Market Failures:
Income Distribution
1
Review
1. Define Market Failure.
2. Identify the four market failures we have
learned in this unit.
3. Explain why are public goods a market failure.
4. Explain why are externalities a market failure.
5. Explain why are monopolies a market failure.
6. By yourself, draw a positive externality.
7. By yourself, draw a negative externality.
8. Use graph to explain the remedy for positive
externalities.
9. Use graph to explain the remedy for negative
externalities.
10.Name 10 best character demises in TV history.
2
Market Failure #4
Unfair Distribution of
Wealth
3
Income Inequality
15% of Americans live in poverty—why is this a
market failure?
In 2013, the average American family made
$69,813. Everyone is obviously rich.
What’s wrong with using the average?
Averages reveal absolutely nothing about how
income is distributed.
4
Measuring Income Distribution
Review the process:
• The government divides all income earning
families into five equal groups (quintiles) from
poorest to richest.
• Each groups represents 20% of the population.
• If there was perfect equality then 20% of the
families should earn 20% of the income, 40%
should earn 40% (and so on).
• The government compares how far the actual
distribution is from perfect distribution then
attempts to redistribute money fairly.
5
Measuring Income Distribution
Summary:
Group #1 (Poorest 20%)
• Total of $5 (5% of total income)
Group #2
• Total of $10 (10% of total income)
Group #3
• Total of $15 (15% of total income)
Group #4
• Total of $25 (25% of total income)
Group #5 (Richest 20%)
• Total of $45 (45% of total income)
6
The Lorenz Curve
100
Percent of Income
80
Perfect Equality
60
40
20
0
20
40
60
80
Percent of Families
100
7
The Lorenz Curve
100
Lorenz Curve
(actual distribution)
Percent of Income
80
Perfect Equality
60
55
40
30
20
15
5
0
20
40
60
80
Percent of Families
100
8
The Lorenz Curve
100
Lorenz Curve
(actual distribution)
Percent of Income
80
Perfect Equality
60
55
40
The size of the
banana shows
the degree of
income inequality.
30
20
15
5
0
20
40
60
80
Percent of Families
100
9
The Lorenz Curve
100
After Distribution
Percent of Income
80
Perfect Equality
60
55
40
The banana gets
smaller when the
government redistributes income
30
20
15
5
0
20
40
60
80
Percent of Families
100
10
Taxes
11
What are Taxes?
Taxes – mandatory payments made to the
government to cover costs of governing.
Why does the government tax?
Two purposes:
1. Finance government operations.
• Public goods-highways, defense, employee wages
• Fund Programs- welfare, social security
2. Influence economic behavior of firms and
individuals.
Ex: Excise taxes on tobacco raises tax revenue and
discourages the use of cigarettes.
12
Three Types of Taxes
1. Progressive Taxes -takes a larger percent of
income from high income groups (takes more
from rich people).
Ex: Current Federal Income Tax system
2. Proportional Taxes (flat rate) –takes the same
percent of income from all income groups.
Ex: 20% flat income tax on all income groups
3. Regressive Taxes –takes a larger percentage
from low income groups (takes more from poor
people).
Ex: Sales tax; any consumption tax.
13
Three Types of Taxes
What kind of taxes are these?
(THINK % of Income)
1. Toll road tax ($1 per day)
2. State income tax where richer citizens pay
higher %
3. $.45 tax on cigarettes
4. Medicare tax of 1% of every dollar earned
5. 8.25% California sales tax
14
Federal Income Tax Debate
Equal Tax of $350 per week (Regressive Tax)
Income
Amount of Tax %
Amount to live on
• $200
$350
175%
-$150)[crime?]
• $350
$350
100%
$0
• $500
$350
70%
$150
• $1,000
$350
35%
$650
• $5,000
$350
7%
$4,650
Tax tax of 20% per week (Proportional Tax)
Income
Amount of Tax
Amount to live on
• $200
$40
$160
• $350
$70
$280
• $500
$100
$400
• $1,000
$200
$800
• $5,000
$1,000
$4,000
15
Federal Income Tax Debate
Marginal Tax
Rate[13][14][15]
Single
Married Filing Jointly or Qualified
Widow(er)
Married Filing Separately
10%
$0 – $8,925
$0 – $17,850
$0 – $8,925
15%
$8,926 – $36,250
$17,851 – $72,500
$8,926 – $36,250
25%
$36,251 – $87,850
$72,501 – $146,400
$36,251 – $73,200
28%
$87,851 – $183,250
$146,401 – $223,050
$73,201 – $111,525
33%
$183,251 – $398,350
$223,051 – $398,350
$111,526 – $199,175
35%
$398,351 – $400,000
$398,351 – $450,000
$199,176 – $225,000
39.6%
$400,001+
$450,001+
$225,001+
This is our current system. Is it fair?
The Progressive tax system is the most
effective way to fight this market
failure
The Laffer Curve
Shows relationship between tax rate and tax
revenue.
What would happen if the highest tax bracket was
75%?
17
THINK ROBIN HOOD!!!!!!
What was his group’s name?
Merry Men
What did they do?
Laugh a lot…they were “Laffers.”
What was his weapon of choice?
Bow and Arrow
What did Robin Hood do?
Steal from the rich and give to the poor.
What would happen to the amount of travelers
through Sherwood forest if he took 95% instead
of 39% of their money?
What would happen to the total amount of
money he collects?
18
The Laffer Curve
% Tax
Rate
If the government
increase taxes rates
tax revenue will
increase
If the tax rate
becomes too high, tax
revenue will fall since
workers have no
incentive to work
harder
Tax Revenue
19