IB Economics Chapter 11 - Macroeconomic objectives II: Economic growth and equity in the distribution of income"

Explain that due to unequal ownership of factors of production, the market system may not result in an equitable distribution of income

1. Every economy, regardless of its form of organisation, must answer three basic economic questions: what to produce, how to produce, and for whom to produce. The first two relate to resource allocation, which we studied extensively in Microeconomics. The third deals with the distribution of income or output, and is concerned with how much of goods and services different individuals or different groups in the population receive. 2. The problem of income distribution arises because ownership of factors of production is highly unequal, and because the prices of factors of production determined in the market vary enormously. While most people have labour resources that they provide in labour markets, for which they receive wages, some people are able to receive very high wages because of special skills and education or natural talents, while others who are less skilled, educated or talented may receive wages so low that they may be unable to cover the most basic needs for themselves and their families (food, shelter, clothing, etc.). 3. As a result, the market-determined distribution of income in an economy is likely to be very unequal, with some people receiving far larger shares than others. It follows that markets cannot ensure that everyone in a population will secure enough income to satisfy their basic needs. Most societies consider this to be a disadvantage of the market economy, because of the belief held by most people that everyone in a population should be able to satisfy a minimum of basic human needs. 4. Governments around the world therefore use a variety of methods to change the market-determined distribution of income and output, and arrive at a more socially desirable outcome. This is referred to as redistribution.

Taxes and allocative efficiency - summary

1. Income taxes, equity and efficiency in resource markets 2. Indirect taxes, equity and efficiency in product markets 3. Countering the idea of a trade-off between income equality and efficiency

The production possibilities model and the causes of economic growth - summary

1. Increases in actual output 2. Increases in production possibilities

Explain possible causes of poverty - summary

1. Low income 2. Unemployment 3. Low levels of human capital 4. Low levels of capital or land ownership 5. Discrimination 6. Geography 7. Age 8. Limited social services 9. Poverty

Explain possible consequences of poverty - summary

1. Low living standards 2. Lack of access to health care and education 3. Higher infant, child and maternal mortality rate 4. Higher levels of preventable diseases 5. Social problems 6. Inability to realise one's full potential

What are the two things governments affect when they subsidise provision or direction provision?

1. Merit goods 2. Infrastructure

How investment in capital leads to economic growth - summary

1. Physical capital, technology and economic growth 2. Human resources, human capital, and economic growth 3. Natural resources, natural capital and economic growth 4. The role of marketable commodities 5. The role of ecological goods and common access resources

Evaluate government policies to promote equity - summary

1. Taxes and allocative efficiency 2. Transfer payments and allocative efficiency 3. Government expenditures on merit goods and allocative efficiency

What are government policies to pursue income redistribution?

1. Transfer payments 2. Subsidised provision or direct provision 3. Government intervention 4. Taxation

Definition of Quintile

20% portion of a country's population divided into categories such as (poorest, richest etc.)

Draw a Lorenz curve and explain its significance

A Lornez curve is used to show the degree of income inequality in an economy. To construct a Lorenz curve, we draw a square box, where the vertical axis measures the total amount of income in an economy in cumulative percentages (therefore it runs from 0 to 100%), and the horizontal axis plots the total population in the economy, also in cumulative percentages (therefore this, too, runs from 0 to 100%). The diagonal line in the diagram represents perfect equality in income distribution, as it shows that if income were perfectly equally distributed. The Lorenz curve plots the actual relationship between percentages of the population and the shares of income they receive. In general, the closer a Lorenz curve is to the diagonal representing perfect income equality, the greater is the equality in income distribution.

Income taxes, equity and efficiency in resource markets

A relatively high degree of equality in income distribution cannot be achieved without a highly progressive tax system, which would involve taxing significant amounts of income away from high- income earners. According to a perspective we will study in Chapter 12, high income taxes act as a disincentive to work as well as to save, particularly among high-income earners who would be taxed more heavily. Income taxes reduce after-tax income, and as a result reduce the quantity of labour offered in the market, and also reduce savings. Lower savings has a negative effect on investment, and therefore on the production of new capital goods. Therefore, in this perspective high income taxes affect the price mechanism in the resource markets of labour and capital, causing allocative inefficiency. Lower quantities of labour and capital in turn translate into lower rates of growth for the economy.

Explain the importance of investment for economic growth, referring to investment in physical capital

Also referred to as 'capital goods' is the standard type of capital; it results from investments, or spending to produce machines, equipment, roads, etc.

Why indirect taxes are regressive?

Although progressive, proportional and regressive taxation are defined relative to income, they do not apply just to income taxes, but to all types of taxes, whether direct or indirect. This is because taxes are paid out of income, and can therefore be compared with income. To see whether a tax is progressive, proportional or regressive, it can be calculated as a fraction of the income out of which it is paid. Indirect taxes (of all types) are regressive. In the real world, some goods and services considered to be necessities, such as food and medicines, may be exempted from general expenditure or sales taxes. This makes indirect taxes somewhat less regressive, though they remain regressive overall.

How investment in capital leads to economic growth - Physical capital, technology and economic growth

An increase in the quantity of physical capital involves an increase in the number of machines, tools, equipment, road systems, ports, etc. available in an economy. An improvement in the quality of physical capital depends on technological advances, which lead to new and better machines, tools and equipment. Technological advances are usually incorporated into new capital goods; for example, a new computer that is faster and more powerful incorporates within it the new technology that makes it faster and more powerful. When a technological advance is incorporated into a capital good, it is referred to as being embodied in the new capital. Therefore, 'improved capital goods' are capital goods that embody a new technology. Use of capital goods embodying new technologies leads to a larger quantity of output produced; for example, the use of a more powerful computer allows a worker to produce more output.

Causes of poverty - Unemployment

An unemployed individual receives no income, but may receive some unemployment benefits; however; these are generally low relative to income received for work, and in most countries are only provided for limited periods. If unemployment is long term (such as with structural unemployment), then an individual or family is more likely to become poor. The risk of falling into poverty is far greater in single-parent households where the parent is unemployed, or if both heads of a household are unemployed over long periods.

Countering the idea of a trade-off between income equality and efficiency

As a counter-argument to the notion that progressive income taxes negatively affect resource allocation, some economists note that this has mainly theoretical merit, because the empirical evidence suggests that tax increases or decreases do not have a very significant effect on labour supplied, saving, investment and capital, and hence on output produced by an economy. Therefore, in practice, while there may be some negative effects on resource allocation, these may not be important enough to significantly reduce economic growth. A separate argument suggesting a possible positive influence of progressive income taxes on economic growth is that these act to reduce short-term fluctuations of economic activity (the business cycle). In fact, the greater the progressivity of income taxes, the greater the potential contribution to making recessions and inflations less severe. A less severe recession means that fewer resources are wasted due to unemployment, and hence a smaller reduction in output. A less severe inflation means the negative effects of inflation on investment will be less pronounced. Therefore, progressive income taxes may have positive effects on economic performance by making business cycle fluctuations milder. In addition, some economists argue that policies in pursuit of both equity and efficiency may actually complement each other. High income inequalities often mean that some groups in a population live in poverty, and the poor have low levels of education and health, fewer opportunities for work, and can become discouraged from trying to find jobs and improve their standard of living. Unemployment, as we know, results in lower output produced. Greater income equality could raise these people out of their poverty, provide them with access to education and health care, thus increasing human capital, increase their opportunities to find employment, and therefore contribute to increasing output produced and economic growth. In this case, greater equality would permit a more efficient use of resources.

Definition of Proportional taxation

As income increases the fraction of income paid as taxes remain constant; there is a constant tax rate

Definition of Progressive taxation

As income increases, the fraction income paid as taxes increases, there is an increasing tax rate

Definition of Regressive taxation

As income increases, the fraction of income pais as taxes decreases, there is a decreasing tax rate

How economic growth can stay stationary or even decrease

As its production possibilities increase, an economy must make efforts to keep unemployment at low levels and reduce inefficiencies to ensure that its actual output continues to grow along with production possibilities. 1. For example, an increase in the size of the labour force will do little to increase actual output produced if much of this labour remains unemployed 2. For example, a technological change favouring the production of one good (X) increases the production of that good proportionately more. 3. Similarly, an influx of unskilled workers into a country results in a larger proportionate increase in the production of goods using relatively more unskilled labour.

Corporate income taxes

Corporations are businesses (firms) that have formed a legal body called a 'corporation' that is legally separate from its owners. Corporate income taxes are taxes on the profits of corporations.

Customs duties, also known as tariffs

Customs duties or tariffs are a type of tax applied on imports of foreign goods into a country. There are two main reasons why governments levy tariffs. One is to keep imports out of the country by making them more expensive to consumers, and the other is to raise tax revenues. Whereas in developed countries tariff revenues are a very small proportion of tax revenues (as little as 1-3%), in many less developed countries, they are sometimes a major proportion, in some cases amounting to more than 50% of total tax revenues.

Definition of direct taxes

Direct taxes are taxes paid directly to the government tax authorities by the taxpayer. They include; 1. Personal income taxes 2. Corporate income taxes 3. Wealth taxes 4. Social insurance (social security) contributions or payroll taxes

How investment in capital leads to economic growth - The role of ecological goods and common access resources

Ecological goods and common access resources are crucially important to long-term growth. Long- term economic growth depends critically on the ability of countries to maintain, and if possible improve, environmental quality, and therefore natural capital that includes common access resources. The reasons can be found in the concept of sustainability, that environmental destruction on a large (unsustainable) scale means leaving behind fewer and lower quality resources for future generations. Environmental destruction can have direct effects on the amount of output produced. Despite this, it can also have important indirect effects; for example, workers whose health is affected by environmental pollution become less productive, and this involves depletion of human capital together with depletion of natural capital. Therefore, continued economic growth in the future requires investments in the present in natural capital for environmental preservation.

Describe, using an LRAS diagram, the factors of economic growth as an increase in potential output

Economic growth in the context of the PPC model is very closely related to economic growth in AD-AS models. We see that improved efficiency and reduced unemployment, causing points of production to move closer to a fixed PPC, can cause the LRAS curve to shift to the right. Also, the LRAS curve can shift to the right as a result of institutional changes, which are not included in the PPC model.

Explain the difference between equity in the distribution of income and equality in the distribution of income

Equity is the condition of being fair or just, while equality is the state of being equal with respect to something. Equality with respect to income would mean that each member of a society receives exactly the same income. This may or may not be equitable, depending on how equity is interpreted. If it is believed that income distribution is equitable or fair if it is distributed equally, then equity in income distribution means income equality. However, if it is believed that it is equitable or fair for people's income to be in proportion to their work effort (a different equity principle), this would give rise to income inequality, since not everyone's work effort is the same.

Explain the connection between income redistribution and 'Subsidised provision or direct provision of merit goods'

From the point of view of income redistribution, the issue here concerns low consumer incomes and poverty. If income distribution were left entirely to the market, two of the most important merit goods that would be under consumed due to low incomes and poverty would be education and health care. Education and health care are so important that they are often viewed as fundamental human rights. This means that it is not enough for governments just to provide education and health care (to supplement the insufficient quantities provided by the market). Governments must also ensure that these are affordable for very low income groups. This can be accomplished when governments offer education and health care services that are free (or nearly free) of charge to consumers, and is called 'subsidised provision' of the goods and services, because the government offers them to consumers at a price (often zero) that is far below the cost of producing them. Governments may also provide subsidies to private providers to increase supply. In addition, education and health care can be made more affordable through transfer payments.

Government intervention in markets and allocative efficiency

Government intervention in markets intended to produce a more equitable distribution of income (minimum wage legislation, food price ceilings and price floors for farmers) clearly conflicts with resource allocation objectives. These types of intervention lead to allocative inefficiency and a loss of social surplus.

Explain the connection between income redistribution and 'Government intervention in markets'

Governments often intervene in markets in ways that change the distribution of income. Examples include: • minimum wage legislation - by setting a legal minimum wage, the government raises the lowest permissible wage above the equilibrium market level, thereby raising the wages of low-income (and usually unskilled) workers • food price ceilings - by setting maximum prices for certain food products (prices below the market- determined equilibrium price), governments can make food more affordable for low-income groups • price floors for farmers - by setting legal minimum prices for certain agricultural products (often involving government purchases of the resulting surpluses), governments raise their prices above the equilibrium market price in order to support farmers' incomes.

Analyse data on relative income shares of given percentages of the population, including deciles and quintiles

If income were completely equally distributed, everyone would receive exactly the same income, in which case every quintile would receive 20% of income. However, in the real world this is a virtual impossibility. In all countries in the world, the presence of inequalities in income distribution means that the poorest quintile of the population receives less than 20% of income, and the richest quintile more than 20%. In general, the higher the percentage share of income received by the poorest quintile, and the lower the percentage share received by the highest quintile, the more equal the distribution of income.

Causes of poverty - Low income

Low incomes are an obvious cause of poverty, since by definition poverty is due to incomes that fall below some predefined level. Therefore, in discussing the causes of poverty, we are in effect asking, what are the factors that lead to low incomes?

Factors to improve productivity of economic growth

Improvements in productivity arise from factors that make labour more productive, so that each hour of work produces more output. These factors include: • increases in quantity and improvements in quality of physical capital (through investments in physical capital and technological change) • improvements in the quality of labour (through investments in human capital) • improvements in (or at least maintenance of) the quantity and quality of ecological resources (through investments in natural capital). In the production possibilities model, productivity improvements result in outward shifts of the PPC.

Which, out of proportional, mildly progressive and strongly progressive taxation, is the most fair?

In all three cases, as income increases, the amount of tax paid becomes larger. All three satisfy the principle of vertical equity, according to which those with greater income should pay a larger tax than those with less income. This is impossible to answer using economic reasoning, because fairness is a normative question that depends on value judgments. The only thing that can be said with certainty is that the more progressive a tax system, the more equal (or less unequal) the after-tax distribution of income becomes. However, by shrinking the difference between the high and low income levels, progressive taxation achieves a more equal income distribution than proportional taxation; and the more progressive the tax system, the greater the income equality achieved.

Excise taxes

In contrast to expenditure/sales taxes, excise taxes are taxes paid on specific goods and services, such as cigarettes and petrol (gasoline). Also in contrast to expenditure/sales taxes, which are ultimately paid by the consumer, payment of excise taxes is split between the consumer and the firm producing the good or service, with the relative size of the tax burden determined by price elasticities of demand and supply.

Is regressive taxation fair?

In regressive taxation, the tax rate decreases as income increases; the proportion of income paid in tax falls as income rises. Regressive taxation therefore makes income distribution less equal.

How proportional taxation is calculated

In the case of proportional taxation, the tax rate remains constant for all income levels; therefore, the amount of tax paid increases in the same proportion as income. In the case of progressive taxation, two examples are presented. In both, the tax rate increases as income increases; as a result, the amount of tax paid increases more than in proportion to income. The first example is 'mildly progressive', meaning that the tax rate increases slowly as income increases. In the 'strongly progressive' example, the tax rate increases much more rapidly.

Explain the importance of investment for economic growth, referring to investment in natural capital

Includes everything that traditionally falls within 'land', or 'natural resources'. It includes everything under the land (mineral deposits, metals, oil, natural gas, etc.) plus everything on the land (rivers, lakes, oceans, forests, soils, etc.), plus a country's overall natural environment and ecosystem (air, wildlife, biodiversity, climate, ozone layer, and so on). Whereas 'land' and 'natural capital' include the same things, there is an important difference in how the two terms are interpreted. 'Land' is assumed to be given by nature and does not change. 'Natural capital' does change, because it can be destroyed (by cutting down forests, polluting the air and water, depleting fish). It can also be improved (by planting more forests, improving soil quality). Maintaining natural capital and improving its quality depend on investments that aim to preserve and improve natural resource quantity and quality.

Indirect taxes, equity and efficiency in product markets

Indirect taxes are regressive, thus leading to a more unequal distribution of income. 1. General expenditure taxes are sometimes applied to different categories of goods and services, while some goods and services are exempted from taxes altogether, the objective being to exclude certain necessities from taxation and make them more affordable to low- income earners. Such exemptions are consistent with the principle of increasing equity in the distribution of income. However, at the same time the allocation of resources is affected because of relative price changes in product markets. 2. In the case of excise taxes, the outcome again affects the allocation of resources by changing relative prices and hence the signals and incentives they convey. Excise taxes intended to correct negative externalities have the effect of improving efficiency in the allocation of resources, though they are regressive and make income distribution more unequal. If excise taxes are not imposed in order to correct negative externalities, they worsen both the allocation of resources and the distribution of income.

Definition of indirect taxes

Indirect taxes are taxes on spending on goods and services. They are called indirect because, while consumers are the ultimate payers of a part or all of these taxes, they pay indirectly through the suppliers of the good or service purchased (the suppliers may be the producers, the retailers, or generally the sellers). The most important kinds of indirect taxes include the following: 1. General expenditure taxes, also known as sales taxes 2. Excise taxes 3. Customs duties, also known as tariffs

Causes of poverty - Low levels of human capital

Low levels of education and skills translate into low incomes because there is generally a positive (direct) relationship between skill/educational attainment and income levels. Poor levels of health also lead to low incomes because an unhealthy person is likely to be less productive and therefore more poorly paid. Unskilled people may rely on the minimum wage, which may be insufficient to support a family.

How investment in capital leads to economic growth - The role of marketable commodities

Marketable commodities can contribute to growth but are not essential. For example, the United States benefited enormously from its large tracts of good quality agricultural land, oil reserves and mineral deposits. Yet the evidence suggests that countries do not need to be rich in marketable commodity-type natural resources to achieve high rates of growth. There are many economies, that have achieved high rates of growth over long periods and have attained high levels of GDP per capita, in spite of producing few if any marketable commodities.

Definition of Absolute poverty

Measures of absolute poverty begin by defining a minimum income level called a 'poverty line'. Most countries have a national poverty line, determined by government authorities as an appropriate amount of income required to satisfy minimum needs. Once a poverty line has been determined, the amount of poverty is found by taking the percentage of a population (or the number of individuals) whose income falls below the poverty line.

Causes of poverty - Age

Older people may receive pensions that are barely enough to cover minimum needs, and in many countries (particularly less developed ones) may receive no pension at all if they have been living and working in the informal economy.

Explain the connection between income redistribution and 'Subsidised provision or direct provision of infrastructure'

Other merit goods that may require subsidised or direct provision by the government, and that are especially important in developing countries that concentrate large groups of people on very low incomes, include infrastructure, which includes water supplies, sanitation and sewerage. Subsidisation or direct provision by the government makes these more affordable to poor people. Whatever the merit good, the government uses tax revenues to provide the good in larger quantities than the market would have provided, and additionally to make it available at very low (or zero) prices. The provision of subsidised merit goods offers some redistribution by making certain goods available to people on low incomes who would not otherwise be able to afford them.

Explain possible consequences of poverty- Inability to realise one's full potential

People in poverty are unable to realise their full potential, leading to a waste of human talent, and in addition to the personal costs, may result in lower economic growth (by adversely affecting the economy's PPC or LRAS curve).

Causes of poverty - Limited social services

People on low incomes must often rely heavily on social services (health care, education, housing) provided or subsidised by the government, as their incomes are insufficient to purchase these in the market. If social services are limited or are reduced by the government, people on low incomes may be forced into poverty by having to purchase these in the market.

Explain possible consequences of poverty - Higher levels of preventable diseases

Poor hygiene and nutrition make both children and adults more prone to illnesses.

Causes of poverty - Poverty

Poverty itself may become a cause of further poverty. If people do not have access to essential services such as health care, education and housing, a self-perpetuating cycle may be set into motion where low incomes lead to low human capital, and further to low incomes. This is part of the 'poverty cycle'.

Definition of Poverty

Poverty refers to an inability to satisfy minimal consumption needs. Beyond this general definition, there are different perspectives on how best to define poverty. In one view, poverty refers to the inability of people to satisfy their basic needs in an absolute sense that is constant and unchanging. In another, poverty is a relative concept that varies across societies and changes over time. These two perspectives are reflected in two definitions of poverty: absolute poverty and relative poverty.

Explain possible consequences of poverty - lack of access to health care and education

Poverty results in a lower ability to access health care and education, leading to lower human capital formation, lower productivity and lower incomes, possibly resulting in the self-perpetuating cycle noted above.

Describe, using a production possibilities curve (PPC) diagram, factors to increase economic growth - Increases in production possibilities

Reduction of unemployment and inefficiencies can only result in a limited amount of economic growth. As the economy moves closer to its PPC, the ability to achieve more growth is exhausted, and more growth can only occur if there is an increase in production possibilities, illustrated by an outward shift of the PPC. The factors that lead to outward shifts of the PPC, or increases in production possibilities are: • increases in the quantity of resources (factors of production) in the economy • improvements in the quality of resources (for example, through more educated labour, or improved physical capital through technological change).

Define economic growth

Refers to an increase in real GDP, or the real quantity of goods and services produced over a period of time (typically a year), and is usually expressed as: • a percentage change in real GDP over a period of time, or • a percentage change in real GDP per capita over a period of time

Explain the importance of investment for economic growth, referring to investment in human capital

Refers to the skills, abilities, knowledge and levels of health of workers. Human capital results from investments, or spending on education, training, provision of health care services, clean water supplies, good nutrition, and generally anything that affects levels of education and health.

Definition of Relative poverty

Relative poverty is a concept that compares the income of individuals or households in a society with median incomes. It is closely related to how equally or unequally society's income is distributed among its total population. If income were equally distributed, there would be no relative poverty, since no one would be poor relative to someone else. In general, the more unequal the distribution of income, the greater is the degree of relative poverty. The idea behind relative poverty is that poverty is much more than being unable to afford a minimum of basic goods and services. Even though people may be able to buy basic necessities, they are still poor if they cannot afford goods and services and a lifestyle that are typical in a society. The measurement of what is 'typical' is based on a standard determined by the median income level. If people's incomes fall far below this median level, they are considered poor.

Transfer payments and allocative efficiency

Some economists argue that transfer payments may have undesirable consequences for efficiency. Supporters of supply-side economic policies argue that certain transfer payments, such as unemployment benefits or other benefits for the poor, are disincentives for unemployed people and poor people to accept work that would shorten their period of unemployment. The result is an extra burden on the government in terms of unemployment and other benefits, as well as higher unemployment rates for the economy, causing output to be lower than it could be. As a counter-argument, others note that while it is likely that some people may take advantage of a system of transfer payments for their own personal gain at the expense of the social interest, on the whole such a system is needed to offer protection to vulnerable groups in need who might otherwise face extreme poverty and destitution. In addition, transfer payments like unemployment benefits act automatically to reduce the effects of short- term fluctuations in economic activity, thus lessening the severity of recession or inflation.

Causes of poverty - Geography

Some people may live in remote, isolated geographical regions, with limited possibilities for employment, and with limited possibilities to relocate (move) to other more economically active regions (due to poverty, age, or lack of communication and lack of marketable skills); this problem may be especially significant in some rural areas in less developed countries.

Causes of poverty - Discrimination

Some social groups (racial and ethnic groups, women) may face discrimination in the job market, with the result that they may receive lower wages than others for the same work, or may find greater difficulty finding work than the worker who does not face discrimination.

Explain the connection between income redistribution and 'taxation'

Taxation makes redistribution possible through transfer payments and subsidised provision of merit goods since these are paid for out of tax revenues. However, over and above this important role, taxation is itself an important instrument for redistribution, because it can lower income inequalities by taking more taxes from the rich than from the poor. Taxes are the most important source of government revenues, and provide the funds for many purposes, such as public goods, transfer payments and merit goods, correcting externalities, providing subsidies, changing the allocation of resources, changing the distribution of income, and many more. We are now interested in seeing how taxes can be used to achieve greater equity in the distribution of income, interpreted as greater equality.

Taxes and allocative efficiency - overall

Taxes affect the allocation of resources and make it different from what would have been achieved in a free market economy (with no government intervention). When taxes are used to correct market failures, they are intended to move the economy towards a more efficient allocation of resources. However, of the very large variety of taxes levied by governments, most are not implemented with the intention of correcting market failures. Many economists argue that a variety of taxes worsen the allocation of resources, causing allocative inefficiency. The reason is that taxes change the after-tax relative prices of goods and services and factors of production. Since resource allocation in the market system is guided by prices that act as signals and incentives, and since prices in the absence of market failures give rise to the 'best' allocation of resources, it follows that some taxes cause allocative inefficiency.

Distinguish between progressive, regressive and proportional taxation

Taxes can be defined as being proportional, progressive or regressive according to the relationship between income and the fraction of income paid as tax. The fraction of income paid as tax, in percentage terms, is referred to as a tax rate.

Explain how the Gini coefficient is derived and interpreted

The Gini coefficient, is a summary measure of the information contained in the Lorenz curve of an economy. It is defined as; Gini coefficient = area between diagonal and Lorenz curve/entire area under diagonal The Gini coefficient has a value between 0 and 1. If there were perfect income equality, the coefficient would be zero. The larger the Gini coefficient, and the closer it is to 1, the greater is the income inequality, since the further away is the Lorenz curve from the diagonal.

Explain the importance of improved productivity for economic growth

The contributions of resource quantities and quality to economic growth can be summarised in the concept of productivity, referring to the quantity of output produced for each hour of work of the working population. For an economy as a whole, productivity can be measured as real GDP divided by the total number of hours worked. An improvement in productivity means that workers become more productive: the quantity of output produced in an hour of work increases. Improvements in productivity lead to economic growth, because each hour of work now produces more output.

Examples of 'transfer payments'

The groups of people who receive the transfer payments may include older people, sick people, very poor people, children of poor families, unemployed people and others; in their entirety they are referred to as vulnerable groups. Transfer payments include old age pensions, disability pensions, unemployment benefits, war veterans' benefits, maternity benefits, child allowances, housing benefits for the poor, student grants, and many more. Transfer payments are made possible by taxes collected by the government. A portion of taxes paid to the government by the working population is used to make transfer payments to vulnerable groups, thereby achieving some income redistribution.

Explain possible consequences of poverty - Higher infant, child and maternal mortality rate

The inability to access needed health care services, as well as poor nutrition for mothers and children lead to large numbers of unnecessary deaths among infants, children and women due to pregnancy-related causes.

Describe, using a production possibilities curve (PPC) diagram, factors to increase economic growth - increases in actual output

The production possibilities curve (PPC) shows combinations of maximum output that can be produced by an economy with fixed resources and technology, provided there is full or maximum employment of resources and productive efficiency. The further away an economy is situated from its PPC, the greater is resource unemployment and productive inefficiency. Therefore, by reducing unemployment and increasing productive efficiency, a country moves closer to its PPC and increases the actual quantity of output produced. Therefore, reductions in unemployment and increases in productive efficiency are two factors that can cause growth of actual output.

How investment in capital leads to economic growth - Human resources, human capital, and economic growth

The quantity of labour can sometimes be an important source of economic growth. However, many countries (especially less developed ones) sometimes face high levels of unemployment and underemployment. Therefore, increases in the quantity of labour may not always be a source of growth. Far more important than increases in the quantity of labour is improvement in the quality of labour, determined by skills, abilities, knowledge and levels of health of the workforce. Improved labour quality is the result of investments in human capital. Higher levels of skills, knowledge and health, resulting from investments in human capital, are a very important source of economic growth because a highly skilled, well-educated and healthy labour force is more productive than an unskilled, uneducated and unhealthy one.

Government expenditures on merit goods and allocative efficiency

The subsidisation or direct provision of merit goods (education, health care and infrastructure, including sanitation, clean water supplies, sewerage, etc.) is a burden on the government budget, and always entails opportunity costs in terms of foregone alternatives. Beyond that, it is likely that government expenditure on merit goods is consistent with the achievement of allocative efficiency. As we learned in Chapter 5, merit goods are underprovided by the market mainly on account of their positive consumption externalities. The purpose of government intervention in this case is to correct the problem of underallocation of resources through policies intended to increase the demand or supply of the goods in question.

Explain possible consequences of poverty - Low living standards

These are an obvious consequence arising from low incomes. Low living standards are associated with greater levels of psychological stress, alcoholism, poor nutrition and poor levels of health, all leading to poorer job and income-earning prospects.

General expenditure taxes, also known as sales taxes

These are taxes on spending or sales of goods and services. In practice, many countries that use general expenditure taxes but exclude certain goods and services from payment of taxes on the grounds of equity (for example, goods and services like food, pharmaceuticals, rents on housing, and others); in some cases there may be different rates for different types of goods and services on the grounds of equity.

Wealth taxes

These are taxes on the ownership of assets. The two most common wealth taxes are property taxes, based on the value of property owned, and inheritance taxes, based on the value of property inherited.

Explain possible consequences of poverty - Social problems

These include higher crime rates, drug use, family breakdowns and homelessness.

Social insurance (social security) contributions or payroll taxes

These taxes are paid by workers and their employers (who pay on behalf of their employees). The revenues from these taxes are not paid into the government's budget, but rather into specific funds, and are used to finance specific expenditures, such as pensions, social insurance and health care (in some countries). This is called earmarked taxation, because it is 'earmarked' or identified to be spent only for a specific purpose.

Personal income taxes

This is the most important source of government tax revenues in many countries (especially more developed countries), and involves taxes paid by households or individuals in households. They are paid on all forms of income, including wages, rental income, interest income and dividends (which are income from ownership of shares in a company, and are therefore income from profits).

How investment in capital leads to economic growth - Natural resources, natural capital and economic growth

When thinking about the contribution of natural resources (natural capital) to economic growth, it is useful to make a distinction between two kinds of natural capital: marketable commodities (commodities that are bought and sold) such as timber, minerals, metals, natural gas, coal and oil; and ecological resources such as soil quality, rivers, clean air, biodiversity, the ozone layer (and, more generally, common access resources).

Explain the importance of investment for economic growth - summary

To understand why increases in resource quantities and improvements in resource quality cause increases in production possibilities, we will use the expanded meaning of capital. 'Capital' generally refers to resources that can produce a future stream of benefits. This future stream of benefits arises from investment, or spending undertaken to create that stream of benefits. The three factors of production: land, or natural resources; labour, or human resources; and physical capital, can be interpreted as a type of 'capital': 1. physical capital 2. human capital 3. natural capital

Explain the term 'transfer payments'

Transfer payments are payments made by the government to individuals specifically for the purpose of redistributing income away from certain groups and towards other groups; they transfer income from those who work and pay taxes towards those who cannot work and need assistance.

Causes of poverty - Low levels of capital or land ownership

Whereas some people may inherit financial capital (stocks and bonds) or other forms of property (such as agricultural land or a home), which gives them both an income advantage and something to fall back on in case of unemployment, many others have no resources to rely on other than their labour, which for the reasons noted above may not provide them with an adequate income. People on low incomes often do not own a home and are forced to pay rent, which may take up a substantial portion of their income. Low incomes may mean poor housing, affecting health and further lowering one's income potential, and may even lead to homelessness.

Definition of Decile

Which are 10% portions of the population (there are ten deciles)

Distinguish between direct and indirect taxes, providing examples of each

Will be seen below. However, it is important to note that, tax systems vary enormously from country to country around the world, and there are no two countries that have the same tax system. While most countries have a mix of direct and indirect taxes, they vary with regard to the degree of reliance on each of these, as well as on the particular mix of types of taxes within each group. In addition, they can vary enormously with respect to tax rates and many other technical details.

Using Lorenz curves to illustrate income redistribution

me, to make the distribution of income more equal. Graphically, this appears as a shift of a country's Lorenz curve closer to the diagonal line, and is reflected in a lower Gini coefficient.