Copyright 2008 The McGraw-Hill Companies 32-1 32 Income Inequality and Poverty

Copyright 2008 The McGraw-Hill Companies32-1

32Income Inequality and Poverty


Chapter Objectives• How Income Inequality in the United

States is Measured and Described• The Extent and Sources of Income

Inequality• How Income Inequality Has

Changed Since 1970• The Economic Arguments For and

Against Income Inequality• How Poverty is Measured and its

Incidence by Age, Gender, Ethnicity, and Other Characteristics

• The Major Components of the Income-Maintenance Program in the United States


Facts About Income Inequality• Average Household Income

$60,258 in 2004 - Among the Highest in the World

(1)Personal

Income Category

(2)Percentage of All

Households in this Category

Under $10,000$10,000 - $14,999$15,000 - $24,999$25,000 - $34,999$35,000 - $49,999$50,000 - $74,999$75,000 - $99,999$100,000 and Above

Distribution of U.S. Income by Households, 2004

8.76.7

12.911.914.818.311.015.7

100.0Source: Bureau of the Census


Facts About Income Inequality• Division Into 5 Equal Groups

(1)Quintile

(2)Percentage ofTotal Income

Lowest 20%

Second 20%

Third 20%

Fourth 20%

Highest 20%

Total

Distribution by Quintiles, 2004

3.4

8.7

14.7

22.2

50.1

100.0Source: Bureau of the Census

(3)Upper

Income Limit

$18,500

34,738

55,331

88,029

No Limit

Income Mobility: The Time Dimension

Copyright 2008 The McGraw-Hill Companies32-5Cumulative % of families

Cumulative % of Income

0 100

100

The Lorenz Curve

Line of Perfect Equality


Facts About Income Inequality• Lorenz Curve and Gini Ratio

The Lorenz Curve

20 40 60 80 100

20

40

60

80

100

0

Perfect Equality

Lorenz Curve(Actual Distribution)

Complete Inequality

A B

ab

c

d

e

f

Gini Ratio =Area A

Area A + Area B

Percentage of Households

Per

cen

tag

e o

f In

co

me

W 32.1

G 32.1


What is theGini Coefficient?

• A numerical measure of the degree on income inequality in an economy


What does the Gini Coefficient have to do with the Lorenze Curve?

• The coefficient transforms the Lorenze Curve into a numerical value


With the Gini Coefficient, what do the #’s mean?

• A number of 0 is perfect income equality

• A number of 1 is perfect income inequality


Gini Coefficients, US

1970 .394

1975 .397

1980 .403

1985 .419

1990 .428

1995 .450


Some problems in measuring income distribution

Life cycle incomeFamily size and effortUnderground economyTaxes and in-kind income


Income Distribution at One Point & Over TimeIncome Distribution at One Point & Over Time

Year John'sAge

John'sIncome

Stephanie'sAge

Stephanie'sIncome

19982008201820282038Total

18 yrs28384858

$ 10,00035,00052,00064,00075,000

$236,000

28 yrs38485868

$ 30,00045,00060,00075,00026,000

$236,000

Point here is that people can have the same lifetime income yet at any moment in time, there will be income differences.


Facts About Income Inequality• Effect of Government

Redistribution

20 40 60 80 100

20

40

60

80

100

0

Lorenz CurveBefore Taxes and

Transfers

Percentage of Households

Per

cen

tag

e o

f In

co

me

Lorenz CurveAfter Taxes and

Transfers

Impact of Government Taxes and Transfers


Facts About Income Inequality• Effect of Government

Redistribution• Noncash Transfers• Percentage of Total Income

Received, 2003

(1)Quintile

(2)Before TaxesAnd Transfers

Lowest 20%

Second 20%

Third 20%

Fourth 20%

Highest 20%

.8

7.2

14.8

24.0

53.1

Source: Bureau of the Census

(3)After Taxes

And Transfers

4.5

10.7

16.4

24.0

44.4


Causes of Income Inequality• Ability

• Education and Training

• Discrimination

• Preferences and Risks

• Unequal Distribution of Wealth

• Market Power

• Luck, Connections, and Misfortune


Income Inequality Over Time

• Rising Income Inequality Since 1970

• Causes of Growing Inequality– Greater Demand for Highly Skilled

Workers

– Demographic Changes

– International Trade, Immigration, and Decline in Unionism


Causes of Income Inequality

GLOBAL PERSPECTIVE

GuatemalaBrazil

South AfricaMexico

United StatesItaly

SwedenGermany

0 10 20 30 40 50

48.3

46.9

44.7

43.1

29.9

26.8

22.2

22.1

Source: World Bank, World Development Indicators, 2005

Percentage of Total Income Received by the Top One-Tenth of Income Receivers, Selected Nations


Equality Versus Efficiency

• The Case for Equality: Maximizing Total Utility

• The Case for Inequality: Incentives and Efficiency

• The Equality-Efficiency Tradeoff


Equality Versus EfficiencyThe Utility-Maximizing Distribution of Income

Anderson’s MarginalUtility From Income

Brooks’ MarginalUtility From Income

0 0M

arg

inal

Uti

lity

Mar

gin

al U

tilit

y

Income Income

$5000 $5000$2500 $7500

MUBMUA

a

a’ b’

b

Utility Gain(Entire Blue Area)

Utility Loss(Entire Red Area)


The Economics of Poverty• Definition of Poverty

–Single in 2004 was $9,645

–Family of 4 was $19,307

–Family of 6 was $25,785

–37 Million Americans

–Poverty Rate 12.7%

Incidence of Poverty


The Economics of Poverty

Female-HouseholdersAfrican-Americans

HispanicsForeign-Born (Not Citizens)

Children Under 18Women

Total PopulationMen

WhitesAsian

Persons 65 or OlderMarried-Couple Families

Full-Time Workers

0 10 20 30

24.7

21.9

21.4

17.8

13.9

12.7

11.5

10.8

9.8

9.8

5.5

2.8

28.4

Poverty Rates Among Selected Population Groups,2004


The Economics of Poverty• Poverty Trends

–Fell Between 1959 and 1969

–Stable in 1970s

–Rose in the Early 1980s

–Up and Down Late 1990s and 2000s

–Rose with Recession 2001 - 2004


Measurement Issues

• Should we use income or consumption?

• Many poor by income may have assets to fall back on

• Non-cash benefits are not counted as income


U.S. Income-Maintenance System

• Entitlement Programs–Social Insurance Programs–Social Security –Medicare–Unemployment

Compensation–Public Assistance “Welfare”–Supplemental Security

Income (SSI) Program–Temporary Assistance for

Needy Families (TANF)–Food-Stamp Program


U.S. Income-Maintenance System

• Medicaid• Earned-Income Tax

Credit (EITC)

W 32.2


Welfare: Goals and Conflicts• Goals: reduce poverty, give

incentives to able-bodied to work, and reasonable cost

• Often these goals conflict with each other

• Welfare Reform: Personal Responsibility Act of 1996 during the Clinton years.

• Replaced AFDC with TANF, temporary assistance for needy families, a grant program run by the states


TANF

• Several reforms, including a lifetime limit of 5 years, able bodied must work after getting TANF for 2 years

• See page 629 for more reforms• Attempting the end the “culture of welfare” that

some felt existed• Number on welfare dropped from over 12 million

in 1996 to 4.5 million in 2005• About half this drop is attributed to welfare

reform, rest to other factors


U.S. Family Wealth and Its Distribution

• Family Wealth Rose Rapidly and Became More Unequal Between 1995 and 2004

Last

Word

Median and Average Family Wealth, 1995-2004 In 2004 Dollars

Year Median Average

1995199820012004

$70,80083,10091,70093,100

$260,800327,500421,500448,200


U.S. Family Wealth and Its Distribution

• Family Wealth Rose Rapidly and Became More Unequal Between 1995 and 2004

Last

Word

Percentage of Total Family Wealth Held by Different

Percentile Groups, 1995-2004

1995199820012004

32.2%31.430.230.5

34.6%33.932.733.4

Year Bottom 90% Top 1%Bottom 10%

Percentile of Wealth Distribution

67.8%68.669.830.5


Key Terms• income inequality• Lorenz curve• Gini ratio• income mobility• noncash transfers• equality-efficiency t

radeoff• poverty rate• entitlement progra

ms• social insurance pr

ograms• Social Security• Medicare

• unemployment compensation

• public assistance programs

• Supplemental Security Income (SSI)

• Temporary Assistance for Needy Families (TANF)

• food-stamp program

• Medicaid• earned-income tax

credit (EITC)

Documents

Copyright 2008 The McGraw-Hill Companies 32-1 32 Income Inequality and Poverty