What Is the Average Income for a Person in the United States

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					ECONOMIC
INEQUALITY    1
             CHAPTER




              8
Objectives

After studying this chapter, you will able to
 Describe the inequality in income and wealth in the
  United States and the trends in inequality
 Explain the features of the labor market that contribute to
  economic inequality
 Describe the scale of income redistribution by
  government
Rags and Riches

Homelessness and abject poverty exists alongside
extreme wealth.
What determines the distribution of economic well-being?
How much redistribution does government do to limit
extreme poverty?
Measuring Economic Inequality

The census bureau defines a household’s income as
money income, which equals market income plus cash
payments to households by the government.
Market income equals wages, interest, rent, and profit
earned by the household in factor markets, before paying
income taxes.
Measuring Economic Inequality


The Distribution of
Income
 Figure 18.1 shows the
 distribution of income
 across the 106 million
 households in the United
 States in 2001.
Measuring Economic Inequality

The mode income is the
most common income and
was about $13,000.
The median income is the
level of income that
separates the population
into two groups of equal
size and was $42,228.
The mean income is the
average income and was
$58,208.
Measuring Economic Inequality

A distribution in which the
mean exceeds the median
and the median exceeds
the mode is positively
skewed, which means it
has a long tail of high
values.
The distribution of income
in the United States is
positively skewed.
Measuring Economic Inequality



Figure 18.2 shows
the distribution of
income shares for
the United States in
2001.
Measuring Economic Inequality

The poorest 20% of
the population in
2001 received only
3.5% of the total
income.
The middle 20% of
the received 14.5%
of total income.
The richest 20%
received 50.1% of
total income.
Measuring Economic Inequality

The Income Lorenz Curve
 The income Lorenz curve
 graphs the cumulative
 percentage of income
 earned against the
 cumulative percentage of
 households.
Figure 18.3 shows the
income Lorenz curve for
the income shares in
Figure 18.2.
Measuring Economic Inequality


The vertical axis of a
Lorenz curve is the
cumulative percentage of
total income.
The horizontal axis is the
cumulative percentage of
households.
Measuring Economic Inequality

If everyone has the same
income, the income Lorenz
curve is a 45 degree line
from the lower left corner
to the upper right corner.
This line is called the line
of equality.
The Lorenz curve shows
the cumulative distribution
of income.
Measuring Economic Inequality



The closer the Lorenz
curve is from the line of
equality, the more equal is
the distribution of income.
Measuring Economic Inequality

The Distribution of
Wealth
 Wealth is the value of all
 the things that are
 owned by a household
 at a given point in time.
The distribution of
wealth is another way of
examining the degree of
economic inequality.
Measuring Economic Inequality

A wealth Lorenz curve
measures the distribution
of wealth in the same way
an income Lorenz curve
measures the distribution
of income.
The distribution of wealth
is even more unequally
distributed than income.
Measuring Economic Inequality

Wealth Versus Income
Wealth is a stock of assets and income is a flow of
earnings that result from a given stock of wealth.
The reason that wealth is more unequally distributed than
income is that wealth does not measure the quantity of
human capital—only income reflects the quantity of human
capital.
Because wealth does not reflect potential for income from
human capital, income is a more accurate measure of
economic inequality.
Measuring Economic Inequality

Annual or Lifetime Income and Wealth?
A household’s income and wealth change over time.
A household headed by a young person starts out with
moderate income and accumulates wealth for retirement
years.
A middle-age headed household is in its highest earning
years and enjoys the highest level of wealth.
A households headed by an older, retired person has
lower earning and is consuming, rather than accumulating,
its wealth.
Measuring Economic Inequality

The Gini Ratio
To measure inequality as an index number, we use the
Gini ratio, which equals the ratio of blue area to the red
area in the two figures below.
Measuring Economic Inequality

The Gini Ratio
With perfect equality, the Lorenz curve is the line of
equality and the Gini ratio is zero.
Measuring Economic Inequality

The Gini Ratio
With the most extreme inequality—one person has all the
income—the Lorenz curve runs along the axes and the
Gini ratio is one.
Measuring Economic Inequality

The Gini Ratio
The closer the Gini ratio is to one, the more unequal is the
distribution of income. In 2001, the U.S. Gini ratio was
0.45.
Measuring Economic Inequality

Trends in Inequality
 Figure 18.5 shows trends
 in the U.S. Gini ratio.
The trend is toward greater
inequality.
Measuring Economic Inequality

Who Are the Rich and the Poor?
Figure 18.6 on the next slide identifies the five
characteristics that appear to influence the amount of
income earned by a household.
These characteristics are:
 Education
 Type of household
 Size of Household
 Age of householder
 Race
Measuring Economic Inequality
Measuring Economic Inequality

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.
In 2000, the poverty level calculated by the Social Security
Administration for a four-person family was $17,761.
31.1 million Americans lived in households with incomes
below this poverty level, which amounts to 11.3 percent of
the total population at that time.
Measuring Economic Inequality

There has historically been an over-representation of
minority households living in poverty in the United States.
In the year 2000, 9.4percent of white households lived in
poverty while 21.7 percent of Hispanic households and
31.3 percent of black households lived in poverty.
The Sources of Economic Inequality

Inequality arises from unequal labor market outcomes and
from unequal ownership of capital.
Two significant features of labor markets create income
differences among individuals:
 Human capital differences
 Discrimination.
The Sources of Economic Inequality

Human Capital
The more human capital a person possesses, the more
income that person likely earns, other things remaining the
same.
On the demand side of the labor market, high-skilled
workers generate a larger marginal revenue product than
low-skilled workers.
So firms are willing to pay a higher wage rate for high-
skilled labor.
The Sources of Economic Inequality



Figure 18.7(a) shows the
difference in demand
curves for high-skilled
versus low-skilled labor.
The Sources of Economic Inequality

On the supply side of the labor market, high-skilled
workers incur a cost of acquiring their skills—money costs
as well as time costs
So high-skilled workers are willing to supply labor only at
wage rates that compensate them for those costs, which
exceed the wage rates at which low-skilled workers are
willing to supply labor.
The Sources of Economic Inequality



Figure 18.7(b) shows the
difference in supply curves
for high-skilled versus low-
skilled labor.
The Sources of Economic Inequality

The combination of higher demand and lower supply for
high-skilled workers relative to low-skilled workers
creates a higher equilibrium wage rate for those workers
who have attained greater levels of human capital.
The Sources of Economic Inequality




Figure 18.7(c) shows the
difference in equilibrium
wages for high-skilled
versus low-skilled labor.
The Sources of Economic Inequality

Figure 18.8 shows how
technological change
combined with skill
differences have widened
the gap between low
incomes and high
incomes.
The demand for low-skilled
labor has decreased and
the wage rate has fallen.
The Sources of Economic Inequality


The demand for high-
skilled labor has increased
and the wage rate has
risen.
The Sources of Economic Inequality

Discrimination
While the level of human capital attained varies across
households, discrimination alone does not explain all the
observed inequality in income.
If the levels of marginal revenue product of one race or
one sex are perceived to be higher than that of another
race or another sex, the equilibrium wages will vary across
each racial or gender group of households, despite
holding the level of human capital constant.
The Sources of Economic Inequality

If firms perceive white males to be more productive
workers than black females, then the perceived marginal
revenue product curves (which are the labor demand
curves) for white men would be higher than that for black
women.
The Sources of Economic Inequality

Figure 18.9 shows the
potential effect of
discrimination of the wage
rates of white men and
black women.
If black women are
discriminated against, the
perceived MRP is lower
and their wage rate and
employment level
decrease.
The Sources of Economic Inequality



If white men are
discriminated for, the
perceived MRP is higher
and their wage rate and
employment level
increase.
The Sources of Economic Inequality

Economists disagree to the extent that discrimination
pervades the labor market.
One line of reasoning states that those firms that practice
race or sex discrimination in the labor market would face
higher production costs (pay higher wages for the same
marginal revenue product) than those firms that do not.
If this line of reasoning is correct, the profit margins for the
firms practicing discrimination will be lower and that the
market price of their goods and services would be higher
than non-discriminating firms.
The Sources of Economic Inequality

Either way, the market pressures increase the opportunity
cost to firms (and the consumers who buy their product)
for practicing race or sex discrimination, eventually
eliminating these practices.
Another line of reasoning is that claims of sex
discrimination can be explained by differences between
the men and women regarding their willingness, on
average, to specialize in providing income generating
labor versus providing non-income generating labor in the
home.
The Sources of Economic Inequality

More women than men work at home for a portion of their
adult life while engaged in child rearing and/or running the
household.
This allocation of time means that women’s wages will be
lower, on average, than men’s wages.
Accounting for this difference in labor specialization has
been found to explain much of the wage differentials
between men and women.
The Sources of Economic Inequality

Unequal Ownership of Capital
Income inequality is increased by the unequal distribution
of wealth.
Unequal wealth results from savings and wealth transfers
between generations.
There are two significant aspects of intergenerational
wealth transfers that increase economic inequality:
 Debt cannot be transferred across generations
 Marriage concentrates wealth
Income Redistribution

The governments in the United States use three main
ways to redistribute income to alleviate some degree of
economic inequality:
 Income taxes
 Income maintenance programs
 Subsidized services.
Income Redistribution

Income Taxes
The U.S. federal government and most state governments
tax incomes.
By taxing incomes of different levels at different tax rates,
economic inequality can be decreased.
A progressive income tax taxes household incomes at
an average rate that rises with income.
The U.S. income tax system and all state income tax
systems are progressive income tax systems.
Income Redistribution

A regressive income tax taxes income at average rates
that fall with income, thereby redistributing income away
from poorer taxpayers.
A proportional income tax (also called a flat-rate income
tax) taxes income at a constant average rate for all income
levels.
Income Redistribution

Income Maintenance Programs
Three major types of programs provide direct payments to
individuals:
 Social Security Programs
 Unemployment Compensation
 Welfare Programs
Income Redistribution

Subsidized Services
A great deal of income redistribution takes the form of
subsidized services, where people other than those who
pay for it consume the services provided.
An example is primary and secondary public education, as
well as state colleges and universities.
The students at these institutions generally pay tuition and
fees that range from 20 to 25% of the actual expenses for
educating a college student.
The families of these students enjoy a sizeable subsidy for
acquiring human capital.
Income Redistribution

The Scale of Income Redistribution
The extent of the government income redistribution can be
determined by looking at the difference between market
income and money income minus income taxes.
In 2001, the poorest 20 percent of households received
only 0.9 percent of total money income earned in the
United States, but received 4.6 percent of total market
income.
In 2001, the richest 20 percent of households received
55.6 percent of total money income earned in the United
States, but received 46.7 percent of total market income.
Income Redistribution


Figure 18.10 shows the
influence of government
income redistribution
efforts in 2001.
The distribution after taxes
and benefits is …
…more equal than the
distribution of market
income.
Income Redistribution




The three lower income
groups gain …
…and the highest income
group loses.
Income Redistribution

The Big Tradeoff
Redistributing income leads to a tradeoff between equity
and efficiency, known as the big tradeoff. Programs to
redistribute income are inefficient for three reasons:
The process of income redistribution uses up resources
that could have otherwise been used for producing goods
and services.
Redistribution of income requires taxes to be imposed on
the economy, which was shown in an earlier chapter to
generate a deadweight loss in the markets that are taxed.
Income Redistribution

Income redistribution decreases the incentives for
taxpaying workers to provide labor when leisure is a
normal good (by decreasing income from work) and
decreases the incentives for income assistance recipient’s
to provide labor and earn income.
A major challenge in the U. S. today is finding ways to
assist the poorest identifiable group: young minority
women who have not completed high school, have
dependent children, and live without a spouse in the
household.
Income Redistribution

The long-term solution to their plight is education and job
training—acquiring human capital.
The short-term solution is enforcing child support
payments from absent fathers and former husbands, and
providing welfare assistance. But it must be designed to
minimize the disincentive to become self-sufficient.
Income Redistribution

Welfare reform occurred in 1996 when the Temporary
Assistance for Needy Families (TANF) program was
implemented.
TANF is a block grant to the states, not an open-ended
entitlement program for individuals.
An adult member of a family receiving assistance must
either work or perform community service and there is a
five-year limit for receiving assistance.
THE END

				
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