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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: $13,000 Median (middle) 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 of households. 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 median. 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 high. 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 2 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 Second fifth Middle fifth Next highest fifth The Income Lorenz Curve in 2007 100 Highest fifth E 80 60 D Line of equality 40 0 10 20 30 40 353 50 Income Lorenz 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 60 80 100 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 household percentages. 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 60 80 100 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 Compression" Globalization, the information revolution: 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 after retirement. 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 definitions 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 median income. 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 Upward trend in inequality 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 household Married couple 60,000 45 to 54 years 35 to 44 years 55 to 64 years Associate degree Some college, no 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 Asian Region White 25 to 34 years Male living alone Grades 9–12, no diploma 20,000 Age of householder West Northeast Midwest 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 only $28,000. 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 ◆ 1 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 incomes? 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 Inequality 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 capital. 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 10 SL 5 DH DL 0 359 1 2 3 4 Labor (thousands of hours per day) (a) Demand for high-skilled and low-skilled labor DL 0 1 2 3 4 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 2 3 4 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 a skill. 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 Information technology and low-skilled labor are substitutes 8 S 6 5 4 2 D0 D1 0 1 2 3 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 are complements 2 D0 4 3 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 Discrimination 60 VMPDF 40 No discrimination 0 VMP 3 2 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 their sixties. 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 ◆ 1 2 3 4 5 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 generations? 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 Unemployment compensation 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 taxes and benefits 80 60 Line of equality 40 Redistribution 20 Market income 20 0 40 60 80 100 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 20 40 60 80 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 continues today. 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 ◆ 1 2 3 How do governments in the United States redistribute income? Describe the scale of redistribution in the United States. What is one of the major welfare challenges today and how is it being tackled in the United States? 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 http://www.nytimes.com 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 5 6 4 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 rate rose. 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 5 6 4 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 human capital. 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 capital. 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 efficiency. Effective redistribution seeks to support the longterm solution to low income, which is education and job training—acquiring human capital. Key Figures Figure 16.1 Figure 16.4 Figure 16.5 The Distribution of Income in the United States in 2007, 352 Lorenz Curves for Income and Wealth, 354 The U.S. Gini Ratio: 1970–2007, 356 Figure 16.6 Figure 16.7 Figure 16.8 Skill Differentials, 359 Explaining the Trend in Income Distribution, 360 Discrimination, 361 Key Terms Big tradeoff, 364 Gini ratio, 355 Lorenz curve, 353 Market income, 352 Money income, 352 Poverty, 356 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% Second 20% Third 20% Fourth 20% Highest 20% 4.0 10.8 17.3 24.2 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 1967? 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. Wage rate (dollars per hour) 1. The table shows money income shares in the United States in 1967. 10 S 8 6 4 8 S 6 2 D 4 D 0 2 6 8 10 4 Labor (thousands of hours per day) 2 0 1 3 4 5 2 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 discriminated against? 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 States? 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. Canadian households Lowest 20% Second 20% Third 20% Fourth 20% Highest 20% Money income (percent of total) 7 13 18 25 37 Money income U.K. households Lowest 20% Second 20% Third 20% Fourth 20% Highest 20% (percent of total) 3 5 14 25 53 a. Create a table that shows the cumulative distribution of income in Canada and the United Kingdom. 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 schemes. Before-tax income Plan A tax Plan B tax Plan C tax (dollars) (dollars) (dollars) (dollars) 10,000 1,000 1,000 2,000 20,000 2,000 4,000 2,000 30,000 3,000 9,000 2,000 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. Market income Households Lowest 20% Second 20% Third 20% Fourth 20% Highest 20% (percent of total) 1.1 7.1 13.9 22.8 55.1 a. What is the definition of market income? b. Draw the Lorenz curve for the distribution of market income. 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 group? b. What are the percentages of total income that are redistributed to the lower income groups? 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 this outcome. c. What are the short-term costs and long-term benefits associated with these two causes of inequality? 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 notice. 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 biggest contribution? 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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