Research Paper on Income Inequality

ECO102-ResearchPaperonIncomeInequality.pptx

Home >Business & Finance homework help >Economics homework help >Research Paper on Income Inequality

Chapter 23

Income Inequality, Poverty, and Discrimination

Because learning changes everything.®

In this chapter we learn about income inequality and actions that can be taken by the government to try to correct this inequality. We will use the Lorenz curve and the Gini ratio to evaluate income inequality. Next, poverty is defined, and we examine how it affects different groups. The various government programs available to aid families in poverty are discussed next. Then there is an analysis of discrimination and how it impacts wages. The Last Word is about the debate surrounding universal basic income.

Facts about Income Inequality

Causes of Income Inequality

Income Inequality over Time

Equality versus Efficiency

The Economics of Poverty

The U.S. Income-Maintenance System

Economic Analysis of Discrimination

Chapter Contents

23-2

Learning Objectives

LO23.1 Explain how income inequality is measured and described.

LO23.2 Discuss the extent and sources of income inequality.

LO23.3 Demonstrate how U.S. income inequality has changed since 1980.

LO23.4 Debate the economic arguments for and against income inequality.

LO23.5 Relate poverty to age, gender, and ethnicity.

LO23.6 Identify the major components of the U.S. income-maintenance program.

LO23.7 Discuss labor market discrimination.

Facts about Income Inequality

Average household income was $61,372 in 2017, among the highest in the world.

But there is income inequality.

Income distribution by quintiles:

Lorenz curve

Gini ratio

LO23.1

23-3

Income inequality is a continuing concern in much of the world, and a debate on how to correct the disparity is ongoing. The United States’ average household income of $61,372 in 2017 is among the highest in the world, but we find that when the population is divided into 5 numerically equal groups, called quintiles, the distribution of income among the different groups varies. The top 20% of households are earning more than 51% of total income. Income inequality is defined as the unequal distribution of an economy’s total income among households. The Lorenz curve is a curve showing the distribution of income in an economy. The Gini ratio is a numerical measure of the overall dispersion of income among households; the higher the number, the more inequality of incomes in the economy.

The Distribution of U.S. Income by Households, 2017

(1) Personal Income Category	(2) Percentage of All Households in This Category
Under $15,000	11.6
$15,000–$24,999	9.8
$25,000–$34,999	9.5
$35,000–$49,999	13.0
$50,000–$74,999	17.7
$75,000–$99,999	12.3
$100,000 and above	26.2
Total	100.0

Source: Bureau of the Census, www.census.gov

LO23.1

23-4

In this table, we can see the distribution of income among households in 2017. Note that 21.4% of all households have an income of less than $25,000 while over 25% have income of more than $100,000. That means about 50% of households have income between $25,000 and $99,999.

The Lorenz Curve and Gini Ratio

100

Perfect equality

Lorenz curve

(actual distribution)

Complete

inequality

Gini Ratio =

Area A

Area A + Area B

Percentage of households

Percentage of Income

LO23.1

(1) Quintile (2017)	(2) Percentage of Total Income	(3) Upper Income Limit
Lowest 20 percent	3.1	$ 24,625
Second 20 percent	8.2	47,169
Third 20 percent	14.3	75,494
Fourth 20 percent	23.0	121,116
Highest 20 percent	51.5	No limit
Total	100.0

Source: Bureau of Labor Statistics.

The Distribution of U.S. Income by Quintiles, 2017

23-5

The Lorenz curve is a graphical way to look at the degree of income inequality. The diagonal line that bisects the graph would illustrate perfect income equality, meaning all groups would have an equal distribution of income. Graphing the results of the U.S. income gives us the curved line showing the unequal distribution. The Gini ratio is a numerical measurement of the overall dispersion of income. Lower ratios reflect less inequality while higher ratios indicate more inequality.

Income Mobility

Income mobility

People change quintiles.

Low or high income not a permanent condition.

Government redistribution

Taxes

Cash transfers and non-cash transfers

LO23.1

23-6

Income mobility is the movement of individuals or households from one income quintile to another over time. Over an individual’s lifetime, the individual or household may change quintiles as income changes. Data suggests that income is more equally distributed over a 5, 10, or 20-year period than in any single year. The government also attempts to redistribute the income through taxing higher income earners and sending this money in the form of transfer payments to lower income households. Cash transfer examples include welfare assistance, unemployment compensation, and Social Security. Non-cash transfers provide specific goods or services rather than cash such as, food stamps, subsidized school lunches, housing subsidies, Medicare, and Medicaid.

100

Lorenz curve before taxes and transfers

Percentage of families

Lorenz curve

after taxes and

transfers

The Impact of Taxes and Transfers on U.S. Income Inequality

100

Percentage of income

LO23.1

	Percentage of Total Income Received, 2015
Quintile	(1) Before Taxes and Transfers	(2) After Taxes and Transfers
Lowest 20 percent	3.7	7.3
Second 20 percent	8.7	11.0
Third 20 percent	13.6	14.7
Fourth 20 percent	20.3	20.3
Highest 20 percent	55.0	48.3

Source: Congressional Budget Office.

23-7

One economic function of government is to redistribute income. They do this by taxing households in higher income brackets and then distributing that money to households in lower brackets. The effect of these actions is to move the Lorenz Curve closer to the perfect equality line.

Causes of Income Inequality

Ability

Education and training

Discrimination

Preferences and risks

Unequal distribution of wealth

Market power

Luck, connections, and misfortune

LO23.2

23-8

There are many different causes of income inequality. The market system rewards individuals based on the contributions that they make or the resources that they own and use in producing society’s output. People have different abilities and talents, and this enables some people to perform in high-paying occupations such as being a doctor or star athlete while others can only perform basic tasks. Education and training can also impact a person’s earning capacity. Typically the higher the education level obtained, the higher the earning capacity. Discrimination of all forms as well as personal preferences and risk-aversions can affect an individual’s earnings. Being born into wealth certainly helps, as does just plain being lucky or having connections.

Top 10% of Income Receivers

Source: World Factbook, Central Intelligence Agency

LO23.2

23-9

In this chart, we see the share of income in various nations that goes to the top 10% of receivers. For example, in Nicaragua, the top 10% of receivers receive more than 40% of the total income of the nation.

Income Inequality over Time

Rising income inequality since 1980

Causes of growing inequality:

Greater demand for highly skilled workers

Demographic changes

International trade, immigration, and decline in unionism

LO23.3

23-10

Since 1980, there has been a growing income inequality in the U.S. The most likely reason for this growing inequality has been the increased demand for highly skilled workers. Modern manufacturing requires a highly educated workforce. Demographic changes also contributed; the “baby boomers” were entering the workforce during the 1970s and 1980s, resulting in a large group of less-experienced and less-skilled workers who tend to earn less income than older workers. The growth of international trade and the transfer of jobs to lower-wage workers in other countries were factors as well. While incomes have risen in all quintiles, income growth has been the fastest in the top quintile. This is happening in other industrially advanced nations too.

Before-Tax Income over Time

Quintile	1980	1985	1990	1995	2000	2005	2010	2015
Lowest 20 percent	4.3	4.0	3.7	3.6	3.4	3.4	3.3	3.1
Second 20 percent	10.3	9.7	9.1	8.9	8.6	8.6	8.5	8.2
Third 20 percent	16.9	16.3	15.2	14.8	14.6	14.6	14.6	14.3
Fourth 20 percent	24.9	24.0	23.3	23.0	23.0	23.0	23.4	23.2
Highest 20 percent	43.7	46.6	48.7	50.4	49.8	50.4	50.3	51.1
Total	100.0	100.0	100.0	100.0	100.0	100.0	100.0	100.0
Top 5 percent	15.8	17.0	18.6	21.0	22.1	22.2	22.3	22.1

Source: Income Data Tables. Bureau of the Census, 2018.

LO23.3

Percentage of Total Before-Tax Income Received by Each One-Fifth, and by the Top 5 Percent of Households, Selected Years

23-11

Note: Numbers may not add to 100.0 percent due to rounding. This is another table showing the income earned by the different quintiles in the U.S. over time. Income was, more and more, unequal for many years, as the percentage of total income in the lowest quintile fell and the percentage of total income earned by the highest quintile rose. In 2015, we do see income slightly decrease in the lowest quintile and an increase in the highest quintile.

Equality versus Efficiency

The case for equality: Maximizing total utility

The case for inequality: Incentives and efficiency

The equality-efficiency trade-off

LO23.4

23-12

The main policy issue regarding income inequality is how much is necessary and justified. The basic argument for an equal distribution of income starts with the idea that income equality maximizes total consumer satisfaction from any particular level of output and income. Critics say that the transfer of income required to create income equality is unfair and unwise. They say income inequality reflects rewards to individuals for supplying their talents and resources to the economy, and that proponents of income equality falsely assume that there is some fixed amount of output and therefore income to be distributed. Regardless, there is a fundamental trade-off between equality and efficiency in that greater income equality comes at the opportunity cost of reduced production and income. Society must choose how much redistribution it desires in view of the costs.

(a)

Anderson’s marginal

utility from income

(b)

Brooks’s marginal

utility from income

Marginal Utility

Income

$5,000

$2,500

$7,500

MUB

MUA

a’

b’

Utility gain

(entire blue area)

Utility loss

(entire red area)

The Utility-Maximizing Distribution of Income

LO23.4

23-13

These graphs illustrate the utility-maximizing distribution of income. Both Anderson and Brooks will maximize their combined utility when any amount of income is equally distributed. If income is unequally distributed, the marginal utility derived from the last dollar will be greater for Anderson than for Brooks.

The Economics of Poverty

Definition of poverty in 2017:

Single person < $12,488

Family of 4 < $24,858

Family of 6 < $32,753

39.7 million Americans

Poverty rate 12.3%

LO23.5

23-14

Poverty is defined as a condition in which a person or family does not have the means to satisfy basic needs for food, clothing, shelter, and transportation. The federal government has established minimum income thresholds below which a person or family are considered to be “in poverty.” As shown in the slide, in 2017, 12.3% of the population of the U.S. was living in poverty.

Population Groups & Poverty

Source: U.S. Census Bureau

LO23.5

23-15

Poverty is disproportionately borne by African Americans, Hispanics, children, foreign-born residents who are not citizens, and families headed by women. People who are employed full-time, are age 65 or older, or are married tend to have low poverty rates.

Poverty Trends

Poverty rate trends:

Significant decline 1959–1969

Stable in 11–13% range since

Rises with recession

Measurement issues:

Arbitrary income threshold

Consumption versus income

LO23.5

23-16

In the decade between 1959 and 1969, the poverty rate declined significantly and was fairly stable in the range of 11–13% until the early 1980s when it started to rise. In 1993, the rate peaked at 15.1% and then began declining. The recession that began in December of 2007 increased the poverty rate for all groups, and many economists expected to see the rates rise even further, but they did not. The rates and trends need to be interpreted cautiously. The income levels used to determine the rates are arbitrary thresholds and may not truly measure the extent of poverty in the U.S. The high cost of living in major metropolitan areas means that the official poverty thresholds may exclude many families whose income is slightly above the threshold but inadequate to meet basic needs. Also, non-cash transfers like food stamps and rent subsidies are not included in determining a household’s poverty status. Some economists believe we should use family consumption rather than family income.

The U.S. Income-Maintenance System

Entitlement programs: All those eligible receive aid

Social insurance programs

Social Security and Medicare

Unemployment compensation

Public assistance programs: Welfare

LO23.6

23-17

To help those who have very low incomes, the U.S. has a wide array of anti-poverty programs including subsidized employment, education and training programs, and anti-discrimination policies. These programs are referred to as entitlement programs because all eligible persons are legally entitled to receive their benefits.

The social insurance programs such as Social Security and unemployment compensation are designed to partially replace earnings that have been lost due to retirement, disability, or temporary unemployment. They are financed primarily out of federal payroll taxes, and the benefits are viewed as earned rights since the recipients must have worked in order to be eligible to receive them.

Public assistance programs or welfare provide benefits to people who are unable to earn an income because of permanent disabling conditions, or who have no, or very low, income and also have dependent children. These programs are financed out of general tax revenues and are regarded as public charity.

Public Assistance Programs

Supplemental Security Income (SSI)

Temporary Assistance for Needy Families (TANF)

Supplemental Nutrition Assistance Program (SNAP)

Medicaid

Earned-income tax credit (EITC)

LO23.6

23-18

There are a wide variety of public assistance programs. The SSI program provides a uniform nationwide minimum income for the aged, blind, and disabled who are unable to work and who do not qualify for Social Security aid.

TANF assists families with children and has work requirements and a limit on the time a family can receive benefits.

SNAP, formerly known as the food-stamp program, permits low-income persons to obtain vouchers with which to buy food. Its goal is to ensure all low-income Americans have a nutritionally adequate diet.

Medicaid is a federal program to provide basic medical care to people covered by the SSI and TANF programs.

The earned-income tax credit (EITC) is a refundable federal tax credit provided to low-income wage earners. It is designed to supplement families’ income while encouraging them to work. These are just a few of the many programs administered by the government to assist those families faced with the challenges of poverty.

Characteristics of Major Income-Maintenance Programs

Program	Basis of Eligibility	Source of Funds	Form of Aid	Expenditures,* Billions		Beneficiaries, Millions
Social Insurance Programs
Social Security	Age, disability, or death of parent or spouse; life-time work earnings	Federal payroll tax on employers and employees	Cash		$911	61
Medicare	Age or disability	Federal payroll tax on employers and employees	Subsidized health insurance		706	60
Unemployment compensation	Unemployment	State and federal payroll tax on employers	Cash		28	5
Public Assistance Programs
Supplemental Security Income (SSI)	Age or disability; income	Federal revenues	Cash		55	8
Temporary Assistance for Needy Families (TANF)	Certain families with children; income	Federal-state-local revenues	Cash and services		14	2
Supplemental Nutrition Assistance Program (SNAP)	Income	Federal revenues	Cash via EBT cards		61	40
Medicaid	Persons eligible for TANF or SSI and medically indigent	Federal-state-local revenues	Subsidized medical services		582	63
Earned-income tax credit (EITC)	Low-wage working families	Federal revenues	Refundable tax credit, cash		63	25

Source: Social Security Administration, Annual Statistical Supplement, 2017, www.socialsecurity.gov; U.S. Department of Agriculture, www.fns.usda.gov; Internal Revenue Service, www.irs.gov/taxstats; and other government sources. Latest data.

LO23.6

23-19

* Expenditures by federal, state, and local governments; excludes administrative expenses.

A number of income-maintenance programs were devised to reduce poverty and to help those who have very low incomes. Here is a list of the major programs used in the United States.

Economic Analysis of Discrimination

Discrimination

Taste-for-discrimination model

Prejudiced people receive disutility

Willing to pay to avoid

Discrimination coefficient

Prejudice and the market African-American-to-White wage ratio

Competition and discrimination

LO23.7

23-20

Discrimination is the practice of according people inferior treatment on the basis of some factor such as race, gender, or ethnicity. Discrimination plays an important role in reducing wages for some and increasing wages for others. The taste-for-discrimination model examines prejudice in the emotion-free language of demand theory. It theorizes that discrimination results from a prejudiced person experiencing a subjective cost, a disutility, when they must interact with those they are biased against. Consequently, the discriminator is willing to pay a certain price to avoid interactions with the non-preferred group. The discrimination coefficient attempts to measure this cost in employment. The taste-for-discrimination model suggests that competition will reduce discrimination in the very long run.

Taste-for-Discrimination Model

African-American employment (millions)

African-American wage rate (dollars)

LO23.7

The African-American wage and employment level in the taste-for-discrimination model

23-21

This graph illustrates the taste-for-discrimination model with a white employer discriminating against African-American workers. An increase in prejudice by white employers would decrease the demand for African-American workers from D1 to D2. Conversely, a decrease in the prejudice of the white employers would increase the demand for African-American workers.

Statistical Discrimination

Statistical discrimination

Judged on average group characteristics

Labor market example

Profitable, undesirable, but not malicious

LO23.7

23-22

The theory of statistical discrimination is based upon the concept that people are judged on the basis of the average characteristics of the group to which they belong, rather than on their own personal characteristics. Insurance rates for teen drivers reflect this type of discrimination. Merely because a driver is a young male, he automatically is charged higher insurance rates because on average, young males tend to have more accidents. The driving history of the individual is not the key factor. In the labor market, statistical discrimination occurs when employers fail to hire someone because of a preconceived notion about the group that the person is from. For example, an employer might hesitate to hire a female of child-bearing age out of concern that if she becomes pregnant, she will need time off or leave the place of employment, which results in lower returns on the employer’s investment in training. The employer is not necessarily being malicious in failing to hire the person but is rather focused on the bottom line which is making as much profit as possible.

Occupational Discrimination

The crowding model

Crowd certain groups into less desirable occupations

Effects of crowding

Eliminating occupational segregation

Costs to society and individuals

LO23.7

23-23

The third type of discrimination is occupational segregation. This discrimination tends to push certain groups into certain types of jobs. The notion that only men could be doctors and women should be nurses is an example. The easing of occupational barriers has led to a surge of women gaining advanced degrees in some high-paying professions.

Quantity of labor (millions)

Wage rate

The Economics of Occupational Segregation

Wage rate

Occupation X

Occupation Y

Occupation Z

LO23.7

23-24

In these graphs, we can see how the effects of occupational segregation result in the crowding of one class (women) into one occupation, in this case Z. Because of the crowding, the labor supply is larger, thus driving down the wage rate, W. On the other hand, in occupations X and Y, the labor supplies are smaller resulting in higher wage rates, M. By eliminating occupational segregation, society benefits overall as wage rates equalize at B.

Last Word: Debating Universal Basic Income

Government guarantees minimum monthly income to each citizen.

Pros: reductions in poverty, income inequality, and income insecurity.

Cons: high costs, unfairness, and unintended consequences.

23-25

The thought of a universal basic income (UBI) is not new. In fact, President Richard Nixon proposed one back in the late 1960s. Other countries have also implemented variations of UBI with limited results. Most trials have focused on providing the income to people with demonstrated financial need, and it remains to be seen if the programs can be replicated in mass.