11: Macroeconomic objectives II: Economic growth and equity in the distribution of income

Question 1

Define economic growth:

Answer 1

A positive percentage change in the real GDP (per capita) over a period of time.

Question 2

How can we calculate the %∆ in real GDP per capita from %∆ in real GDP?

Answer 2

%∆ in real GDP per capita = %∆ in real GDP - %∆ in population

Question 3

What factors lead to movements from a point inside to PPF to a point on the PPF?

What factors lead to an outwards shift of the PPF?

Answer 3

1. Better employment of resources
2. Improvements in efficiency
3. Increases in the quantity of resources in the economy
4. Improvements in the quality of resources (e.g. technological advancements, more education)

Question 4

Is the outwards shift of the PPF always parallel?

Answer 4

No, there can be technological advancements specifically for one good. Alternatively if the labour force increases due to less strict immigration laws, then the workers are likely to be less skilled and will gravitate toward manufacturing jobs so the production of certain goods increase.

Question 5

How does investment into different types of capital effect the economy?

Answer 5

Investment in physical capital is the most important as it leads to technological advancements. Investment into human capital, such as education and healthcare, are also important to improving the quality of the workforce, rather than the quantity.
You can split natural capital into two kinds: marketable commodities and ecological goods and common access resources, Marketable commodities can contribute to growth but are not essential. Ecological goods and common access resources are crucially important to long term growth.

Question 6

What factors improve productivity:

Answer 6

Anything that makes labour more productive.

1. Increases in quantity and improvements in physical capital.
2. Improvements in the quality of labour.
3. Improvements in the quantity or quality of ecological resources.

Question 7

Distinguish between equity and equality? How do there two terms relate in the case of income?

Answer 7

Equity is the condition of being fair and just while equality is the state of being equal with respect to something.

Some believe that income equality, where everyone receives the same income, is equitable. However some do not believe it is equitable as people have different jobs so to receive the same income is unjust.

Question 8

Why is there unequal distribution of income?

Answer 8

1. There is an unequal ownership of factors of production
2. Humans are not homogenous - some have special skills, some have invested in themselves in terms of education in order to get a better job in the future
3. Different jobs have different risk levels
4. Some people cannot work due to illnesses.
5. There are not enough jobs in the economy to provide for everyone.

Question 9

What is a Lorenz curve? Draw one.

Answer 9

A Lorenz curve is a visual representation of income inequality in an economy.
cumulative percentage of income on y, cumulative percentage of income on x.
A diagonal line starting from the origin represents perfect income equality as 20% of the population receives 20% of the income.

Question 10

What is the Gini coefficient?

How do you calculate the Gini coefficient?

Answer 10

A summary measure of income inequality. It is the ratio between the diagonal (representing income equality) and the Lorenz curve to the total area under the diagonal. It is between 0 and 1 and the closer the value is to 0, the greater the income equality. The closer it is to 1, the greater the income inequality.

Gini coefficient = area between diagonal and Lorenz curve / entire area under diagonal.

Question 11

How do you calculate the Gini coefficient?

Answer 11

Gini coefficient = area between diagonal and Lorenz curve / entire area under diagonal

Question 12

How can the Lorenz curve be used to illustrate income redistribution?

Answer 12

If a country moves closer to the Lorenz curve the distribution of income is becoming more equal.

Question 13

Distinguish between absolute poverty and relative poverty:

Answer 13

Absolute poverty is when people are living below the poverty line. The poverty line is an income level that is considered minimally sufficient to sustain a family with basic needs.

Relative income compares the income of individuals or households in a society with median incomes.

Question 14

How is absolute poverty calculate with worldwide figures?

How is relative poverty generally calculated?

Answer 14

Extreme poverty < $1.25 a day
Moderate poverty < $1.50 a day

By taking the median income of a society and dividing it in half. Anyone below this is considered poor, in relative terms.

Question 15

Possible causes of poverty:

Answer 15

1. Low incomes
2. Unemployment, particularly for single-parent households.
3. Low levels of human capital (low levels of education, skills and health)
4. Low levels of capital or land ownership - no inheritance. May rely on agriculture which is unreliable due to dependence on weather.
5. Discrimination - some groups struggle more to get good jobs.
6. Geography - if you live in an isolated region.
7. Age - retirement, pensions may not be good.
8. Limited social services (merit goods) - healthcare in the US is not very subsidised so it can impoverish people/
9. Poverty leads to more poverty, cycle of poverty.

Question 16

Possible consequences of poverty:

Answer 16

1. Low living standards
2. Lack of access to health and education - repeats cycle of poverty
3. High infant and maternal mortality
4. Higher levels of preventable diseases - lack of hygiene and nutrition
5. Social problems - higher crime rates, drug problems, family breakdowns and homelessness.
6. Inability to realise one’s full potential which leads to a waste of human talent which could lead to less economic growth.

Question 17

What are transfer payments?

Answer 17

Payments made by the government to individuals specifically for the purpose of redistributing income away from certain groups and towards more vulnerable groups. They do this through taxes as those who work provide for those who don’t.

Question 18

Examples of transfer payments?

Answer 18

1. Old age pensions
2. Disability pensions
3. Unemployment benefits
4. Veteran’s benefits
5. Maternity benefits
6. Child allowances
7. Housing benefits for the poor
8. Student grants etc.

Question 19

Distinguish between direct and indirect taxes:

Answer 19

Direct taxes are paid directly to the government by the tax payer. Indirect taxes are paid indirectly by consumers through the supplies of the good or service produced.

Question 20

Examples of direct taxes:

Answer 20

1. Personal income taxes - taxes paid on all forms of income
2. Corporate income taxes - taxes on the profit of corporations
3. Wealth taxes - taxes on the ownership of assets such as property taxes (like the mansion tax in the UK) and inheritance taxes

Question 21

What is earmarked taxation and what is an example of it?

Answer 21

Earmarked taxation is taxes which are identified to be spend on only a specific purpose. An example of this is payroll taxed which are paid by employers, who pay on behalf of their employees. The revenues are put into specific funds and are used to finance specific expenditures such as pensions.

Question 22

Examples of indirect taxes:

Answer 22

1. Sales tax or value added tax - these two differ, but they are both paid fully by the consumer. Some goods are excluded from this for the purpose of equity (e.g. food, rent)
2. Excise taxes - paid on specific goods and services, often considered to have negative externalities such as cigarettes or petrol. The burden is split between consumers and producers, with the relative size depending on price elasticities of demand.
3. Customs duties/tariffs - a tax on imports of foreign goods into a country.

Question 23

Distinguish between proportional, progressive and regressive taxes:

Answer 23

Proportional taxation is a constant rate of taxes, meaning as income increases the percentage of income paid as taxes remains constant.

Progressive taxation means that there is an increasing tax rate as income increases.

Regressive taxation means that there is a decreasing tax rate as income increases.

Question 24

How does tax progressively relate to the distribution of income?

Answer 24

In general the more progressive the tax is, the more equal the after-tax distribution of income compared to the pre-tax distribution of income.

Question 25

Why are indirect taxes regressive?

Answer 25

Since they are fixed prices, they are higher for those with lower incomes as they are a higher percentage of their incomes. Thus, they are regressive. This means they are inconsistent with the objective of a more equal distribution of income.

Question 26

How do you calculate average tax rate?

How do you calculate marginal tax rate?

Answer 26

Average tax rate is the amount of tax you pay divided by your total income.

Marginal tax rate is the amount of tax paid on additional income.

Question 27

Evaluate the use of income taxes to promote equity and efficiency in resource markets?

Answer 27

A relatively high degree of income redistribution cannot be achieved without a highly progressive tax system, meaning high marginal tax rates on high income earners. High income taxes are disincentives to work. They reduce the quantity of labour offered in the market and result in lower savings which leads to less investment which in turn leads to less production of capital goods, leading to less economic growth. Thus, high income taxes result in allocative inefficiency.
Economists argue that although taxes do have some negative effects on resource allocation, they are not enough to significantly reduce economic growth.
In addition, greater income equality through progressive taxes can lead to a more efficient use of resources as it raises the income level of those in poverty. They can now access education and health care and so the work force of the country becomes more efficient and output increases, leading to economic growth.

Question 28

Evaluate the use of indirect taxes to promote equity and efficiency in resource markets?

Answer 28

Indirect taxes such as sales taxes are levied on all goods and services in the same percentage meaning there is no change in relative prices, and there is no impact on resource allocation because the signals and incentives remain the same. However, these taxes are regressive since they are a higher percentage of the income of lower income earners meaning they lead to a more unequal distribution of income. 
There are different VAT rates in the EU on necessary goods and luxury goods. This makes them more affordable to low income earners, in line with economic objectives, but also changes the allocation of resources as the relative price changes. 
Excise taxes (taxes on specific goods like cigarettes) change the allocation of resources, although this may be beneficial if the good has negative externalities. In this case allocative efficiency is achieved. If the tax is not imposed to correct negative externalities then the tax worsens the distribution of income and the allocation of resources.

Question 29

Evaluate the use of transfer payments?

Answer 29

They are good as they reallocate income to those who really need it. However some economists argue they act as disincentives for work. This results in an extra burden on the government in terms of unemployment and other benefits, as well as higher unemployment rates for the economy which is a waste of resources, causing output rates to be lower than necessary. Some may also turn to the informal market and pretend to be looking for a job.
However, the system is necessary to offer protection to those who may otherwise face poverty and destitution.