Inequality and Poverty
CHAPTER
20
CHAPTER CHECKLIST
When you have completed your study of this
chapter, you will be able to
1
Describe the economic inequality and poverty in the
United States.
2
Explain how economic inequality and poverty arise.
3
Explain why governments redistribute income and
describe the effects of redistribution on economic
inequality and poverty.
20.1 ECONOMIC INEQUALITY
We measure economic inequality by looking at the
distributions of income and wealth.
Market income is a household’s wages, interest, rent,
and profit earned from the markets for factors of
production before paying income taxes.
Money income is market income plus cash benefits
paid by the government.
A household’s wealth is the value of the things that it
owns at a point in time.
Table 20.1 shows these distributions in the United
States in 2006.
20.1 ECONOMIC INEQUALITY
20.1 ECONOMIC INEQUALITY
20.1 ECONOMIC INEQUALITY
Lorenz Curves
A Lorenz curve is a curve that graphs the cumulative
percentage of income (or wealth) against the cumulative
percentage of households.
Figure 20.1 on the next slide shows the Lorenz curves
for the U.S. income in 2006 and U.S. wealth in 1998.
These Lorenz curves are based on Table 20.1
20.1 ECONOMIC INEQUALITY
The cumulative percentages of income and wealth are
graphed against the cumulative percentage of households.
1. If each 20 percent of
households received
20 percent of total
income, there would
be no rich and poor—
there would be
equality as shown by
the Line of equality.
20.1 ECONOMIC INEQUALITY
2. The distribution of income shows that the poorest 20 percent
of households received 3.4 percent of total income, and the
richest 20 percent received 49.4 percent.
3. The distribution of
wealth shows that the
poorest 40 percent of
households owned
0.2 percent of total
wealth, and the
richest 1 percent
owned 38.1 percent.
20.1 ECONOMIC INEQUALITY
The farther the Lorenz curve is from the Line of equality,
the greater is the inequality.
The distribution of
wealth is much more
unequal than the
distribution of income.
20.1 ECONOMIC INEQUALITY
Inequality over Time
U.S. income inequality has increased the past few
decades.
The highest incomes have increased much faster than
the lower incomes.
The gap between rich and poor has widened.
Figure 20.2(a) on the next slide shows how the
distribution of income changed from 1967 to 2006.
20.1 ECONOMIC INEQUALITY
The average income of
the lowest quintile
increased from $7,900 to
$11,400—an increase of
43 percent.
The average income of
three middle quintiles
increased by 42 percent.
The average income of
highest quintile increased
by 91 percent.
20.1 ECONOMIC INEQUALITY
Economic Mobility
Economic mobility is the movement of a family up or
down the income ladder and through the income
quintiles.
If there were no economic mobility, a family would be
stuck at a given point in the income distribution—
persistently rich to persistently poor.
How much economic mobility has there been?.
Figure 20.2(b) shows the percentage of families that
moved by one quintile or more over a ten-year period.
20.1 ECONOMIC INEQUALITY
The figure shows quite a lot of economic mobility.
About 30 percent of
families move up a quintile
or more in a decade;
A similar percentage move
down by a quintile or
more;
Between 35 and 40
percent remain in the
same quintile.
Mobility decreased over
the 1980s and 1990s.
20.1 ECONOMIC INEQUALITY
Who Are the Rich and the Poor?
The lowest-income household in the United States
today is likely to be a black woman over 65 years of
age who lives alone somewhere in the South and has
fewer than nine years of elementary school education.
The highest-income household in the United States
today is likely to be a college-educated white married
couple between 45 and 54 years of age living together
with two children somewhere in the Northeast or the
West.
20.1 ECONOMIC INEQUALITY
The median
income in 2005
was $46,326.
Education is the
single biggest
factor affecting
household
income
distribution.
20.1 ECONOMIC INEQUALITY
Size of
household,
marital status,
and age of
householder are
also important.
Race and region
are the least
important.
20.1 ECONOMIC INEQUALITY
Poverty
Poverty is a state 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.
In 2005, the poverty level for a household with 2 adults
and 2 children was an income of $19,806.
In 2006, 36 million Americans lived below the poverty
level.
Figure 20.4 on the next slide shows the distribution of
poverty by race in 2006.
20.1 ECONOMIC INEQUALITY
Part (a) shows the distribution
of poverty in 2006:
56 percent of white families
20 percent of black families
21 percent of Hispanic families
3 percent of Asian families
20.1 ECONOMIC INEQUALITY
Poverty Incidence and Trends
To measure the incidence of poverty, we look at the
poverty rate.
The poverty rate is the percentage of families living in
poverty.
In 2006, the poverty rate was 12.3 percent.
Figure 20.4(b) on the next slide shows the poverty rates
and their trends for whites, blacks, and Hispanic
families from 1996 to 2006.
20.1 ECONOMIC INEQUALITY
The white poverty rate
has been fairly steady.
The Hispanic poverty
rate fell in the 1990s.
The black poverty rate
fell during the 1960s
and the 1990s.
Poverty rates for
blacks and Hispanics
are double that for
whites.
20.1 ECONOMIC INEQUALITY
Poverty Duration
Another measure of poverty is duration.
Duration of poverty is an important indicator of the
hardship poverty brings.
Figure 20.5 on the next slide shows the duration of
poverty in the United States from 1996 to 1999.
20.1 ECONOMIC INEQUALITY
More than 50
percent of poverty
last for between 2
and 4 months.
But almost 30
percent of poverty
lasts for more than 9
months. These
families experience
chronic poverty.
20.2 HOW INEQUALITY AND POVERTY ARISE
Economic inequality and poverty arise from five key
factors
•
•
•
•
•
Human capital
Discrimination
Financial and physical capital
Entrepreneurial ability
Personal and family characteristics
We look at each in turn.
20.2 HOW INEQUALITY AND POVERTY ARISE
Human Capital
High-skilled workers have a higher value of marginal
product than low-skilled workers.
Figure 20.6(a) on the next slide illustrates the demand
for high-skilled and low-skilled labor.
20.2 HOW INEQUALITY AND POVERTY ARISE
Demand for High-Skilled
and Low-Skilled Labor
High-skilled labor has a
higher VMP than low-skilled
labor and a greater demand.
The demand curve for highskilled labor, DH, lies above
the demand curve for lowskilled labor, DL, by the VMP
of skill.
20.2 HOW INEQUALITY AND POVERTY ARISE
The Supply of High-Skilled and Low-Skilled Labor
Skills are costly to acquire, and a worker pays the cost
of acquiring a skill before benefiting from a higher
wage.
Figure 20.6(b) on the next slide illustrates the supply of
high-skilled and low-skilled labor
20.2 HOW INEQUALITY AND POVERTY ARISE
High-skilled labor bears the
cost of acquiring skill.
The supply curve of highskilled labor, SH, lies above
the supply curve of low-skilled
labor, SL, by the
compensation for the cost of
acquiring skill.
20.2 HOW INEQUALITY AND POVERTY ARISE
Wage Rates of High-Skilled and Low-Skilled Labor
The combined effects of skill on the demand for and
supply of labor generate a higher wage for high-skilled
labor than for low-skilled labor.
Figure 20.6(c) on the next slide illustrates the skilled
wage differential.
20.2 HOW INEQUALITY AND POVERTY ARISE
The demand for low-skilled
labor, DL, and the supply of lowskilled labor, SL, determine the
wage rate of low-skilled labor—
in this example at $10 an hour.
The demand for high-skilled
labor, DH, and the supply of highskilled labor, SH, determine the
wage rate of high-skilled labor—
in this example at $20 an hour.
20.2 HOW INEQUALITY AND POVERTY ARISE
Discrimination
Human capital differences explain much of the income
inequality that exists.
Economists are not sure whether and by how much
discrimination adds to income inequality.
One line of argument is that competition prevents
discrimination. But race and sex income differences do
persist.
20.2 HOW INEQUALITY AND POVERTY ARISE
Financial and Physical Capital
People with high incomes are usually those who own
large amounts of financial capital and physical capital.
They receive income in form of interest, dividends, and
capital gains.
Families with a lot of capital tend to become even more
wealthy because
• They bequeath wealth to their children.
• Rich people marry rich people (on average).
20.2 HOW INEQUALITY AND POVERTY ARISE
Saving and wealth accumulation is not inevitably a
source of inequality.
When a family saves to redistribute an uneven income
over the life cycle, it enjoys more equal consumption.
If a lucky generation that has a high income saves and
makes a bequest to an unlucky generation, this saving
decreases economic inequality.
20.2 HOW INEQUALITY AND POVERTY ARISE
Entrepreneurial Ability
Some people become extremely rich through a
combination of hard work, good luck, and outstanding
entrepreneurial ability.
But others who borrow to create a business, work hard,
and have bad luck become extremely poor.
Personal and Family Characteristics
Personal and family characteristics play a crucial role,
for good or evil, in influencing economic well-being.
20.3 INCOME REDISTRIBUTION
How Governments Redistribute Income
Three main ways in which governments in the United
States redistribute income are
• Income taxes
• Income maintenance programs
• Subsidized services
20.3 INCOME REDISTRIBUTION
Income Taxes
Income taxes may be progressive, regressive, or
proportional.
• A progressive tax
One that taxes income at an average rate that increases
with the level of income.
• A regressive tax
One that taxes income at an average rate that decreases
with the level of income.
• A proportional tax
One that taxes income at a constant rate, regardless of
income.
20.3 INCOME REDISTRIBUTION
Income Maintenance Programs
Three main types of program are
• Social Security programs
• Unemployment compensation
• Welfare programs
20.3 INCOME REDISTRIBUTION
Social Security Programs
OASDHI or Old age, Survivors, Disability, and Health
Insurance
Medicare, which provides hospital and health insurance
for the elderly and disabled.
20.3 INCOME REDISTRIBUTION
Unemployment Compensation
To provide an income to unemployed workers.
A tax is paid based on the income of each covered
worker.
Each worker receives a benefit when he or she
becomes unemployed.
20.3 INCOME REDISTRIBUTION
Welfare Programs
1. Supplementary Security Income (SSI), designed to
help the neediest elderly, disabled, and blind people.
2. Temporary Assistance for Needy Families (TANF)
program, designed to help households that have
inadequate income.
3. Food Stamp program, designed to help the poorest
households obtain a basic diet.
4. Medicaid, designed to cover the costs of medical
care for households receiving help under the SSI and
TANF programs.
20.3 INCOME REDISTRIBUTION
Subsidized Services
Services provided by the government at prices far
below the cost of production. The most important of
these are
• Education
• Health care
20.3 INCOME REDISTRIBUTION
 The Scale of Income Redistribution
Market income is the income that a household earns in
factor markets with no redistribution.
Money income is the market income plus cash benefits
paid by the government.
Disposable income is market income plus cash
benefits paid by the government minus taxes.
20.3 INCOME REDISTRIBUTION
 The Scale of Income Redistribution
Market income is the income that a household earns in
factor markets with no redistribution.
Disposable income is market income plus cash
benefits paid by the government minus taxes.
We can measure the scale of income redistribution by
calculating the percentage of market income paid in
taxes minus the percentage received in benefits at each
income level.
20.3 INCOME REDISTRIBUTION
Figure 20.7 shows income
redistribution in 2005.
In part (a), the Lorenz curve for
the distribution of money income
is closer to the line of equality
than the distribution of market
income.
The distribution of disposable
income is even closer to the line
of equality.
20.3 INCOME REDISTRIBUTION
Part (b) shows the amount of
redistribution in 2005.
The quintile with the lowest
incomes received net benefits
that increased their share of
total income by 2.9 percent.
The quintile with the highest
incomes paid taxes that
decreased their share of total
income by 6.5 percent of total
income.
20.3 INCOME REDISTRIBUTION
Why We Redistribute Income
Two approaches:
• Normative approach
Discusses why we should compel everyone to help
the poor and looks for principles to guide in the
appropriate scale of redistribution.
• Positive approach
Seeks reasons why we do compel everyone to help
the poor and tries to explain the actual scale of
redistribution.
20.3 INCOME REDISTRIBUTION
Normative Theories of Income Redistribution
Utilitarianism points to the ideal distribution being one of
equality. But efficiency is also desirable.
Greater equality can be achieved only at the cost of
inefficiency—the big tradeoff.
John Rawls proposed the principle that income should
be redistributed to the point at which the poorest
person’s share is maximized.
20.3 INCOME REDISTRIBUTION
Libertarian philosophers, such as Robert Nozick, say
that any redistribution is wrong because it violates the
sanctity of private property and voluntary exchange.
Modern political parties stand in the center of these
extremes—some favor a bit more redistribution than
others, but the major parties are basically happy with
the current scale of redistribution.
20.3 INCOME REDISTRIBUTION
Positive Theories of Income Redistribution
There is no good positive theory, but economists have a
promising idea called the median voter theory.
Median voter theory is a theory that government
pursues policies that make the median voter as well off
as possible.
In the majority voting system, the voter whose views
carry most weight is the one in the middle—the median
voter.
Political parties will deliver the scale of redistribution
that the median voter prefers.
20.3 INCOME REDISTRIBUTION
The Major Welfare Challenge
The poorest people in the United States are young
women who have not completed high school, have a
child (or children), live without a partner, and are more
likely to be black or Hispanic than white.
These young women and their children present the
major welfare challenge:
• The long-term solution involves education and job
training.
• The short-term solution is welfare.
20.3 INCOME REDISTRIBUTION
Welfare must be designed to strengthen the incentive to
pursue the long-term solution while giving support in the
short term.
The Current Approach: TANF
TANF is a block grant paid to the states to administer
payments to individuals.
An adult member of a household receiving assistance
must work or perform community service. Assistance is
limited to 5 years.
Some economists suggest a negative income tax.
20.3 INCOME REDISTRIBUTION
Negative Income Tax
A negative income tax is a tax and redistribution
scheme that provides every household with a
guaranteed minimum annual income and taxes all
earned income above the guaranteed minimum at a
fixed rate.
A negative income tax does not remove the burden of
the tax but it does improve the incentives to work and
save at all levels of income.