Economics - Chapter 12: Economics of Inequality and Poverty
Gini Coefficient Range
0-1 0 = perfect equality 1 = perfect inequality
List the sources of economic inequality
1. Differences in income 2. Differences in wealth 3. Differences in education opportunities 4. Differences in healthcare 5. Differences in nutrition
List the problems with measuring poverty
1. Different approaches to measuring poverty in different countries 2. Hard to define poverty 3. The way poverty is measured - Surveys - Door-to-door - Many people will either give inaccurate or no information on their income (personal subject) - Only talk to people who live in homes (do not talk to people affected most by poverty: homeless people) 4. Poverty line is a national average - Regional differences throughout a country 5. Poverty line only tells us the percentage of people under it, but not how far below it they are - Hard to tell the extent of the poverty 6. Government could mask their poverty (underestimate numbers) - Make themselves look good 7. Government could overestimate their poverty levels for aid - Manipulate foreign/international bodies into supporting them financially
List the 3 Impacts of Income and Wealth Inequality.
1. Impact on Economic Growth 2. Impact on Standards of Living 3. Impact on Social Stability
List the 8 causes of Economic Equality and Poverty.
1. Inequality of Opportunity 2. Different Levels of Resource Ownership 3. Different Levels of Human Capital 4. Discrimination 5. Unequal Status and Power 6. Government Tax and Benefit Policies 7. Globalisation and Technological Change 8. Market-Based Supply Side Policies
List other policies, other than taxation, which can reduce poverty, income and wealth inequalities, through reducing inequality of opportunity.
1. Investment in Human Capital 2. Transfer Payments 3. Targetted Spending on Goods and Services 4. Universal Basic Income (UBI) 5. Policies to Reduce Discrimination 6. Minimum Wage Legislation
Ways to measure poverty
1. Minimum Income Standards (MIS) 2. Composite Indicator: - Multidimensional Poverty Index (MPI)
US wealth and income statistics
10% of the population own 80% of the wealth The bottom 40% own only 2% of the wealth The top 8% earn over 28% of all income in the US
Denmark wealth and income statistics
3rd in the world for highest wealth inequality. The bottom 60% of households in Denmark earn more than they owe. - High levels of indebtedness (high levels of debt) Income inequality is very low - Shows that income inequality and wealth inequality are not necessarily correlated
What percentage of the world population (approximately) lives under the poverty line of upper-middle income countries ($5.50)?
50% of the world population lives under this poverty line
Gini Coefficient/Index Formula
A / (A+B)
Define Wealth tax
A tax on the value of one's assets. - A type of direct tax
Define Sales Tax (VAT)
Amount of tax goes up as the price of the goods goes up. - A type of indirect tax; hence, regressive
Define Excise Tax
Amount of tax is per unit (e.g. $1 per bottle of wine) - A type of indirect tax; hence, regressive
Explain how income and wealth inequality impact social stability
Areas with a high degree of income inequality in the society often exhibit tensions between the income groups Higher-income groups often control the power and political influence - Pass laws to benefit themselves, so the income inequality widens Lower-income groups often feel socially inferior and become dissatisfied with their situation - Causes social conflicts - Riots, protests, demonstrations Becomes more difficult to reach consensus betweeen the groups
How do you calculate income tax
Break income down into tax brackets - Pay everything up to the given income level
Explain Discrimination as a cause of economic inequality and poverty
Certain members of a society face discrimination, based on various factors/criteria Discrimination manifests itself in the job market, and can affect the wages/incomes that individuals receive Discrimination can also be found in the outcomes they obtain - Can lead to certain sectors of the economy not getting access to good education or health care
Explain Composite Indicators and Multidimensional Poverty Index (MPI) as measurements of poverty.
Composite indicators: indicators that measure complex issues, that can not just be measured by one indicator. MPI is a composite indicator, because it is "multidimensional". MPI Scale between 0 and 1 - The closer to 1, the worse/higher the poverty To be considered poor, you must be deprived of at least 1 of the 3 dimensions/criteria (health, education, living standards) Countries are grouped by which of the 3 criteria they do or do not meet
Total Spending Formula
Disposable income × portion of income spent
Relationship between equity and equality
Equity: - Normative concept (subjective) - Refers to "fairness" Equality: - Positive concept (objective) - Refers to being equal and the same
Explain proportional tax
Example: 15% tax on income regardless of income - Flat tax Being considered by many governments to simplify their tax systems Increases the incentive to work harder to make more money; a more progressive system can be discouraging to people wanting to make more money if they have to pay a higher percentage of their income as they make more money
What could discrimination be based on?
Gender Race Ethnicity Age Religion Sexual orientation
Explain Universal Basic Income (UBI) as a policy to reduce inequality of opportunity
Government gives everyone a certain amount of income - Everyone deserves a set amount of income, no matter their background Finland was one of the first countries to introduce this Combats structural unemployment - Unemployed people have time to sort themselves out and find a new job, while being able to provide themselves with essentials Helps recent university graduates, young couples, and more Stabilises the economy Problems with UBI: - Opportunity cost - Huge expense to government - Can disincentivise people from working - Research suggests otherwise (research shows people are equally/more incentivised to work with a UBI), but could still be true in some cases
Explain Targetted Spending on Goods and Services as a policy to reduce inequality of opportunity
Government uses its revenues to make sure people can afford socially desirable goods (AKA merit goods) - These goods have positive externalities of consumption - If left to the free market, these goods and services would be underprovided and underconsumed - Note: in a free market, public goods would not be provided at all Merit goods: - Education - Healthcare - Clean water - Sanitation - Sewage Government can either provide these themselves, or make the private sector do this - Subsidises the private sector to do this - Costs of production decrease (S shifts rightward/down) - Lower prices, higher quantity demanded Problems with this policy: - Opportunity cost - Could be quality issues - Government may be inexperienced in providing these goods - If government hands out many contracts, competitiveness decreases - Firms work less hard to be efficient; inefficiency of allocation increases
Explain Policies to Reduce Discrimination as a policy to reduce inequality of opportunity
Governments need ti ensure that firms enforce discrimination laws - Ensure everyone is treated equally and have access to all types of jobs - People being discriminated against have fewer opportunities Discrimination can be based on: - Age - Race - Ethnicity - Gender - Sexuality/sexual orientation
Explain how income and wealth inequality impact economic growth
Higher income inequality often results in lower economic growth Lower-income families invest less in education - Lower quality of labour; low/negative LR economic growth The wider the gap of income inequality, the less will be spent on consumption (C) - The rich spend a smaller fraction of an increase in income than the poor - C does not increase much; low/negative SR economic growth However, income inequality is in some ways necessary - Incentivise the poor to work harder and invest more in education - Quality of labour increases; LR economic growth - Need an upper-class to have high levels of savings, as savings are funds for firms' investments - Investments (I) increase; SR economic growth
What is an unequal distribution of income?
How evenly (or unevenly) income is distributed in a population. These incomes being distributed unevenly include: - Wages (labour) - Rent (land) - Interest (borrowing / capital) - Interest on savings deposit - Dividends (stocks / shares)
Define Economic Inequality
How people in a population differ in their ability to meet their economic needs, and thus have different living conditions.
In OECD countries, what is the relationship between wealth inequality and income inequality?
In OECD countries, wealth inequality is two times (double) the level of income inequality
Explain direct taxes
Includes personal income tax on individuals, and corporate income tax on company's profit It reduces the income earners in society; redistributes income
Define Transfer Payments
Income received without there being any corresponding output in the economy.
Total tax paid formula
Income tax + VAT paid or Direct tax + indirect tax
What kinds of concepts are income and wealth?
Income: flow concept Wealth: stock concept
Explain Globalisation and Technological Change as a cause of economic inequality and poverty
Increased global trade means firms can locate anywhere in the world - Usually means MDCs locate their production in other cheap countries (LDCs) Results in demand for manufacturing jobs in MDCs decreasing, while demand for highly-skilled labour in MDCs increases People with more education/skill (highly-skilled labour) earn higher incomes in MDCs than those in LDCs, where demand is high for manufacturing (lower-skill) jobs As technology increases, it replaces jobs that require repetitive work with machines - Low-income jobs replaced with machines - Worsens economic inequality
Explain Unequal Status and Power as a cause of economic inequality and poverty
Individuals earn higher status through income, wealth, or education Individuals of higher status often have more power in a society and can control or influence policy-making People with more status can use their income/wealth to influence policy-makers to introduce policies which benefit them, as opposed to poorer people Those without status do not have such power, and often do not have a voice for their interests
Which types of economies suffer most from inequitable distribution of income, and why?
Inequitable distribution of income is prevalent in free-market economies. - Ownership of factors of production is unequal (e.g. quantity or quality of labour is better for some firms/families than others)
What are the three poverty lines?
International poverty line: $1.90 Low-middle income countries poverty line: $3.20 Upper-middle income countries poverty line: $5.50
Explain Investment in Human Capital as a policy to reduce inequality of opportunity
Invest in labour Give everyone an equal opportunity/outcome in life Done through two factors: - Education - Healthcare Someone with a deprivation in education or healthcare can not achieve the same as someone in a higher income family Government must intervene to guarantee good access to education and healthcare - Therefore, these must be available for free - Gives everyone the same opportunities
How to find amount of spending before VAT, and amount paid in VAT, from the VAT percentage
Let X = the amount of spending before VAT X + (VAT)X = Total spending (1+VAT)X = Total spending X = Total spending / (1+VAT) Amount paid in VAT = Total spending - Amount of spending before VAT
Reasons for wealth inequality being greater than income inequality
Limited growth in wages makes it difficult for low-income and middle-income people to save and accumulate wealth. High-income people tend to consume a smaller fraction of their income than lower-income people therefore have greater possibilities of saving and accumulating wealth. Income and wealth inequalities feed on each other. The greater the income, the more possibilities for accumulating wealth, but many types of wealth (stocks, bonds, real estate) lead to even more income and hence even more possibilities for accumulating more wealth.
What 3 dimensions does MPI use to measure poverty?
MPI measures poverty by 3 dimensions: 1. Health - Child Mortality - Nutrition 2. Education - Years of schooling - Attendance Percentage 3. Living Standards - Housing - Assets (TV, phone, etc.) - Cooking fuel - Drinking water - Electricity - Sanitation - (Access to public services)
Define Relative Poverty
Measurement of people in a population with an income level below that which allows them to afford a lifestyle typical of their society. If a person or a family makes less than 50% of the median income level of a country, they are considered relatively poor.
Explain Minimum Wage Legislation as a policy to reduce inequality of opportunity
Minimum wage is above the equilibrium wage rate (equilibrium wage rate: where S and D meet in an S-D diagram for the labour market) - Equilibrium wage rate is a price floor - Quantity supplied (Qs) > quantity demanded (Qd); excess supply of labour Government raising minimum wage will benefit poor people / minimum wage workers - Costs of production increase - Theory predicts quantity demanded for labour decreases when minimum wage increases, but evidence suggests this is not the case
Evaluate redistributive effects as a side effect of taxation.
New classical economists don't believe in this much taxation - Income tax ↑ decreases output; people work less, which could mean quantity of labour ↓; LRAS↓ - Firms don't like corporate taxes; I↓, production↓, quality of capital (technology) ↓; LRAS↓ As poorer people are given/earn more money, consumption (C) increases - Hence, AD increases, so Y increases, meaning SR economic growth The more money rich people have, the more savings - Investments (I) increase (AD rightwards) - Quantity of capital increases (LRAS rightwards)
Statistics for population living under the poverty line in: - Norway - The US - India - China
Norway: 0.2% USA: 1.2% India: 13.4% China: 0.7%
Portion of population living in relative poverty in: - Norway - The US
Norway: 8.4% USA: 17.8%
Explain indirect tax
Paid to tax officials by suppliers of goods and services, NOT by consumer Sales tax may be reduced on certain items the government feels are essential (food, medicine, rent) to promote equity
List circumstances that affect life's opportunities
Parents' level of education Parents' level of income Access to healthcare as a child Place of birth Access to education Gender, race, ethnicity
Explain Inequality of Opportunity as a cause of economic inequality and poverty
People are born into different circumstances - beyond one's control - Different opportunities as they grow up Due to one's inability to control the circumstance, there will be vastly different economic equality for people in different countries
Explain Different Levels of Human Capital as a cause of economic inequality and poverty
People possess different levels of education, skills, and good health to be productive labour resources The less education/skills/good health one has, the lower the income potential and the higher the degree of income inequality
Explain Market-Based Supply-Side Policies as a cause of economic inequality and poverty
Policies which increase LRAS - Get the markets to work more efficiently and reduce government intervention Includes policies such as: - Reducing labour union power - Reducing minimum wages - Deregulating the financial markets - Help the rich earn more from investments - Deregulating the labour markets - Worsened conditions for labourers All these policies are seen to help the rich but disadvantage the poor - Increase income inequality and poverty
Define Regressive Tax
Proportion of income paid in taxes goes down as income of taxpayer goes up.
Define Progressive Tax
Proportion of income paid in taxes goes up as income of taxpayer goes up.
Define Proportional Tax
Proportion paid in tax remains the same as income of taxpayers changes.
Explain regressive tax
Same amount paid in taxes, regardless of income - The higher the income, the smaller percentage the tax takes up The average tax rate (amount of tax paid ÷ income) falls as income rises - Denominator increases, but numerator stays the same Indirect taxes (VAT) are regressive - A larger percentage of low income households' budget is spent on alcohol, cigarettes, etc.
Explain Minimum Income Standards (MIS) as a measurement of poverty
Sets the poverty line at the minimum amount of income needed to be able to enjoy a basic standard of living in a particular country. Done by creating a basket of goods and services that are considered to be essential. MIS is found by finding the amount of income needed to afford this basket. - Basket is weighted by importance (e.g. fuel is important, so it is weighted) Different family types (e.g. number of children) and different geographical regions (urban or rural) can have different MIS values, as the value/quantity of essential goods changes. MIS can be used for different types of people/families, and can be used to find the number of people living under these "poverty lines".
Explain Government Tax and Benefit Policies as a cause of economic inequality and poverty
Some countries use a progressive tax system (tax highest incomes more than the lowest), but most developed countries lower their tax brackets to favour the rich - They also tax savings and corporate profits at lower rates than income taxes; this favours the rich and widens the economic inequality Poorer members of society rely heavily on transfer payments (benefits from unemployment, child support, etc.) - A government can cut these benefits to reduce their government expenses, and this would widen economic inequality
Explain why some economists believe progressive taxes will have disincentive effects.
Some economists believe that people do not want to work harder for more money, when they know that their money will be taxed away (through personal income tax). Wealth tax - People are discouraged from saving; fewer funds available for firms' investments - LRAS shifts leftward; LR negative economic growth Corporate Tax - Profit is taxes - Disinventivised to invest - Investments (I) decrease, so AD decreases; SR negative economic growth Due to disincentive effects, many countries are moving away from progressive taxation - This means increased economic inequality - Lowering taxes does not make people work harder New Classicals: Taxes are government intervention, so taxes are bad - Dislike taxes for reasons mentioned above - Leads to resource misallocation and inefficiency - Society's welfare is maximised when there is no taxation
Explain Different Levels of Resource Ownership as a cause of economic inequality and poverty
Some people own, inherit, or are able to save vast amounts of money (financial capital) - Enables them to affird things that people of lower incomes can not (e.g. houses, shares of stock, companies) Poor housing → poor sanitation → poor health and earning potential
Define Direct Tax
Tax imposed directly on an individual or organisation.
Define Indirect Tax
Tax on a good or service; tax on spending. - Regressive - Consumers pay it to the government through a producer
Explain Transfer Payments as a policy to reduce inequality of opportunity
Tax revenue from rich people is transferred to poorer people - Transferred from one sector to another Examples of transfer payments: - Maternity benefits - Unemployment benefits - Disability benefits - Sick/illness benefits Transfer payments do not contribute to GDP There is an opportunity cost to transfer payments - Less money for infrastructure, healthcare, etc. People may not work as hard with transfer payments - Can live off unemployment benefits - People may not re-enter the labour as quickly as they could - Disincentive effect
Which is typically greater: the Gini coefficient of wealth, or of income?
The Gini coefficient of wealth is typically greater than the Gini coefficient of income. This is because wealth inequality is much greater than income inequality.
What does the government do to combat inequitable income distribution, and why?
The government intervenes by introducing policies to reduce income inequalities - e.g. invest in human capital and improve education opportunities As more workers gain education and skill, they can be hired for better-paying jobs - The government intervenes because more people in higher-paying jobs means higher tax revenues, in addition to increased consumption (C↑), meaning real GDP increases
Explain how income and wealth inequality impact standards of living
The more unequal a society, the more people live in poverty and do not enjoy an adequate standard of living Low incomes → lack of investment in proper healthcare and education → lower human capital (quality of labour) → lower productivity → poverty cycle In areas of low-income residents, there is often crime, drug abuse and homelessness
Explain progressive tax
The more you make, the more you pay - % increases as income increases Average tax rate increases as income increases Includes income tax - Usually, there is a certain level of income that is not taxed, but beyond that, income is taxed The more progressive the tax, the greater the chance it will result in redistribution of income from better off to less well off
How do taxes impact equity?
The taxation system plays a crucial role in determining the distribution of income in a society. Taxes reduce the income and wealth of some groups in society and increase the income and wealth of other groups
Evaluate regressive tax
These taxes can provide the government with many tax revenues and could discourage consumption of demerit goods However, they can worsen income inequality as poorer citizens are paying a higher percentage of their income in regressive taxes than richer citizens
Disposable Income Formula
Total income - income tax paid Disposable income is the amount of income you have after paying your income tax.
What is believed about unequal distribution?
Unequal distribution is inequitable. - Many consider unequal distribution as unfair
Statistics for the Multidimensional Poverty Index (MPI)
Used by LEDCs/LDCs (Lesser (Economically) Developed Countries) Used in 105 countries - 77% of the world's population 25% of the 105 countries are in poverty Of these 25% (approx. 26 countries) in poverty, 89% (approx. 23 countries) are in Sub-Saharan Africa or South-East Asia
What is an unequal distribution of wealth?
Wealth: the value of what you own / assets (stock concept) - Stocks - Property - Money in savings account Wealth is distributed much more unequally than income - Wealth inequality is two times (double) the level of income inequality (in OECD countries) Wealth inequality effects income inequality - If wealth inequality rises, income inequality also rises
Define Absolute Poverty
When a person or a family does not have enough money to meet their basic needs (food, shelter, clothing). If you make less than $1.90 (international poverty line), you are in extreme poverty
Gini Coefficient
a number that summarizes a country's level of income inequality based on how unequally income is distributed across certain subdivisions (e.g. quartiles, quintiles, percentiles, etc. but typically quintiles (i.e. 20% x5))