Chapter 18

PowerPoint Lectures for
Principles of
Microeconomics, 9e
CHAPTER 18 Income Distribution and Poverty
; ; By
Karl E. Case,
Ray C. Fair &
Sharon M. Oster
© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster 1 of 34
PART III MARKET IMPERFECTIONS AND
THE ROLE OF GOVERNMENT
Income Distribution
and Poverty
18
Prepared by:
Fernando & Yvonn Quijano
© 2009 Pearson Education, Inc. Publishing as Prentice Hall Principles of Economics 9e by Case, Fair and Oster
PART III MARKET IMPERFECTIONS AND
THE ROLE OF GOVERNMENT
Income Distribution
and Poverty
18
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
The World Distribution of Income
Causes of Increased Inequality
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
How Effective Are Antipoverty Programs?
Government or the Market? A Review
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?
The Utility Possibilities Frontier
 FIGURE 18.1 Utility

Possibilities Frontier
If society were made up of
two people, I and J, and all
the assumptions of perfect
competition held, the market
system would lead to some
point along PP′. Every point
along PP′ is efficient; it is

impossible to make I better
off without making J worse
off, and vice versa. Which
point is best? Is B better
than C?
utility possibilities frontier A graphic

representation of a two-person world that shows
all points at which I’s utility can be increased only if
J’s utility is decreased.
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.
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.
Wages and Salaries
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.
Wages and Salaries
The Minimum Wage Controversy
minimum wage The lowest wage that firms are

permitted to pay workers.
 FIGURE 18.2 Effect of
Minimum Wage Legislation
If the equilibrium wage in the

market for unskilled labor is
below the legislated
minimum wage, the result is
likely to be unemployment.
The higher wage will attract

new entrants to the labor
force (quantity supplied will
increase from L* to LS), but
firms will hire fewer workers
(quantity demanded will
drop from L* to LD).
Wages and Salaries
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.
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.
Income from the Government: Transfer Payments

transfer payments Payments by government to

people who do not supply goods or services in
exchange.
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 on are sources of
economic income.
TABLE 18.1 Distribution of Total Income and Components in the United States, 2006
(Percentages)
Labor Property Transfer
Households Total Income Income Income Income
Bottom fifth 3.4 1.3 2.2 17.2

Second fifth 9.2 6.7 6.3 24.6
Third fifth 16.3 14.1 11.7 21.2
Fourth fifth 23.6 24.5 14.3 18.3
Top fifth 47.5 53.4 65.5 18.7
Top 1 percent 13.2 10.8 30.6 1.0
Source: Julie-Anne Cronin, US Department of the Treasury, OTA Paper 85, pg 19 and author’s calculations.
Changes in the Distribution of Income
TABLE 18.2 Distribution of Money Income of U.S. Families by

Quintiles, 1967–2006 (Percentages)
1967 1975 1985 1995 2000 2006
Bottom fifth 4.0 4.3 3.9 3.7 3.6 3.4
Second fifth 10.8 10.4 9.8 9.1 8.9 8.6

Third fifth 17.3 17.0 16.2 15.2 14.8 14.5
Fourth fifth 24.2 24.7 24.4 23.3 23.0 22.9
Top fifth 43.6 43.6 45.6 48.7 49.8 50.5
Top 5% 17.2 16.4 17.6 21.6 22.1 22.3
Source: Bureau of the Census, Current Population Survey, Annual Social and Economic Supplements.
money income The measure of income used by

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

distribution of income, with cumulative percentage
of households plotted along the horizontal axis and
cumulative percentage of income plotted along the
vertical axis.
Gini coefficient A commonly used measure of

the degree of inequality of income derived from a
Lorenz curve. It can range from 0 to a maximum
of 1.
The Lorenz Curve and the Gini Coefficient
TABLE 18.2 Distribution of Money Income of

U.S. Families by Quintiles, 1967–
2006 (Percentages)
1967 1975 1985 1995 2000 2006
Bottom 4.0 4.3 3.9 3.7 3.6 3.4
fifth
Second 10.8 10.4 9.8 9.1 8.9 8.6

fifth
Third 17.3 17.0 16.2 15.2 14.8 14.5
fifth
Fourth 24.2 24.7 24.4 23.3 23.0 22.9
fifth
Top fifth 43.6 43.6 45.6 48.7 49.8 50.5
Top 5% 17.2 16.4 17.6 21.6 22.1 22.3
Source: Bureau of the Census, Current Population Survey,
Annual Social and Economic Supplements.
 FIGURE 18.3 Lorenz Curve for the United States, 2006

The Lorenz curve is the most common way of presenting income distribution graphically. The larger the
shaded area, the more unequal the distribution. If the distribution were equal, the Lorenz curve would be the
45-degree line 0A.
Differences Among African-American Households, White
Households, and Single-Person Households
TABLE 18.3 Mean Household Income Received by the Top, Middle, and Bottom Fifth
of Households in 2006
White (non-Hispanic) African-American Hispanic
Bottom 20% $ 13,129 $ 6,317 $ 9,671

Middle 20% 52,920 32,575 37,934
Top 20% 178,326 117,346 123,684
Top 5% 315,193 200,678 209,819
Source: U.S. Census Bureau, www.census.gov, Historical Income Tables, Table H3, 2006.
The World Distribution of Income
TABLE 18.4 Income and Income per Capita Across the World in 2006
Population Gross National Income Per-Capita Income
Billions % Trillions of $ % (Dollars)
World 6.5 100 48.5 100.0 7,439
Low-Income Countries 2.4 37 1.6 3.3 650

Middle-Income Countries 3.1 48 9.4 19.4 3,051
High-Income Countries 1.0 15 37.5 77.3 36,487
Source: World Bank, World Development Report 2008, Key development indicators Table 1.
The increased income inequality we see in the

United States and in many other regions has
become the subject of much political debate. Much
of the debate concerns what we as a nation and
as a member of the world community should do to
improve the position of the poorest of our citizens.
Is it the forces of free trade, immigration, and

globalization all working together to worsen the
position of the middle-income workers who find
themselves competing with workers in lower-
income countries? Is it the declining power of
unions and deregulation that have opened up
more labor markets to the forces of competition?
The Evidence: The Net Costs of Immigration
To determine whether the net benefits of

immigration outweigh its net costs, we must ask
one important question: To what extent does
immigration reduce domestic wages and increase

unemployment?
Poverty
Poverty is a very complicated word to define. In

simplest terms, it means the condition of people
who have very low incomes.
The Problem of Definition

One school of thought argues that poverty should

be measured by determining how much it costs to
buy the “basic necessities of life.”
Some say that poverty is culturally defined and is

therefore a relative concept, not an absolute one.
Although it is difficult to define precisely, the word

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

level that distinguishes the poor from the non poor.
It is set at three times the cost of the Department
of Agriculture’s minimum food budget.
Poverty in the United States Since 1960

TABLE 18.5 Percentage of Persons in Poverty by Demographic Group, 1964 and 2006
Official Measure 1964 Official Measure 2004
All 19.0 12.3
White 14.9 8.2
African-American 49.6 24.3
Hispanic NA 20.6
Female householder–no husband present 45.9 28.3
Elderly (65+) 28.5 9.4
Children under 18 20.7 17.4
Source: U.S. Census Bureau. Income, Poverty and Health Insurance Coverage in the U.S., 2006.
The Distribution of Wealth
Data on the distribution of wealth are not as readily

available as data on the distribution of income.
The distribution of wealth is more unequal than the

distribution of income.
Arguments Against Redistribution
Those who argue against government

redistribution believe that the market, when left to
operate on its own, is fair.

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.
In declaring war on poverty in 1964, President

Lyndon Johnson put it this way:
There will always be some Americans who are better off than
others. But it need not follow that the “poor are always with
us.”...It is high time to redouble and to concentrate our efforts to
eliminate poverty....We know what must be done and this nation
of abundance can surely afford to do it.
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.
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.
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 goods and

services we want that will not be provided
adequately if we act separately.
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.
TABLE 18.6 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
Source: Julie-Anne Cronin, US Department of the Treasury, OTA paper 85 and authors’ estimate.
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.
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 they have

children.
Supplemental Security Income
The Supplemental Security Income program (SSI)

is a federal program that was set up under the
Social Security Administration in 1974.
SSI is designed to take care of the elderly who end

up very poor and have no or very low Social
Security entitlement.
As with welfare, qualified recipients must have

very low incomes and virtually no assets.
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.
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.
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
Over the years, the federal government and state

governments have administered many different
housing programs designed to improve the quality
of housing for low-income people.
The Earned Income Tax Credit
The program is quite complex but essentially

allows lower-income families with children a credit
equal to a percentage of all wage and salary
income against their income taxes.
How Effective Are Antipoverty Programs?
Does Price Matter in

Charitable Giving?
In the United States, one of the

ways in which people try to help the
poor is through charity. Almost 90
percent of the population
contributes each year to some
charitable organization. Recent
work in experimental economics
has explored the factors that lead
people to make these contributions.
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.
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 compensation
Medicaid and Medicare utilitarian justice
minimum wage utility possibilities frontier

Chapter 18

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Chapter 18

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PowerPoint Lectures for

Why do some people get more than others? What

 FIGURE 18.1 Utility

along PP′ is efficient; it is

utility possibilities frontier A graphic

Required Skills, Human Capital, and Working Conditions

human capital The stock of knowledge, skills,

compensating differentials Differences in

Multiple Household Incomes

Another source of wage inequality among

more the rule than the exception for U.S. families.

The Minimum Wage Controversy

minimum wage The lowest wage that firms are

If the equilibrium wage in the

The higher wage will attract

Unemployment hurts primarily those who are laid

paid out of a fund accumulated with receipts from

property income Income from the ownership of

Income from the Government: Transfer Payments

transfer payments Payments by government to

economic income The amount of money a

Bottom fifth 3.4 1.3 2.2 17.2

TABLE 18.2 Distribution of Money Income of U.S. Families by

Second fifth 10.8 10.4 9.8 9.1 8.9 8.6

money income The measure of income used by

Lorenz curve A widely used graph of the

Gini coefficient A commonly used measure of

TABLE 18.2 Distribution of Money Income of

Second 10.8 10.4 9.8 9.1 8.9 8.6

 FIGURE 18.3 Lorenz Curve for the United States, 2006

Bottom 20% $ 13,129 $ 6,317 $ 9,671

Low-Income Countries 2.4 37 1.6 3.3 650

The increased income inequality we see in the

improve the position of the poorest of our citizens.

Is it the forces of free trade, immigration, and

The Evidence: The Net Costs of Immigration

To determine whether the net benefits of

immigration reduce domestic wages and increase

Poverty is a very complicated word to define. In

The Problem of Definition

One school of thought argues that poverty should

Some say that poverty is culturally defined and is

Although it is difficult to define precisely, the word

The Official Poverty Line

poverty line The officially established income

Poverty in the United States Since 1960

Data on the distribution of wealth are not as readily

The distribution of wealth is more unequal than the

Those who argue against government

Arguments in Favor of Redistribution

The argument most often used in favor of

In declaring war on poverty in 1964, President

utilitarian justice The idea that “a dollar in the

income from the rich to the poor will increase total

Social Contract Theory—Rawlsian Justice

Rawlsian justice A theory of distributional justice

being of the worst-off member of society.

The Works of Karl Marx

labor theory of value Stated most simply, the

Income Distribution as a Public Good

We turn to government to provide goods and

Redistribution always involves those who end up

Social Security system The federal system of

Insurance (OASI) program, the Disability

public assistance, or welfare Government

(2) the very poor regardless of whether they have

Supplemental Security Income

The Supplemental Security Income program (SSI)

SSI is designed to take care of the elderly who end

As with welfare, qualified recipients must have

Unemployment compensation A state

time for a covered employer.

Medicaid and Medicare

Medicaid and Medicare In-kind government

food stamps Vouchers that have a face value

Over the years, the federal government and state