ECON 1100 Global Economics (Fall 2013) The Distribution Function of Government portions for Exam 3

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1 ECON Global Economics (Fall 23) The Distribution Function of Government portions for Exam 3 Relevant Readings from the Required Textbooks: Economics Chapter 2, Income Distribution and Poverty Problems from the Economics Textbook: Chapter 2 Problems (Pages 24-25): 2, 6, and 3 Definitions and Concepts: distribution function government policies aimed at changing the final distribution of goods/services across consumers, usually with the intention of realizing a fairer apportionment of consumption/income/wealth. redistribution government policies designed to alter the distribution of income/wealth/consumption across members of society. income support monetary payments (such as unemployment benefits and social security payments) made to certain individuals, which directly alter the distribution of income within a society. redistribution in-kind public provision of goods/services (such as healthcare, education, housing, food) for certain individuals, which alter the consumption of goods/services within society. 7 Determinants of Productivity, Income, and Wealth:. natural talent and ability ability is not distributed equally at birth; some people possess attributes (e.g., intelligence, strength) that make them more productive 2. Acquired Skills individual productivity depends in large part upon skills and experiences acquired during education, training, and work experience 3. Effort productivity is often largely dependent upon effort ( workers are more productive than shirkers ) 4. Compensating Differentials differences in wages that results from differences in working conditions (e.g., risky jobs pay more; glamour jobs pay less) 5. Inherited Wealth wealth is distributed less evenly than income (due partly to differences in inheritances) 6. Accumulated Savings the stock of wealth that a person has at any point in time is partly determined by previous consumption/savings decisions 7. Seemingly Unrelated Market Conditions income depends in part upon economic conditions beyond our control; a worker s value depends greatly upon the price of the product he helps produce (e.g., wage of a coal miner would increase if we ran out of oil) Lorenz Curve a graph illustrating the cumulative amount of income earned by each cumulative portion of the population Gini-Coefficient a quantitative measure of income inequality based upon the Lorenz Curve, defined as the ratio of the area between 45-degree line and the Lorenz Curve to the entire area below 45-degree line.

2 Utilitarian Justice the argument that society should strive for the greatest happiness for the greatest number of people (i.e., attempt to maximize the summation of utility or happiness over all members of society) total social welfare can be increased by transferring income/wealth from the rich to the poor, so long as the marginal utility of income/wealth is diminishing. arguments first put forth by Jeremy Bentham ( ) and John Stuart Mill (86-873) Rawlsian Justice (Social Contract Theory) the argument that the socially best income distribution is the one which maximizes the well-being of the worst-off member of society developed by the philosopher John Rawls in A Theory of Justice (97) consider the ideal society that would be designed by someone in the beforelife behind a veil of ignorance (i.e., not knowing what their realized lot in life would be, but just knowing that it would be a random draw in this ideal society ) => Rawls argues that such a person would be particularly concerned about the situation of the poorest person (i.e., the worst possible outcome) => such an objectively ideal society should implement policies to apply the maximin criterion Maximin Criterion a claim that the government should aim to maximize the wellbeing of the worst off person in society Labor Theory of Value the theory that the value of a commodity depends upon the amount of labor used to produce it redistribution as a public good (i.e., Overcoming the Free Rider Problem) the recognition that private charity may lead to less than the socially best level of redistribution since, in many respects, income equality is a public good

3 Distribution of Income in the U.S. over time: United States Real Per Capita GDP $25,64 $3,877 $37,238 $43,926 % of Income earned by Bottom 5% 7.68% 4.96% 3.67% 2.26% % of Income earned by Bottom 75% 43.3% 37.72% 34.37% 3.29% % of Income earned by Bottom 9% 67.87% 6.% 56.23% 5.95% % of Income earned by Bottom 99% 9.54% 85.8% 8.53% 77.7% Not only did Real Per Capita GDP increase over this time, but Real Household Income (i.e., adjusted for inflation) increased for every segment of the population over these years => table below reports the income cutoff level (in real terms, that is adjusted for inflation) for each stated percentile in each year. Real Household Income th Percentile $24,96 $25,837 $27,439 $27,864 4 th Percentile $4,95 $45,27 $47,882 $49,5 6 th Percentile $59,45 $65,873 $7,64 $75, 8 th Percentile $83,372 $96,45 $6,38 $2, th Percentile $3,766 $59,779 $84,452 $97,26 Over the past three decades in the U.S. the rich have become richer => 35.% increase ($83,372 to $2,638) in cutoff of 8 th Percentile the middle class has become richer => 8% increase ($4,95 to $49,5) in cutoff of 4 th Percentile the poor have become richer =>.8% increase ($24,96 to $27,864) in cutoff of 2 th Percentile

4 Lorenz Curve and Gini-Coefficient: Fraction of Total Income 45 Line or Line of Perfect Income Equality Lorenz Curve for U.S. (27) Fraction of Total Population (Gini-Coefficient) = Green Green Blue Fraction of Total Income 45 Line or Line of Perfect Income Equality Lorenz Curve for U.S. (27) Fraction of Total Population

5 Extreme Equality => Lorenz Curve on 45-degree line => Gini-Coefficient equal to zero: G 2 Fraction of Total Income Fraction of Total Population Extreme Inequality (one person having all income) => Lorenz Curve lies along 2 horizontal axis => Gini-Coefficient equal to one: G 2 Fraction of Total Income Fraction of Total Population United States Gini Coefficient

6 Comparison of Income Inequality across countries: in general there is a trend for societies with higher levels of per person income to have a more even distribution of income (or equivalently, for societies with lower levels of per person income to have a less even distribution of income ). Notable exceptions: U.S., Hong Kong, Singapore (economies closer to the free market side of the spectrum) Per Capita Gini Country: GDP (PPP): Coefficient: Norway $55,6.28 Singapore $48,9.52 United States $46,.45 Canada $38,2.32 Sweden $36,9.23 United Kingdom $35,3.34 France $33,8.28 New Zealand $26,.36 Russia $4,6.4 Mexico $2,5.5 South Africa $,3.65 Brazil $,.57 Turkey $9,4.44 Colombia $7,2.54 India $2,7.37 Zimbabwe $5.5

7 Problems: 2. The graph below illustrates the Lorenz Curves for Algeria and Burundi. Answer the following questions based upon the information conveyed in this graph. Cumulative share of total income Lorenz Curve for Algeria Lorenz Curve for Burundi Cumulative share of total population 2A. In which country is there a more even distribution of income? Explain. 2B. For which country will the value of the Gini-Coefficient be greater? Explain.

8 Multiple Choice Questions:. Charles income is higher than Debbie s income. Two of the notable differences between their jobs are that Charles must work outside year round (even when it is very hot in the summer and very cold in the winter) and Charles runs a greater risk of being injured on the job. This would seem to suggest that the difference in incomes between the two individuals is A. due to gender discrimination. B. an indication of the Labor Theory of Value. C. a compensating differential. D. a consequence of Debbie being paid a wage rate below the minimum wage. 3. wrote A Theory of Justice (97), in he argued that a social contract designed behind a veil of ignorance would aim to maximize the wellbeing of the worst-off member of society. A. Karl Marx B. Jeremny Bentham C. John Rawls D. Robert Nozick 4. The Gini-Coefficient provides a quantitative measure of A. the rate at which a society is depleting its natural resources. B. income equality/inequality within a society. C. average levels of income in society. D. the rate at which prices are increasing in an economy over time. 5. One of the 7 Determinants of Productivity, Income, and Wealth is effort, which refers to the recognition that differences in income or wealth across individuals could result from differences in A. the amount of money that individuals receive as inheritances during their lifetime. B. the natural talents that people are endowed with at birth. C. the skills and experiences that people acquire through education, training, and work experience. D. how hard individuals choose to work. 6. The Function of Government refers to government policies aimed at changing the final distribution of goods/services across consumers, usually with the intention of realizing a fairer apportionment of consumption, income, and wealth. A. Allocation B. Distribution C. Stabilization D. Free Rider

9 8. Examining how Real (i.e., inflation adjusted) Household Incomes have changed over time in the U.S., between 98 and 27 the household at the 6 th Percentile of the income distribution saw its Real Income A. decrease from about $39,5 down to $3,95 B. remain relatively constant at roughly $45,. C. increase from about $59,45 up to $75,. D. increase from about $22,96 up to $87,26.. Incomes may differ across different individuals in a free market society due to A. only factors which are beyond the control of the individual (such as their endowment at birth of natural talent and ability ). B. only factors which are under the direct control of the individual (such as how much education to acquire ). C. some factors which are under the control of the individual (such as how much education to acquire ) and some factors which are beyond the control of the individual (such as their endowment at birth of natural talent and ability ). D. None of the above answers are correct (since in general, income levels in a free market society are essentially entirely random ). 2. Suppose that the Lorenz Curve for the U.S. in 2 lies completely below the Lorenz Curve for France in 2. This implies that A. Per Capita Incomes are higher in France than in the U.S. B. the Unemployment Rate is lower in the U.S. than in France. C. incomes are distributed more equally in France than in the U.S. D. incomes are distributed more equally in the U.S. than in France. 3. The Labor Theory of Value, which states that the value of a commodity depends upon only the amount of labor required to produce the commodity, is most closely associated with the ideas of A. John Rawls. B. Jeremy Bentham and John Stuart Mill. C. Robert Nozick. D. Karl Marx.

10 5. Based upon to the values of Gini-Coefficients noted in lecture, incomes in the market oriented economies of Singapore ( G Sing. 52 ) and the United States ( G US. 45) are distributed less equally than in the less market oriented economies of Sweden ( G Swdn. 23 ) and France ( G Fr. 28 ). Which of the following statements is also true? A. Also, each of the former countries is currently experiencing very negative annual rates of GDP growth (-5.3% in Singapore and -4.4% in the United States), while each of the latter countries is currently experiencing very positive annual rates of GDP growth (8.2% in Sweden and 6.4% in France). B. Further, GDP Per Capita (PPP) is higher in the latter countries ($55,6 in Sweden and $55,2 in France), than in the former countries ($39,29 in Singapore and $36,5 in the United States). C. However, GDP Per Capita (PPP) is higher in the former countries ($48,9 in Singapore and $46, in the United States), than in the latter countries ($36,9 in Sweden and $33,8 in France). D. None of the above answers are correct. 6. Focusing on the real household income of the household at the 2 th percentile and real household income of the household at the 8 th percentile in the U.S. over the past three decades, over this time period A. the rich became richer while the poor became poorer (i.e., the real income cutoff level of the 8 th percentile increased while the real income cutoff level for the 2 th percentile decreased). B. both the rich and the poor became richer (i.e., the real income cutoff level of both the 2 th percentile and the 8 th percentile increased). C. both the rich and the poor became poorer (i.e., the real income cutoff level of both the 2 th percentile and the 8 th percentile decreased). D. the rich became poorer while the poor became richer (i.e., the real income cutoff level of the 8 th percentile decreased while the real income cutoff level for the 2 th percentile increased). 2. In 26, the value of the Gini-Coefficient in the United States was.45, while the value of the Gini-Coefficient in South Korea was.35. These values directly suggest that in 26 A. incomes were distributed more equally in South Korea than in the United States. B. average incomes were higher in the United States than in South Korea. C. fewer workers were unemployed in South Korea than in the United States. D. the economic system in South Korea was closer to Capitalism, while the economic system in the United States was closer to Socialism.

11 2. were two of the central figures in the formulation of the ideas of Utilitarianism, which argues that total social welfare can be increased by income redistribution, so long as people have a diminishing marginal utility of income. A. Yair Tauman and Pradeep Dubey B. Jeremy Bentham and John Stuart Mill C. Ronald Coase and Adam Smith D. James Buchanan and Gordon Tullock 24. is a broad term which refers to monetary payments made by the government to certain individuals in society, with the impact of altering the distribution of income within a society. A. Monetary Policy B. Redistribution In-Kind C. Income Support D. Income Taxation

12 Answers to Problems: 2A. Based upon the Lorenz Curves that are illustrated, there is a more even distribution of income in Algeria than in Burundi. Observe that in comparison to the Lorenz Curve for Burundi, the Lorenz Curve for Algeria is closer to the 45- degree line. Thus, for each possible cumulative fraction of the population, a greater cumulative share of the total income of society is earned by individuals in Algeria than in Burundi. This implies that the distribution of income in Algeria is closer to the extreme of perfect equity (in which all individuals have equal incomes or equivalently, the case in which the (x)% of individuals with the lowest incomes earn exactly (x)% of the total income of society.) 2B. Based upon the Lorenz Curves illustrated, we can infer that the value of the Gini- Coefficient is greater for Burundi than for Algeria. Recall that the Gini- Coefficient is defined as the ratio of the area between the 45-degree line and the Lorenz Curve to the entire area below the 45-degree line. When computing each different Gini-Coefficient, there is always a common area below the 45- degree line. However, since the Lorenz Curve for Burundi lies below the Lorenz Curve for Algeria, the area between the 45-degree line and the Lorenz Curve is greater for Burundi than for Algeria. As a result, the value of the Gini-Coefficient is greater for Burundi than for Algeria. Equivalently, looking at the graph below, the value of the Gini-Coefficient for Algeria is the blue area divided by the sum of the blue, red, and green areas. Likewise, the Gini-Coefficient for Burundi is the sum of the blue and red areas divided by the sum of the blue, red, and green areas. Again, when calculating either of these ratios, the sum of the blue, red, and green areas is the same, so that the Gini-Coefficient is greater for Burundi than for Algeria since the sum of the blue and red areas is greater than the blue area. Cumulative share of total income Lorenz Curve for Algeria Lorenz Curve for Burundi Cumulative share of total population

13 Answers to Multiple Choice Questions:. C 2. A 3. C 4. B 5. D 6. B 7. D 8. C 9. A. C. C 2. C 3. D 4. B 5. C 6. B 7. C 8. B 9. D 2. A 2. B 22. C 23. B 24. C 25. B 26. C