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Income Distribution

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					         Income Distribution
• Household Income   Percentage of Total
      Group            Money Income
•   Lowest 20%                  3.4%
•   Second 20%                  8.7%
•   Third 20%                  14.8%
•   Fourth 20%                 23.4%
•   Highest 20%                49.7%
        Economic Mobility

• There is significant economic mobility in
  the U.S. economy.

• Over a typical ten year period, most of the
  households in the Lowest Income 20% will
  move up to one of the four higher Income
  Groups.
            Lorenz Curve

• The degree of income inequality can be
  expressed with a Lorenz curve.

• A Lorenz curve contrasts the actual
  distribution of income with perfect equality.
                  Lorenz Curve
         100% -

                           Perfect
          80% -            Equality


          60% -
  % of
Income
          40% -


          20% -


          0%       ‫׀‬      ‫׀‬      ‫׀‬         ‫׀‬      ‫׀‬
            0%    20%    40%    60%       80%   100%

                        % of Households
                  Lorenz Curve
         100% -

                           Perfect
          80% -            Equality


          60% -
  % of                                            Actual
Income                                          Distribution
          40% -


          20% -


          0%       ‫׀‬      ‫׀‬      ‫׀‬         ‫׀‬      ‫׀‬
            0%    20%    40%    60%       80%   100%

                        % of Households
                  Lorenz Curve
         100% -

                           Perfect
          80% -            Equality


          60% -
  % of                                              Actual
Income                                            Distribution
          40% -
                                          Degree of
          20% -                           Inequality


          0%       ‫׀‬      ‫׀‬      ‫׀‬         ‫׀‬        ‫׀‬
            0%    20%    40%    60%       80%     100%

                        % of Households
  Increasing Income Inequality
• The distribution of income has been
  growing more unequal in recent decades.

• See Example 1 on page 31-3.

• The increase in income inequality was due
  largely to increased immigration.
    Overstating the Degree of
       Income Inequality
• The distribution of money income
  overstates the degree of inequality:
• 1. It does not take into account the effect
  of taxes paid or of in-kind transfer
  payments received.
• Higher income households pay a higher
  percentage of income in taxes, and
  receive a smaller proportion of in-kind
  transfer payments.
    Overstating the Degree of
       Income Inequality
• The distribution of money income
  overstates the degree of inequality:
• 2. It focuses on income distribution at a
  point in time rather than over the course of
  a lifetime.
• Income is distributed more equally over
  the course of a lifetime than at a point in
  time.
      Distribution of Wealth
• The distribution of wealth is much more
  unequal than the distribution of income.
• See Example 2 on page 31-4.
• The greater inequality in the distribution of
  wealth is caused by differences in savings
  rates and by measuring wealth distribution
  at a point in time.
• See Examples 3 and 4 on page 31-4.
Overstating the Inequality in Wealth
            Distribution
• The inequality of wealth distribution is
  overstated because:

• 1. Wealth distribution compares persons
  at different career stages.
• 2. Human capital is not included in
  measuring wealth.
• See Example 5 on page 31-4.
         Causes of Continuing Income
                  Inequality

•   1.   Natural ability.
•   2.   Human capital.
•   3.   Work and leisure choices.
•   4.   Risk taking.
•   5.   Wrongful employment discrimination
•   6.   Luck.
          Human Capital
• Human capital – developed ability that
  increases a person’s productivity.

• Human capital is developed primarily
  through education and training and
  through work experience.

• See Example 6 and the tables on pages
  31-5 and 31-6.
  Work and Leisure Choices
• People differ in the work and leisure
  choices that they make.

• Example 7: In 2006, for households in the
  Lowest Income 20%, only 15% of
  households included a full-time, year-
  round worker. 75% of households in the
  Highest Income 20% had at least two
  earners in the household.
              Risk Taking
• People differ in their willingness to take
  risks.
• Risk takers are more likely to rise to the
  top of the income scale or to sink to the
  bottom.
• Example 8: Less than 20 percent of the
  American labor force is self-employed.
  But nearly 70 percent of American
  millionaires are (or were) self-employed.
    Wrongful employment Discrimination
•    Wrongful employment discrimination
     occurs when employers make hiring,
     promotion, and pay decisions based on
     factors unrelated to worker productivity.

•    One viewpoint holds that wrongful
     employment discrimination can be
     reduced by making markets more
     competitive.
•    See Examples 9A and 9B on page 31-6.
 Wrongful employment Discrimination

• Another viewpoint contends that increased
  government regulation of labor markets is
  necessary to reduce wrongful employment
  discrimination.
• This viewpoint assumes that markets will not be
  competitive enough or that employers will be so
  biased against certain employee characteristics
  that they will willingly put themselves at a
  competitive disadvantage.
        Standards of Income
            Distribution
• 1. Marginal productivity standard
  (market).
• a. Provides maximum incentive for
  productivity.
• b. Provides maximum individual
  freedom.
• c. Does not redistribute income to
  attempt to achieve greater total utility.
        Standards of Income
            Distribution
• 2. Equality standard.
• a. May increase total utility for society.
• b. The quantity of total production is
  likely to fall since the equality standard
  breaks the market link between effort and
  reward.
• c. The government intervention to
  redistribute income will decrease individual
  freedom.
      Income Redistribution
• The basic justification for income
  redistribution is to increase total utility for
  society.
• Redistribution to achieve greater equality
  may increase total utility up to a point.
• At some point, the disincentive effect of
  income redistribution will decrease the
  total quantity of production so much that
  total utility decreases.
 Ideal Income Redistribution
• An ideal income redistribution system
  would:
• 1. Transfer most from those with the
  highest income.
• 2. Transfer most to those with the lowest
  income.
• 3. Interfere with private market decisions
  as little as possible.
 Ideal Income Redistribution
• An ideal income redistribution system
  would:
• 4. Interfere with the incentive for
  productivity as little as possible.
• 5. Provide as little opportunity for rent
  seeking as possible.
• 6. Be as simple and inexpensive to
  administer as possible.
Actual Income Redistribution
• The actual income redistribution program
  in the U.S. is badly flawed:
• 1. The income that funds income
  redistribution is not necessarily transferred
  from those with the highest income.
• 2. Most income redistribution transfers are
  not received by those with the lowest
  income.
Actual Income Redistribution

• 3. Income redistribution policies often
  interfere strongly with private market
  decisions.

• 4. Income redistribution efforts have a
  strong disincentive effect on both
  taxpayers and transfer recipients.
Actual Income Redistribution

• 5. Income redistribution policies often are
  subject to rent seeking.

• 6. The income redistribution program is
  very complex.
      Negative Income Tax
• A negative income tax would transfer
  income to low income households.
• A basic support amount would be set and
  then the support would be reduced by a
  fraction of income earned.
• At some level of income, support would be
  eliminated.
• See Example 11 on page 31-10.
                 Poverty
• Poverty – a family whose income falls
  below a minimum necessary for an
  adequate standard of living is classified as
  living in poverty.
• Poverty rates tend to be higher for minority
  groups, single parent families, the young,
  and the poorly educated.
• See the table on page 31-11.
 Poverty and Economic Mobility

• In an average ten year period, about a
  quarter of households will have income
  below the poverty line in at least one year.

• Fewer than 3% of households will have
  income below the poverty line for eight or
  more of the ten years.
 Four Keys to Achieving Financial Security

• 1. Believe that you can achieve financial
  security.

• 2. Invest in your human capital. Investing
  in human capital pays an even higher
  return today than it did in the past.

• See Example 13 on page 31-12.
 Four Keys to Achieving Financial Security

• 3. Make good personal choices;
• a. Health.
• b. Marriage.
• c. Self-control.

• 4. Get on the good side of compound
  interest.
       Compound Interest

• Compound interest refers to interest paid
  on interest.

• Compound interest is the saver’s best
  friend and the borrower’s worst enemy.

• See Examples 14A, 14B, 14C, and 15 on
  page 31-13.
           Gini coefficient

• The Gini coefficient is a measure of
  income inequality based on the Lorenz
  curve.

• See the graph and the formula on page
  31-14.
            Gini coefficient

• The higher the Gini coefficient, the greater
  the degree of income inequality.

• See the comments about various countries
  on page 31-14.

				
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