Wealth, Income, and Functional Inequality in Economics

Wealth distribution and inequality

The allocation of assets (such as property, stocks, and savings) across individuals or groups in society, often measured by metrics like the Gini coefficient for wealth. Inequality refers to disparities in this allocation, which can be exacerbated by factors like inheritance, market returns, and policy.

Personal income distribution and inequality

The division of total income (from wages, investments, transfers, etc.) among individuals or households. Inequality measures how uneven this distribution is, often using Gini coefficients for market or disposable income, influenced by wage dispersion, taxes, and transfers.

Functional income distribution and inequality

The allocation of national income between factors of production, such as labor (wages) and capital (profits, interest, rents). Inequality here refers to shifts like declining wage shares, often measured by the wage share (WS = W / pY) and profit share (PS = Π / pY), where WS + PS = 1.

Primary or market distribution

The initial allocation of income generated through market processes before government intervention, such as wages, profits, and rents based on production and ownership.

Secondary or state (re)distribution

The adjustment of primary income distribution through government policies like taxes, transfers, and social benefits to reduce inequality (e.g., progressive taxation or welfare programs).

Poverty as an absolute measure

A fixed standard of living below which individuals are considered poor, often based on a minimum income threshold needed for basic needs (e.g., $1.90/day globally or national poverty lines).

Poverty as a relative measure

Poverty defined relative to the median income in a society, typically below 50-60% of the median, emphasizing social exclusion and inequality within a specific context.

Lorenz curve

A graphical representation of income or wealth distribution, plotting the cumulative share of income/wealth against the cumulative share of the population (from poorest to richest). Perfect equality is a 45-degree line; deviation indicates inequality.

Gini coefficient

A measure of inequality derived from the Lorenz curve, ranging from 0 (perfect equality) to 1 (perfect inequality). It represents the area between the Lorenz curve and the line of equality, doubled.

Ricardo-Matrix

A framework from David Ricardo illustrating the distribution of income among three classes: workers (wages from labor), capitalists (profits from capital), and landowners (rents from land ownership), summing to national income.

Unadjusted wage share

The proportion of national income going to wages without correcting for self-employment income (e.g., WS = W_t / pY_t, where W_t is total wages).

Adjusted wage share

The wage share modified to account for self-employment by imputing labor income to self-employed individuals (e.g., WS = (W_t * L_o / L_t) / pY_t, where L_o is employees, L_t is total employed).

Economic phases since the 1950s

Periods including the Golden Age (1950s-late 1960s: high growth, stable wage shares), Turbulence (1970s: oil shocks, inflation), Neoliberalism (1980s-2007/9: falling labor shares, rising inequality, deregulation), and Stagnation (2007-2019: post-crisis slow recovery).

Walrasian general equilibrium theory

A model explaining how prices and quantities are determined simultaneously across all markets through supply and demand, assuming perfect competition, price-taking agents, and market clearing (prices adjust to equate supply and demand).

Aggregate marginal productivity theory of distribution

The neoclassical view that factors of production (labor, capital) are paid according to their marginal product (e.g., wage = MPL, profit = MPK), assuming a production function like Y = F(L, K) with diminishing returns.

Say's Law

The classical principle that supply creates its own demand, implying no general overproduction or involuntary unemployment in the long run, as all income is spent or saved/invested.

Definition of growth (of GDP)

The increase in real gross domestic product (GDP) over time, measured as the percentage change in output (ΔY/Y), driven by factors like labor force growth, capital accumulation, and technology.

Goods market equilibrium condition

The state where aggregate supply equals aggregate demand (Y = C + I + G + NX), or equivalently, saving equals investment (S = I) in a closed economy without government.

Warranted rate of growth

The growth rate of capital/output that maintains goods market equilibrium, given by g_w = s / v, where s is the saving rate and v = K/Y is the capital-output ratio.

Equilibrium growth

A balanced growth path where all macroeconomic variables (output, capital, labor) grow at constant rates, often determined by exogenous factors like labor force growth in neoclassical models.

Stability of equilibrium growth rate

In neoclassical models, the equilibrium is stable if deviations (e.g., from shocks) lead to automatic adjustments back to the steady state via changes in capital-labor ratios or prices.

Shocks: increase in marginal propensity to save

In neoclassical models, a rise in saving rate (s) temporarily boosts growth but leads to a higher capital-output ratio and capital-labor ratio; long-run growth rate remains unchanged (determined by labor force growth), but the equilibrium path shifts upward.

Introduction of technological progress into the neoclassical growth theory

Incorporating exogenous technical change (e.g., A in Y = A L^α K^β) to explain sustained growth, shifting the production function upward and allowing per capita growth without diminishing returns.

Main purpose of the new Neoclassical Growth Theory

To endogenize technological progress through human capital accumulation, R&D investment, and knowledge spillovers, explaining incomplete convergence and policy roles in growth.

Accumulation of human capital in new Neoclassical Growth Theory

Investment in education and skills increases effective labor supply, endogenizing growth by raising productivity and allowing sustained per capita growth without exogenous tech assumptions.

R&D Investment in new Neoclassical Growth Theory

Firms invest in research and development to generate innovations, creating knowledge as a non-rival good with spillovers, driving endogenous growth and explaining differences in growth rates.

The role of income distribution in new growth theory

Inequality can hinder growth by limiting human capital investment for the poor (due to imperfect credit markets) or stimulate it via incentives; overall, high inequality often reduces growth potential.

Kuznets curve

A hypothesis that inequality rises with early economic development (industrialization) but falls at higher income levels (hump-shaped curve), due to shifts from agriculture to industry and later redistribution.

Neoclassical explanations for the relationship between growth and income distribution

Growth is supply-driven; inequality may promote growth via savings/incentives but can hinder it through imperfect markets limiting poor households' investments; skill-biased tech change increases inequality.

Crucial differences between Neoclassical and PK growth theories

Neoclassical: supply-side, full employment, exogenous/endogenous tech, steady-state equilibrium. PK: demand-led, variable capacity utilization, endogenous distribution, path-dependent growth.

Potential output

The maximum sustainable output given full employment and capital utilization; in neoclassical: Y = F(L, K) at full factors; in PK: upper bound influenced by demand, often below due to underutilization.

Characteristics of Kaleckian growth models

Demand-driven, variable long-run capacity utilization (no full utilization), mark-up pricing determines distribution, capital accumulation independent of saving (I > S via finance), paradox of thrift/costs.

Kalecki's pricing and distribution theory

Firms set prices via mark-up on variable costs (p = (1+m)(w a + p_m μ)), where m reflects monopoly power; determines profit share h = m (1+z) / (m (1+z) +1), z = material/labor cost ratio.

Mark-up and its determinants

The percentage added to unit variable costs to set prices (m >0); determinants: degree of monopoly/price competition, trade union power (negative effect), overhead costs (positive if protecting profits).

Profit share (definition and simplified equation h

m/(1+m))\ = The proportion of national income as gross profits (including overheads): h = Π / (Π + W); simplified: h = m / (1+m) assuming no imported materials (z=0).

Relationship between unit raw material costs and unit labor costs (z)

z = (p_m μ) / (w a); if z rises (e.g., higher material prices), profit share h falls unless m adjusts upward, as materials squeeze the margin for profits.

Profit rate

The ratio of profits to capital stock (r = Π / K); in Kaleckian: r = h u / v, where h is profit share, u is capacity utilization, v is capital-potential output ratio.

Saving rate

The proportion of income not consumed (s = S / Y), exogenous in neoclassical models, determining warranted growth but not long-run equilibrium growth.

Capital accumulation

The increase in capital stock (ΔK = I), driven by investment; in PK: independent of saving, financed via credit, affects demand and growth.

Animal spirits

Keynesian term for entrepreneurs' spontaneous optimism/pessimism influencing investment decisions, independent of fundamentals, driving instability in PK models.

Equilibrium solutions for neo and post-Kaleckian models

Stable points where capacity utilization (u) and growth (g) balance; neo-Kaleckian: wage-led/profit-led regimes; post-Kaleckian: allows for profit-led demand with wage-led growth via international effects.

Analysis of different shocks in the neo-Kaleckian model: change in animal spirits

Increase in animal spirits (higher autonomous investment) raises u and g in wage-led regimes; partial derivatives show positive effects on equilibrium.

Analysis of different shocks in the neo-Kaleckian model: change in the profit share

Rise in h boosts g in profit-led regimes (via investment) but reduces it in wage-led (via lower consumption); paradox of costs applies in wage-led.

Difference between neo and post-Kaleckian models

Neo: assumes closed economy, often wage-led; post: incorporates openness, financialization, allowing profit-led demand but wage-led global regimes.

Implications of the post-Kaleckian model for the paradox of cost

In profit-led regimes, higher wages reduce profits/costs but may harm growth; globally wage-led, so redistribution can boost demand without loss.

Table 6.1 with possible regimes

Likely refers to wage-led vs. profit-led demand/growth regimes: wage-led if higher wage share boosts consumption/demand; profit-led if boosts investment/exports.

Policy implications as discussed in class (12/08)

In wage-led regimes: strengthen unions, regulate finance, coordinate regionally to avoid beggar-thy-neighbor; even in profit-led, room for intra-wage redistribution.

Skill-biased technological change (SBTC)

Technological progress favoring high-skilled workers, increasing their productivity/demand, leading to wage inequality and declining aggregate labor share.

Capital deepening

Increasing capital per worker through investment, raising MPK relative to MPL, shifting income toward capital.

Capital-skill complementarity

New technologies complement skilled labor (boosting productivity) but substitute unskilled, increasing skill premium and inequality.

Kuznets curve hypothesis

Inequality rises then falls with development (hump-shaped), but empirical evidence mixed.

Financialization

The increasing role of financial motives, markets, actors, and institutions in the economy, leading to falling labor shares and rising inequality.

Finance-dominated capitalism

A regime with rising rentier incomes, shareholder orientation, short-termism, contributing to inequality via channels like overheads and weakened unions.

Shareholder value orientation impact on management

Imposes short-termism, reducing real investment, favoring downsizing/distribution over retain/invest, weakening unions.

Financialization on consumption

Increases wealth-based/debt-financed consumption, compensating for stagnant wages but raising fragility.

Financialization on sectoral composition

Shifts toward financial sector (lower wage share), increasing overall profit share.

Old Neoclassical Growth Theory

Supply-driven growth at natural rate (labor force + tech), stable equilibrium, no role for demand/distribution.

New Neoclassical Growth Theory

Endogenizes growth via human capital/R&D, allows policy to address market failures, explains non-convergence.

Post-Keynesian growth theories

Demand-led, variable utilization, distribution affects growth via consumption/investment; wage-led vs. profit-led regimes.

Principle of effective demand

Demand determines output/employment; replaces Say's Law in PK, allowing persistent unemployment.

Paradox of thrift

Higher saving reduces demand/growth in short run (PK view), unlike neoclassical where it boosts growth.

Paradox of costs

Higher wages (costs) can boost demand/growth in wage-led regimes, contradicting neoclassical view.

Mark-up pricing

Firms add mark-up to costs: p = (1+m)(unit variable costs), determining distribution.

Degree of monopoly

Kalecki's term for factors like concentration, non-price competition, affecting mark-up size.

Top incomes

Share of national income held by top 0.1%/1%, rising since 1980s due to salaries, entrepreneurial income.

Rentiers' income

Interest, dividends, rents; rising share under financialization at expense of labor.

Wage-led demand

Regime where higher wage share boosts consumption/aggregate demand more than it reduces investment/exports.

Profit-led demand

Regime where higher profit share boosts investment/exports more than it reduces consumption.

Beggar-thy-neighbor strategies

Competitive wage cuts/devaluations to gain exports, but harmful globally if all pursue.

Working rich

Top earners from high salaries (management), contributing to inequality alongside capital income.