FPE Week 8: Income Inequality

Name 3 reasons to worry about inequality

1. Instrumental concerns; inequality has bad consequences for society

2. Intrinsic / normative concerns; utilitarianism

3. Distributive justice; Rawls difference principle

Name a few examples of bad consequences inequality has on today's society

Lack of social cohesion, crime, health issues, money politics, macroeconomic stability, etc.

What is one concern of utilitarianism regarding inequality?

Excessive inequality reduces the sum of total utility.

How does excessive inequality affect the value of additional income according to utilitarianism?

The value of an additional unit of income is lower for the well-off.

What is one argument for improving redistribution according to utilitarianism?

Efficient redistribution can increase overall utility.

Rawl's difference principle in relation to inequality

Inequality in social primary goods (including income and wealth) should be arranged to the greatest benefit of the least advantaged

Name 3 types of assets

1. Labor

2. Human capital (education)

3. Capital

Explain the basic conceptual framework: a proximate determinant

Income (Y)=assets × its rate of return / ∆ Y = ∆ assets distribution × ∆ return on assets

Income (Y) is determined by assets multiplied by their respective rate of return.

Changes in income (∆Y) are influenced by alterations in assets distribution (∆assets distribution) and returns on assets (∆return on assets).

Name 4 types of return(s)

1. Wage

2. Salaries

3. Rent

4. Interest

Asset distribution

A function of ownership structure, which is determined by initial distribution, saving and investment behaviour, demography, political economy, etc

f(ownership structure)

Asset return

Influenced by supply and demand dynamics, market structure, and redistribution policies

f(supply/demand, market structure, redistribution policy)

Name 6 contributing factors / mechanisms of economic inequality

1. Globalisation

2. Technological change

3. Growth of financial services

4. Changing pay norms

5. Reduced role of trade unions

6. Scaling back of the redistributive tax-and-transfer policy

What did Malthusian theory propose in 1798?

Overpopulation during the Industrial Revolution initially strained agricultural production's capacity to feed the growing population

How did the Malthusian theory view the relationship between economic growth and inequality?

The potential for agricultural productivity improvement offered a solution

What is the concept of Ricardian scarcity?

As output and population increase, land becomes scarce, driving up land rent and enriching landowners relative to labor

How does industrialization and technological progress impact wealth distribution in the context of Ricardian scarcity?

It offers the opportunity to transition the economy away from land-based production, mitigating the impact of land scarcity on wealth distribution

What is the Marxian perspective on economic growth and inequality?

The conflict between capital owners and labor arises from the tendency of capital to accumulate in the hands of fewer capitalists, potentially leading to diminishing returns on capital or a highly concentrated share of capital income in the total national income.

What can the conflict between capital owners and labor lead to according to Marx?

Violent conflicts among capitalists or worker revolts.

What offers a potential solution to the conflict between capital owners and labor according to Marxian theory?

Durable technological progress and increased labor productivity.

What is the Kuznets inverted U-curve (1955) related to?

The relationship between economic growth and inequality

What does the Kuznets inverted U-curve suggest about inequality in capitalist development?

There is a spontaneous force that eventually brings inequality down

Give an example of a factor that can drive the wage premium down according to the Kuznets inverted U-curve.

Broader education

The relationship between economic growth and inequality: Piketty's model of capitalist economy; r > g (2017)

β = K/Y

K = stock of capital

Y = flow of income

β = the ratio between these two

Piketty's definition of K (stock of capital) / wealth

All forms of explicit or implicit return-bearing assets

Ex, housing, land, machinery, financial capital in the form of cash, bonds and shares, intellectual property, and even human persons at the time of legalised slavery

Piketty's definition of Y (flow of income)

The total income earned by individuals or households within a specific period, typically annually

Ex, earnings from various sources such as wages, salaries, profits, rents, and interest

Piketty's 1st fundamental law of capitalism

α = r × β; a simple transparent relationship among three most important concept for analysing capitalist economy

α = the share of capital incomes in total national income

r = the rate return of capital

β = capital/income ratio

Piketty's 2nd fundamental law of capitalism

β = s/g; implies that a country that save a lots and grows slowly will in the long run accumulate large stock of capital

s = saving rate

g = growth rate

β = saving/growth ratio

What does Piketty's fundamental law of wealth divergence state?

If r > g (when α = r × β), this demonstrates that the share of capital income (α) in total national income increases.

How does the capital/income ratio (β) change according to Piketty's theory?

Unless all capital income is consumed, the capital/income ratio (β) also rises, creating a feedback loop where both α and β reinforce each other's growth.

What impact does Piketty's theory have on inequalities between capital owners and labor?

This dynamic worsens inequalities between capital owners and labor, as capital accumulates faster than the economy grows, leading to a disproportionate role of capital income relative to labor income, particularly in low-growth economies.

What is the "key" to solving Piketty's fundamental law of wealth divergence?

The stickiness of r being greater than g is crucial.

Historically, r is around 4-5%, while g is about 2.5%. But theoretically, r can't always be higher than g bc of diminishing returns; Piketty argues that it's easier to swap labor for capital when labor gets expensive, but in reality, it's not that easy (for example in the US)

Name 2 factors that help explain the rise of Asia

1. Factor accumulation; or catching up process in Solow model of long run growth

2. Diffusion of knowledge and skills; stronger effects