Chapter 21: Microeconomics

Absolute vs Relative Poverty Measures

-Absolute and relative poverty measures each have merits -An absolute poverty line captures a family's ability to consume essential goods like food, shelter, and clothing -It defines as poor someone who can't afford basic necessities, regardless of how well off the rest of society is -In contrast, a relative poverty line captures the fact that people tend to measure themselves against the people around them, rather than against an absolute standard -It defines poverty as not whether you're starving, but whether you're keeping up with the rest of society

Poverty Trap Example

-Bad health is a straightforward example of a poverty trap (more relevant in very low-income countries than it is in the United States) -Malnutrition makes your body weak, which means you are not able to do physical work as effectively -This in turn decreases your ability to earn income, which means you have less to eat, which makes you even weaker, and so on -The fact of being poor makes it hard to stay healthy and productive, and the resulting vicious cycle may be hard to escape

Conditional Cash Transfer Programs

-Conditional cash transfer programs are an increasingly popular antipoverty strategy, both inside and outside the United States -Often, the conditions attached to financial transfers require recipients to invest in health and education for their children -Such conditional cash transfer programs combine redistributive goals with economic-development goals

Criticism of US Poverty Line

-Critics of the U.S. definition of poverty note that it fails to account accurately for expenditures other than food -This is a real worry since most families devote a smaller share of their income to food than they did in the 1960s -Critics also point out that the U.S. poverty definition does not account for regional differences in the cost of living -In 2011, the Census Bureau introduced an "alternate" poverty measure, which bases the poverty line on the prices of food, clothing, shelter, and utilities, and adjusts for geographic differences in the cost of living (to help solve this issue)

Long-Term Effects of Discrimination

-Discrimination can have long-lasting effects on people and markets, even after the active discrimination itself ends -One important example is segregated communities -Even after that active discrimination ends, imagine that they still tend to cluster together in neighborhoods -The kids who grow up in these neighborhoods are surrounded by adults who have low education or job experience, affecting the development of the kids' human capital -This is one reason often put forward for "affirmative action" programs that ensure people of other races gain access in college admissions or hiring decisions

Skill-Biased Technical Change

-Economists also attribute a large part of the increase in inequality within countries like the United States to something called skill-biased technical change -The benefits of economic growth have increasingly been going to highly skilled workers with a lot of education -Add this technical change to increased trade between countries (which allows more manual and rote jobs to be done overseas in low-wage countries) and people in rich countries are specializing more and more in high-tech, high-skill, high-education work, and they reap huge benefits

Situational Necessity For Discrimination

-Economists recognize that statistical discrimination—making a choice based on the difference in average characteristics between two groups—can sometimes be rational -For instance, imagine that an employer has to make a quick decision on which of two candidates to employ, a younger candidate versus an older one -She decides to hire the younger one as she believes that the younger candidate would be healthier and miss work less frequently -Society loses when talented individuals who face discrimination are discouraged from acquiring the skills, education, and positions that they otherwise might get -In short, statistical discrimination can be rational for an individual employer, but that doesn't necessarily make it right, socially efficient, or even legal

Welfare

-Government programs that give money to the poor are commonly referred to as "welfare" -The term welfare is used to refer broadly to the various income-support programs for the poor run by each state

Measuring Inequality

-However visually striking the parade analogy may be, economists need more precise ways of summarizing the income distribution -The simplest method divides those marchers into five equally sized group -Since we have divided the country into five groups, we call each one a quintile, or 20 percent of the population -Income is not distributed perfectly equally anywhere in the world and we always see that the top quintiles earn a disproportionately high share of income (more than 20 percent) and the lower quintiles earn a disproportionately low share (less than 20 percent)

Aid to Families with Dependent Children (AFDC)

-In 1996, Congress passed a law that greatly changed the role of the federal government in providing welfare -Until then, the federal government administered a program called Aid to Families with Dependent Children (AFDC) -As the name suggests, this program gave money to poor households with children -To be eligible, the children had to be "deprived of parental support" in some way, usually having a single or divorced parent -We can think of AFDC as an "unconditional" cash-transfer program; it provided financial support to any eligible person, without any restrictions on how the money could be used

Who is Poor?

-In 2010, 46.2 million people—15.1 percent of the population—lived under the official poverty line in the United States (up from a near all-time low of 11.3 percent in 2000) -Almost a quarter of the population lived in poverty in 1959 -That number plummeted throughout the 1960s and early 1970s and since then, the poverty rate has fluctuated between 11 and 15 percent of the population -What changed in the 1960s? -One important factor was economic growth -Between 1959 and 1973, the total size of the U.S. economy grew at an average rate of 4.4 percent -Because the U.S. poverty line is an absolute measure rather than a relative one, the official U.S. poverty rate fell steadily when there was economic growth that raised the incomes of low-income families -The development during the 1960s of new government programs to assist the poor also made a big difference (reduced poverty rate among the elderly, from 35 percent down to 10 percent)

Poverty in The Community

-In certain places, opportunities may not exist, at least not for the majority of the population -Even in wealthy countries, community-wide poverty creates problems beyond those faced by individuals -In these communities, transportation may be limited, jobs scarce, and schools below average -When most of the region is poor, it's hard for local governments to raise money through taxes; that makes it harder in turn for the region as a whole to invest in infrastructure, jobs, and schools -Long-term solutions to poverty must, then, involve ways to grow the economy and expand the range of opportunities available to the population

Temporary Assistance to Needy Families

-In contrast, the program that replaced AFDC in 1996—called Temporary Assistance to Needy Families—is a conditional cash transfer program -Under this program, financial support is given only to people who engage in certain actions (vary by state) -Generally, welfare recipients are eligible for benefits for a maximum of five years, must start working within two years of joining the program, and must work a minimum number of hours per week -These conditions have shifted the nature of welfare away from a redistribution program toward a social insurance program (help people through hard times rather than providing long-term income support)

Largest. Social Insurance Programs

-In the United States, the largest social insurance programs are: -Social Security, which provides pensions to retired and disabled people -Medicare, which provides medical insurance to retired and disabled people -Unemployment insurance, which gives short-term income support to the unemployed -Disability and unemployment benefits are examples of social insurance in a straight-forward sense -Retirement benefits are less like private insurance (which is generally used to protect against unexpected events) and more like a collective saving program (widely seen as an example of social insurance)

US Poverty Line

-In the United States, the official poverty line is based on the price of food (They set the poverty line by taking the cost of food for a family of a given size, and multiplying it by three) -Recognizing that the price of food and other goods increases over time, the government adjusts the poverty line each year based on the Consumer Price Index (CPI)

In-Kind Vs Cash-Transfer Programs

-In-kind transfer programs are, by design, more restrictive than cash-transfer programs -When a poor household receives income support, it can use the money to buy whatever goods and services it wishes -When that same household receives an in-kind transfer, the choice of how to spend the money has already been made -Why might a government prefer in-kind transfers? -One reason is that it prevents recipients from spending cash on luxury items or on socially disapproved goods such as alcohol or drugs

Cause and Effect for Human Capital and Poverty

-It is often difficult to tell cause from effect: -Does low human capital cause poverty (because people with low human capital are less productive in jobs and therefore likely to earn less money)? -Or does poverty cause low human capital (because growing up in a poor community can reduce access to education, health care, and informal learning opportunities)? -Likely, the causality runs both ways, creating a negative cycle of poverty and low human capital -To the extent that low human capital causes poverty, policies that break this cycle by improving schools, offering training in job skills, and providing health care can help

How to Fix Cons of Means-Testing

-It is possible to fix this sort of perverse incentive by designing more nuanced means-tests -For instance, a program could phase out benefits as income increases (like the EITC) rather than use a strict cutoff -In general, the more narrowly targeted support is to those with low income, the greater the potential inefficiency caused -These examples show why economists often see a trade-off between equity and efficiency in poverty policy -This is not to say that poverty policy is always inefficient -Some policies, like those that alleviate credit constraints, can improve both equity and efficiency -In this case, a market failure is being solved, so there is no trade-off

Safety Nets

-Many policies are designed to protect against the temporary hard times that can lead to transient poverty (social insurance) -One of the three different types of public policy approaches related to poverty and inequality

Measuring International Poverty

-Measuring poverty on an international scale is similar to measuring it on a national one -The same concerns about differences in the cost of living and relative standards of wealth apply, only more so, since these differences are much more dramatic on a global scale than a national one -The most common international poverty measure is the number of people living on less than $1.25 per day (much lower than the official U.S. poverty line) -Calculating the $1.25 per person per day international poverty line involves a series of steps -Most importantly, poverty lines have to be adjusted to account for differences in prices across countries -Fortunately, there's a useful tool to make those adjustments, called the purchasing power parity (PPP) index

Inequality in The US and Around The World

-Most countries in the world have Gini coefficients ranging from 0.25 to 0.60 -Most of Europe has relatively low inequality and much of Latin America and southern Africa has relatively high inequality -The global pattern of inequality has been changing in recent decades -Inequality between countries, in terms of differences in their average national incomes, has been decreasing; economic growth has lifted billions of people out of poverty, especially in China and India -Inequality within countries has largely been on the rise (for both rich and poor ones) -Gini coefficients in China have risen significantly since the 1980s, as the country has experienced strong economic growth -In India and other Asian countries, though, which have experienced similar amounts of growth, income inequality has not changed much at all: Gini coefficients are essentially the same as they were three decades ago

Public Policy Goals for Poverty and Inequality

-Most governments, in both rich and poor countries, aim to limit poverty and inequality to some extent -We can distinguish among three different types of public policy approaches related to poverty and inequality: economic development, safety nets, and redistribution -Knowing which goals are being pursued has important implications for designing public policies

Chronic and Transient Poverty

-Not all experiences of poverty are the same -The most fundamental distinction is between chronic and transient poverty -The difference between the two is essentially the difference between always being poor and being poor for a short time -Only about 3 percent of people living under the poverty line in any given year are chronically poor, usually defined as spending three or more years in poverty -Transient poverty is usually measured as a spell of poverty that lasts at least two consecutive months within a year -More than a quarter of the population experiences transient poverty at some point in their lives, perhaps due to losing a job or experiencing sickness or injury

Economic Development

-Often, policy-makers look for investments that will spur future economic growth -The goal is not only the immediate effect of the policy on poverty but also the growth it will produce for the entire economy -Common examples include public investments in education, job training, and infrastructure -These policies help reduce poverty indirectly, through increased economic growth and opportunities in the future -Many of these policies serve dual goals—providing services in the short run and contributing to long-run growth -Similarly, a plan to revitalize the downtown area of a struggling city may have dual goals: It may make living there more pleasant in the short run -The hope is also that it will attract businesses and new residents, improving the city's economy and reducing poverty in the long run -One of the three different types of public policy approaches related to poverty and inequality

Private vs Social Insurance Programs

-One difference from private insurance programs is that social insurance programs usually serve everyone who meets baseline eligibility requirements -For instance, people who paid payroll taxes during their working years can draw on Social Security and Medicare when they retire or suffer a disability; those who live longer or have higher health care costs don't have to pay higher premiums in order to receive benefits

What causes such big differences in income distribution between countries?

-One factor is the extent to which governments redistribute income through the public budge -In many European countries, for instance, taxes on the rich are higher than in the United States; public services and income support to the poor are also higher -The result is that the after-tax income distribution is more equal than the income distribution before taxes were paid and public services provided

Earned Income Tax Credit (EITC)

-One tax policy, the Earned Income Tax Credit (EITC), has a particularly large effect on the poor -Those with low income are eligible for a tax credit, proportional to the amount of income they earn and the size of their families -For those with very low incomes, the credit may be larger than the amount owed in taxes, in which case the balance is paid to the family as a tax "refund" -The EITC is a way to encourage work while still providing income support to families with very low income

Poverty From Generation to Generation

-People who grow up in poor families are more likely to be poor themselves -One reason is straightforward: Poor parents tend to have limited money to bequeath to the next generation -Two other economic ideas— human capital and social networks—capture somewhat more subtle mechanisms -Family and community poverty may also pass from generation to generation through more subtle channels -Economic research shows that people at all income levels find jobs and other opportunities through their social networks (friends of your parents, neighbors, and others in your community)

Why are people poor?

-Poverty can be a matter of bad circumstances, bad choices, bad luck, or a combination -But we know from observation that some common factors make falling into poverty more likely, and climbing out of it harder -Poverty from generation to generation -Poverty creates poverty -Poverty in the community -Inequality

Inequality

-Poverty in the United States has decreased over the last few decades, however, income inequality has increased, mostly as a result of gains by the rich -The degree of inequality can be an important factor that signals or causes other things going on in the economy, such as the incentive people at the top have to work hard or the resources available to people at the bottom to invest in human capital

The Face of US Poverty Graphic

-Poverty rates may have improved for the elderly, but they remain high for other parts of the population (black and Hispanic Americans have poverty rates twice as high as white American) -One other notable fact is that households headed by single women are especially likely to be poor

Trade-offs Between Equity and Efficiency

-Public welfare programs can be costly and have to be paid for by taxes -Pursuing equity (that is, greater income equality) thus means accepting some inefficiency due to increased taxation -Welfare programs themselves can also distort choices and create inefficiencies -Some government programs that aim to reduce poverty are universal, meaning that everyone qualifies regardless of whether or not they are poor

Social-Insurance Programs

-Social-insurance programs are designed to help people weather temporary bad periods, but they also help people survive old age, disability, or other long-term conditions -The government plays a role similar to that of a private insurance company: It collects contributions from working people in a common pool, defines the circumstances under which people are eligible to draw benefits, and administers and monitors the allocation of those benefits

Redistribution

-Some policies explicitly seek to redistribute resources with the aim of alleviating the effects of poverty or income inequality -Homeless shelters and food banks don't have much to do with long-run economic development -Instead, they are meant to provide comfort and security to people who face an immediate lack of food and shelter -Similarly, government-subsidized housing, food stamps, Medicaid (health insurance for low-income households), and many other programs offer resources to the poor over the long term -These programs used to ensure a basic minimum standard of living for its poorer members -One of the three different types of public policy approaches related to poverty and inequality

Why Are Programs Called "Social Insurance"?

-Such programs are referred to as "social insurance" because they share important characteristics with private insurance programs, pooling risks across a large population -The same is true for Social Security and Medicare, but the risks in these programs are spread across time -In both programs, benefits are provided by younger workers, who pay into the system under the promise that they'll get benefits when they retire

How The $1.25 Was Chosen

-The $1.25 (PPP) per day line was chosen by averaging the national poverty lines of 15 poor countries -The idea is that this low poverty line represents absolute (not relative) poverty by some globally comparable standard -The $1.25 line is so low that it's not very relevant for the United States, but it gives a useful global snapshot -Overall, rapid economic growth has reduced the global poverty rate from above 50 percent to below 25 percent (heavily concentrated in China) -To get a better picture, economists also use poverty lines higher than $1.25 per person per day, most often an alternative line set at $2 per person per day -It turns out, though, that most families' income fluctuates up and down around the average over the course of the year -Instead the income earned in any given week depends on factors like whether jobs are available and the bounty of the recent harvest

Income Mobility in Rich Countries Graphic

-The United States has had high absolute mobility in the last century -In relative terms, however, the United States has much less income mobility -It takes an average of six generations for the benefits of being born into a wealthy family to disappear

Progressive Taxation

-The design of the U.S. federal income tax system is progressive, which means that the government charges lower tax rates to those with lower incomes -This design has the effect of reducing income inequality: Those with high income tend to pay a larger proportion of their income as taxes than those with low income -The result is that the after-tax gap between rich and poor is smaller than the pre-tax gap -Other types of taxation— such as sales and payroll taxes—can be regressive, but the overall burden of federal taxation in the U.S., though, is progressive

When The Difference Between Chronic and Transient Poverty Matters

-The difference between transient and chronic poverty matters when evaluating anti-poverty policies -Programs like unemployment insurance, disability or health insurance, and job training can be helpful in tackling transient poverty, but are unlikely to make a big dent in chronic poverty -Addressing long-lasting poverty requires digging deeper to understand what causes a person to be poor over many years, or a family over many generations

The Welfare State

-The term "welfare state" describes the idea that government has a responsibility to promote the economic well-being of its citizens -The basics of the welfare state in the United States started as part of the New Deal legislation that responded to the Great Depression in the 1930s (Social Security and the Civilian Conservation Corps) -These programs range from food stamps that help the poor buy food, to Head Start, an early-childhood education program

Poverty Traps in Rich Countries

-There are also many poverty traps that affect people in rich countries -Suppose you lose your job, can't pay your rent, and suddenly become homeless and you want to apply for new jobs -What should you put down as your contact address? -Where will you shower and change before interviews? -Not having a job to begin with actually makes it harder to find a job

Do free markets reduce discrimination?

-Under some conditions, markets may help to eliminate discrimination as the shop owner's competitors will take advantage of his discrimination -If the market is competitive, the discriminatory shop owner will get pushed out of the market; his competitors will benefit from his inefficient choices -Under other circumstances, however, discrimination can be consistent with an efficient market -For much of the twentieth century, for instance, shopkeepers who discriminated against black customers were the norm rather than the exception

Cons of Means-Testing

-Unfortunately, means-testing can create perverse incentives -If your income is under the poverty line, you are eligible for a cash transfer of $5,000 per year, but if your income is over the poverty line, you are not -Unless there is some sort of extra benefit we're not considering (gaining experience or favor with your boss that will improve your job opportunities down the road, for example), most people would say no to longer hours for lower income

Measuring Discrimination in The Labor Market

-We should be careful about confusing correlation with causation -In this case, income is correlated with race and gender -That doesn't necessarily mean that discrimination based on race and gender is causing the difference in wages (could be because of omitted variables) -It's also important to remember that we don't know what might be causing differences in those other factors -Suppose that a large part of the difference in wages between men and women can be explained by differences in occupational choice -This doesn't tell us why women are more likely to be nurses—maybe it's a response to social pressures, or a need for flexibility in work hours, or maybe it has to do with differences in how girls and boys are brought up

Lorenz Curve

A graphic representation of income distribution that maps percentage of the population against cumulative percentage of income earned by those people -It shows the cumulative percentage of the population on the y-axis, and the cumulative percentage of income those people earn on the x-axis -If every person earned the exact same amount, the curve would be a straight line with a slope of 1 -However, if income is unequally distributed, the Lorenz curve will be bowed out in a U-shape

Absolute Poverty Line

A measure that defines poverty as income below a certain amount, fixed at a given point in time -In the United States, for instance, a single person with three children who earns less than $22,350 per year is below the poverty line, as shown in Table 21-1 -An absolute poverty line is usually set based on the cost of certain essential goods

Relative Poverty Line

A measure that defines poverty in terms of the income of the rest of the population -Rather than measuring absolute deprivations, the relative poverty line defines poverty in relation to the income of the rest of the population -A 5% economic growth helps poor families, but it won't necessarily reduce the official poverty rate -In fact, the official poverty rate might even rise if the income of the median household grows faster than 5 percent

In-Kind Transfer

A program that provides specific goods or services, rather than cash, directly to needy recipients -In the United States, common in-kind transfers include public housing, free school lunches, and the medical treatment benefits provided by Medicaid -Often, in-kind transfers take the form of vouchers that are redeemable only for certain items -For example, the Supplemental Nutrition Assistance Program (formerly known as the Food Stamp Program) sends vouchers to families that can be used to purchase only approved food items

Gini Coefficient

A single-number measure of income inequality; ranges from 0 to 1, with higher numbers meaning greater inequality -The Lorenz curve allows us to calculate a final and even more concise inequality metric—the Gini coefficient -The Gini coefficient is equal to the area between the Lorenz curve and the line of perfect equality (area A in Figure 21-4) divided by the total area under the line of perfect equality (area A plus area B in the figure) -If everyone earned the same amount and the income distribution were perfectly equal, the Gini coefficient would be zero: The Lorenz curve would be the line of perfect equality, and so the area between them would be 0 -If one person earned all of the income and no one else earned anything, the Gini coefficient would be 1 -In reality, the distribution is always somewhere between these extremes -The closer the Gini coefficient is to 1, the more unequal the income distribution

Social Insurance

Government programs under which people pay into a common pool and are eligible to draw on benefits under certain circumstances -Under these programs, people pay into a common pool and are in turn eligible to draw on benefits under certain circumstances -Important examples in the United States include unemployment insurance, Social Security, and Medicare

Credit Constraint

Inability to get a loan even though a person expects to be able to repay the loan plus interest -Even in the United States, where the financial sector is much more developed, it can be difficult for people without collateral or with bad credit histories to get loans -Even in the United States, where the financial sector is much more developed, it can be difficult for people without collateral or with bad credit histories to get loans -As a result, credit constraints can limit the ability of talented but poor individuals to make profitable investments that will help them climb up the income ladder

Purchasing Power Parity Index (PPP)

Index that describes the overall difference in prices of goods between countries -To create the PPP index, economists collect data on prices in every country and develop an index that describes the overall difference in prices between countries -The aim is to capture the fact that most goods are cheaper in India than they are in the United States, cheaper in the United States than they are in Sweden, and so on -Nevertheless, the PPP index captures key price differences

Discrimination

Making choices by using generalizations based on people's observable characteristics like race, gender, and age

Poverty Trap

Self-reinforcing mechanisms that cause the poor to stay poor -There can also be self-reinforcing mechanisms that make it hard for individuals to break out of poverty once they are already poor, regardless of family background

Income Mobility

The ability to improve one's economic circumstances over time -One way to consider the relationship between inequality and opportunities is to look at income mobility -Just as with poverty, we can measure income mobility in both absolute and relative terms (both important) -In absolute terms, we can look at whether a person's income is higher than her parents' -In relative terms, we can look at whether a person's income places her higher up in the income distribution than her parents

Means-Tested

The characteristic of a program that defines eligibility for benefits based on recipients' income -The goal of means-testing is to target resources toward those who need them the most -Often, means-testing is more complex than a simple eligible/not-eligible distinction -For instance, under the Earned Income Tax Credit described earlier, the size of the credit at first increases with earned income at very low income levels and then begins to decrease as income rises past the poverty line

Poverty Rate

The percentage of the population that falls below the absolute poverty line

Human Capital

The set of skills, knowledge, experience, and talent that determine the productivity of workers -You acquire human capital by getting a good education, being healthy, and gaining experience in jobs -You also benefit from watching and learning from the people around you -Workers have different amounts and types of human capital that allow them to be more or less productive at different tasks, and therefore earn more or less money -Evidence shows that children in poor communities typically have reduced opportunities to acquire human capital, for many reasons