Income Distribution and Poverty: Fernando & Yvonn Quijano

Chapter
16
Income Distribution
and Poverty
Prepared by:
Fernando & Yvonn Quijano
© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair
Income Distribution
and Poverty
16
Chapter Outline
The Utility Possibilities Frontier
The Sources of Household Income

Wages and Salaries
Income from Property
Income from the Government: Transfer
Payments
The Distribution of Income

Income Inequality in the United States
Poverty
The Distribution of Wealth
The Redistribution Debate

Arguments against Redistribution
Arguments in Favor of Redistribution
Redistribution Programs and Policies

Financing Redistribution Programs: Taxes
Expenditure Programs
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How Effective Are Antipoverty Programs?
Government or the Market? A Review

© 2007 Prentice Hall Business Publishing Principles of Economics 8e by Case and Fair 2 of 38
INCOME DISTRIBUTION AND POVERTY
equity Fairness.
Why do some people get more than others? What

are the sources of inequality? Should the
government change the distribution generated by
the market?
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THE UTILITY POSSIBILITIES FRONTIER
FIGURE 16.1 Utility Possibilities Frontier
utility possibilities frontier A graphic

representation of a two-person world that
shows all points at which A’s utility can be
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increased only if B’s utility is decreased.

THE SOURCES OF HOUSEHOLD INCOME
Households derive their incomes from three basic sources: (1) from wages or salaries
received in exchange for labor; (2) from property—that is, capital, land, and so forth; and (3)
from government.
WAGES AND SALARIES
Required Skills, Human Capital, and Working

Conditions
human capital The stock of knowledge,

skills, and talents that people possess; it
can be inborn or acquired through education
and training.
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compensating differentials Differences in

wages that result from differences in working
conditions. Risky jobs usually pay
higher wages; highly desirable jobs usually
pay lower wages.
According to experts, the Alaskan

fishing industry faces the most
dangerous working conditions in the
country. For this reason, Alaskan
fishermen are paid compensating
differentials that raise their average
wage high above the average wage
of the U.S. general population.
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Multiple Household Incomes
Another source of wage inequality among

households lies in the fact that many households
have more than one earner in the labor force.
Second, and even third, incomes are becoming more
the rule than the exception for U.S. families.
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The Minimum Wage Controversy
minimum wage The lowest wage that

firms are permitted to pay workers.
Many fast-food restaurants pay their

employees minimum wage. In some
locations, however, restaurants
find that they must pay above
minimum wage to attract and retain
staff.
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FIGURE 16.2 Effect of Minimum Wage Legislation
Unemployment
Unemployment hurts primarily those who are laid off,

and thus its costs are narrowly distributed. For some
workers, the costs of unemployment are lowered by
unemployment compensation benefits paid out of a
fund accumulated with receipts from a tax on
payrolls.
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INCOME FROM PROPERTY
property income Income from the

ownership of real property and financial
holdings. It takes the form of profits,
interest, dividends, and rents.
The amount of property income that a household earns depends on (1) how much property it
owns and (2) what kinds of assets it owns. Such income generally takes the form of profits,
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interest, dividends, and rents.
INCOME FROM THE GOVERNMENT: TRANSFER

PAYMENTS
transfer payments Payments by

government to people who do not supply
goods or services in exchange.
Transfer programs are by and large designed to provide income to those in need. They
are part of the government’s attempts to offset some of the problems of inequality and
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poverty.
THE DISTRIBUTION OF INCOME
economic income The amount of money a

household can spend during a given period
without increasing or decreasing its net
assets. Wages, salaries, dividends, interest
income, transfer payments, rents, and so
forth are sources of economic income.
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INCOME INEQUALITY IN THE UNITED STATES

TABLE 16.1 Distribution of Total Income and Components in the United States, 2000
(Percentages)
TOTAL LABOR PROPERTY TRANSFER
HOUSEHOLDS INCOME INCOME INCOME INCOME
Bottom fifth 2.7 1.7 0.7 19.2

Second fifth 7.2 6.3 4.2 25.8
Third fifth 12.6 12.7 9.2 23.0
Fourth fifth 21.3 23.6 15.1 17.0
Top fifth 56.7 55.6 73.2 14.8
Top 1 percent 14.8 10.9 31.6 1.2
Source: Julie-Anne Cronin, US Department of the Treasury, OTA Paper 85, pg 19.
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Changes in the Distribution of Income
TABLE 16.2 Distribution of Money Income of U.S. Families by Quintiles, 1947–2000

(Percentages)
1947 1960 1972 1980 1984 1994 1997 2000
Bottom fifth 5.0 4.8 5.4 5.2 4.7 4.2 4.2 4.2
Second fifth 11.8 12.2 11.9 11.5 11.0 10.0 9.9 9.7
Third fifth 17.0 17.8 17.5 17.5 17.0 15.7 15.7 15.5
Fourth fifth 23.1 24.0 23.9 24.3 24.4 23.3 23.0 23.0
Top fifth 43.0 41.3 41.4 41.5 42.9 46.9 47.2 47.6
Top 5% 17.2 15.9 15.9 15.3 16.0 20.1 20.7 20.8
Source: Statistical Abstract of the United States, various editions; Department of Commerce, HHES Division.
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money income The measure of income

used by the Census Bureau. Because it
excludes noncash transfer payments and
capital gains income, it is less inclusive than
“economic income.”
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The Lorenz Curve and the Gini Coefficient
Lorenz curve A widely used graph of the

distribution of income, with cumulative
percentage of families plotted along the
horizontal axis and cumulative percentage
of income plotted along the vertical axis.
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FIGURE 16.3 Lorenz Curve for the United States, 2002
Gini coefficient A commonly used

measure of inequality of income derived
from a Lorenz curve. It can range from
0 to a maximum of 1.
If income is equally distributed, there is no shaded area (because the Lorenz curve and
the 45-degree line are the same), and the Gini coefficient is zero. The Lorenz curves for
distributions with more inequality are farther down to the right, their shaded areas are
larger, and their Gini coefficients are higher. The maximum Gini coefficient is 1. As the
Lorenz curve shifts down to the right, the shaded area becomes a larger portion of the
total triangular area below 0 A. If one family earned all the income (with no one else
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receiving anything), the shaded area and the triangle would be the same, and the ratio
would equal 1.
Differences among African-American
Households, White Households, and Single-
Person Households
TABLE 16.3 Distribution of Money Income of Households, 2002 (Percentages)
AFRICAN-
ALL AMERICAN WHITE HISPANIC ONE-PERSON
HOUSEHOLDS HOUSEHOLDS HOUSEHOLDS HOUSEHOLDS HOUSEHOLDS
0-15,000 16.1 27.4 14.5 19.1 36.3

15-25,000 13.2 16.4 12.8 17.2 19.8
25-35,000 12.3 14.5 12.0 15.7 13.7
35-50,000 15.1 14.8 15.2 16.4 13.4
50-75,000 18.3 13.9 18.9 16.9 9.7
75,-100,000 11.0 6.7 11.6 7.5 3.7
>100,000 14.1 6.4 15.0 7.2 3.5
Total 100.0 100.0 100.0 100.0 100.0
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Note: Totals may not add to 100 due to rounding.

Source: Statistical Abstract of the United States, 2002, Tables 665 and 667.
POVERTY
The Problem of Definition
Although it is difficult to define precisely, the word

poverty is one that we all understand intuitively to
some degree.
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The Official Poverty Line
poverty line The officially established

income level that distinguishes the poor
from the nonpoor. It is set at three times
the cost of the Department of Agriculture’s
minimum food budget.
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The official poverty line has been set at a figure that is simply three times the cost of
the Department of Agriculture’s minimum food budget.
Poverty in the United States Since 1960

TABLE 16.4 Percentage of Persons in Poverty by
Demographic Group, 1964–2001
OFFICIAL OFFICIAL
MEASURE MEASURE
1964 2004
All 19.0 12.7

White 14.9 10.8
African-American 49.6 24.7
Hispanic NA 21.8
Female householder –
no husband present 45.9 28.4
Elderly (65+) 28.5 9.8
Children under 18 20.7 17.8
Includes food, housing, and medical benefits.

a
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Source: Statistical Abstract of the United States, 2002-2005.
THE DISTRIBUTION OF WEALTH
TABLE 16.5 Percentage of Different Assets Owned by Households, 1998 Survey of

Consumer Finances
COMMON STOCK NONEQUITY
PERCENTAGE OF EXCLUDING ALL COMMON FINANCIAL HOUSING NET
OWNERS PENSIONS STOCK ASSETS EQUITY WORTH
Top .5% 41.4 37.0 24.2 10.2 25.6
Top 1% 53.2 47.7 32.0 14.8 34.0
Top 10%t 91.2 86.2 72.2 50.7 68.9
Bottom 80% 1.7 4.1 14.0 29.3 18.5
Source: James Poterba, “Stock Market Wealth and Consumption,” Journal of Economic Perspectives, 14(2), 99 – 118 , Spring 2000.
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THE REDISTRIBUTION DEBATE
ARGUMENTS AGAINST REDISTRIBUTION
Those who argue against government redistribution

believe that the market, when left to operate on its
own, is fair.
ARGUMENTS IN FAVOR OF REDISTRIBUTION
The argument most often used in favor of

redistribution is that a society as wealthy as the
United States has a moral obligation to provide all its
members with the necessities of life.
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Utilitarian Justice
utilitarian justice The idea that “a dollar in

the hand of a rich person is worth less than
a dollar in the hand of a poor person.” If
the marginal utility of income declines with
income, transferring income from the rich to
the poor will increase total utility.
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Social Contract Theory—Rawlsian Justice
Rawlsian justice A theory of distributional

justice that concludes that the social
contract emerging from the “original
position” would call for an income
distribution that would maximize the well-
being of the worst-off member of society.
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The Works of Karl Marx
labor theory of value Stated most simply,

the theory that the value of a commodity
depends only on the amount of labor required
to produce it.
Income Distribution as a Public Good
We turn to government to provide things we

want that will not be provided adequately if we
act separately—in this case, help for the poor
and hungry.
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REDISTRIBUTION PROGRAMS AND POLICIES
FINANCING REDISTRIBUTION PROGRAMS: TAXES
Redistribution always involves those who end

up with less and those who end up with more.
Because redistributional programs are
financed by tax dollars, it is important to know
who the donors and recipients are—who pays
the taxes and who receives the benefits of
those taxes.
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All people pay about the same percentage of their income in total taxes.
TABLE 16.6 Effective Rates of Federal, State, and Local Taxes, 2000
(Taxes as a Percentage of Total Income)
FEDERAL TOTAL
Bottom 20% 5.9 28.1

Second 20 11.7 26.3
Third 20 17.4 29.2
Fourth 20 20.1 32.6
Top 20 24.6 33.9

Top 10 25.7 34.5
Top 5 26.6 34.9
Top 1 29.1 37.0
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Source: Julie-Anne Cronin, US Department of the Treasury, OTA Paper 85 and authors’ estimate.
EXPENDITURE PROGRAMS
Social Security
Social Security system The federal

system of social insurance programs. It
includes three separate programs that are
financed through separate trust funds: the
Old Age and Survivors Insurance (OASI)
program, the Disability Insurance (DI)
program, and the Health Insurance (HI, or
Medicare) program.
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Public Assistance
public assistance, or welfare Government

transfer programs that provide cash benefits
to (1) families with dependent children
whose incomes and assets fall below a very
low level and (2) the very poor regardless of
whether or not they have children.
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Supplemental Security Income
The Supplemental Security Income program (SSI) is

a federal program that was set up under the Social
Security Administration in 1974.
Unemployment Compensation
unemployment compensation A state

government transfer program that pays
cash benefits for a certain period of time to
laid-off workers who have worked for a
specified period of time for a covered
employer.
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Medicaid and Medicare
Medicaid and Medicare In-kind

government transfer programs that provide
health and hospitalization benefits:
Medicare to the aged and their survivors
and to certain of the disabled, regardless of
income, and Medicaid to people with low
incomes.
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Food Stamps
food stamps Vouchers that have a face

value greater than their cost and that can be
used to purchase food at grocery stores.
Housing Programs
The Earned Income Tax Credit

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HOW EFFECTIVE ARE ANTIPOVERTY

PROGRAMS?
Some say economic growth is the best way to cure

poverty.
The opposite view is that poverty would be much

more widespread without antipoverty programs.
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GOVERNMENT OR THE MARKET? A REVIEW
Remember that government is not a cure for all

economic woes. There is no guarantee that public-
sector involvement will improve matters. Many argue
that government involvement may bring about even
more inequity and inefficiency because bureaucrats
are often driven by self-interest, not public interest.
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REVIEW TERMS AND CONCEPTS
compensating differentials money income

economic income poverty line
equity property income
food stamps public assistance, or welfare
Gini coefficient Rawlsian justice
human capital Social Security system
labor theory of value transfer payments
Lorenz curve unemployment
Medicaid and Medicare compensation
minimum wage utilitarian justice
utility possibilities frontier
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Income Distribution and Poverty: Fernando & Yvonn Quijano

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Chapter

Fernando & Yvonn Quijano

The Sources of Household Income

The Distribution of Income

The Redistribution Debate

Redistribution Programs and Policies

How Effective Are Antipoverty Programs?

Government or the Market? A Review

Why do some people get more than others? What

FIGURE 16.1 Utility Possibilities Frontier

utility possibilities frontier A graphic

increased only if B’s utility is decreased.

WAGES AND SALARIES

Required Skills, Human Capital, and Working

human capital The stock of knowledge,

compensating differentials Differences in

According to experts, the Alaskan

Multiple Household Incomes

Another source of wage inequality among

The Minimum Wage Controversy

minimum wage The lowest wage that

Many fast-food restaurants pay their

FIGURE 16.2 Effect of Minimum Wage Legislation

Unemployment hurts primarily those who are laid off,

INCOME FROM PROPERTY

property income Income from the

interest, dividends, and rents.

INCOME FROM THE GOVERNMENT: TRANSFER

transfer payments Payments by

economic income The amount of money a

INCOME INEQUALITY IN THE UNITED STATES

Bottom fifth 2.7 1.7 0.7 19.2

Changes in the Distribution of Income

TABLE 16.2 Distribution of Money Income of U.S. Families by Quintiles, 1947–2000

money income The measure of income

The Lorenz Curve and the Gini Coefficient

Lorenz curve A widely used graph of the

FIGURE 16.3 Lorenz Curve for the United States, 2002

Gini coefficient A commonly used

0-15,000 16.1 27.4 14.5 19.1 36.3

Note: Totals may not add to 100 due to rounding.

Although it is difficult to define precisely, the word

The Official Poverty Line

poverty line The officially established

Poverty in the United States Since 1960

All 19.0 12.7

Includes food, housing, and medical benefits.

Source: Statistical Abstract of the United States, 2002-2005.

THE DISTRIBUTION OF WEALTH

TABLE 16.5 Percentage of Different Assets Owned by Households, 1998 Survey of

Top .5% 41.4 37.0 24.2 10.2 25.6

Top 1% 53.2 47.7 32.0 14.8 34.0

Top 10%t 91.2 86.2 72.2 50.7 68.9

Bottom 80% 1.7 4.1 14.0 29.3 18.5

ARGUMENTS AGAINST REDISTRIBUTION

Those who argue against government redistribution

ARGUMENTS IN FAVOR OF REDISTRIBUTION

The argument most often used in favor of

utilitarian justice The idea that “a dollar in

Social Contract Theory—Rawlsian Justice

Rawlsian justice A theory of distributional

The Works of Karl Marx