Chapter 20: Income Inequality, Poverty & Discrimination

Causes of Income Inequality

- Ability - Education and Training - Discrimination - Preferences and Risks - Unequal Distribution of Wealth - Market Power - Luck, Connections, and Misfortune

Discrimination 2

- African-Americans (AA) & Hispanics (H) are in two categories disproportionally to their total populations - AA and H receiving public assistance from the TANF, SSI, and food stamp programs are also well above the average for the entire population - Discrimination plays in reducing wages for some and increasing wages for others - Discrimination is the practice of according people inferior treatment on the basis of some factor such as race, gender, or ethnicity - Ppl who practice discrimination are said to exhibit a prejudice or a bias against the groups they discriminate against

Unemployment Compensation

- All 50 states sponsor unemployment insurance programs - Federal-state social insurance program that makes income available to workers who are unemployed - Financed by a relatively small payroll tax, paid by employers - Any insured worker who becomes unemployed can become eligible for benefit payments - Size of payments and the number of weeks they are made varies by state - # of beneficiaries and the level of total disbursements vary with economic conditions - Unemployment compensation payments last for a max 26 weeks

Temporary Assistance for Needy Families (TANF)

- Basic welfare program for low-income families in the US - Financed through general Federal tax revenues and consists of lump-sum payments of Federal money to states to operate their own welfare and work programs - Lump-sum payments are called TANF funds - Established work requirements and placed limits on the length of time a family can receive welfare payments 1. Set a lifetime limit of 5 years on receiving TANF benefits and requires able-bodied adults to work after receiving assistance for 2 years 2. Ended food-stamp eligibility for able-bodied persons age 18 to 50 (with no dependent children) who are not working or engaged in job-training programs 3. Tightened the definition of "disabled children" as it applies for eligibility of low-income families for SSI assistance 4. Established a 5-year waiting period on public assistance for new legal immigrants who have not become citizens

Equality vs. Efficiency

- Cases for Equality: Maximizing MU - Cases for Inequality: Incentives and Efficiency

The Model

- Character and income consequences of occupational discrimination are revealed through a labor supply and demand model

Definition of Poverty

- Condition in which a person or family does not have the means to satisfy basic needs for food, clothing, shelter, and transportation - Means include: Currently earned income, transfer payments, past savings, and property owned - Determinants of basic needs: family size and health and age of its members

Cases for Inequality: Incentives and Efficiency

- Critics attack equality's fundamental assumption that there is some fixed amount of output produced and therefore income to be distributed; the way in which income is distributed is an important determinant of the amount of output or income that is produced and is available for distribution - When taxed, no incentives to both parties - Taxes are a reduction in the rewards from increased productive effort; redistribution through transfers is a reward for diminished effort - If a 100 percent tax is levied, the economic incentives to get ahead will have been removed, greatly reducing society's total production and income - Income inequality is essential to maintain incentives to produce output and income - to get the output produced and income generated year after year

The Economics of Poverty

- Definition of Poverty - Incidence of Poverty - Poverty Trends - Measurement Issues

Preferences & Risks

- Differ b/c of differences in preferences for market work relative to leisure, market work relative to work in the household, and types of occupations - Ppl who choose to stay home have less income; ppl who choose to work for long hours generate more income - Differ in their willingness to assume risk - Many entrepreneurs fail, but some who are successful generate substantial incomes; thus, contributing to income inequality

The Lorenz Curve

- Display of the quintile distribution of personal income - Cumulative percentage of household on the horizontal axis - Percentage of income they obtain on the vertical axis - Diagonal line represents a perfectly equal distribution of income b/c each point indicates that a particular percentage of households receive the same percentage of income - Brown area indicates the degree of income inequality - Complete equality; Lorenz curve coincides with diagonal line - Complete Inequality; Lorenz curve starts from horizontal min to horizontal max & shoots straight up (all households but one have zero income) - Farther away from the diagonal line, more inequality

Distribution by Quintiles (Fifths)

- Divide the total number of individuals, households, or families into five numerically equal groups, or quintiles - Examine the percentage of total personal (before-tax) income received by each quintile

S.D: Labor Market Example

- Employers with job opening want to hire the most productive workers available - Some employers looking for inexpensive info may consider the average characteristics of women and minorities and whom to hire - Using attributes as a crude indicator of production-related attributes - Average characteristics for a group are being applied to individual members of that group

Demographic Changes

- Entrance of large numbers of less-experienced/skilled into the labor force in 1970 (baby-boom) may have contributed to greater income inequality; young workers make less than old - Tendency of high earning men and women increasing household income among the highest income quintiles - Increasing number of households headed by single or divorced women - Trends increase income inequality b/c of no second major wage earner and b/c of high poverty rate for female-headed households

Cases for Equality: Maximizing MU

- Equal distribution of income is that income equality maximizes total consumer satisfaction from any particular level of output and income - When income distribution is initially unequal, distributing income more equally can increase the combined utility of the two individuals - When evenly distributed, marginal utility from the last dollar of income is equal - Income equality yields greater combined total utility than income inequality does

Taste-for Discrimination Model

- Examines prejudice by using the emotion-free language of demand theory - Views discrimination as resulting from a preference or taste for which the discriminator is willing to pay - Assumes that prejudiced people experience a subjective or psychic cost - a disutility - whenever they must interact with the nonpreferred group; size of price depends directly on the degree of prejudice - Can be applied to any type of discrimination

Medicare

- Federal insurance program -Provides health insurance benefits to those 65 or older and ppl who are disabled - Financed by payroll taxes on employers and employees - # of retirees drawing Social Security and Medicare benefits is rapidly rising relative to the number of workers paying payroll taxes - Faces long-term funding problems

Supplemental Security Income (SSI)

- Federal program (financed by general tax revenues) - Provide a uniform nationwide minimum income for the aged, blind, and disabled who are unable to work and who do not qualify for Social Security aid - More than half of the states provide additional income supplements to the aged, blind, and disabled

Medicaid

- Federal program (financed by general tax revenues) - Provides medical benefits to people covered by the SSI and TANF - Helps finance the medical expenses of individuals participating in those programs

Food-Stamp Program

- Federal program (financed through general tax revenues) - Permits eligible low-income persons to obtain vouchers that can be used to buy food - Designed to provide "nutritionally adequate diet" - Eligible households receive monthly allotments of coupons that are redeemable for food - Amount of food stamps received varies inversely with a family's earned income

S.D: Profitable, Undesirable, but Not Malicious

- Firm that practices S.D is not being malicious in its hiring behavior - The decision it makes will be rational and profitable b/c on average its hiring decisions are likely to be correct - Many ppl suffer from statistical discrimination since it blocks the economic betterment of capable people

Effects of Crowding

- For example, if women are crowded into one of three occupations and men are distributed into two of three occupations, the wages rate of women is much lower than M - B/C of discrimination, this is an equilibrium situation that will persist as long as the crowding occurs - Occupational barrier means that a certain group cannot move into another occupation in pursuit of a higher wage - Result is a loss of output for society; sum of area of output loss exceeds the output gain, producing a net output loss for society

Causes of Growing Inequality

- Greater Demand for Highly Skilled Workers - Demographic Changes - International Trade, Immigration, and Decline in Unionism - Does not mean that rich get richer and poor get poorer, but their real incomes rise, but the top quintile experience the fastest growth - Happens globally

The Equality-Efficiency Trade-Off

- Greater income equality comes at the opportunity cost of reduced production and income - And greater production and income comes at the expense of less equality of income

The U.S Income-Maintenance System

- Helping those who have very low income is a widely accepted goal of public policy - Programs are designed to increase the earnings of the poor; they involve large expenditures and beneficiaries - US I.M System contains: (1) Social Insurance and (2) public assistance - (1) and (2) are known as entitlement programs, b/c all eligible persons are ensured the benefits set forth in the programs

Discrimination

- If discrimination confines certain racial, ethnic, or gender group to lower-pay occupations, the supply of labor in those occupations will increase relative to demand, and hourly wages and income in those lower-pay jobs will decline - On the contrary, labor supply will be reduced in the higher-pay occupations populated by "preferred" workers, raising their wages and income - Economists cannot account for all discrimination in work earnings on the basis of differences in years of education, quality of education, occupations, and annual hours of work - Economists attribute the unexplained residual to discrimination - Do not see as a dominant factor explaining income inequality - Important concern since it harms individuals and reduces society's overall output and income

Eliminating Occupational Segregation

- If occupation segregation is eliminated, it would reach wage equality - It would also eliminate the incentive for further reallocations of labor - Society also gains; sum of area of output gain is bigger than area of output loss - Women that achieve equality of occupations results from the contribution to domestic output being low to higher paying occupations with contribution to higher domestic output (MRP) - Society gains a more efficient allocation of resources from the removal of occupational discrimination

Unequal Distribution of Income

- Income is a flow; represents a stream of wage and salary earnings, along with rent, interest, and profits - Wealth is a stock, reflecting at a particular moment the financial and real assets an individual has accumulated over time - Ownership of wealth in the US is more unequal than the inequality in rent, interest, and dividends, which in turn contributes to income inequality

Luck, Connections, and Misfortune

- Luck, being in the right place at the right time, have helped individuals stumble into fortunes - Personal contacts and political connection are other potential routes to attaining higher income - In contrast, economic misfortunes may plunge a family into a low range of income; burden of such misfortune is borne very unevenly by the population and thus contributes to income inequality

Social Security

- Major S.I Program - Federal Pension Program - Replaces part of the earnings lost when workers retire, become disabled or die - Financed by compulsory payroll taxes levied on both employers employees - Workers may retire at 65, or 62 w/ reduced benefits - When workers due, benefits accrue to his or her family survivors - Special provisions provide benefits for disabled workers

Growing Demand for Highly Skilled Workers

- Most significant contributor to growing inequality - Highly skilled workers remain relatively scarce, their wages have been bid up - Wage difference between skilled and less-skilled have increased - 90-10 ratio increased - Rising pay of CEOs, increase in income from stock options, athletes, and so on contributed to rising income inequality

Education and Training

- Native ability alone rarely produces high income - Ppl must refine or develop their capabilities through education and training - The amount of education and training affect their capacity to earn income - Some workers who earn valuable new skills on the job experience significant income growth over time - Some do not develop skills & they remain with an unchanging income - Added training magnifies the education-based income differences between less-educated and better-educated individuals

Effect of Government Redistribution

- Non-cash transfer: provide specific goods or services rather than cash, but they are income-like b/c they enable recipients to purchase goods or services ie. Medicare, Medicaid, housing subsidies, and so on - One economic function of government is to redistribute income - Transfers contribute more to distribution and most important mean of alleviating poverty in the US (with job opportunities) - After-tax data would reveal only about 20 percent less inequality b/c it is only modestly progressive - 80 percent of the reduction in income inequality is attributable to transfer payments; accounts for more than 75% if the income of the lowest quintile

Gini Ratio

- Numerical measure of the overall dispersion of income - G.R = area between Lorenz curve & diagonal/total area below the diagonal - High ratio denotes more inequality; Small ratio denotes less inequality - Complete Equality; 0 - Complete Inequality; 1

Measurement Issues

- Official income thresholds for defining poverty are necessarily arbitrary and therefore may inadequately measure the true extent of poverty in the US - High cost of living in major metropolitan areas mean that the official poverty thresholds exclude millions of families whose income is slightly above the poverty level, but inadequate to meet basic needs - Using income to measure poverty understates the standard of living of many of the ppl who are officially poor - When consumption than income is considered, some poverty in the US disappears - This can happen b/c low-income families receive substantial noncash benefits such as food stamps and rent subsidies that boost their standards of living - "in-kind" benefits are not considered when measuring a family's official poverty status

Income Inequality over Time

- Over period of years, economic growth has raised incomes - In absolute dollar amounts, the entire distribution of income has been moving upwards; while, the relative distribution of income can come out as less equal, more equal, or unchanged

Social Insurance Program

- Partially replace earnings that have been lost due to retirement, disability, or temporary unemployment; they also provide health insurance for the elderly - Main S.I Programs: Social Security, Unemployment Compensation, and Medicare - Benefits are viewed as earned rights - Financed primarily out of Federal payroll taxes - Entire population shares the risk of an individual's losing income b/c of retirement, unemployment, disability, or illness - Employees/employers pay a part of wages into a government fund while they are working - Workers are then entitled to benefits when they retire or when a specified misfortune occurs

Distribution by Income Category

- Percentage of households in a series of income categories - Suggest a wide dispersion of household income and considerable inequality of income

Discrimination Coefficient

- Prejudiced person behaves as if employing nonpreferred worker would add a cost - The amount of this cost is reflected in a discrimination coefficient (d), measured in monetary units i.e Prejudiced employer not prejudiced against whites so white rate = AA workers wage plus the cost (d) involved in the employer's prejudice, or W(aa) + d - Prejudiced employer will have no preference if, W(w) = W(aa) + d - The greater a white employer's taste for discrimination, the larger the difference between white wages and the lower wages at which AA will be hired - Color-blind employer will hire AA and w equally - Prejudiced employer, whose d is infinity, will not hire AA - Prejudiced employer will prefer to hire AA if actual w and AA wage difference in the market exceeds the value of d - If difference is higher than d, prejudiced employer will hire w

Public Assistance Programs

- Provide benefits to people who are unable to earn income b/c of permanent disabling conditions or who have no or very low income and also have children - Financed out of general tax revenues and are regarded as public charity - Include "means test" that require individuals to verify low incomes in order to qualify for aid - Federal government finances about two-thirds of the welfare program expenditures, and the rest is paid for by the states - Program has greatly increased the employment rate (employment/population) for single mothers

Prejudice and the Market African-American-White Wage Ratio

- Ratio = AA wage/w wage - Prejudice against AA increases, (collective d increases), reduces demand, reduce employment, reduces wage, reduces ratio - Less biased, collective d decreases. increases demand, increase employment, increase wage, increase ratio

Earned-Income Tax Credit (EITC)

- Refundable Federal tax credit provided to low-income wage earners to supplement their families' incomes and encourage work - Available for low-income families, with or without children - Credit reduces the Federal income taxes that such families owe or provides them with cash payments if the credit exceeds their tax liabilities - Purpose of the credit is to offset Social Security taxes paid by low-wage earners & thus keep the Federal government from taxing families into poverty - Wage subsidy from the Federal government that works out to be as much as $2 per hour for the lowest-paid workers with families - Many ppl owe no income tax and receive direct checks from the Fed gov once a year

Ability

- Some people have different mental, physical, and aesthetic talents which vary the amount of income they receive - Intelligence and skills fall in between these talents

Other Welfare Programs

- Some provide help in the form of non-cash transfers - Head Start provides education, nutrition, and social services to economically disadvantaged 3 and 4-year-olds - Housing assistance in the form of rent subsidies and funds for construction is available to low-income families - Pell grants provide assistance to undergraduate students from low-income families - Low-income home energy assistance provides help with home heating bills - Veteran's Assistance and Black lung benefits provide cash assistance to those eligible

Poverty Trends

- Stabilized than past - Fluctuations due to recessions or slow growth

International Trade, Immigration, and Decline in Unionism

- Stronger international competition from imports has reduced the demand for and employment of low-paying industries, placing further downward pressure on wages there - Transfer of jobs to lower-wage workers in developing countries has exerted downward wage pressure on less-skilled workers - An upsurge in the immigration of unskilled workers has increased the number of low-income households - Unions tend to equalize pay within firms and industries; however, there has been a decline in unionism

Competition and DIscrimination

- T4D model suggests that competition will reduce discrimination in the very long run - Nondiscriminators that hire nonpreferred workers will have lower actual wage costs per unit of output and lower average total costs than the firms that do discriminate. Lower cost will allow nondiscriminators to underprice discriminating competitors, driving them out of the market - Critics of this implication of T4D model say that is overlooks entry barriers to new firms and point out that progress in eliminating racial discrimination has been slow - Discrimination based on race has persisted in the US and other economies

Market Power

- The ability to rig the market on one's own behalf also contributes to income inequality - In resource markets, unions or groups adopt policies to limit the supply, thereby boosting the income of insiders - In product markets, it can mean gaining or enhancing monopoly power, which results in greater profit and thus greater income to owners

Income Mobility

- The movement of individuals or households from one income quintile to another over time - Income starts at relatively low level at youth, reaches its peak at middle age, and declines - Income is more equally distributed over a longer period than in any single year - Income mobility over time is significant; low and high incomes are not permanent conditions - Longer the time period considered, more equal the distribution of income becomes

Poverty Rate

- The percentage of the population living in poverty

Incidence of Poverty

- The poor are heterogeneous, can be found in all parts of the nation, all race and ethnicities, rural and urban, young and old - Not randomly distributed - African-Americans and Hispanics are above national average; while, white and Asians are below avg. - Female-headed households, foreign-born citizens, and children under 18 yrs of age have high incidences of poverty - Social security system prevents poverty for ppl who married and with work - Poverty breeds poverty - Poor children are at a greater risk for a range of long-term problems; unhealthy & illiterate

Income Inequality

- Unequal distribution of an economy's total income among households or families

Statistical Discrimination

- ppl are judged on the basis of the average characteristics of the group to which they belong, rather than on their own personal characteristics or productivity - Uniqueness of the theory of statistical discrimination is its suggestion that discriminatory outcomes are possible even where there is no prejudice

Occupational Segregation: The Crowding Model

- the crowding of women, AA, and certain ethnic groups into less desirable, lower-paying occupations - Statistics indicate that women are disproportionately concentrated in a limited number of occupations such as teaching, nursing, and secretarial and clerical jobs - AA and H are crowded into low-paying jobs

Costs to society as Well as to Individuals

- three models of discrimination impose costs on those who are discriminated against - Lower wages, less access to jobs, or both - Preferred workers, in turn, benefit from discrimination through less job competition, greater job access, and higher wages - Discrimination contributes to income inequality and increases poverty - Discrimination also diminishes the economy's total output and total income - Discrimination locates society inside the PPC - Discrimination redistributes a diminshed amount of total income