equilibrium occurs in the market for low-skilled
labor (on the blue supply and demand curves) at a
wage rate of $5 an hour, and a quantity of low-skilled
labor of 2,000 hours. Equilibrium occurs in the market for high-skilled labor (on the green supply and 9160335_CH16_p351-372.qxd 6/22/09 9:08 AM Page 359 The Sources of Economic Inequality 12.50
10.00 5.00 VMP
of skill DH 10.00 Compensation
for cost of
acquiring skill SH
SL 8.50 5.00 Wage rate (dollars per hour) Skill Differentials
Wage rate (dollars per hour) Wage rate (dollars per hour) FIGURE 16.6 SH
5 DH DL
0 359 1
Labor (thousands of hours per day) (a) Demand for high-skilled
and low-skilled labor DL
Labor (thousands of hours per day) (b) Supply of high-skilled
and low-skilled labor Part (a) illustrates the value of marginal product of skill. Lowskilled labor has a value of marginal product that gives rise to
the demand curve marked DL. High-skilled labor has a higher
value of marginal product than does low-skilled labor, so the
demand curve for high-skilled labor, DH, lies to the right of DL.
The vertical distance between these two curves is the value of
marginal product of the skill.
Part (b) illustrates the cost of acquiring skill. The supply 0 1
Labor (thousands of hours per day) (c) Markets for high-skilled
and low-skilled labor curve for low-skilled labor is SL. The supply curve for highskilled labor is SH. The vertical distance between these two
curves is the required compensation for the cost of acquiring
Part (c) shows the equilibrium employment and the wage
differential. Low-skilled workers provide 2,000 hours of labor
at a wage rate of $5 an hour. High-skilled workers provide
3,000 hours of labor at a wage rate of $10 an hour. animation demand curves) at a wage rate of $10 an hour, and a
quantity of high-skilled labor of 3,000 hours.
The equilibrium wage rate of high-skilled labor is
higher than that of low-skilled labor for two reasons:
First, high-skilled labor has a higher value of marginal
product than low-skilled labor, so at a given wage rate,
the quantity of high-skilled labor demanded exceeds
that of low-skilled labor. Second, skills are costly to
acquire, so at a given wage rate, the quantity of highskilled labor supplied is less than that of low-skilled
labor. The wage differential (in this case, $5 an hour)
depends on both the value of marginal product of the
skill and the cost of acquiring it. The higher the value
of marginal product of a skill or the more costly it is
to acquire a skill, the larger is the wage differential
between high-skilled and low-skilled labor.
Do Education and Training Pay? Rates of return on
high school and college education have been estimated to be in the range of 5 percent to 10 percent a
year after allowing for inflation, which suggest that a
college degree is a better investment than almost any
other that a person can undertake. Inequality Explained by Human Capital Differences Human capital differences help to explain some of
the inequality that we observe.
High-income households tend to be better educated, middle-aged, Asian or white, and married couples (see the figure on p. 357). Human capital
differences are correlated with these household characteristics. Education contributes directly to human
capital. Age contributes indirectly to human capital
because older workers have more experience than
younger workers. Human capital differences can also
explain a small part of the inequality associated with
sex and race. A larger proportion of men (25 percent)
than women (20 percent) have completed four
years of college, and a larger proportion of whites
(24 percent) than blacks (13 percent) have completed
a bachelor’s degree or higher. These differences in
education levels among the sexes and the races are
becoming smaller, but they have not been eliminated.
Career interruptions can decrease human capital. A
person (most often a woman) who interrupts a career
to raise young children usually returns to the labor
force with a lower earning capacity than a similar 9160335_CH16_p351-372.qxd 9:08 AM Page 360 CHAPTER 16 Economic Inequality Trends in Inequality Explained by Technological
Change and Globalization You’ve seen that high- income households have earned an increasing share
of total income while low-income households have
earned a decreasing share: The distribution of income
in the United States has become more unequal.
Technological change and globalization are two possible sources of this increased inequality.
Technological Change Information technologies such as
computers and laser scanners are substitutes for
low-skilled labor: They perform tasks that previously
were performed by low-skilled labor. The introduction
of these technologies has lowered the marginal product
and the demand for low-skilled labor. These same
technologies require high-skilled labor to design,
program, and run them. High-skilled labor and the
information technologies are complements. So the
introduction of these technologies has increased the
marginal product and demand for high-skilled labor.
Figure 16.7 illustrates the effects on wages and
employment. The supply of low-skilled labor (part a)
and that of high-skilled labor (part b) are S, and initially, the demand in each market is D0. The low-skill
wage rate is $5 an hour, and the high-skill wage rate
is $10 an hour. The demand for low-skilled labor
decreases to D1 in part (a) and the demand for highskilled labor increases to D1 in part (b). The low-skill
wage rate falls to $4 an hour and the high-skill wage
rate rises to $15 an hour. The entry of China and other developing countries into the global economy has lowered the prices of many manufactured goods. Lower
prices for the firm’s output lowers the value of marginal product of the firm’s workers and decreases
the demand for their labor. A situation like that in
Fig. 16.7(a) occurs. The wage rate falls, and employment shrinks.
At the same time, the growing global economy
increases the demand for services that employ highskilled workers, and the value of marginal product
and the demand for high-skilled labor increases. A
situation like that in Fig. 16.7(b) occurs. The wage
rate rises, and employment opportunities for highskilled workers expand. FIGURE 16.7
Wage rate (dollars per hour) person who has kept working. Likewise, a person who
has suffered a spell of unemployment often finds a new
job at a lower wage rate than that of a similar person
who has not been unemployed. Explaining the Trend in
Income Distribution 10
and low-skilled labor
are substitutes 8 S 6
4 2 D0
0 1 2
Labor (thousands of hours per day) (a) A decrease in demand for low-skilled labor Wage rate (dollars per hour) 360 6/22/09 20 S 15 D1 10 5 Globalization 0 Information technology
and high-skilled labor
2 D0 4
Labor (thousands of hours per day) (b) An increase in demand for high-skilled labor Low-skilled labor in part (a) and information technologies
are substitutes. Advances in information technology
decrease the demand for low-skilled labor and lower its
wage rate. High-skilled labor in part (b) and information
technologies are complements. Advances in information
technology increase the demand for high-skilled labor and
raise its wage rate.
animation 9160335_CH16_p351-372.qxd 6/22/09 9:08 AM Page 361 The Sources of Economic Inequality Counteracting Forces Economists disagree about whether prejudice actually causes wage differentials,
and one line of reasoning implies that it does not.
In the above example, customers who buy from
white men pay a higher service charge for investment advice than do the customers who buy from
black women. This price difference acts as an incentive to encourage people who are prejudiced to buy
from the people against whom they are prejudiced.
This force could be strong enough to eliminate the
effects of discrimination altogether. Suppose, as is
true in manufacturing, that a firm’s customers never
meet its workers. If such a firm discriminates
against women or minorities, it can’t compete with
firms who hire these groups because its costs are
higher than those of the nonprejudiced firms. Only
firms that do not discriminate survive in a competitive industry.
Whether because of discrimination or from some
other source, women and visible minorities do earn
lower incomes than white males. Another possible
source of lower wage rates of women arises from differences in the relative degree of specialization of
women and men. Wage (thousands of dollars per year) Human capital differences can explain some of the
economic inequality that we observe. Discrimination
is another possible source of inequality.
Suppose that black females and white males have
identical abilities as investment advisors. Figure 16.8
shows the supply curves of black females, SBF (in
part a), and of white males, SWM (in part b). The
value of marginal product of investment advisors,
shown by the two curves labeled VMP in parts
(a) and (b), is the same for both groups.
If everyone is free of race and sex prejudice, the
market determines a wage rate of $40,000 a year for
investment advisors. But if the customers are prejudiced against women and minorities, this prejudice is
reflected in the wage rate and employment.
Suppose that the perceived value of marginal product of the black females, when discriminated against,
is VMPDA. Suppose that the perceived value of marginal product for white males, the group discriminated in favor of, is VMPDF. With these VMP curves,
black females earn $20,000 a year and only 1,000
black females work as investment advisors. White
males earn $60,000 a year, and 3,000 of them work
as investment advisors. Discrimination FIGURE 16.8 SBF Discrimination No
discrimination 40 20 VMPDA
0 1 VMP 2
Investment advisors (thousands) (a) Black females Wage (thousands of dollars per year) Discrimination 361 SWM
60 VMPDF 40 No
discrimination 0 VMP 3
Investment advisors (thousands) (b) White males With no discrimination, the wage rate is $40,000 a year
and 2,000 of each group are hired. With discrimination
against blacks and women, the value of marginal product
curve in part (a) is VMPDA and that in part (b) is VMPDF. The
wage rate for black women falls to $20,000 a year, and
only 1,000 are employed. The wage rate for white men
rises to $60,000 a year, and 3,000 are employed.
animation 9160335_CH16_p351-372.qxd 362 6/22/09 9:08 AM Page 362 CHAPTER 16 Economic Inequality Differences in the Degree of Specialization Couples
must choose how to allocate their time between
working for a wage and doing jobs in the home, such
as cooking, cleaning, shopping, organizing vacations,
and, most important, bearing and raising children.
Let’s look at the choices of Bob and Sue.
Bob might specialize in earning an income and
Sue in taking care of the home. Or Sue might specialize in earning an income and Bob in taking care of
the home. Or both of them might earn an income
and share home production jobs.
The allocation they choose depends on their preferences and on their earning potential. The choice of
an increasing number of households is for each person to diversify between earning an income and
doing some household chores. But in most households, Bob will specialize in earning an income and
Sue will both earn an income and bear a larger share
of the task of running the home. With this allocation, Bob will probably earn more than Sue. If Sue
devotes time and effort to ensuring Bob’s mental and
physical well-being, the quality of Bob’s market labor
will be higher than it would be if he were diversified.
If the roles were reversed, Sue would be able to supply market labor that earns more than Bob’s.
To test whether the degree of specialization
accounts for earnings differences between the sexes,
economists have compared the incomes of nevermarried men and women. They have found that, on
the average, with equal amounts of human capital,
the wages of these two groups are the same.
We’ve examined some sources of inequality in the
labor market. Let’s now look at the way inequality
arises from unequal ownership of capital. Unequal Wealth
You’ve seen that wealth inequality—excluding
human capital—is much greater than income
inequality. This greater wealth inequality arises from
two sources: life-cycle saving patterns and transfers
of wealth from one generation to the next.
Life-Cycle Saving Patterns Over a family’s life cycle, wealth starts out at zero or perhaps less than zero. A
student who has financed education all the way
through graduate school might have lots of human
capital and an outstanding student loan of $30,000.
This person has negative wealth. Gradually loans get
paid off and a retirement fund is accumulated. At the
point of retiring from full time work, the family has maximum wealth. Then, during its retirement years,
the family spends its wealth. This life-cycle pattern
means that much of the wealth is owned by people in
Intergenerational Transfers Households that inherit
wealth from the previous generation or that save
more than enough on which to live during retirement
end up transferring wealth to the next generation.
But intergenerational transfers are not always a source
of increased inequality. If a generation that has a high
income saves a large part of that income and leaves
wealth to a succeeding generation that has a lower
income, this transfer decreases the degree of inequality. But one feature of intergenerational transfers of
wealth leads to increased inequality: wealth concentration through marriage.
Marriage and Wealth Concentration People tend to marry within their own socioeconomic class—a phenomenon called assortative mating. In everyday language, “like attracts like.” Although there is a good
deal of folklore that “opposites attract,” perhaps such
Cinderella tales appeal to us because they are so rare
in reality. Wealthy people seek wealthy partners.
Because of assortative mating, wealth becomes
more concentrated in a small number of families and
the distribution of wealth becomes more unequal. Review Quiz ◆
6 What role does human capital play in accounting for income inequality?
What role might discrimination play in
accounting for income inequality?
What are the possible reasons for income
inequality by sex and race?
How might technological change and globalization influence the distribution of income?
Does inherited wealth make the distribution of
income less equal or more equal?
Why does wealth inequality persist across
Work Study Plan 16.2
and get instant feedback. Next, we’re going to see how taxes and government programs redistribute income and decrease the
degree of economic inequality. 9160335_CH16_p351-372.qxd 6/22/09 9:08 AM Page 363 Income Redistribution ◆ Income Redistribution
The three main ways in which governments in the
United States redistribute income are
■ Income taxes
Income maintenance programs
Subsidized services Income Taxes
Income taxes may be progressive, regressive, or proportional. A progressive income tax is one that taxes
income at an average rate that increases with income.
A regressive income tax is one that taxes income at an
average rate that decreases with income. A proportional
income tax (also called a flat-rate income tax) is one
that taxes income at a constant average rate, regardless of the level of income.
The income tax rates that apply in the United
States are composed of two parts: federal and state
taxes. Some cities, such as New York City, also have
an income tax. There is variety in the detailed tax
arrangements in the individual states, but the tax
system, at both the federal and state levels, is progressive. The poorest working households receive
money from the government through an earned
income tax credit. Successively higher-income
households pay 10 percent, 15 percent, 25 percent,
28 percent, 33 percent, and 35 percent of each
additional dollar earned. Income Maintenance Programs
Three main types of programs redistribute income
by making direct payments (in cash, services, or
vouchers) to people in the lower part of the income
distribution. They are
■ Social Security programs
Welfare programs Social Security Programs The main Social Security program is OASDHI—Old Age,
Survivors, Disability, and Health Insurance.
Monthly cash payments to retired or disabled
workers or their surviving spouses and children are
paid for by compulsory payroll taxes on both
employers and employees. In 2007, total Social 363 Security expenditure was budgeted at $550 billion,
and the standard monthly Social Security check for
a married couple was a bit more than $1,000.
The other component of Social Security is
Medicare, which provides hospital and health insurance for the elderly and disabled.
Unemployment Compensation To provide an income
to unemployed workers, every state has established an
unemployment compensation program. Under these
programs, a tax is paid that is based on the income of
each covered worker and such a worker receives a benefit when he or she becomes unemployed. The details
of the benefits vary from state to state.
Welfare Programs The purpose of welfare is to provide incomes for people who do not qualify for Social
Security or unemployment compensation. They are 1. Supplementary Security Income (SSI) program,
designed to help the neediest elderly, disabled,
and blind people
2. Temporary Assistance for Needy Households
(TANF) program, designed to help households
that have inadequate financial resources
3. Food Stamp program, designed to help the poorest households obtain a basic diet
4. Medicaid, designed to cover the costs of medical
care for households receiving help under the SSI
and TANF programs Subsidized Services
A great deal of redistribution takes place in the
United States through the provision of subsidized
services—services provided by the government at
prices below the cost of production. The taxpayers
who consume these goods and services receive a
transfer in kind from the taxpayers who do not consume them. The two most important areas in which
this form of redistribution takes place are health
care and education—both kindergarten through
grade 12 and college and university.
In 2007–2008, students enrolled in the University
of California system paid annual tuition fees of
$6,780. The cost of providing a year’s education at
the University of California was probably about
$20,000. So households with a member enrolled in
one of these institutions received a benefit from the
government of more than $13,000 a year. 9160335_CH16_p351-372.qxd 9:08 AM Page 364 The Scale of Income Redistribution
Only the Richest Pay
A household’s market income tells us what a household earns in the absence of government redistribution. You’ve seen that market income is not the
official basis for measuring the distribution of
income that we’ve used in this chapter. The Census
Bureau’s measure is money income (market income
plus cash transfers from the government). But market income is the correct starting point for measuring the scale of income redistribution.
We begin with market income and then subtract
taxes and add the amounts received in benefits. The
result is the distribution of income after taxes and
benefits. The data available on benefits exclude the
value of subsidized services such as college, so the
resulting distribution might understate the total
amount of redistribution from the rich to the poor.
The figures show the scale of redistribution in
2001, the most recent year for which the Census
Bureau has provided these data. In Fig. 1, the blue
Lorenz curve describes the market distribution of
income and the green Lorenz curve shows the distribution of income after all taxes and benefits, including Medicaid and Medicare benefits. (The Lorenz
curve based on money income in Fig. 16.3 lies
between these two curves.)
The distribution after taxes and benefits is less
unequal than is the market distribution. The lowest
20 percent of households received only 0.9 percent of
market income but 4.6 percent of income after taxes
and benefits. The highest 20 percent of households
received 55.6 percent of market income, but only 46.7
percent of income after taxes and benefits.
Figure 2 highlights the percentage of total income
redistributed among the five groups. The share of
total income received by the lowest 60 percent of
households increased. The share received by the
fourth quintile barely changed. And the share
received by the highest quintile fell by 8.9 percent. Government provision of health-care services
has grown to the scale of private provision. Programs
such as Medicaid and Medicare bring high-quality
and high-cost health care to millions of people who
earn too little to buy such services themselves. Cumulative percentage of income CHAPTER 16 Economic Inequality 100 Income after
benefits 80 60
income 20 0 40
Cumulative percentage of households Figure 1 Income Distribution Before and After Redistribution 5 Redistribution
(percentage of total income) 364 6/22/09 0 –5 –10
Cumulative percentage of households 100 Figure 2 The Scale of Redistribution Source of data: U.S. Bureau of the Census, “Money Income in the United
States: 2001,” Current Population Reports, P-60-200 (Washington, DC: U.S.
Government Printing Office, 2003). The Big Tradeoff
The redistribution of income creates what has been
called the big tradeoff, a tradeoff between equity and
efficiency. The big tradeoff arises because redistribution uses scarce resources and weakens incentives. 9160335_CH16_p351-372.qxd 6/22/09 9:08 AM Page 365 Income Redistribution 365 A dollar collected from a rich person does not
translate into a dollar received by a poor person.
Some of it gets used up in the process of redistribution. Tax-collecting agencies such as the Internal
Revenue Service and welfare-administering agencies (as well as tax accountants and lawyers) use
skilled labor, computers, and other scarce resources
to do their work. The bigger the scale of redistribution, the greater is the opportunity cost of administering it.
But the cost of collecting taxes and making welfare
payments is a small part of the total cost of redistribution. A bigger cost arises from the inefficiency
(deadweight loss) of taxes and benefits. Greater equality can be achieved only by taxing productive activities such as work and saving. Taxing people’s income
from their work and saving lowers the after-tax
income they receive. This lower after-tax income
makes them work and save less, which in turn results
in smaller output and less consumption not only for
the rich who pay the taxes but also for the poor who
receive the benefits.
It is not only taxpayers who face weaker incentives
to work. Benefit recipients also face weaker incentives. In fact, under the welfare arrangements that
prevailed before the 1996 reforms, the weakest incentives to work were those faced by households that
benefited from welfare. When a welfare recipient got
a job, benefits were withdrawn and eligibility for programs such as Medicaid ended, so the household in
effect paid a tax of more than 100 percent on its
earnings. This arrangement locked poor households
in a welfare trap.
So the agencies that determine the scale and methods of income redistribution must pay close attention
to the incentive effects of taxes and benefits. Let’s
close this chapter by looking at one way in which
lawmakers are tackling the big tradeoff today. $10 billion was not paid and 30 percent of the women
received no support from their children’s fathers.
The long-term solution to the problem these
women face is education and job training—acquiring
human capital. The short-term solutions are enforcing child support payments by absent fathers and former spouses and providing welfare.
Welfare must be designed to minimize the disincentive to pursue the long-term goal of becoming
self-supporting. The current welfare program in the
United States tries to walk this fine line.
Passed in 1996, the Personal Responsibility and
Work Opportunities Reconciliation Act strengthened
the Office of Child Support Enforcement and
increased the penalties for nonpayment of support.
The act also created the Temporary Assistance for
Needy Households (TANF) program. TANF is a
block grant paid to the states, which administer payments to individuals. It is not an open-ended entitlement program. An adult member of a household that
is receiving assistance must either work or perform
community service, and there is a five-year limit for
assistance. A Major Welfare Challenge Young women who have We’ve examined economic inequality in the
United States. We’ve seen how inequality arises and
that inequality has been increasing. Reading Between
the Lines on pp. 366–367 looks at the increasing
inequality that began during the early 1980s and
The next chapter focuses on some problems for
the market economy that arise from uncertainty and
incomplete information. But unlike the cases we
studied in Chapters 14 and 15, this time the market
does a good job of coping with the problems. not completed high school, have a child (or children), live without a partner, and more likely are
black or Hispanic are among the poorest people in
the United States today. They and their children present a major welfare challenge.
First, their numbers are large. In 2007, there were
14 million single-mother families. This number is
12 percent of families. In 1997 (the most recent
year with census data), single mothers were owed
$26 billion in child support. Of this amount, Review Quiz ◆
3 How do governments in the United States
Describe the scale of redistribution in the
What is one of the major welfare challenges
today and how is it being tackled in the United
Work Study Plan 16.3
and get instant feedback. ◆ 9160335_CH16_p351-372.qxd 6/22/09 9:08 AM Page 366 READING BETWEEN THE LINES Trends in Inequality
Income Gap in New York Is Called Nation’s Highest
January 27, 2006 New York continues to have the highest income disparity between rich and poor of any state,
according to a new study by two national economic policy groups.
The average income of the richest fifth of New York State families is 8.1 times the average income of the poorest fifth, according to the study, which drew from census data compiled by
the Economic Policy Institute and the Center on Budget and Policy Priorities, two liberal research groups based in Washington.
Nationwide, families in the top fifth made 7.3 times more than those in the bottom fifth.
While New York has been at the top of the income gap list for several years, it ranked 11th in
the early 1980s, when the difference between the average income of the top and bottom
fifths was 5.6 times. …
The average income of families in the top 20 percent in New York State was $130,431, compared with $16,076 for the bottom fifth, according to data in the report.
From 1980–1982 to 2001–2003, the periods examined in the study, average incomes grew
by 18.9 percent nationwide, or $2,664, for the poorest families and 58.5 percent, or
$45,101, for families among the top fifth of income earners.
“The biggest thing is the decline in wages for the low and moderate income people,” said
Elizabeth McNichol, an author of the report. “Part of it is large periods of higher than average unemployment, globalization—jobs going overseas—the shift from manufacturing jobs
to lower paying service sector jobs, immigration, the weakening of unions, and the fact that
the federal minimum wage has been declining relative to inflation.” …
Copyright 2006 The New York Times Company. Reprinted with permission. Further reproduction prohibited. Essence of the Story
■ In 2001–2003, the average income of families in the
top 20 percent in New York State was 8.1 times the average income of the bottom 20 percent. ■ In 1980–1982, the average income of families in the
top 20 percent in New York State was 5.6 times the average income of the bottom 20 percent. ■ 366 In 2001–2003, the average income of families in the
top 20 percent in the United States was 7.3 times the
average income of the bottom 20 percent. ■ From 1980–1982 to 2001–2003, average incomes
grew by 58.5 percent for families in the top 20 percent and by 18.9 percent for families in the bottom 20
percent. ■ Several factors contributed to the increased inequality. 6/22/09 9:08 AM Page 367 Economic Analysis
■ Between 1980–1982 and 2001–2003, according
to the study reported in the article, the income share
of the highest 20 percent of New York families increased from 5.6 times to 8.1 times that of the lowest
20 percent. ■ Elizabeth McNichol lists some factors that she says
caused these changes. ■ Wage rate (dollars per hour) 9160335_CH16_p351-372.qxd But these factors have a deeper cause that we can understand as a consequence of changes in demand and
supply in the markets for low-skilled and high-skilled
labor during the 1980s and 1990s. ■ In Fig. 1, the demand curve for low-skilled labor in
1979 is D79 and the supply curve of low-skilled labor is
S79. By 2000, demand increased to D00 and supply increased to S00. The supply of low-skilled labor increased partly because of immigration. The demand for low-skilled labor
increased but by less than supply for the reason that
we identify in the chapter: New technologies are a
substitute for low-skilled labor. S79 S00 8 6 4 D00
D79 2 0 1 2 3
Labor (thousands of hours per day) Figure 1 A market for low-skilled labor Because supply increased by more than demand, the
quantity of low-skilled labor increased but the wage
rate fell. ■ Supply increases by
more than demand
and the wage rate falls 5 ■ ■ ■ ■ In Fig. 2, the demand curve for high-skilled labor in
1979 is D79 and the supply curve of high-skilled labor
is S79. By 2000, demand increased to D00 and supply
increased to S00.
Because demand increased by more than supply, the
quantity of high-skilled labor increased and the wage
The supply of high-skilled labor increased slowly because the new technologies require a higher level of
education to complement them.
The demand for high-skilled labor increased by a large
amount because the new technologies that changed
the structure of the economy increased the value of
marginal product of highly educated workers. Wage rate (dollars per hour) ■ 10 100 Demand increases by
more than supply and
the wage rate rises S79 80 S00 60
50 D00 40 20 D79 0 1 2 3
Labor (thousands of hours per day) Figure 2 A market for high-skilled labor 367 9160335_CH16_p351-372.qxd 368 6/22/09 9:08 AM Page 368 CHAPTER 16 Economic Inequality SUMMARY ◆ Key Points ■
■ Measuring Economic Inequality (pp. 352–357)
■ ■ ■ ■ In 2007, the mode money income was $13,000 a
year, the median money income was $50,233, and
the mean money income was $67,609.
The income distribution is positively skewed.
In 2007, the poorest 20 percent of households
received 3.4 percent of total income and the wealthiest 20 percent received 49.7 percent of total income.
Wealth is distributed more unequally than income
because the wealth data exclude the value of
Since 1970, the distribution of income has
become more unequal.
Education, type of household, age of householder,
and race all influence household income. ■ Income Redistribution (pp. 363–365)
■ ■ ■ The Sources of Economic Inequality (pp. 358–362)
■ ■ Inequality arises from differences in human
Trends in the distribution of human capital that arise
from technological change and globalization can
explain some of the trend in increased inequality. Inequality might arise from discrimination.
Inequality between men and women might arise
from differences in the degree of specialization.
Intergenerational transfers of wealth lead to
increased inequality because people can’t inherit
debts and assortative mating tends to concentrate
wealth. ■ Governments redistribute income through progressive income taxes, income maintenance programs, and subsidized services.
Redistribution increases the share of total income
received by the lowest 60 percent of households
and decreases the share of total income received by
the highest quintile. The share of the fourth quintile barely changes.
Because the redistribution of income weakens
incentives, it creates a tradeoff between equity and
Effective redistribution seeks to support the longterm solution to low income, which is education
and job training—acquiring human capital. Key Figures
Figure 16.5 The Distribution of Income in the
United States in 2007, 352
Lorenz Curves for Income and
The U.S. Gini Ratio:
1970–2007, 356 Figure 16.6
Figure 16.8 Skill Differentials, 359
Explaining the Trend in Income
Discrimination, 361 Key Terms
Big tradeoff, 364
Gini ratio, 355
Lorenz curve, 353
Market income, 352 Money income, 352
Progressive income tax, 363
Proportional income tax, 363 Regressive income tax, 363
Wealth, 354 9160335_CH16_p351-372.qxd 7/1/09 3:48 PM Page 369 Problems and Applications PROBLEMS and APPLICATIONS 369 ◆ Work problems 1–7 in Chapter 16 Study Plan and get instant feedback.
Work problems 8–15 as Homework, a Quiz, or a Test if assigned by your instructor. Money income
Households (percent of total) Lowest 20%
Highest 20% 4.0
43.7 Wage rate (dollars per hour) a. What is money income?
b. Draw a Lorenz curve for the United States in
1967 and compare it with the Lorenz curve in
2007 shown in Fig. 16.3.
c. Was U.S. money income distributed more
equally or less equally in 2007 than it was in
d. What are some reasons for the differences in
the distribution of money income in the
United States in 1967 and 2007?
2. The following figure shows the demand for and
supply of low-skilled labor. 10 b. What is the quantity of low-skilled labor employed?
c. What is the wage rate of high-skilled labor?
d. What is the quantity of high-skilled labor employed?
e. Why does the wage rate of a high-skilled
worker exceed that of a low-skilled worker by
exactly the cost of acquiring the skill?
3. The figure shows the demand for and supply of
workers who are discriminated against. Suppose
that there is a group of workers in the same
industry who are not discriminated against, and
their value of marginal product is perceived to be
twice the value of marginal product of the workers who are discriminated against. Suppose also
that the supply of workers who do not face discrimination is 2,000 hours per day less at each
Wage rate (dollars per hour) 1. The table shows money income shares in the
United States in 1967. 10 S 8
4 8 S 6 2 D
4 D 0 2 6
Labor (thousands of hours per day) 2 0 1 3
Labor (thousands of hours per day) The value of marginal product of high-skilled
workers is $8 an hour greater than that of lowskilled workers. (The value of marginal product
at each employment level is $8 greater than that
of a low-skilled worker.) The cost of acquiring
the skill adds $6 an hour to the wage that must
be offered to attract high-skilled labor.
a. What is the wage rate of low-skilled labor? a. What is the wage rate of the workers who are
b. What is the quantity of workers employed
who are discriminated against?
c. What is the wage rate of the workers who do
not face discrimination?
d. What is the quantity of workers employed
who do not face discrimination?
4. Incomes in China and India are a small fraction
of incomes in the United States. But incomes in
China and India are growing at more than twice
the rate of those in the United States. Given this 9160335_CH16_p351-372.qxd 370 6/22/09 9:08 AM Page 370 CHAPTER 16 Economic Inequality information, what can you say about
a. Changes in inequality between people in
China and India and people in the United
b. The world Lorenz curve and world Gini ratio?
5. Household Incomes Rise but …
Household income crept higher and the poverty
rate edged lower last year. … But more people
had to be at work in each household … because
median earnings for individuals working fulltime year-round actually fell. … The percent of
Americans living below the poverty line, meanwhile, slipped to 12.3 percent in 2006. … The
poverty threshold varies based on age and household size. … Poverty thresholds are not adjusted
for geographical differences in cost of living so
the same threshold applies in Brownsville, Texas,
as it does in New York City. Nor do they reflect
the value of household subsidies intended to alleviate the effects of poverty (e.g., food stamps, tax
credits, Medicaid). … The gap between highincome and low-income households has grown
over the years, but income inequality remained
statistically unchanged between 2005 and 2006,
according to the bureau.
CNN, August 28, 2007
a. Why are the recent increases in median household income a misleading statistic when attempting to measure the improvement in the
economic well-being of households?
b. How does using set poverty thresholds that
apply to the entire U.S. complicate attempts
to measure poverty?
c. Why does excluding household subsidies from
consideration when measuring household income lead to a misleading measurement of the
percentage of people actually living in poverty?
d. Why has the gap between high-income and
low-income households grown in the U.S.
over the past few decades?
6. Most Lucrative College Degrees for 2007 Grads
With less than four months to go before saying
sayonara to the quad for good, the class of 2007
is finding it easier than recent classes to get their
foot in the work world. Employers have said they
expect to hire 17.4 percent more college grads
than they did last year, and in many instances they plan to pay them more, too … The average
starting offer for seniors majoring in marketing is
up 14 percent from last year to $41,323. Those
majoring in business administration are seeing a
9.2 percent jump to $43,523 in average starting
salaries. … Finance: $47,905 … Economics:
$51,631 … There have been slight decreases in
the average starting salary offers for just a few
majors … [such as] Liberal arts (including psychology, political science, history, and English):
Down 1.1 percent to $30,502.
CNN, February 8, 2007
a. Why do college graduates with different majors have drastically different starting salaries?
b. Draw a graph of the labor markets for economics majors and political science majors to
illustrate your explanation of the differences in
the starting salaries of these two groups.
7. Where Women’s Pay Trumps Men’s
Men work more than women … on the job
anyway … at least in terms of overall hours.
That’s just one reason why when you make a
general comparison of men’s and women’s earnings in most fields, men usually come out
ahead. … [But Warren] Farrell … found … 39
… occupations [in which] women’s median
earnings exceeded men’s earnings by at least 5
percent and in some cases by as much as 43 percent. … In fields like engineering, a company
may get one woman and seven men applying
for a job. … If the company wants to hire the
woman, they may have to pay a premium to get
her. … Also, where women can combine technical expertise with people skills—such as those
required in sales and … where customers may
prefer dealing with a woman—that’s likely to
contribute to a premium in pay. …
CNN, March 2, 2006
a. Draw a graph to illustrate why discrimination
could result in female workers getting paid
more than male workers for some jobs.
b. Explain how market competition could potentially eliminate this wage differential.
c. If customers “prefer dealing with a woman” in
some markets, how might that lead to a persistent wage differential between men and
women? 9160335_CH16_p351-372.qxd 6/22/09 9:08 AM Page 371 Problems and Applications 8. The tables show the money income shares in
Canada and the United Kingdom.
households Lowest 20%
Highest 20% Money income
(percent of total) 7
Money income U.K. households Lowest 20%
Highest 20% (percent of total) 3
53 a. Create a table that shows the cumulative distribution of income in Canada and the United
b. Draw a Lorenz curve for Canada and compare
it with the Lorenz curve in Fig. 16.3. In which
country is income less equally distributed,
Canada or the United States?
c. Draw a Lorenz curve for the United Kingdom
and compare it with the Lorenz curve in Fig.
16.3. In which country is income less equally
distributed, the United Kingdom or the United States?
d. Is the distribution of income more unequal in
Canada than in the United Kingdom?
e. What are some reasons for the differences in
the distribution of income in the United
States, Canada, and the United Kingdom?
9. In the United States in 2000, 30 million people
had full-time managerial and professional jobs
that paid an average of $800 a week. At the same
time, 10 million people had full-time sales positions that paid an average of $530 a week.
a. Explain why managers and professionals are
paid more than salespeople.
b. Explain why, despite the higher weekly wage,
more people are employed as managers and
professionals than as salespeople.
c. If the online shopping trend continues, how
do you think the market for salespeople will
change in coming years? 371 10. The table shows three income-tax payments
income Plan A
tax Plan B
tax Plan C
tax (dollars) (dollars) (dollars) (dollars) 10,000
Which income-tax payment plan
a. Is proportional?
b. Is regressive?
c. Is progressive?
d. Increases inequality?
e. Lessens inequality?
f. Has no effect on inequality?
11. The table shows the distribution of market
income in the United States in 2007.
Households Lowest 20%
Highest 20% (percent of total) 1.1
55.1 a. What is the definition of market income?
b. Draw the Lorenz curve for the distribution of
c. Compare the distribution of market income
with the distribution of money income shown
in Fig. 16.3. Which distribution is more
unequal and why?
12. Use the information provided in problem 11 and
in Fig. 16.3.
a. What is the percentage of total income that
is redistributed from the highest income
b. What are the percentages of total income
that are redistributed to the lower income
c. Describe the effects of increasing the amount
of income redistribution in the United States
to the point at which the lowest income group
receives 15 percent of total income and the
highest income group receives 30 percent of
total income. 9160335_CH16_p351-372.qxd 372 6/22/09 9:08 AM Page 372 CHAPTER 16 Economic Inequality 13. Bernanke Links Education and Equality
Ben Bernanke, the chairman of the Federal
Reserve, said … that an expansion of education
opportunities would help curb the economic
inequality that has increased considerably in the
last 30 years. … [Bernanke] said … that globalization and the advent of new technologies, two
prime causes of income inequality, would ultimately lead to economic growth, and inhibiting
them “would do far more harm than good over
the longer haul.”
Instead, the Fed chief said the best method to
improve economic opportunities for Americans
was to focus on raising the level of and access to
education. Workers would be provided with better skills, he said, and innovation in the private
sector would remain unchecked.
“As we think about improving education and
skills, we should also look beyond the traditional
K-12 and 4-year-college system … to recognize
that education should be lifelong and can come
in many forms,” Bernanke said. … “Early childhood education, community colleges, vocational
schools, on-the-job training, online courses,
adult education—all of these are vehicles of
demonstrated value in increasing skills and lifetime earning power.”
International Herald Tribune, June 5, 2008
a. Explain how the two main causes of increased
income inequality in the United States identified by Mr. Bernanke work.
b. Draw a graph to illustrate how the two main
causes of increased income inequality generate
c. What are the short-term costs and long-term
benefits associated with these two causes of
d. Explain Bernanke’s solutions to help address
growing income inequality.
14. The Tax Debate We Should be Having
Here’s a cold reality that none of the presidential
candidates want to tell you: A shrinking number
of Americans are bearing an even bigger share of
the nation’s income tax burden. … In 2005, the
bottom 40 percent of Americans by income had,
in the aggregate, an effective tax rate that’s negative: Their households received more money
through the income tax system, largely from the
earned income tax credit, than they paid. … The top half ’s share of total payments [97%] has been
growing steadily for the past 20 years. The top
10% of taxpayers kicked in 70% of total income
tax. And the famous top 1% paid almost 40% of
all income tax, a proportion that has jumped dramatically since 1986. …
Now consider some of the heated tax controversies of recent years. Did Bush cut taxes for the
rich? Yes. But he cut taxes for the poor even
more. If we look at the measure that really matters—the change in effective tax rates [total tax
they pay as a percentage of their income]—the
bottom 50% got a much bigger tax cut than the
top 1%. Did the dollar value of Bush’s tax cuts
go mostly to the wealthy? Absolutely. It could
hardly be otherwise. Since the well-off pay the
overwhelming majority of taxes, any tax cut with
a prayer of influencing the economy would have
to go mostly to them. You could completely
eliminate income taxes for the bottom half of the
population, and the Treasury would hardly
Fortune, April 14, 2008
a. Explain why tax cuts in a progressive income
tax system are consistently criticized for favoring the wealthy.
b. How might the benefits of tax cuts “trickle
down” to others whose taxes are not cut?
15. After you have studied Reading Between the Lines
on pp. 366–367, answer the following questions.
a. What are the broad facts reported in the news
article about the gap in the incomes of the
highest and lowest 20 percent?
b. List the factors that contributed to the rising
income gap according to Elizabeth McNichol.
Of these factors, which do you think made the
c. Which of the factors listed in b account for
the national trend and which account for the
more extreme changes in New York State?
d. What policy issues are raised by the information reported in the news article?
16. Use the link on MyEconLab (Chapter Resources,
Chapter 16, Web links) to download the
Deininger and Squire Data Set on income distribution. Select two counties that interest you.
a. Which of the countries you’ve selected has the
more unequal distribution of income?
b. What reasons that might explain the differences? ...
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- Fall '08
- Microeconomics, Household income in the United States