Chapter 12
The Distribution of Income
12.1
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The Lorenz Curve
The Lorenz Curve measures income distribution
by ranking individuals by income and then
plotting their cumulative number against the
cumulative percentage of income received.
 A perfectly equal distribution of income would
be 45 degree line.
 The more unequal the distribution of income,
the more “bowed” the Lorenz Curve becomes.

12.2
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Figure 12.1 A Lorenz curve
12.3
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Distributive Justice
 The
productivity principle asserts
that each person ought to receive
the monetary equivalent of what
they have produced individually from
our human resources (labour) and
our nonhuman resources (property).
12.4
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Product Exhaustion
 If
any measure of productivity is to serve
as a distributional principle, it must fulfill
the product exhaustion criterion.
 The product exhaustion criterion states
that if owners of all resources receive
what their resources produce, then the
individual shares of the total product pie
must sum to 1.
12.5
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Product Exhaustion
 Consider
a firm in long-run equilibrium
using 2 inputs to producing y* of output.
 The value of the firm’s output (py*), is
the sum of the firm’s input payments
(w1z1*) + (w2z2*).
 If, at the firm level, the product is just
used up, the two must be equal.
 Therefore: py*=w1z1*+w2z2*
12.6
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Product Exhaustion
 Re-writing
gives:
p=(w1z1*+w2z2*)/y=LAC(y*)
 This
equality follows from the price being
equal to minimum average cost in longrun perfectly competitive equilibrium.
 The product-exhaustion criteria is
therefore satisfied in a competitive
equilibrium.
12.7
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The Redistributionist Principle
 The
redistribution principle is at odds
with the productivity principle.
 Redistributionists find significant
economic inequalities unacceptable.
 They argue that wealth and income
in the real world should be
redistributed from rich to poor.
12.8
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Redistribution of Income
 Regardless
of why income distribution
takes place, some methods are better
than others.
 Many of the schemes inevitable result in
a conflict between equity and efficiency.
 The challenge is to design economic
institutions that achieve the desired
distribution and minimize the resulting
inefficiencies.
12.9
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Minimum Wage Legislation
 The
-
real question regarding minimum
wage legislations is, “do they help the
working poor?”
Does it achieve the desired redistribution
of income?
Are workers in the industry better-off?
Whose income falls to make up for the
rise in minimum wage income?
Is inefficiency an invariable side effect?
12.10
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Figure 12.2 Minimum-wage legislation
in a competitive labour market
12.11
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Minimum Wage Legislation
 In
a competitive market, inefficiency
is a necessary by-product of an
effective minimum wage law.
 As labour services are no longer put
to there most productive uses, either
unemployment or underemployment
will signal that inefficiency.
12.12
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Figure 12.3 Minimum wage and a
monopsonist’s marginal factor cost
12.13
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Monopsonistic Labour Markets
Once a minimum wage is brought into a
monopsony, the marginal factor cost will
change.
 From Figure 12.3, if the monopsonist hires an
amount of labour less than z’, its marginal
factor cost is w’.
 If it hires beyond that point, its marginal factor
cost is segment BC of its original marginal
factor cost function because it can hire
additional workers only at a wage rate higher
than w’.

12.14
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Figure 12.4 Minimum wage and monopsony
12.15
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Minimum Wage and Monopsony
Does a minimum wage increase workers
incomes?
 Yes, if wage is not higher than w”’ some
workers are better off and none worse off
because:
- At w* or below, it has no effect.
- At above w* but below w’’’ workers hired
before the introduction of the minimum
wage will paid more and new workers will be
hired at the new (minimum) wage.
- If the rate is w”’, no new workers are hired,
but existing workers will be paid more.

12.16
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Minimum Wage Legislation
The attractiveness of minimum wage legislation
depends upon whether labour markets are
competitive or a monopsony.
 Empirical evidence suggests that labour
markets covered by minimum wage laws are
competitive, and the laws are problematic.
 Workers who remain employed are better off.
Its is not clear at whose expense the gain is
made (we do not know who pays).
 By creating un/underemployment the
legislation will hurt some people it was
intended to help.

12.17
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Figure 12.5 Title
12.18
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Figure 12.5: The Underemployment
Equilibrium
Imposing the wage floor means that some
workers are reallocated from sector 1 to
sector 2 and as a result the wage rate in
sector 2 falls.
 Because $6 is less than the competitive
wage of $9, workers are not allocated to
their most productive jobs.
 The wage floor yields an equilibrium with
underemployment.

12.19
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Figure 12.6 Wage floors and search
unemployment in a two-sector model
12.20
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Figure 12.6: The Unemployment
Equilibrium
The equilibrium wage in sector 2 of the
underemployment model is lower than the
sector 2 wage of the unemployment
model.
 In unemployment model, some nonunionized workers will leave sector 2 to
chase union jobs in sector 1.
 As a result, the smaller number on nonunionized workers remaining in sector 2
will earn a higher wage.

12.21
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Figure 12.6: The Unemployment
Equilibrium

1.
2.
12.22
Two sources of inefficiency arise in
this model:
There is unemployment equal to u
in quadrant I of Figure 12.6.
The allocation of workers who are
employed is inefficient because the
wage floor exceeds the equilibrium
wage.
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Figure 12.7 An efficient incometransfer mechanism
12.23
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The Efficient Transfer Mechanism
 Although
the lump-sum mechanism
is efficient, it is not practical.
 There is no systematic way of
choosing a target indifference curve
or identifying individual preferences
and budgets to pinpoint recipients.
 As a result, maintenance policies are
formulated in terms of income rather
than utility (income-maintenance).
12.24
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Income-Maintenance Programs
 Income-maintenance
programs have
the objective of raising the income of
anyone below a targeted level of
income, up to that level.
 In practical income-maintenance
schemes, the amount of the income
transfer is conditional upon the
amount of the recipient’s earned
income.
12.25
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Figure 12.8 An inefficient
income-transfer mechanism
12.26
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Figure 12.9 A negative income tax
12.27
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