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Ch020EndOfChapterQuestions - Income Inequality and Poverty...

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Income Inequality and Poverty ANSWERS TO END-OF-CHAPTER QUESTIONS 32-1 Using quintiles to briefly summarize the degree of income inequality in the United States. How and to what extent does government contribute to income equality? The income share received by the highest 20 percent was 50.1 percent in 2004, which is more than ten times the 3.4 percent received by the lowest 20 percent. The middle three quintiles receive under 50 percent of the total before-tax income. The top two quintiles receive twice as much as the bottom three quintiles combined; in fact, the top 20 percent receives more than the bottom 80 percent. The effect of government on the distribution of income occurs through both taxes and transfer payments. The total effect of federal, state, and local taxes on income distribution is mildly progressive in that high-income households pay a somewhat higher proportion of their incomes in taxes than low-income families. But about 80 percent of government’s contribution to income equality takes place through transfer programs. This contribution is particularly significant for those in the lowest quintile, for whom government transfer payments comprise over 75 percent of total income. These statistics do not necessarily mean that the contribution of government in furthering equality is entirely positive. To the extent that transfer programs aimed at lower-income households decrease the incentive to work, the earned incomes of these households will be less than otherwise. Also, some transfer programs go to the non-poor. For example, most farm subsidies go to the wealthiest farmers, and higher education funding tends to benefit middle to high-income students. 32-2 ( Key Question ) Assume Al, Beth, Carol, David, and Ed receive incomes of $500, $250, $125, $75, and $50 respectively. Construct and interpret a Lorenz curve for this five-person economy. What percentage of total income is received by the richest and by the poorest quintiles? See the figure below. In this simple economy each person represents a complete income quintile —20 percent of the total population. The richest quintile (Al) receives 50 percent of total income; the poorest quintile (Ed) receives 5 percent. 32-3 How does the Gini ratio relate to the Lorenz curve? Why can’t the Gini ratio exceed 1? What is implied about the direction of income inequality if the Gini ratio declines from 0.42 to 0.35? How would one show that change of inequality in the Lorenz diagram? The Gini ratio is the numerical measurement of the inequality depicted by the Lorenz curve. It is calculated by dividing the area between the curve and the diagonal by the total area below the diagonal. 221
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Income Inequality and Poverty The Gini ratio can’t exceed 1 because if the Lorenz curve is as far as possible from the diagonal (line of equality), the area between the curve and the diagonal will equal the total area below the diagonal. The equality will result in a Gini ratio of 1.
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