CH 15

CHAPTER 15
Income Distribution
and Poverty
Prepared by: Fernando

Quijano and Yvonn Quijano
2002 Prentice Hall Business Publishing Principles of Economics, 6/e Karl Case, Ray Fair
The Utility Possibilities Frontier
The utility possibilities

frontier is a graphic
representation of a two-
person world that shows all
points at which As utility
can be increased only if Bs
utility is decreased.
The Utility Possibilities Frontier
Any point inside the

utility possibilities
frontier is inefficient. At
point A, both I and J
could be better off.
Point B is preferable to
point A.
Both B and C are
efficient, but may not
be equally desirable.
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 propertythat is, capital, land,
and so forth; and
3. from government.
Wages and Salaries
All factors of production are paid a

return equal to their marginal
revenue productthe market value
of what they produce at the margin.
The rewards of a skill that is limited

in supply depend on the demand for
that skill. People with rare skills can
make enormous salaries.
Wages and Salaries
Human capital is the stock of

knowledge, skills, and talents that people
possess; it can be inborn or acquired
through education and training.
Compensating differentials are

differences in wages that result from
differences in working conditions. Risky
jobs usually pay higher wages; highly
desirable jobs usually pay lower wages.
Income from Property
Property income is income derived

from 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.
Income from Government
Transfer payments are payments

by the government to people who do
not supply goods or services in
exchange.
Transfer programs are part of the

governments attempts to offset
some of the problems of inequality
and poverty.
The Distribution of Income
Economic income is 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.
Income Inequality in the United States
Distribution of Total Income and Components in the United States, 1997

(Percentages)
TOTAL WAGES AND PROPERTY TRANSFER
HOUSEHOLDS INCOME SALARIES INCOME INCOME
Bottom fifth 6.0 5.7 1.0 27.6
Second fifth 9.1 11.9 4.0 26.1
Third fifth 14.7 19.9 8.4 18.7
Fourth fifth 23.6 27.3 16.4 13.9
Top fifth 46.6 35.2 70.2 13.7
Top 1 percent 10.0 3.2 29.7 1.5

Source: Brookings Merge File and authors estimates.
Money Income
Money income is a measure of the

income used by the Census Bureau.
Because it excludes noncash
transfer payments and capital gains
income, it is less inclusive than
economic income.
Changes in the Distribution of Income
Distribution of Money Income of U.S. Families by Quintiles, 1947 1997

(Percentages)
1947 1960 1972 1980 1984 1994 1997
Bottom fifth 5.0 4.8 5.4 5.2 4.7 4.2 4.2
Second fifth 11.8 12.2 11.9 11.5 11.0 10.0 9.9
Third fifth 17.0 17.8 17.5 17.5 17.0 15.7 15.7
Fourth fifth 23.1 24.0 23.9 24.3 24.4 23.3 23.0
Top fifth 43.0 41.3 41.4 41.5 42.9 46.9 47.2
Top 5 percent 17.2 15.9 15.9 15.3 16.0 20.1 20.7

Source: Statistical Abstract of the United States,
States, various editions; Department of Commerce, HHES Division.
The Lorenz Curve
The Lorenz curve is 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.
The Lorenz Curve
If income is equally
distributed, there is no
shaded area.
More unequal
distributions of income
produce Lorenz Curves
that are farther from
the 45-degree line.
The Gini Coefficient
The Gini coefficient

is a commonly used
measure of inequality
of income derived
from a Lorenz Curve.
It can range from zero
(maximum equality) to
a maximum of 1
(maximum inequality).
Differences Between African-American
Households, White Households, and Single-
Person Households
Distribution of Money Income of Households, 1997 (Percentages)
AFRICAN-
ALL AMERICAN WHITE HISPANIC ONE-PERSON
HOUSEHOLDS HOUSEHOLDS HOUSEHOLDS HOUSEHOLDS HOUSEHOLDS
0-10,000 11.0 21.4 9.5 16.8 25.4

10-15,000 8.1 10.5 7.8 10.7 15.8
15-25,000 14.9 17.9 14.6 19.7 20.7
25-35,000 13.3 14.2 13.2 15.0 14.0
35-50,000 16.3 14.9 16.5 16.6 11.6
50-75,000 18.1 13.1 18.8 12.2 7.7
75,000 + 18.4 7.9 19.7 9.1 4.7
Total 100.0 100.0 100.0 100.0 100.0

Note: Totals may not add to 100 due to rounding.
States, 1999, Tables 742 and 744.
Poverty
In simplest terms, poverty is the

condition of people who have very
low incomes.
The poverty line is the officially

established income level that
distinguishes the poor form the
nonpoor. It is set at three times the
cost of the Department of
Agricultures minimum food budget.
Poverty in the United States
Since 1960
Percentage of Persons in Poverty by Demographic Group, 1964 - 1997
OFFICIAL OFFICIAL ADJUSTED FOR
MEASURE MEASURE IN-KIND TRANSFERS
1964 1964 AT MARKET VALUE, 1997a
All 19.0 13.3 10.0
White 14.9 11.0 8.4
African-American 49.6 26.5 19.3
Hispanic NA 27.1 19.6
Female householder
no husband present 45.9 35.1 NA
Elderly (65+) 28.5 10.5 NA
Children under 18 20.7 19.9 NA
Includes food, housing, and medical benefits.
a

States, 1999, Tables 760, 763, 766, and 770.
The Distribution of Wealth
The distribution of wealth is much

more unequal than the distribution of
income. Wealth is passed from
generation to generation and
accumulates.
Some argue that unequal distribution

of wealth is a natural consequence
of risk taking in a market economy.
The Distribution of Wealth
Percentage of Different Assets Owned by Households, 1998 Survey of

Consumer Finances
COMMON STOCK ALL
PERCENTAGE OF EXCLUDING COMMON NONEQUITY HOUSING NET
OWNERS PENSIONS STOCK FINANCIAL ASSETS EQUITY WORTH
Top .5 percent 41.4 37.0 24.2 10.2 25.6
Top 1 percent 53.2 47.7 32.0 14.8 34.0
Top 10 percent 91.2 86.2 72.2 50.7 68.9
Bottom 80 percent 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.
The Redistribution Debate
Philosophical arguments against

redistribution:
The market, when left to operate on its
own, is fair. One is entitled to the fruits
of ones efforts.
Taxation of income for redistribution
purposes is against freedom of contract
and the protection of property rights.
Practical arguments against

redistribution:
Taxation and transfer programs interfere
with the incentives to work, save, and
invest.
Bureaucratic waste and inefficiency is
inevitable in the administration of social
programs.
Arguments in favor of redistribution:

A wealthy country, such as the United
States, has the moral obligation to
provide all its members with the
necessities of life. The Constitution does
carry a guarantee of the right to life.

Utilitarian justice is 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.

Rawlsian justice is 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
Marx did not write very much about

socialism or communism.
He wrote a critique of capitalism, but

was not very clear about what would
replace it.
In one essay he wrote, from each

according to his ability, to each
according to his needs.
The Works of Karl Marx
The labor theory of value, stated

most simply, is the theory that the
value of a commodity depends only
on the amount of labor required to
produce it.
The owners of capital are able to

extract surplus value out of labor.
Redistribution Programs and Policies
The income tax is progressivethose with higher incomes

pay a higher percentage of their incomes in taxes.
Effective Rates of Federal, State, and Local Taxes,
2000 (Taxes as a Percentage of Total Income)
Bottom 20% 34.0 %
Second 20 31.2
Third 20 32.3
Fourth 20 32.6
Top 20 33.9
Top 10 34.5
Top 5 34.9
Top 1 37.0
Source: Authors estimate.
Expenditure Programs
The Social Security system is a 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, or welfare, consists

of 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.
The Supplemental Security Income

(SSI) program is designed to take care of
the elderly who end up very poor.
Unemployment compensation is 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 are 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 are vouchers that have a face

value greater than their cost and that can be
used to purchase food at grocery stores.
Housing programs are designed to improve the

quality of life for low-income people.
The Earned Income Tax Credit is an important

program that allows lower income families with
children a credit equal to a percentage of all
wage and salary income against their income
taxes.

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CH 15

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CHAPTER 15

Prepared by: Fernando

The utility possibilities

Any point inside the

Households derive their incomes

All factors of production are paid a

The rewards of a skill that is limited

Human capital is the stock of

Compensating differentials are

Property income is income derived

The amount of property income that

Transfer payments are payments

Transfer programs are part of the

Economic income is the amount of

Wages, salaries, dividends, interest

Distribution of Total Income and Components in the United States, 1997

Top 1 percent 10.0 3.2 29.7 1.5

Money income is a measure of the

Distribution of Money Income of U.S. Families by Quintiles, 1947 1997

Top 5 percent 17.2 15.9 15.9 15.3 16.0 20.1 20.7

The Lorenz curve is a widely

The Gini coefficient

0-10,000 11.0 21.4 9.5 16.8 25.4

Total 100.0 100.0 100.0 100.0 100.0

In simplest terms, poverty is the

The poverty line is the officially

Source: Statistical Abstract of the United States,

The distribution of wealth is much

Some argue that unequal distribution

Percentage of Different Assets Owned by Households, 1998 Survey of

Top .5 percent 41.4 37.0 24.2 10.2 25.6

Top 1 percent 53.2 47.7 32.0 14.8 34.0

Top 10 percent 91.2 86.2 72.2 50.7 68.9

Bottom 80 percent 1.7 4.1 14.0 29.3 18.5

Philosophical arguments against

Practical arguments against

Arguments in favor of redistribution:

Arguments in favor of redistribution:

Arguments in favor of redistribution:

Marx did not write very much about

He wrote a critique of capitalism, but

In one essay he wrote, from each

The labor theory of value, stated

The owners of capital are able to

The income tax is progressivethose with higher incomes

The Social Security system is a federal

the Health Insurance (HI, or Medicare)

Public assistance, or welfare, consists

The Supplemental Security Income

Unemployment compensation is a state

Medicaid and Medicare are in-kind

Food stamps are vouchers that have a face

Housing programs are designed to improve the

The Earned Income Tax Credit is an important

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