Chapter 14: The Distribution of Income and Poverty
CHAPTER 14: THE DISTRIBUTION OF INCOME AND POVERTY
Overview
This chapter covers two main topics in economics: the distribution of income and poverty. Understanding these concepts is essential for analyzing economic wellbeing in society.
The Distribution of Income
Key Points in the Lecture:
Definitions
Distribution of Income: Refers to how the total income of a nation is shared among its population.
Income Shares: Different segments of the population receive varying percentages of total income.
Percentage Distribution of Household Income - 2005:
Lowest fifth of households: 3.4% of total income
Second fifth: 8.9% of total income
Third fifth: 14.7% of total income
Fourth fifth: 23.0% of total income
Top fifth: 50.0% of total income
This highlights a significant disparity, where the top fifth earns half of the total income.
Income Distribution: 1967 vs 2005
A graph showcases the distribution of income by quintiles for the years 1967 and 2005, demonstrating changes over time:
1967 Distribution:
Lowest Fifth: 4.0%
Second Fifth: 10.8%
Third Fifth: 17.3%
Fourth Fifth: 24.2%
Top Fifth: 43.8%
2005 Distribution:
Lowest Fifth: 3.4%
Second Fifth: 8.6%
Third Fifth: 14.6%
Fourth Fifth: 23.0%
Top Fifth: 50.4%
Result: This shows a growing income inequality over the forty-year span.
Factors Determining a Person’s Income
The distribution of income can be influenced by government policies, particularly through:
Taxes
Transfer Payments
Formula for Individual Income:
\text{Individual Income} = \text{Labor Income} + \text{Asset Income} + \text{Transfer Payments} - \text{Taxes}
Types of Transfer Payments
Direct Transfer Payments:
Payments made that are not in exchange for goods or services, often funded by the government.
In-Kind Transfer Payments:
Payments made in the form of goods and services rather than cash—examples include food stamps and subsidized housing.
Income Distribution Over Time
Illustrations involving two individuals, John and Stephanie:
Income varies across specific years, demonstrating inequality in singular instances (e.g., Stephanie earns more in multiple years, while John earns more in future instances).
Over five years, total income for each equates to $236,000, indicating that time can equilibrate perceived income inequality.
Self-Tests
Test 1:
Question: How can government change the distribution of income?
Answer: Through transfer payments and taxation adjustments, redistributing income among individuals.
Test 2:
Statement: "Income inequality at one point in time is sometimes consistent with income equality over time.”
Comment: True, as demonstrated by varying income over different years for individuals.
Test 3:
Query: Smith and Jones earn the same income; does this mean the income streams are identical?
Answer: No, their incomes could arise from different sources such as labor or assets.
Measuring Income Equality
Lorenz Curve
Definition: A graphical representation that illustrates income distribution.
The curve reflects the cumulative percentage of total income earned against the cumulative percentage of households.
Gini Coefficient
Definition: A statistical measure that quantifies income inequality ranging from 0 (perfect equality) to 1 (complete inequality).
A higher Gini coefficient signifies greater income disparity among households.
Application of the Gini Coefficient
The coefficient is instrumental in assessing both absolute and relative income distribution effectively.
Example: A country with a Gini coefficient of 0.45 signifies moderate inequality, while 0.60 indicates more disparity.
Limitations of the Gini Coefficient
Cannot Indicate Quintile Income: A low Gini does not guarantee a larger share for the lowest quintile.
Comparative Ineffectiveness: Different distributions can yield lower Gini coefficients without improving the bottom quintile's share.
Factors Leading to Income Inequality
Income inequality arises from various individual differences, such as:
Innate abilities and skills
Work-leisure choice balance
Education level (human capital)
Risk attitudes
Luck and opportunities
Presence of wage discrimination in the labor market.
Human Capital & Wage Discrimination
Human Capital: Refers to the education and skills that enhance productivity.
Wage Discrimination: Occurs when individuals of equal skill levels receive unequal compensation.
Normative Standards of Income Distribution
Marginal Productivity Normative Standard:
Income should correlate to marginal productivity in the economy.
Absolute Income Equality Normative Standard:
Advocates for overall equality in income distribution.
Rawlsian Normative Standard:
Focuses on equitable distribution derived from a “veil of ignorance,” ensuring fairness irrespective of individual circumstances.
Veil of Ignorance
Conceptual construct where individuals design the distribution structure without knowledge of their future economic status.
Poverty and Its Measurement
Poverty Threshold Definition
The poverty line indicates the income level below which individuals or families are classified as living in poverty.
Limitations of Statistics:
Exclusion of in-kind benefits
Failure to account for unreported income
Regional cost of living variances
Overlooking hidden poverty, including many homeless individuals.
Government Interventions to Address Poverty
Public Good/Free Rider Justification:
Advocacy for income redistribution as it benefits society collectively, enhancing overall wellbeing by reducing poverty levels.
Social Insurance Justification:
Individuals support redistribution measures anticipating personal future returns in case of need.
Self-Tests on Poverty and Inequality
Existence of Poverty: Dependent on definitions and contextualizations relative to absolute metrics.
U.S. Poverty Rate in 2006: Recorded at 12.3%.
Demographics of Poor: Disproportionately, many belong to underrepresented groups, specifically young, less-educated female heads of households from minority backgrounds.