Chapter 2: The Economics of Poverty and Discrimination - Inequality

The formula for how compound interest accumulates over time is: (PowerPoint, Taylor 4E CH 02)

(Present amount) × (1 + Interest rate) number of years = Future amount.

Age-Related Mobility: (Page 29)

A prime source of income mobility is the life cycle itself, such as how young people start out with little, though, over time and age, they gain more.

Why Society Must Choose: (Positive & Normative Statements) (End: PowerPoint, Taylor 4E CH 02)

• *Positive statements* describe the world as it is. • *Normative* statements describe how the world should be. • Even when economics analyzes the gains and losses from various events or policies, and thus draws normative conclusions about how the world should be, the analysis of economics is rooted in a positive analysis of how people, firms, and government actually behave, not how they should behave.

Productive Efficiency & Allocative Efficiency: (PowerPoint, Taylor 4E CH 02)

• All choices in a production possibilities frontier display *productive efficiency*. • That is, it is impossible to use society's resources to produce more of one good without decreasing the production of the other good. • The specific choice along a production possibilities frontier that reflects the mix of goods that society prefers is the choice with *allocative efficiency*.`

Choosing What to Consume in a World of Scarcity: (Start: PowerPoint, Taylor 4E CH 02)

• Due to a world where people's desires exceed what is possible, economic behavior involves trade-offs in which individuals, firms, government, and society must give up things that they desire to obtain other things that they desire

Gini Coefficient: (Page 27)

(Quizlet) Summation: A measure of income inequality within a population, ranging from zero for complete equality, to one if one person has all the income. Textbook Notes: A single statistic is often used to summarize the information arrayed along the Lorenz curve (almost as if a representation of the Lorenz curve) and provides a remarkably simple way to track and see inequality changes Developed in 1912 by an Italian mathematician, the Gini coefficient measure how far the Lorenz curve departs from the diagonal of equality. It is measured as the area between the diagonal and the Lorenz curve, divided by the area of the triangle formed by the diagonal.

Benefits of Inequality: (Page 19)y

(Quizlet) Summation: Inequality acts as an incentive to workers to earn more by increasing their productivity. Workers deserve to earn high wages if their skills merit this. Inequality may be better than none, as it can result in a trickle-down effect, and so although an entrepreneur may earn far more than those he employs, at least there is some added income, which may alleviate poverty or raise living standards in general. Textbook Notes: Before seeking to eliminate income inequalities, however, we should at least consider the potential virtues of inequality. Economists also emphasize that inequalities can be a powerful motivation for working, studying, or investing. Inequalities create the same kind of material incentive in labor markets. Inequalities are also the by-product of incentives for saving and investing. The focus on the size of the collective pie is important. The allure of economic growth is that the entire pie is larger, as well as the total quantity of goods and services produced.

The Lorenz Curve: (Page 26)

(Quizlet) Summation: The curve that illustrates income distribution. Specifically, the degree of equality of income distribution in an economy. It plots the cumulative percentage of income received by cumulative shares of the population. Textbook Notes: A popular method for illustrating the size distribution of income is the Lorenz curve, graphically illustrating the relationship between population shares and income shares. Suppose again that the population is arrayed in order of relative income; starting with the lowest, the Lorenz curve depicts the cumulative share of total income received by cumulative percentages of the population. If incomes were equally distributed, then 20% would receive exactly 20% of all income. The Lorenz curve not only provides a visual summary of the size distribution of income but also provides a convenient mechanism for illustrating changes in that distribution. The closer the Lorenz curve is to the diagonal, the more equal the distribution, and through this one can see via comparison the increasing or decreasing of inequality.

Income Mobility: (Page 28)

(Quizlet) Summation: The extent to which income receivers move from one part of the income distribution to another over some period of time. Textbook Notes: No one has an objective measure for ascertaining the optimal degree of inequality. As noted earlier, the inequality that some people regard as excessive, others may see as completely fine. One criterion used to judge the harshness of inequality is fairness in how it came to be, such as if every individual had an equal chance of "winning".

Income Shares: (Page 25)

(Quizlet) Summation:: Shares in which you get all the dividend rather than have it reinvested. Textbook Notes: To develop broader measures of the distribution of income, the population must first be arrayed in order of relative income. The size distribution of income refers to the rank ordering of individuals (families, or households) by the size of their incomes. The most common category is quintiles, or subgroups containing 1/5th the population. To articulate further, the top 10% is a decile, the top 5% is a ventile, and the top percent is the top 1%. Most people use much less precise references to income ranks.

Individuals face three main categories of trade-offs: (PowerPoint, Taylor 4E CH 02)

1) The consumption choice of what quantities of goods to consume. 2) The labor-leisure choice of what quantity of hours to work. 3) And, the intertemporal choices that involve costs in the present and benefits in the future, or benefits in the present and costs in the future.

An interest rate has three components: (PowerPoint, Taylor 4E CH 02)

1) The risk premium to cover the risk of not being repaid. 2) The rate of expected inflation. 3) And, the time value of money, as compensation for waiting to spend.

Earnings Mobility: (Page 31-33)

A source of longitudinal data is the US Social Security Administration. The SSA's earnings were used to complete one of the first studies of earnings mobility. Within this study, the latter intra-cohort observations are vital to note due to them excluding the inter-generational mobility due to life-cycle patterns. Although earnings mobility is pervasive, it is not as common at the ends of the income distribution. Overall, the indications of earnings mobility were confirmed to be as prevalent since the study in the 1980s and common among women/POC workers, also.

Mobility Patterns: (Page 30)

All of these and other forces keep relative income positions in constant flux. The reshuffling of income positions isn't so random nor so frequent; there is far more income mobility than most people expect. An analogy of this representation is the outcomes of a game of "Musical Chairs" with some "comfy", "uncomfy", or with nothing at all.

Trend Distortions: (Page 22-23)

All of these complications become more pressing when trends in inequality are sought. When examining demographic effects on inequality, for instance, the average household slice may seem to shrink in certain cases, yet this statistical reduction in average incomes and equality is not very informative. Similar distortions in income trends arise when the composition of incomes changes. International comparisons of income suffer from these same distortions. Concerning this, available data via surveys can only offer rough international comparisons of income equality.

Chapter 2 Web Links: (Page 35)

American Enterprise Institute: www.aei.org Federal Reserve: www.fereralreserve.gov Pew Research Center: www.people-press.org/surveyreports US Census Bureau www.census.gov/hhes/www/income

Immigration: (Page 29)

Another important source of intra-generational and inter-generational mobility is immigration. The influx of immigrants into the lowest ranks of the income distribution has two (2) important effects on measured inequality: 1) It pushes nonimmigrants up into higher quintiles, due to crowding into the lowest income ranks 2) The process of assimilation starts often at low wages though aspire, and move up the economic ladder.

Changes in Family Structure: (Page 29)

Changes in family structure also cause a lot of income mobility, such as marriage (and divorce, or death of a spouse to contrast), and childbirth.

Marginal Analysis: (PowerPoint, Taylor 4E CH 02)

Decisions on the margin, involving a little more or a little less. (Concerning this, please note that most economic decisions and trade-offs are not all-or-nothing.)

Alternative Yardsticks: (Page 24)

Despite the many difficulties in defining income and its distribution, people want to measure the distribution and track changes therein. To this end, several related yardsticks are commonly employed.

Sunk Costs: (PowerPoint, Taylor 4E CH 02)

Due to this specific type of costs occurring in the past, which cannot be recovered, they should be disregarded in making current decisions.

Income Mobility: (Page 33-34)

Earnings are the largest but not the sole component of income. (Other components of income, like profits and capital gains, may, in fact, be even more variable, thus making income mobility greater than earnings mobility.) Despite these difficulties, some longitudinal surveys have been successfully undertaken. Over a lifetime, income mobility is even more substantial. For instance, 80% of Americans will experience a year of affluence, a year of poverty, and/or both situations during their life while 1/5 experience neither. Intergenerational mobility appears to be just as pervasive, as in children of the rich have no permanent hold on the highest rungs of the income ladder nor do the children of the poor forever entrapped in a poverty trap, as income mobility persists.

Sources of Mobility: (Page 29)

If equal opportunity is the test for accepting status inequality, then the extent of inter-class mobility is critical to normative judgments about inequality patterns. It is very extensive for a variety of reasons and illustrations include these sources: - Age-Related Mobility, - Changes in Family Structure, - Immigration, - Labor-Market Changes, - Financial Markets Volatility.

Budget Constraint: (AKA: Opportunity Set) (PowerPoint, Taylor 4E CH 02)

Illustrates the range of choices available. • The slope of the budget constraint is determined by the relative price of the choices. • Choices beyond the budget constraint are impossible. Choices inside the budget constraint are wasteful.

Labor-Market Changes: (Page 29-30)

In addition to the demographic forces of aging, family dynamics, and immigration, changes in the labor market also foster income mobility, like recovering after a depression (or, on the contrary, deterioration in recessions).

The Mobility Matrix: (Page 30-31)

In principle, income mobility is easy to measure by raking everyone according to their relative yearly income from year-to-year and observe the changes. Imagine a completely stratified society. Within there, everyone would be consistently at the same rank of income from year-to-year, as a representation of complete equality of opportunity (rather than scattered randomly across incomes). Although the mechanisms of measuring income mobility are straightforward, evidence of actual mobility patterns is scarce because the evidence must be gathered by observing the same individuals over a period of time. This is a longitudinal study, which is complex, expensive, and rarer than the norm, this norm is cross-sectional surveys across a few years.

Normative Versus Objective Observations: (Page 27-28)

In principle, some value for the Gini coefficient represents the optimal level of inequality, which is not zero. Without making a normative judgment about how much inequality is acceptable, we can still compare and contrast income distributions across time and space. To illustrate the Gini coefficient further, a tax cut that increases the coefficient favors the rich, while if economic growth lowers the Gini coefficient, then it is sure to pro-poor redistribution.

Summary of Chapter 2, Inequality: (Page 34-35)

Inequality is an issue that evokes great social concern. Many people worry that inequality is not only inherently unjust, but that it also spawns social resentment, political isolation, and crime. On the other hand, inequalities also act as economic incentives to study, work, save, and invest harder. The optimal degree of inequality entails a subjective balancing of these equity and efficiency concerns. At best, incomes gauge only a portion of social status. Wealth, political power, and social access are also important, and not always correlated with current income. Income itself is also difficult to measure, especially when fringe benefits, in-kind transfers, profits, capital gains, and other receipts are available. Inequality in the US has increased by the last 30 years, and offset to an extent due to the amazing growth of mobility. However, income inequality need not imply class stratification. People move from one income rank to another, as income mobility makes income inequality more acceptable.

Why Inequality Matters: (Page 1)

Many people regard inequality as a synonym for unfairness. Less extreme visions of a just society relax the inequality standard. Incomes don't have to be exactly equal; some inequality is acceptable. Evaluating the standards of inequality requires a subjective judgment of how much is acceptable.

Opportunity Cost: (PowerPoint, Taylor 4E CH 02)

Measures cost by what is given up in exchange. • Sometimes, opportunity cost can be measured in money. • But, it is often useful to consider whether time should be included as well. • Or, to measure it in terms of the actual resources that must be given up.

Between-Group Averages: (Page 24-25)

One of the most common measures of inequality is the difference in incomes between distinct groups, such as between Whites, Blacks, and Hispanics in contrast; as well as married couples, and single-male or single-female parental households. These between-group averages are often the primary focus of inequality concerns. In later chapters, we will explore some of the reasons why such inequalities arise and persist. Before doing so, however, we will examine broader measures of inequality -- measures that go beyond simple between-group differences.

Costs of Inequality: (Page 19)

Other critics of inequality empathize the importance of social consequences of inequality. Inequalities of income may also foster more troubling inequities. Last, but certainly not least, income inequalities may skew the distribution of political power. Inequalities of income need not spawn all these other inequities. Strategies, such as campaign-finance reforms, focus on the consequences of inequality, not the existence of inequality; if income inequalities were eliminated, such compensatory interventions wouldn't be necessary.

Within a budget constraint, what is the effect of personal preferences? (PowerPoint, Taylor 4E CH 02)

Personal preferences determine specific choices, as well as the actual choice.

Introduction to Chapter 2: (Page 18)

The Declaration of Independence boldly proclaims that all men are created equal, which is not true. This chapter describes the degree of inequality in the United States. As we'll see, understanding the broader phenomenon of inequality is an important foundation for addressing the narrower issue of poverty, how inequality is measured, and patterns have changed. We start with a basic question, "Why is inequality such a critical issue?"

In making a choice within the labor-leisure budget constraint, people will choose their budget constraints in a way that maximizes their satisfaction or utility. What is the definition of utility? (PowerPoint, Taylor 4E CH 02)

The basis on one's own distinctive personal preferences.

Financial Markets Volatility: (Page 30)

The financial markets also reshuffle income shares. In the late 1990s, the stock market bestowed multi-million-dollar prizes on dot-com entrepreneurs and investors; workers at some companies became overnight millionaires. When the dot-com bubble burst in the early 2000s, this income mobility reversed course, from rags to riches to rags after the value of their sticks crashed.

Equity Versus Efficiency: (Page 20)

The link between incentives and economic growth suggests a certain trade-off between equity and efficiency. The promise of material riches may spur some people to produce more and better products, enhancing our economic efficiency. One last consideration in assessing the degree of inequality is the perceived level of fairness in slicing the pie. Although opinion polls reveal that few Americans begrudge millionaires for their wealth, and the non-rich believe the rich earned what they got, in the case of suspicious sources of wealth, respect turns into resentment.

Stratification Versus Equality: (Page 28)

The same kind of normative considerations is relevant to income inequality. Income disparities are less onerous if everyone has a plausible chance of "hitting it big." Equality of opportunity, not equality of status, is the principle that commands near-universal allegiance. Class stratification refers to a situation in which people are trapped in a particular income rank. In such a stratified society, low-income people have no chance of becoming richer and/or escaping poverty due to class stratification.

Production Possibilities Frontier (PPF) (& Social Choices): (PowerPoint, Taylor 4E CH 02)

The set of choices faced by society as a whole. • The shape of the PPF is typically curved outward, rather than straight. • Choices outside the PPF are unattainable, and choices inside the PPF are wasteful. • Over time, a growing economy will tend to shift the PPF outwards.

Social Inequality: (Page 34)

The studies on mobility shed important new light on inequality statistics. It is important to note that the principle of equal opportunity commands more universal acceptance than the principle of equal income; even increasing inequality may be accepted alongside increasing mobility. However, even extensive income mobility is not synonymous with increased social equality...

Income Concepts: (Page 21-22)

The term income refers to the flow of economic compensation received in a given time period which takes many forms, such as salaries (and access to benefits on top of the salary). Furthermore, capital gains, when a stock or other asset is sold for a price higher than it was bought, has the gain counted as income. Wealth, distinguished from income, is the stock of assets one owns. The existence of wealth, fringe benefits, and unrealized capital gains imply that "income" won't always be reflected in the size of the pie. In other words, consumption patterns (the distribution of slices) may depart significantly from the distribution of incomes. Also, upon sale, a realized capital gain remains as wealth, not income. The gap between consumption and income may be particularly large for low-income people. The tax system also creates a divergence between income and consumption patterns... However, this representation may be distorted, as most income data comes from tax returns, which can affect the observation of income distribution.

Law of Diminishing Returns: (PowerPoint, Taylor 4E CH 02)

This law holds that as increments of additional resources are devoted to producing something, the marginal increase in output will become smaller and smaller.

Diminishing Marginal Utility: (PowerPoint, Taylor 4E CH 02)

This law of points out that as a person receives more of something—whether it is a specific good or another resource—the additional marginal gains tend to become smaller.

Unit of Observation: (Page 22)

We run into another conceptual problem with the unit of observation. Two questions arise: 1) Is our primary concern with the income received by individuals? 2) Or, is the family a more appropriate unit of observation? Here, a common unit of observation is the household, defined as one or more persons living under the same roof and sharing kitchen facilities. A family, however, is people related by blood/marriage. The US Census Bureau data is collected from households, and because of this, income patterns may not accurately demonstrate individual/inter-family patterns of well-being & consumption.

Inequality of What? (Page 21)

When we speak of inequality, most people immediately think in terms of income or wealth. But, these aren't the only relevant dimensions of social status, nor are the concepts of income and wealth, as precise as one assumes; we have to clarify what we are seeking in a description of inequalities.