Chapter 9 - Equity Flashcards
Why does gov’t wanted equity
The federal governments goal of seeking to maximise living standards of Australian’s is closely linked to the ‘equity’ goal due to the close communication between incomes received and living standards – in particular the economic welfare of individuals is actually tied to the command that they have over economic resources or the ability to purchase goods + services
The goal of equity distribution is not about achieving ‘equity’ in the way incomes are shared. This is because some inequalities is a necessary feature of a ‘capitalist’ economy that is underpinned by self-interest + desire to maximise personal income + wealth – instead the govt’s goal is t ensure that incomes earned and received in Australia are ‘messaged’ or ‘manipulated’ so that three important sub-goals can be achieved
Equity is determined by
To ensure that all Australian’s have sufficient income to purchase those goods + services that enables them to have a ‘dignified standard of living’ – this involves being able to afford goods + services that allows them to live in our affluent and modern society with some ‘dignity’ and ‘self-respect’
To ensure there are no persons or households in Australia experiencing ‘absolute poverty’ – defined as the situation where one cannot afford to purchase the goods + services necessary for survival
To ensure that huge or ‘obscene inequalities’ in incomes (and to a lesser extent wealth) are avoided such that the social and economic costs of inequality do not exceed the benefits
Define equity In distribution of income
the goal of ensuring that all Australians have sufficient income to purchase those goods + services that enables them to have a ‘dignified’ standard of living, to avoid absolute poverty and to ensure that huge obscene inequalities in incomes are avoided
Define absolute poverty
A situation where a person or household has insufficient income to purchase basic necessities e.g. Food, shelter + clothing
Explain sources and types of incomes
The abs collects statistics via the survey of income and housing, focusing on income of persons aged 15 + who are residents in private houses throughout Australia. Approx 18,000 households are questioned from a cross section of Australian households and the information is then ‘extrapolated’ to reflect the position that is expected to exist for Australia
Abs define ‘household income as – ‘household income consists of all current receipts, whether monetary or in kind, that are received by the household or by individual members of the household, and which are available for, or intended to support current consumption’
Accordingly, income is typically money that is received on a regular or recurring basis – the most common form of income is wages and salaries but incomes also include profits, investments returns, profit shares, royalties, government pensions or allowances and private cash transfers
Most income that is received by Australians is earned – in this sense it represents a reward to individuals for their direct or ‘physical’ contribution to the production process e.g. wages represent the return for providing labour to the business sector
E.g dividends represent the return for providing capital (or equity) interest is the return for providing debt (or loans) and rent is the return for providing property – taken together earned and unearned incomes are referred to as ‘factor incomes’ - which in turn refers to factors of production for the contribution to production.
Another source of income is ‘transfer income’ – which represents income that is transferred from one group to another, usually via the government – common example = pensioners + unemployed
Define household incomes
Household incomes consist of all current receipts whether monetary or in kind that they are received by the household or by indivdual members of the household and which are available for or intended to support current consumption
Define a factor income
The total returns of factors of production for the contribution to production and includes earned and unearned income
Define a transfer income
Income that is transferred from one group to another, usually via the government. Common examples include pensioners and unemployment benefits
Incomes can be classified according to the extent to which gov’t has manipulated it - explain types of incomes
Private or market incomes Gross income Disposable income Social income Financial income Equalised household income
Earned income - wages salaries for efforts
Unearned income - dividends interest rent
Explain private or market income
income that is received in the market place primarily as a result of individuals making a contribution to the production process, such as supplying their labour (including entrepreneurship) to the business sector – in this respect it is very similar to ‘factor income’ (but it also includes private transfers such as child support payments + scholarships income) and is mainly received in the form of wages, interest, dividends + royalties
Explain gross income
This is private or market income plus direct cash benefits received from the government, such as pensioners, family tax benefits and job search allowance (unemployment benefits) – this type of income provides a better indicator of the ability of households
to purchase goods + services
Explain disposable income
This is gross income less direct taxes levied by governments (personal income tax) and provides an even better indicator of households ability to purchase goods + services
Explain social wage income
This is disposable income plus indirect government benefits provided in the form of goods + services such as public housing, education, health + welfare – this type of income is referred to as ‘disposable income plus social transfers in kind’ Once more, it provides a superior indication of the ability of households to purchase and access goods + services
Explain final income
This is the most extensive type of income and includes social wages income, less production (or indirect) taxes. Represents the best measure of the overall command that income has over economic resources
Explain equalised household income
most income are earned by individuals and then share within households – the ABS has formed a specific type of income that seeks to provide a better measure of peoples economic wellbeing
The measure for equalized household incomes uses disposable income and adjusts it to take into account the size and composition of households – this provides a better comparison of ‘incomes’ and economic living standards by taking into account the number of people relying on the incomes earned
E.g. a person earning 100,000 is seen as relatively high, however a household earing 100,000 is relatively lower and would experience lower living standards – accordingly the equalized income for households would be significantly less
Define private income
Also referred to as ‘market income’ income that is received in the market place primarily as a result of individuals supply their labour (+entrepreneurship) to the business sector
Define gross income
Private or market income in addition to direct cash benefits received from the government
Define disposable income
Total income that the households have received in exchange for their participation in the production process
Plus government transfers less direct (income taxes)
Define social wage income
Disposable income plus indirect government benefits provided in the form of g+s such as public housing, education, health + welfare
Define final income
Social wage income plus production (or indirect) taxes
Define equalised household income
Disposable income adjusted for the size and composition of households
Define earned income
Representing a reward to individuals for their physical contribute in the production process
eg wages, salaries
Unearned income
A reward for providing resources other than labour
Dividends interest rent
Explain how income distribution is measured
Income distribution tables:
From the survey of income and household,
the ABS determines equalized household incomes and places the, in a ranking lowest earning to highest earning households – once ordered lowest to highest they are typically placed into 5 groups (quintiles) ranked from lowest earning quintile to the highest
While ‘mean’ incomes provide useful information in terms of the growth in ‘absolute’ income levels for households, it is not immediately obvious what is occurring to the ‘share’ of total income earned by each group
What is the Lorenz curve
Information contained in income distribution tables can also be conveyed in a Lorenz curve – derived from the household income data and is a diagrammatical representation of the degree of equity in the distribution of income
Define the Lorenz curve
A diagrammactial representation of the degree of inequality in the distribution of income
Explain the Lorenz curve
The horizontal axis shows the cumulative proportion of the persons in the population ranked according to household income,
and the vertical axis shows the corresponding cumulative proportion of income
The line of absolute equality (also called the 45 degree line) represents the situation of perfect equality, where everyone earns an identical income (or each quintile receives 20% of total income
The Lorenz curve for an economy will lie below the line of absolute equality – if the Lorenz curve was to sit further away from the line of absolute equality it would suggest the inequality was higher – if is sat closer to the line of absolute equality, it would mean inequality was lower
Define the gini coefficient
Derived from the Lorenz curve, a number between zero and one, providing an indication of the degree of inequality in the distribution of income –
as the coefficient approaches zero, equality improves
Explain the gini coefficient
Calculated by measuring the area between the actual Lorenz curve an the line of absolute equality and dividing it by the total area under the line of absolute equality
As inequality worsens, the Lorenz curve moves further away from the 45 degree line and the size of the area increases – at the extreme total inequality would mean that the total area ‘b’ covers the entire space and ‘a’ disappears
Gini coefficient formula
A + B
Total inequality =1
Total equality = 0
Explain the ‘incidence of poverty’
In general terms ‘poverty’ refers to people living in a situation where they have insuffucent means to adequately provide for themselves – however there are many different way we can define ‘adequate’ – there are 2 main ways poverty can be defined
Absolute poverty
Relative poverty
Define absolute poverty
When a country is more efficient than another country in producing all goods + services in the sense that it can produce more of every good or service using the same inputs as another country
Define relative poverty
a situation where a person or household has a low level of income compared to other individuals or households in society or compared to a generally agreed standard (refer to Henderson poverty line)
What does the gov’t focus on absolute of relative
Absolute poverty is the most dangerous form of poverty and the federal government seeks to reduce the number of persons living in ‘absolute poverty’
Welfare groups + charities have focused on relative poverty over many years
Define the Henderson poverty line
a benchmark level of income for various household sizes, below which a household is considered to be living in relative poverty
Explain the Henderson poverty line
As household sizes change so does the poverty line
The Henderson line increases over time to ensure that it is a fixed proportion of average household disposable income
Determines whether households are able to afford goods + services that allows them to live with ‘dignity’ – the gov’t will therefore use the ‘Henderson line’ as one of a number of indicators to help it determine the changes needed to welfare benefits – such as pensions + unemployment benefits
Explain economic and social costs
Usually there is a clear distinction between ‘economic and social costs’ with the former being able to be quantified in dollar terms – however the existence of social costs will often result in economic costs over time (long-term)
Social costs of inequality provide the overriding motivation for government to reduce the degree of ‘inequality
Define social costs
costs borne by a country that are non-economic in nature, such as the depletion of natural resources related to negative externalities (re market failure) and the social unrest that may accompany a society with huge inequity in the distribution of income
Social costs of inequality include
There is a direct social cost that is borne by those people living in absolute poverty or relative poverty. They are more likely to experience a sense of helplessness or despair and may find it increasingly difficult to provide positive contribution to society
There is likely to be increased incidence of mental health problems (e.g. depression) in society with a large degree of inequality. This negatively impacts on living standards of those affected, in addition to other members of society providing care ($) or living in the same community
There is the potential for social unrest that can develop when particular groups (e.g. those living in poverty) become increasingly marginalized from mainstream society – these groups are more likely to engage in ‘anti-social’ behavior or resort to crime having a detrimental affect on non-material living standards of the average Australian as social unrest intensifies
A class system is more than likely to become evident when income inequality reaches high levels – some individuals on higher incomes may consider themselves to be in a higher ‘social class’ compared to those on lower incomes – which tends to impair social harmony
Income inequality can promote conspicuous consumption which occurs when individuals purchase expensive goods or services (Ferrari 430’s) in order to signal their wealth or ‘status’ to other members of society – this can be socially troublesome as the perception of inequality grows and some people become less satisfied with their current standard of living
Income inequality will tend to create wealth inequality which then feeds back to add to income inequality over time – e.g. children of wealthy parents more likely to be wealthy due to the incomes earned on wealth inheritance
Inequality of opportunity – will develop in a society with greater income (and wealth) inequality, with the opportunities to enjoy the ‘highest quality’ education or health services for example being limited to those of wealthy households
Existence of poverty (practically absolute poverty) and or huge inequality can cause some members of society to feel a sense of guilt or happiness about the plight of marginalized groups – the sight of desperate or homeless people for example could reduce enjoyment of life, thereby reducing living standards of average Australian’s
These social costs can directly add to economic costs via the impact that, crime, mental illness etc will have on government emergency services and health budgets – higher gov’t spending on crime prevention or health adds to taxation pressures or results in spending cuts in other areas – this can add to business costs, raise prices + can slow eco growth. Further the increase incidence of crime, social tension and visible homelessness can directly reduce tourism export income – further reducing AD + eco growth
Define economic costs
The value of the next best alternative that is forgone whenever a choice is made
Economic costs of inequality include
Cost to the government (or tax payers) of supporting persons who require income support – this can require higher average tax levels (or bigger budget deficits) that add to business costs, prices and economic growth. Alternatively Gov’t may be forced to cut spending from other areas (education + health) which can have negative impacts on average living standards
There can be short term costs to economic growth – related to the fact that lower income earners have much higher ‘marginal prosperity’ to consume than high income earners. As income inequality grows, less of society’s ‘income cake’ may be received by relatively low income earners – as this group spends more of their every extra dollar of income earned on goods + services rather than saving it – the contribution to consumption expenditure (and AD) is likely to be lower
There is the cost in terms of lost satisfaction that relates to the law of diminishing marginal utility – as relatively more income is earned by higher income earners to lower income earners, the extra satisfaction they enjoy from each extra additional dollar of consumption is likely to be less than the utility that would be enjoyed by lower income earners – in this respect greater levels of income inequality may have negative impacts on total consumer satisfaction in the economy
Increased gov’t spending on crime
Lower mls for lower income earners
Define social benefits
benefits enjoyed by society that are non-economic in nature, such as the benefits of education that are related to positive externalities and the social harmony that may accompany a society with a more ‘equitable’ distribution of income
Explain the social benefits of SOME inequality
People being motivated or entrepreneurial in the hope of increasing their income and wealth over time. While this will have clear economic benefits – there will be clear social benefits that are derived from having more individuals who are able to add to the nation’s stock of social capital and improve the quality of lives of others. These can also be consider examples of positive externalities in production
Similarly there are likely to be more individuals whose pursuit of greater income + wealth provides them with a constant goal and feeling of making progress – this can provide a certain degree of happiness or satisfaction that can also generate positive externalities in production or consumption
The fact that people are motivated to be more creative or entrepreneurial in a market capitalist economy creates huge eco benefits for the country – which cannot be captured by an economy seeking to achieve total equality. The incentive to work harder, develop skills and take financial risks provides the underpinning for all eco benefits that will accrue to any economy that permits some degree of inequality in income distribution – these economic benefits include the following points:
The quality of the nations labour force will be higher as a result of individuals seeking to improve their skills (training) With better skills, labour productivity levels across the economy rise, Similarly individuals will have grater incentive to work harder and longer, further boosting productivity levels
The quality of the nations capital stock will be enhanced by continuing drive for greater profits by entrepreneurs and those investing in businesses. As entrepreneurs seek new profit opportunities, it leads to greater investment in new technologies which ultimately leads to higher levels of capital productivity over time
With higher levels of labour and capital productivity a country will enjoy all the benefits that higher productivity brings
As a result of some inequality higher productivity levels would benefit other Eco goals
Lower costs of production leads to lower prices and therefore helps to achieve low inflation goal
Lower inflation rates will lead to an improvement in international competiveness and help to achieve strong sustainable growth
The creation of paid employment as the size of the economy expands helps to achieve the governments full employment goal
The boost in international competitiveness helps to boost net exports, achieving a reduction in both the CAD and NFD thereby helping to achieve the goal of external stability
Governments do not target inequality for eco benefits – inequality is a byproduct of our market capitalist economy and gov’ts are willing to tolerate what can be loosely referred to as ‘optimal level of inequality’ – this is where at the margin of total benefits of inequality (both social + eco) just out weigh the total costs. Hypothetically any movement away from the ‘optimal level of inequality’ will result in a detrition of national living standards. If inequality increases than the costs of inequality will start to outweigh the benefits, and if it falls the general cost of equality will also start to outweigh the benefits – though not specially stated the optimal level of inequality is estimated around 0.3-0.4 for the ‘gini coefficient’
Define optimal level of inequality
A point where the total social and economic benefits on inequality – as the margin – just outweigh that total costs. Any movements away from this ‘optimal level of inequality’ will result in a detrition of national living standards
Explain the trade off between efficiency and equity
conflict between maximising equity in income distribution and maximising efficiency in resource allocation
The achievement of the government’s key economic goal of equity might result in a reduction in economic growth over the long-term, therefore having negative consequences for material living standards. For example, a decision to increase social welfare benefits in an attempt to increase support for the disadvantaged may actually discourage citizens from participating as active and productive members of the labour force, creating a financially costly climate of welfare dependency. The inherent cost to efficiency here is the fact that the labour force participation rate might be lower than optimum and there will be an opportunity cost to national efficiency as government resources allocated to welfare are then lost to such areas as investment in infrastructure.
So, greater equity may stifle incentive, motivation, drive, personal effort, innovation and enterprise, resulting in lower productivity (output from inputs). A decrease in productive efficiency (shift in the AS curve to the left), all other things being equal, will result in higher prices, leading to a contraction in aggregate demand (AD) and lower levels of output and employment. Similarly, if the greater equity has come about as a result of higher taxes (e.g. particularly steep marginal rates of tax on personal incomes), the same result occurs. That is, the achievement of greater equity comes at the expense of efficiency.
Rational economic decisions that result in greater efficiencies may come at a cost to equity. The economy may achieve a more efficient allocation of resources through improvements in productivity or productive (technical) efficiency. To the extent that these are caused by structural reform (industry restructuring), labour redundancies are likely, causing some structural unemployment in the shorter-term, with negative consequences for equity as more people become reliant on welfare. However, higher efficiency levels exert downward pressure on costs and prices, ultimately contributing to stronger economic growth and causing reductions in the unemployment rate. In this respect, greater efficiency can actually contribute to an improvement in equity over time.
The optimal level of inequality can also be referred to as ‘optimal level of equality’ (simply the other side of the coin) – every economic concept faces a trade off between equity and efficiency. A more equitable distribution of income may not provide the right incentives for individuals and businesses to increase their productivity, to innovate, or take risks that may lead to more prosperous society with higher levels of real gdp per capita over time. Conversely an economy focused on achieving efficiency without regard for equity consequences, then societies overall living standards may fall
e.g. gov’t replaces progressive tax with 15% proportional flat tax on all income earners, combined with a reduction in welfare payments – this would encourage greater entrepreneurism and foster a huge increase in productivity and innovation. The nations level of real gdp would expand in the long run + average incomes would rise however it would intensify all economic + social costs
The trade off between equity and efficiency can also be considered in more ‘microeconomic’ terms an it is often referred to when discussing labour market reforms
The trade off can also be illustrated with reference to the implementation or increase in a host of indirect taxes such as excise alcohol or tobacco – these taxes are designed to achieve a more efficient allocation of resources (Allocative efficiency) by introducing price signals that ultimately deter the production + consumption of ‘non-merit’ goods
3 gov’t tools used to redistribute income
Progressive tax system
Transfer payments
Gov’t provision of services
These infinitives will improve equity in the distribution of Income over time exerting downward pressure on the gini coefficient over time
Define means testing
related to the provisional government benefits where the receipt of such benefits will only occur if recipient’s level of income (or wealth) is below a benchmark level. It is designed to ensure that support is only provided to those welfare recipients genuinely in need of support
Relationship Eco growth and equity
Strong rates of eco growth create substantial employment gains – helping to reduce unemployment rates – reducing reliance of welfare
In isolation the rise in unemployment rate is having negative effects of the equity goal as the reliance of the gov’t transfer payments increases + more households find it difficult to purchase goods + services to give them a dignified standard of living
The benefits for equity stemming from storng + sustainable growth can also be viewed in terms of the increase in the size of the economy – there is a possibility that high rates of growth lifted income levels and MLS, without actually impacting the income spread (or the gini coefficient) e.g. strong rates of growth exceed population thereby leading to strong increases in real gdp per person
An increase in gdp per capita (the most common measure of mls) can benefit equity via a boost to welfare payments as the government is much more likely to use it’s growing revenue base to increase transfers or other non-cash benefits that assist the plight of lower income earners – in this respect stronger eco growth and any accompanying boost to real gdp per person may have helped to provide more Australians with the necessary income to avoid relative or absolute poverty
On the other hand a fall in disposable income makes the distribution of income less ‘equitable’ as it is likely to contribute to lower eco growth, higher unemployment and increased welfare dependency.
Impact of micro economic reforms on equity
Policies have been applied to improve productivity, efficiency and international competitiveness of Australian industries in an effort to boost productive capacity and sustainable rates of eco growth – unfortunately a downside to these policies is the negative impact they have on structural unemployment, underemployment + potentially long term unemployment – many businesses were forced to restructure in the newly deregulated (or competitive) market place, which often involves the substitution of labour for capital. Other businesses were forced to re-allocate offshore – where labour was relatively cheaper or close all together. This causes many to join the pool of unemployed – overtime MRP’s are likely to have created an even greater employment, but the effect of welfare dependency and equity was likely to be negative for some time
Micro reform policies – government reforms that seek to improve the structure and operation of markets (or industries) in an effort to achieve a more efficient allocation of resources
One of the major MRP’s that have been focused on is increasing dependency on free trade agreements – designed to encourage Aus’t businesses to achieve greater efficiency enabling them to target global markets
Australian businesses have begun focusing their efforts on the production of goods+ services in which they have a ‘comparative advantage’ (agriculture, mining + service industries) – the dislocation of labor within those industries undergoing structural change (e.g shipbuilders and automotive producers) will have negative implications for the equity goal particularly in the short term
Labour market reforms over the past 10 years have also had mixed implications for equity. The overriding emphasis of reforms was to downgrade the prevalence and importance of ‘awards’ and allow wages and conditions to be determined more by the forces of demand + supply existing in particular labour markets – this would increase in the spread of enterprise or collective agreements, as well as ‘individual contracts’ called Australian workplace Agreements (AWA’s)
How has low inflation benefited equity
Helped protect real wages, particularly those who have little barging in power (low skilled)
Further lower income earners tend to spend a larger proportion of their income on g+s’s “higher marginal prosperity to consume”
