Distribution of income Flashcards
What is the difference between income and wealth
Income is a flow concept measured over given period of time e.g. income per year
Wealth is a stock concept measured at a given point in time. i.e. what is the value of your assets at a given point in time where an asset is anything with market value that can generate income
How are income and wealth mutually reinforcing
High income means you can buy more assets which can generate more income when bought and sold. This income can be used to buy more assets.
Therefore, high income generally means a high wealth and high wealth generally means a high income so policies that improve DofW improve DofI in long run and vice versa
What are the reasons for differentials in income and wealth for different people
- Age as more experience means higher MRP so higher income which means more wealth is accumulated over time
- Education as more qualifications increasing earning potential, causing distribution of income
- Ownership of financial assets for some people leads to unequal distribution of wealth i.e. some employers give better pensions
- Ownership of property for some people leads to unequal distribution of wealth. (Inheritance of any assets makes distribution of wealth worse and therefore distribution of income) - for 3 and 4
- Wage differentials cause unequal distribution of income
How can you draw a Lorenz curve
- y axis is cumulative % of income and x axis is cumulative % of population
- Draw the line of perfect equality which is straight line through origin as first 10% of population owns 10% of income, first 20% owns 20% of income etc
- Lorenz curve is a curved line intersecting line of perfect equality at origin and 100% income (label it in the exam)
- The further the Lorenz curve is away from the line of perfect equality, the more income inequality as shallow gradient at the start means first 10% of population earns very little of income and steeper gradient at the end means top 10% earns a lot of the cumulative income
How can you use the Lorenz curve to get the Gini coefficient
Gini coefficient is area between Lorenz curve and line of perfect equality divided by the total area under the line of perfect equality
- In the exam, label area between Lorenz and LoPE as A and area under Lorenz as B
So Gini = A / A+B
What values of Gini coefficient show different levels of equality
0 is perfect equality as area between lorenz curve and line of perfect equality = 0
1 is perfect inequality as area B = 0 so area A can’t be any bigger (1 person owns all of the income)
How can you show the effectiveness of a policy using the Lorenz curve
Shift in of Lorenz curve if policy reduces inequality
Shift out of Lorenz curve if policy increases inequality
What is the difference between absolute poverty and relative poverty
Absolute poverty is where incomes are below a threshold (according to world bank, this is below $2 a day) to access the most basic, life sustaining goods and services, mainly suffered by people in developing countries
Relative poverty is where incomes are below a given average in society, mainly suffered by people in developed countries
What is the difference between equity and equality
Equity is the fair distribution of income
Equality is an equal distribution of income
What is the difference between horizonal and vertical equity
Horizontal is where 2 individuals with the same income are taxed the same amount
Vertical is where higher income earners are taxed more e.g. progressive and proportionate tax systems
What are the causes of poverty
- Unemployment (cyclical in recession or structural e.g. due to deindustrialisation leading to hysteresis and poverty trap)
- Poor education/skills means people can’t get a high enough MRP to access jobs
- Poor health/healthcare limits amount that people work and kind of jobs that they can work in so MRP is lower
- Wage differentials
- Born into poverty
- Tax cuts for well off increases relative poverty
- Subsistence agricultural industry in developing countries instead of education
What are the advantages of a national minimum wage
- Poverty alleviation as incomes rise
- Reduce wage differentials as wage floor is higher
- Incentive to work for higher wages reduces voluntary unemployment
- Fiscal benefit to gov as less benefits need to be paid and more tax revenue, which can be spent on redistributing income further
- Higher wage increase productivity due to moral boost
- Incentive for firms to train workers to justify the higher wages they have to pay
- Counter monopsonist employer
What are 2 diagrams you can draw to show the impacts of a minimum wage
Labour market demand and supply curve with Wmin higher than the equilibrium wage
Monopsony diagram with Wmin at the wage rate in competitive outcomes increasing wage and quantity of workers
What are the disadvantages of a national minimum wage
- Real wage unemployment as there is excess supply of labour, shown by area of triangle between D, S and equilibrium wage
- Less demand for labour means youth lose out the most as they have less MRP to justify the higher wage so more dispensable, could lead to long term unemployment and poverty trap if they never gain the skills needed
- Increased costs for businesses means risk of shutting down, less competitiveness of exports, more inflation. Especially if people with very high wages demand higher wages to maintain wage differential as they believe their job is much harder
- NMW doesn’t account for regional differences as e.g. cost of living in london is much higher
- If government employs a lot of low paid workers themselves (e.g. the UK), government costs rise
How does elasticity of supply and demand for labour impact the effectiveness of a minimum wage policy
More unemployment if demand and supply are more elastic
Evaluate whether the government should implement tax policies to redistribute income/wealth
Option 1:
Make system more progressive by taxing rich more or increasing tax free allowance so either rich has less income or poor has more
However, laffer curve suggests too high tax for rich would decrease tax revenue
Option 2:
Make system less regressive by reducing regressive taxes like VAT, duties which take up higher % of poor people’s income, so poor can keep more income to spend
However, hit to gov finances as regressive tax is a big revenue earner
Evaluate whether the government should implement benefits and transfer payments to redistribute income/wealth
Increasing means tested benefits e.g. for unemployed, increases their incomes
However, could cause poverty trap and unemployment trap as means tested benefits are taken away when incomes goes up enough so less incentive to work. Leading to strain on government and hysteresis
Evaluate whether the government should implement min and max wages to redistribute income/wealth
Directly increases wages of poorest people to boost their living standards and incomes or control how much wages can increase beyond a certain level e.g. with bonuses
However, max wage means less incentive to work and be entrepreneurial and min wage causes unemployment, especially for youth
Evaluate whether the government should implement legislation to redistribute income/wealth
- Antidiscrimination laws reduce wage differentials
- Make it harder for firms to fire workers to reduce unemployment
- Min wage
However, big cost to businesses means big risk of gov failure e.g. businesses leaving to countries with less legislation and enforcement needs to be strong for a notable impact
Evaluate whether the government should implement supply side policies to redistribute income/wealth
- Government spending on education/training increases skills so higher MRP so higher wages and incomes
- Government spending on quicker and better quality healthcare means productivity is higher as people take less days off. This increases MRP so higher wages and incomes
However, these policies are too expensive for many governments and they are very long term so don’t cause short term improvements
What are evaluation points about policies to redistribute income/wealth
- Worsened incentives and government finances were very common disadvantages
- Equity vs Efficiency e.g. min and max wage distorts efficient labour market outcomes
- Intervention based on normative judgements has high risk of government failure
- Intervention may not be necessary as the inequality is not too high and it is just part of the capitalist market, so increasing government failure risk not worth it
What is the Universal Basic Income (UBI)
A welfare policy that generates a monthly income to everyone in the population regardless of their current income, employment or other factors
Why are the characteristics of a UBI policy
- It covers basic needs of individuals
- Unconditional so everyone gets it
- Funded through taxation and borrowing
Why are the pros of a UBI policy
- Supports those out of work as boosts living standards, reduces poverty, gives them time to choose a job where they are most happy and productive
- Overcomes problems of means tested benefits as less unemployment and poverty trap, less expensive for gov to keep track, people don’t have to worry about whether they will meet criteria, freedom of how to spend income so not forced to pay for things they don’t need benefits for
- Income top up for people on flexible jobs means those roles more likely to persist in economy
- Supports socially beneficial activity like looking after children/relatives
- Supports entrepreneurship as people can afford it and less pressure to make profit quick and keep the business going
