Econ 1110-1 TA Session Sep. 4 (Fri) Donghwee Kwon Discussion 214/215 Agenda 1. Key Concepts 2. Measurement of Inequality 1. Poverty Line (skip) 2. Problems in measuring inequality (skip) 3. Gini coefficient 3. Production Possibilities Curve 2 1
Key Concepts from LN2 poverty rate, p. 417 poverty line, p. 417 in- kind transfers, p. 419 life cycle, p. 419 permanent income, p. 419 Gini coefficient, class Lorenz curve, class inequality, class income distribution, class 3 Guiding Question 1(0904) You are told that the Gini coefficient of income inequality has risen from.35 to.85. Which of the following is a likely cause of this change? A) Market power in the factor and output markets has increased. B) Labor market discrimination has been eliminated. C) The distribution of wealth and property has become more equitable. D) The vast majority of adults have achieved at least a college degree. E) The tax system has become even more 4 2
Measurement of Inequality How much inequality is there in our society? How many people live in poverty? How often do people move among income classes? 5 Problems 1. The Poverty in Measuring Line Inequality The poverty line is an absolute level of income set by the federal government for each family size below which a family is deemed to be in poverty. my case 3
Problems in Measuring Inequality Head Start, the Supplemental Nutition Assistance Program (SNAP), the National School Lunch Program, and the Children s Health Insurance Program Example: SNAP - Food stamp program - Electronic benefits - Use like cash at food stores Q: Consider two of the income security programs in the United States: Temporary Assistance for Needy Families (TANF) and the Earned Income Tax Credit (EITC). When a woman with children and very low income earns an extra dollar, she receives less in TANF benefits. This feature of TANF will cause the labor supply of low- income women to be higher/lower. The EITC provides greater benefits as low- income workers earn more income (up to a point). This feature of EITC has a negative/positive effect on the labor supply of low- income workers. 8 4
Problems in Measuring Inequality 2. Problems in measuring inequality Data on income distribution and the poverty rate give an incomplete picture of inequality in living standards because of the following: In- kind transfers Life cycle Transitory versus permanent income Economic Mobility Problems in Measuring Inequality 1) In- Kind Transfers Transfers to the poor given in the form of goods and services rather than cash are called in- kind transfers such as food stamps Measurements of the distribution of income and the poverty rate are based on families money income The failure to include in- kind transfers as part of income greatly affects the measured poverty rate. 5
Problems in Measuring Inequality 2) The Economic Life Cycle The regular pattern of income variation over a person s life is called the life cycle. A young worker has a low income at the beginning of his or her career. Income rises as the worker gains maturity and experience. Income peaks at about age 50. Income falls sharply at retirement, around age 65. Theories to relate income and consumption Traditional Keynes consumption theory C t =f(current income Y t ) Life- cycle theory Ct=f(Y t, expected future income ortotal wealth) For example, young John s current income is $1,000. Traditional theory : C t > 1000 impossible Life cycle theory : C t > 1000 possible(borrow money) 12 6
Life-cycle Theory Graph 13 Problems in Measuring Inequality Transitory versus Permanent Income Incomes vary because of random and transitory forces Temporary layoffs due to illness or economic conditions, etc. A family s ability to buy goods and services depends largely on its permanent income(pi), which is its normal, or average, income. PI excludes transitory changes in income. - PI is the average level of one s expected future income stream - One time tax rebate or tax rate change have little effect on household behavior (Transitory income) 7
Quick Questions about LC 1. Milton Friedman, a friend of Richard, argued that, on average, consumption is: a) Proportional to income b) A fraction of permanent income that raises as permanent income rises c) A fraction of permanent income that falls as permanent income falls d) Proportional to permanent income 15 Quick Questions about LC 2. According to the permanent- income(=life cycle) hypothesis, if consumers receive a one- time income bonus, then they will: a. Save most of it in the current year b. Spend most of it in the current year c. Spend 1/2 of it and save 1/2 of it in the current year d. Not alter their consumption or saving in the current year 3. If consumers receive a permanent increase in their salary then they will: a. Save most of it in the current year b. Spend most of it in the current year c. Spend 1/2 of it and save 1/2 of it in the current year d. Not alter their consumption or saving in the current year 16 8
Problems in Measuring Inequality 3. Gini Coefficient - Lorenz curve shows the distribution of income - Use Lorenz curve to get the following coefficient G=A/(A+B) 1) G=1, A=A+B => B=0 2) G=0, A=0(A+B) => A=0 3) 0<G<0, A and B > 0 Problems in Measuring Inequality Q(1) Did the distribution become more equal in 2010 than it was in 2009, or did it become less equal? If area A = 2,150, area B = 250, and area C = 2,600, calculate the Gini coefficient for 2009 and the Gini coefficient for 2010. 9
Problems in Measuring Inequality Q(2): If Gini Coefficient is increasing, does it mean that the poor become poorer? Use the following example. Assume there are only two people called the rich and the poor. - The rich owns 60% of the total wealth - The poor owns 40% If Rich s wealth increases by 100% and Poor s by 50% The total wealth grows by 80% Gini coefficient increases? Guiding Question 2(0904) You are told that the Gini coefficient of income inequality has risen from.35 to.85. Which of the following is a likely cause of this change? A) Market power in the factor and output markets has increased. B) Labor market discrimination has been eliminated. C) The distribution of wealth and property has become more equitable. D) The vast majority of adults have achieved at least a college degree. E) The tax system has become even more progressive 20 10
Economics: Economics is about constrained optimization; choice under conditions of scarcity To do so, we construct models Look at the world; Hypothesize a model; Analyze the model; Use the model to make predictions; See if the model holds up under empirical scrutiny 21 Model Example: The Production Possibilities Frontier How people and nations should decide what goods to produce how much to produce (goods type) (amount) for whom they should produce it (resource allocation) 22 11
The Production Possibilities Frontier Often introduced in the first couple of lectures in both micro and macro intro courses. What is the PPF? A description of the possible or feasible combinations of commodities an economy can produce, using all of the available resources efficiently. Allows us to understand opportunity cost. The opportunity cost of an activity is the value of the resources used in that activity when they are measured by what they would have produced when used in their next best alternative. Modeling(=Simplification), Assumptions, Efficiency Guns Bananas Not easy to understand the model below 24 12
Guiding Question 2(0904) What causes the production possibilities curve to shift? A) Advances in technology B) Changes in resources C) More education or training(human capital) D) Changes in the labor force E) All of the above 25 The PPF: Assumptions Given: Endowments of resources Labor (L) : 5 Units Given: Outputs produced with the resources Guns (G) Bananas (B) Given: Technologies G = g(l) and B = b(l) Given: Efficient production Efficiency means society gets the most that it can from its scarce resources. 13
Gun Production Data (Given) & The Gun Production Function L GUNS Guns (tons) 0 0 1 1 2 2 3 3 4 4 5 5 G G=g(L) L Banana Production Data (Given) & The Banana Production Function L BUTTER Banana (lbs) 0 0 1 21 2 30 3 37 4 39 5 40 B B=b(L) L 14
Efficient / Inefficient / unobtainable Guns Car efficient Banana PC 29 Shift in the PPF curve Anything that causes economic output to increase or decrease will shift this curve Car Output increasing What does different assumption causes? Output decreasing PC 30 15
Why the PPF moves Shifts in the production possibilities curve are caused by changes in these things: Advances in technology Changes in resources More education or training (human capital) Changes in the labor force 31 Changes in Technology Car Car PC PC 32 16
Shifts in Resources 33 Shifts In Education & Training Human Capital Education=knowledge=increased productivity Car Output increasing PC 34 17
Changes in Labor Force 1. Increase in Labor Force More people working More production 2. Decrease in Labor Force More people not working Decrease output of the nation 35 1. PPF Summary What goods to produce / how much to produce / for whom they should produce it We build a model 2. Shifts in the curve: caused by things that change the output of an economy The model changes when we use different assumptions 36 18
Enjoy Labor-Day Weekend! 37 19