Chapter 15+: Economics

Welfare

-"Welfare" is not the name of a specific government program, but rather an umbrella term for a series of initiatives designed to help the poor by supplementing their income (government assistance programs) -Welfare can take a variety of forms, such as monetary payments, subsidies and vouchers, health services, or subsidized housing provided by the government -Intended to help the unemployed, those with illnesses or disabilities that prevent them from working, the elderly, veterans, and households with dependent children -An individual's eligibility for welfare is often limited to a set amount of time and is valid only as long as the recipient's income remains below the eligibility cutoff -One of the four main policies related to the problem of poverty

The Role of Wealth

-According to controlled studies, children born into wealthy households earn about 10% more than children born into low-income households -Wealth gives a child from an affluent home access to better education, private tutoring, a healthier diet, and many other intangible benefits that provide a head start in life -These early advantages often lead to higher levels of human capital that translate into higher wages -One of the five factors that lead to income inequality

Problems with Traditional Aid Example

-As an example, consider a family of five with a combined income of $30,000 a year -Suppose that the family qualifies for public assistance that amounts to another $10,000 in benefits ($40,000 combined income) -If another family member gets a part-time job and income from wages rises from $30,000 to $40,000, they're now disqualified from most of the financial assistance it had been getting -As a result, the family's benefits fall from $10,000 to $2,000 per year ($42,000 combined income now) -The person who secured part-time employment may feel that working isn't worth it, because even though the family earned an additional $10,000, they lost $8,000 in welfare benefits -The loss of those benefits as they are phased out feels like an 80% tax, which creates a large disincentive to work

Difficulties in Measuring Income Inequality

-Because the Gini index and the Lorenz curve reflect income before taxes, these indicators of income inequality do not reflect disposable income, which is the portion of income people actually have to spend -Along with in-kind transfers or underground economies

Gender Wage Gap: Time Off

-But economists try to study the topic of wage discrimination further by examining the data -Additionally, more women than men take time off from work to raise a family, meaning that women ultimately have fewer years of work experience, put in fewer paid work hours per year, are less likely to work a fulltime schedule, and leave the labor force for longer periods -In contrast, men normally take less, if any, time off to raise children -In the long term, these differences tend to lead to lower levels of human capital and overall lower wages for women

Gender Wage Gap: Type of Job

-But economists try to study the topic of wage discrimination further by examining the data -For example, women and men often hold different types of jobs, and certain jobs pay more than others -Higher wages in jobs such as road work and construction reflect in part a compensating differential for exposure to extreme temperatures, bad weather, and other dangers, and men are more likely to work in these jobs -In the long term, these differences tend to lead to lower levels of human capital and overall lower wages for women

Location and Lifestyle 2/2

-Choice of lifestyle is also a major factor in determining wage differences -Some workers are not particularly concerned with maximizing their income; instead, they care more about working for a cause -Others follow a dream of being a musician, writer, or actor -And still others are guided by a passion such as skiing or surfing -Indeed, many workers view their pay as less important than doing something they are passionate about -For these workers, lower pay functions as a compensating differential -One of the five main nonmonetary determinants of wages

Claudia Goldin's Examination of Gender Wage Gap

-Claudia Goldin's careful examination of the gender wage gap data suggests that the gap stems not from gender discrimination, but from work design -She found that people who work the longest and least flexible hours make the highest salaries per unit of time—and those people tend to be men -One way to help close the gap is for employers to be more flexible about work hours and pay parttime workers a pro-rated share of what full-time workers earn

The Role of Corruption

-Corruption can play a large role in income inequality -In societies where corruption is common, working hard or being innovative is not enough; getting ahead often requires bribing officials to obtain business permits or to ward off competitors -Moreover, when investors cannot be sure their assets are safe from government seizure or criminal activity, they are less likely to develop a business -Corruption drives out legitimate business opportunities and magnifies income inequality -One of the five factors that lead to income inequality

Discrimination

-Discrimination harms the workers who are discriminated against, and it makes the overall distribution of income in a country more unequal -Workers who are passed over for promotions or job openings because of their gender, race, age, religion, or other traits earn lower wages that do not reflect their ability, training, or education (like a price ceiling) -Since discriminated workers are concentrated among women and minorities, the net effect is that discriminated groups end up concentrated among the lowest-paid groups—leading to more income inequality -One of the five factors that lead to income inequality

Benefits of The Earned Income Tax Credit (EITC)

-EITC, which was established in 1975, helps over 25 million families, making it the largest poverty-fighting tool in the United States -In addition, EITC creates stronger work incentives than those found under traditional antipoverty programs that critics argue discourage recipients from working

Measuring Income Inequality

-Economists study the distribution of household income in the United States by quintiles, or five groups of equal size, ranging from the poorest fifth (20%) of households to the top fifth -If we divide the percentage of income earned by households in the top fifth (51.4%) by the percentage of income earned by households in the bottom fifth (3.1%), we get an income inequality ratio of about 16.5 -We can say that households in the top fifth have approximately 16 to 17 times the income of those in the bottom fifth -When taxes and subsidies are included the U.S. income inequality ratio drops to 9.9 (high compared with that of other highly developed nations) -In general, highly developed nations have lower degrees of income inequality

Examples of Welfare

-Examples of welfare programs include Temporary Assistance for Needy Families (TANF), which provides financial support to families with dependent children; the Supplemental Security Income (SSI) program, which provides financial support to those who are unable to work; and the Subsidized Nutrition Assistance Program (SNAP), which gives financial assistance to those who need help to purchase basic foods

Number of Workers Per Household and Median Age of Each Worker

-Finally, the number of workers per household and the median age of each worker differ from country to country -When households contain more workers or those workers are, on average, older and therefore more experienced, comparing inequality across countries is more likely to be misleading -One of the five main difficulties in Measuring Income Inequality

Society's Well-Being

-Finally, the standard calculations and models we have discussed assume that the income distribution is a direct reflection of a society's well-being -People also value leisure time, nonwage benefits, a sense of community, safety from crime, and social networks, among other things -One of the five main difficulties in Measuring Income Inequality

Conditions for All Workers to Get Same Wages

-For all workers to get the same wages, three conditions would have to be met -First, every worker would have to have the same skills, ability, and productivity -Second, every job would have to be equally attractive to potential employees -Third, all workers would have to be perfectly mobile -In other words, perfect equality of income would require that workers be clones who perform the same job (not a reality) -In fact, our traits, our desires, and our differences all help to explain income inequality, which is the natural result of a market economy

What High Inequality Ratio Indicates

-High levels of income inequality also occur when the poorest are really poor -For example, there are many successful people in Mexico, Brazil, Bolivia, and Namibia -Therefore, high inequality ratios can be a telltale sign of a serious poverty problem -In sum: A high income inequality ratio can occur if people at the bottom earn very little or if the income of high-income earners is much greater than the income of others -Even though income inequality ratios give us some idea about the degree of inequality in a society, a single number cannot fully reflect the sources of the underlying differences in income

Highly Desirable vs Undesirable Jobs

-If the characteristics of a job make it unattractive, firms must offer more to attract workers -For instance, roofing, logging, and deep-sea fishing are some of the most dangerous occupations in the world -In contrast, some jobs are highly desirable -For example, restaurant critics sample a lot of great food, radio DJs spend the day playing their favorite music, and video game testers try beta versions before they are released -In these cases, the compensating differential is negative and the firm offers lower wages

Measures Passed to Fight Poverty

-In 1964, Congress passed the Equal Opportunity Act and a number of other measures designed to fight poverty (poverty rate is somehow slighter higher now though) -Unfortunately, the stagnant poverty rate suggests that the gains from economic growth over that period have accrued to households in the middle and upper quintiles, rather than to the poor -Poverty has remained persistent, in part, because many low-income workers lack the necessary skills to earn a living wage and, at the same time, investments by firms in automation and technology have reduced the demand for these workers

In-Kind Transfers (Problem of Poverty)

-In addition to financial assistance, the poor can receive direct assistance in the form of goods and services (Medicaid) -The idea behind in-kind transfers is that they protect recipients from the possibility of making poor decisions if they receive cash instead -For example, some recipients may use cash transfers to support drug or alcohol addictions, to gamble, or to buy unnecessary goods and services -One of the four main policies related to the problem of poverty

Median Weekly Earnings by Group Graphic

-In particular, female workers earn 19% less than their male counterparts -In 2009, President Obama signed the Lilly Ledbetter Fair Pay Act, which gives victims of wage discrimination more time to file a complaint with the government

Comparing Inequality Data

-In short, comparing inequality data from this year with data from last year is generally fine, but comparing inequality data from this year with data from 50 years ago is more difficult (violates ceteris paribus) -A good economist tries to make relevant comparisons by examining similar countries over a relatively short period during which there were no significant socioeconomic changes

Education and Human Capital

-Many complex jobs require substantial education, training, and industry experience -Qualifying to receive the specialized education required for certain occupations—for example, getting into medical school—is often very difficult -Relatively few students are able to pursue these degrees -In addition, such specialized education is expensive, in terms of both tuition and forgone income -One of the five main nonmonetary determinants of wages

Household Goods and Services

-Many economists also note that income data alone do not capture the value created from goods and services produced in the household -For example, if you mow your own lawn or grow your own vegetables, those activities have a positive value not expressed in your income data -In less developed countries, many households engage in very few market transactions and produce a large portion of their own goods and services (overstating the amount of inequality) -One of the five main difficulties in Measuring Income Inequality

Economic Ladder Division

-Mobility data enable us to separate those at the bottom of the economic ladder into two groups: -The marginal poor, or people who are poor at a particular point in time but have the skills necessary to advance up the ladder -In other words, for many people, a low income at a point in time does not necessarily reflect a low standard of living as changes in borrowing and saving patterns over one's life smooth out the consumption pattern -The long-term poor, or people who lack the skills to advance to the next quintile -The differences in income mobility between these two groups provide a helpful way of understanding how income mobility affects poverty

Training and Education

-More ability is a necessary but not sufficient condition for high wages -Workers of all ability levels benefit from receiving additional training and education -The acquisition of specific skills through training and additional education enhances each worker's human capital -More human capital often makes workers more valuable in the marketplace, helping them earn higher wages -One of the five factors that lead to income inequality

Income Inequality Ratio Graphic

-More-developed countries have less poverty, so those individuals who are at the bottom of the income ladder in the developed countries earn more than those at the bottom in less developed countries

Factors That Lead to Income Inequality

-Next we look at five factors that can contribute to income inequality: ability, training and education, discrimination, wealth, and corruption

Occupational Crowding Example

-Now imagine that not everyone in Utopia has the same opportunities -Suppose we roll back the clock to a time when women in Utopia are not allowed to work as engineers -Women who want to work can only find employment as secretaries -As a result of this occupational crowding, workers who have limited opportunities (women, in this example) find themselves competing with one another, as well as with the men who cannot get engineering jobs, for secretarial positions -As a result, wages fall in secretarial jobs and rise in engineering -Because only men can work in engineering, they are paid more than their similarly qualified female counterparts -Furthermore, because women who want to work can only receive a low wage as a secretary, many effectively decide to stay at home and produce nonmarket services, such as child-rearing (have a higher value to the women who make this choice than the wages they could earn as secretaries)

Benefit of Winner-Take-All

-Paying so much to a relatively small set of workers may seem unfair, but the prospect of much higher pay or bonuses motivates many ambitious employees to exert maximum effort -If we look beyond the amount of money that some people earn, we can see that winner-take-all creates incentives that encourage supremely talented workers to maximize their abilities

Race/Ethnic Group Wage Gap Explained

-Similarly, differences in human capital can help explain wide gaps in earnings data by race or ethnic group -Asian Americans (56% of whom have a bachelor's degree or higher) have higher education levels than whites (44%), who in turn generally have much higher levels than blacks (24%) and Hispanics (20%) -Economists expect the wage disparities between groups to decrease as these educational differences (and the resulting differences in human capital) become less pronounced -Socioeconomic factors also play a significant role in these disparities -For instance, the low quality of some inner-city schools can limit the educational attainment of students, many of whom are minorities

The Nonmonetary Determinants of Wages

-Some jobs have characteristics that make them more desirable or less desirable -Differences in jobs and worker ability affect the supply and demand of labor -We examine the nonmonetary determinants of wages, including compensating differentials, education and human capital, location and lifestyle, unions, and efficiency wages

The Earned Income Tax Credit (EITC)

-The Earned Income Tax Credit (EITC) is a tax credit designed to encourage low-income workers to work more by supplementing earned income with a tax credit of approximately $6,000 a year -The amount is determined, in part, by the number of dependent children in the household and the location -Once a family reaches an income level above its earnings threshold, EITC is phased out, and workers gradually lose the tax credit -EITC is gradually reduced, which means that workers do not face a sizable disincentive to work as the program is phased out (unlike other welfare/in-kind programs that have a specific cutoff point) -One of the four main policies related to the problem of poverty

How The Gini Index is Calculated

-The Gini index is calculated by taking the area between the two curves, shaded and labeled A, and dividing that amount by the total of area A plus area B -Area A represents the amount of income inequality in society, while area B represents the amount of income equality in society -Calculating the Gini index gives us a number between 0 and 1 -Economists multiply this number by 100 to represent the score as a whole number between 0 and 100

Human Capital and The Life-Cycle Wage Pattern

-The earnings gap between mid-career workers and others also reflects differences in human capital -As these workers age, they accumulate on-the-job training and experience that make them more productive and enable them to obtain higher wages -However, for older workers the gains from increased experience are eventually offset by diminishing returns -Consequently, wages peak when these workers are in their early 60s and then slowly fall thereafter

Effect of Unions Today

-The effect of unions in the United States has changed since the early days of unionization in the late 1800s -Today, only about one in eight workers belongs to a union -Today, most empirical studies find the wage premium to be between 10% and 20% -The demise of many unions has coincided with the transition of the U.S. economy from a manufacturing base to one with a greater emphasis on the service sector, which is less centralized

The Minimum Wage

-The minimum wage is often viewed as an antipoverty measure (creates trade-offs though) -At the same time, a higher minimum wage makes those jobs more difficult to find -Predictably, firms respond to higher minimum wages by hiring fewer workers and utilizing more capital-intensive production processes, such as self-checkout lanes and robotic production -One of the four main policies related to the problem of poverty

What Are the Determinants of Wages?

-The reasons why some workers get paid more than others are complex -Various nonmonetary factors cause some occupations to pay higher or lower wages than supply and demand would seem to dictate -In other contexts, discrimination on the basis of gender, race, or other characteristics is an unfortunate but very real factor in wages -And in some markets, a "winner-take-all" structure can lead to a small number of workers capturing a large majority of the total earnings

The Poverty Rate

-To keep up with inflation, the poverty threshold is adjusted each year for changes in the overall level of prices in the economy -However, an individual family's threshold is calculated to include only the money that represents income earned by family members in the household -It does not include in-kind transfers, nor are the data adjusted for cost-of-living differences in the family's specific geographical area -For these reasons, poverty thresholds are a crude yardstick

Criticism of In-Kind Transfers

-To limit the likelihood of such poor decisions, in-kind transfers can be targeted at essential services -Although skeptics argue that cash payments allow recipients to make the choices that best fit their needs

False Impression of Annual Income Inequality Data

-When we examine how people live in societies with substantial income mobility, we see that the annual income inequality data can create a false impression about the spending patterns of young and old -The young are generally upwardly mobile, so they spend more than one might expect by borrowing -The middle-aged, who have relatively high incomes, spend less than one might expect because they are saving for retirement -And the elderly, who have lower incomes, spend more than one might expect because they are drawing down their retirement savings

Location and Lifestyle 1/2

-Where the climate is more pleasant, all other things being equal, people are willing to accept lower wages because the nonmonetary benefits of enjoying the weather act as a compensating differential -Similarly, jobs in metropolitan areas—where the cost of living is significantly higher than in most other places—pay higher wages as a cost-of-living adjustment -The higher wage helps employees afford a quality of life similar to what they would enjoy if they worked in less expensive areas -One of the five main nonmonetary determinants of wages

The Gender Gap is Shrinking

-While the number is hotly debated, most economists estimate that discrimination accounts for less than 5% of observed wage differences (there are signs of improvement) -Though it is still real, the gender gap is shrinking -Today women earn 81 cents for every dollar men earn, and the gap continues to close by about half a cent each year -In addition, women are no longer clustered in less rigorous academic programs than men, so women are more prepared to get jobs that pay better -The number of women at every level of academia has been rising for decades -There are now three women for every two men enrolled in postsecondary education

Problems with Traditional Aid

-While trying to be well-meaning, many welfare programs can create unintended work disincentives, especially when we examine the combined effects of welfare and in-kind transfer programs -This is a basic dilemma that poverty-reducing programs face: those that provide substantial benefits can discourage participation in the workforce because a recipient who starts to work, in many cases, no longer qualifies for the benefits and loses them -While few people dispute that welfare programs are well intentioned, many economists are concerned about the programs' unintended consequences

Why do occupational crowding and wage differentials continue?

-Why do occupational crowding and wage differentials continue? -Rigidity in changing occupations, social customs (including discrimination), and personal preferences are all part of the explanation (change might be coming though) -Because more women than men attend colleges and universities, women are now primarily responsible for expanding the supply of workers in most fields -As the supply of workers expands, the net effect will likely be lower wages in traditionally male-dominated jobs -At the same time, traditionally female-dominated jobs will see rising wages as women leave those jobs for better opportunities (wage gap will narrow)

Why does the president get paid less than jobs with far less value to society?

-Why does the president get paid less than jobs with far less value to society? -Part of the answer involves compensating differentials -Being president of the United States means being the most powerful person in the world, so paid compensation is only a small part of the benefit of holding that office -The other part of the answer has to do with the way labor markets function -Pay at the top of most professions is subject to a form of competition known as winner-take-all

Ability

-Workers who have more ability (for example, mental acuity, physical strength, fortitude) than less-able workers generally earn higher wages -Differences in ability can lead to large differences in wages because more-able workers have the potential to create much larger marginal products than their less-able counterparts -One of the five factors that lead to income inequality

Union

A group of workers who bargain collectively for better wages and benefits -Unions are able to secure increased wages by creating significant market power over the supply of labor available to a firm -A union's ability to achieve higher wages depends on a credible threat of a work stoppage -In effect, unions can raise wages because they represent labor, and labor is a key input in the production process -One of the five main nonmonetary determinants of wages

Medicaid

A joint federal and state program that helps low-income individuals and households pay for the costs associated with long-term medical care -Communities or cities often provide organized assistance like shelters, and local community food banks, religious organizations, and private charities

The Gini Index

A measurement of the income distribution of a country's residents (An alternative way of representing income inequality across countries) -Its value fluctuates between 0 (no income inequality) and 100 (extreme income inequality) -If every individual's income is equal in a society, the Gini index (or Gini coefficient) is 0 -A nation where one individual gets all the income, while everyone else gets nothing, would have a Gini index of 100 -The average Gini index is approximately 40

Lorenz Curve

A visual way of representing the Gini index -As the income distribution becomes more unequal, the Lorenz curve, shifts downward and to the right -The Lorenz Curve is especially helpful for seeing how income inequality has changed over time -Notice that the red Lorenz curve from 2018 shifted down and to the right, away from the perfect income equality line, indicating more income inequality in 2018 compared to 1968 (34 to 42)

Strike

A work stoppage designed to aid a union's bargaining position -U.S. law prohibits some unions from going on strike, including those representing many transit workers, some public school teachers, law enforcement officers, and workers in other essential services -If workers in one of these industries reach an impasse in wage and benefit negotiations, the employee union is required to submit to the decision of an impartial third party, a process known as binding arbitration

Income Inequality Ratio

Calculated by dividing the top quintile's income percentage by the bottom quintile's income percentage

Underground Economies

Composed of markets in which goods or services are traded illegally -Because less developed countries generally have larger underground economies than developed countries do, their income data are even less reliable -One of the five main difficulties in Measuring Income Inequality

Samaritan's Dilemma

Occurs when an act of charity creates disincentives for recipients to take care of themselves -President Bill Clinton's 1996 vow "to end welfare as we know it" and for welfare to be "a second chance, not a way of life" attempted to address this dilemma by providing benefits for only a limited period of time -This strategy changed welfare from an entitlement under the law into a temporary safety net, thereby reducing the Samaritan's dilemma (by adding employment searches as a requirement)

Winner-Take-All

Occurs when extremely small differences in ability lead to sizable differences in compensation -Has been common in professional sports and in the entertainment industry for many years, but it also exists in the legal profession, medicine, journalism, investment banking, fashion design, and corporate management

Income Mobility

The ability of workers to move up or down the economic ladder over time -When workers have a realistic chance of moving up the economic ladder, each person has an incentive to work harder and invest in human capital -In other words, economic mobility reduces inequality over long periods of time

Compensating Differential

The difference in wages offered to offset the desirability or undesirability of a job -If a job's characteristics make it unattractive, the compensating wage differential must be positive -Some jobs are more unpleasant, risky, stressful, inconvenient, or monotonous than others -One of the five main nonmonetary determinants of wages

Productivity

The effectiveness of effort as measured in terms of the rate of output per unit of input -If the gains in overall labor productivity are higher than the increased cost, the result is greater profit for the firm -Automaker Henry Ford used efficiency wages to generate more productivity on the Model T assembly line (doubled the pay of the workers and decreased workday hours) -The resulting productivity increase per worker was more than enough to offset the wage increase -In addition, reducing the length of each shift enabled Ford to add an extra shift, which increased productivity even more

Poverty Threshold

The income level below which a person or family is considered impoverished

Occupational Crowding

The phenomenon of relegating a group of workers to a narrow range of jobs in the economy

Life-Cycle Wage Pattern

The predictable effect age has on earnings over the course of a person's working life -Wages peak for people in their early 60s and then slowly fall thereafter

Human Capital

The set of skills that workers acquire on the job and through education -Unlike other forms of capital, investments in human capital accrue to the employee -As a result, workers who have high human capital can market their skills among competing firms -In contrast, low-skilled workers such as ushers, baggers, and sales associates earn less because the human capital required to do those jobs is quite low; it is easy to find replacements

In-Kind Transfers

Transfers (mostly to the poor) in the form of goods or services instead of cash -Examples of in-kind services are government-subsidized housing and the Subsidized Nutrition Assistance Program (SNAP) that provides food-purchasing assistance for low- and no-income people living in the United States -One of the five main difficulties in Measuring Income Inequality

Efficiency Wages

Wages higher than equilibrium wages, offered to increase worker productivity -Decrease turnover -Increase productivity by attracting a larger applicant pool, from which the most productive ones can be chosen -Increase the cost of being fired, because other jobs in the same industry don't pay as well—giving every worker a greater incentive to work hard and not shirk -One of the five main nonmonetary determinants of wages

Wage Discrimination

When workers with the same ability as others are not paid the same because of their race, ethnic origin, sex, age, religion, or some other group characteristic

Poverty Rate

he percentage of the population whose income is below the poverty threshold