Distribution of Wealth and Inequality

Question 1

What is equity in economics?

Answer 1

Equity means fairness in the overall distribution of income and wealth.

Question 2

Is the market system fair?

Answer 2

No, we will discuss different ways of thinking about inequality and its measurement.

Question 3

What does distrubtion mean?

Answer 3

spread the product throughout the marketplace ( whether everyone can access the product/service.

Question 4

What is income again in the general equilibrium model?

Answer 4

aij = talent of producing good
pj = price
so aij x price = wage rate

Question 5

Looking at income in the general equilibrium model, what can we say about it in terms of distrubtion?

Answer 5

There is nothing natural within the market system, that equalizes income, the distubtion of income that occurs is a function of wages, there is no way the market moves towards equality, as it depends on talents and scarity of things people produce.

Question 6

To summarise again So we said that there is nothing that equalises income, as?

Answer 6

prices are determined by supply and demand, so there is no reason to think that the market system will tend towards equality.

Question 7

Summarising what are the 4 things from last week that determine distribution of income in general equilibrium?

Answer 7

1) Distrubtion of endownments ( property rights)
2) Market prices
3) Distubtion of talents ( if talent is high demand, you get higher price)
4) Distubtion of effort ( labour supply)

Question 8

Data we have on income inequality is not a good reflection of the income inequality because what and what are remedies to this ?

Answer 8

Complicated by the fact that people live in a mutli-person household, thus doesn’t show at individual level, but household level ( including children)
Remedy of this is that data now uses equivalized income ( adjusting for household composition)

Question 9

What is inequality mostly explained by?

Answer 9

Inequality is mostly explained by disturbtion of wages ( last lecture showed this), distrubtion is similar to income.

Question 10

What are 2 ways to measure inequality?

Answer 10

Lorenz curve and Gini coefficient.

Question 11

What does Lorenz curve represent, what are the axes and draw a line of equality?

Answer 11

Lorenz curve represents income distribution.
Y axis is share of income ( 0-1)
X axis share of people. (0-1)
A line of equality, means equal society = income equlivalised ( 50% of households have 50% of income.
So if 70% have more than 70% income there is inequality

Question 12

What is equivalised income?

Answer 12

Equivalised income is the total household income that’s been recalculated to take into consideration differences in household demographic composition and size. If households show identical equivalised incomes, their standard of living can be said to be equal.

Question 13

Now draw a lorenz curve that shows the y axis ( share of income), x axis ( share of people), a line of perfect equity and a line of not perfect equity and what does the gap show? What does this mean if the lorenz curve you draw is closer or away from the line of equality?

Answer 13

e.g. the first 10% of people own less than 10% of the income in society ( hence inequality)

The closer the lorenz curve to the line of perfect equality the more equal the distribution of income is, and the further away the lorenz curve is from the lone of perfect equality the more unequal the distribution of income is.

Question 14

Why does the lorenz curve always go through the axes (0,0 ) and (1,1)?

Answer 14

100% of population owns 100% of income and 0% of population have 0% of income.

Question 15

What is the Gini coefficient and show the quadrants of it on the lorenz curve attached?
What are is the link between Gini coefficient and Lorenz curve?

Answer 15

Gini coefficient converts lorenz curve into a number, which tells us how much distance there is between lorenz curve and line of perfect equity.
0 = perfect equality ( no area B)
1 = Perfect inequality ( means last person owns all the income)

Question 16

What does this say and what would happen if curves intersect?

Answer 16

Here shows, lorenz dominance, every point of distrubtion, the share of the population is getting a smaller share of income. If the curves intersect we cannot say Lorenz dominance, hence we look at Gini coefficient.

Question 17

In problem sets and exams, we will not be likely to be given quadratic functions to draw lorenz curve, but linear, so what does it mean for the lorenz curve?

Answer 17

It will be linear.

Question 18

What is the formula for gini coefficient and how is it composed?

Answer 18

m bar is average income AND mi is your income
M is individuals in population and ordered poorest to richest
People’s income get weighted by a rank ( the more weight you get the lower income)

In words its the weighted average of the gaps between your income and average income, weighted by your rank in the income distribution.

Question 19

In general again income disturbtion is a product of what, is it the only source of income differences?

Answer 19

It is a by-product of the market system.
Labour markets are not the only source of income differences, e.g. firms use capital , natural resources and tech, and own them, which they can have a patent, which they can sell and make money.

Question 20

In last weeks class we were thinking about the impact of a productivity change and we see the impact on disturbtion, how does this feed through via price changes, the distrubtion of income and also utility. What did we find?

Answer 20

If B is less productive, price of that good goes up, so A has less utility. and income falls for B.

Question 21

So far what have we done?

Answer 21

We have thought of ways to measure income inequality, as we can typically measure, if income is what we care about then there isn’t straightforward issues measuring peoples incomes( adjusting for family size, what we count for income extra)

Question 22

Last term we focused on people maximising utility, is utility the same as income because if its not and we think utility is the thing we should be caring about then is their a risk that things we say about income, is not going to translate immediately to thing we care about, utility. So if i asked a question who is better of between 2 individuals, how would we do this?

Answer 22

It would probably be a judgement based on income, it could be utility, but its all value judgement

Question 23

Now we are going to go on from now that we care about utility inequality in terms of welfare and not income, what is the standard assumption we make about utility? What is the problem of this?

Answer 23

It is ordinal ( we cannot compare utility, it can look at relative things, but not absolute judgements)
If we are studying social welfare, we need to be able to compare the ultity of individuals. ( this is important ( especially in policy making) , because any policy advice will have some who gain and some who lose, and unless you can provide advice on are the benefits to gainers bigger or smaller to the loses to the losers, you will not be much help to a policy maker, just pointing out their are gainers and losers. )

Question 24

In policy can there be a science of welfare as utility is ordinal so we cant compare ultity?

Answer 24

In small scale policy, there might be gainers and losers and so economists might wish to say which policy is best and worst without getting into how much people gain and loses .

Question 25

What is the difference between ordinal and cardinal utility and what is income?

Answer 25

Ordinal utility = so we can only say something is better or worse but not by how much
Cardinal utility = allows us to think about how much better or worse off something is.
Income is a cardinal measure of utility.

Question 26

What is the maxmin princple?

Answer 26

According to this principle the system should be designed to maximize the position of those who will be worst off in it

Question 27

One thing to notice is that interpersonal comparisons is quite separate from ordinality and cardinality.

Answer 27

ordinal comparability = we can say whether someone is better or worse
o§ than some else but not by how much ( this is all that is needed for maxmin ( we need to identify whos first off not if they are 10 times worse off )
cardinal comparability = we can measure how much better o§ or worse
o§ someone is than someone else

Question 28

What is a basic reason to use income and not use income for a measure of welfare?

Answer 28

Income is cardinal and comparable across individuals.
Problem lets say one person works 60 hours a week and one doesn’t work 60 hours a week but gets samem income, income says they are equally well off, but there is a disultiy of work, hence they might not well off.

Question 29

According to consumer theory what would be the demands of this cobb douglas preferences weighted by parameter n

Answer 29

Question 30

By plugging in optimal consumption into ultity function, what is utility function?

Answer 30

So utility not proportional to income, but proportional to income raised to the power 1-aida, hence this is a ulitiy function concave in income. HENCE DIMISIHING MARGINAL UTLITY OF INCOME.

Question 31

Prove mathematically that this function is diminishing in marginal utility?

Answer 31

first derative positive, second negative

Question 32

What does the diminishing marginal utility imply about distrubtion?

Answer 32

If i have a fixed amount of money and i can choose to give it unequally to 2 individuals or equally to 2 individuals, i will generate more utlitiy in the aggregrate by giving equally ( as if it transfer income from richest person to the poorer person the lose in ultity for richest person is smaller than gain in ulitty of poorer person, in other words unequal distrubtion will mean the gain in one person, will not lead to as much utility, in comparison to if both were equal.

Question 33

What does concave utltiy say about redistrubting wealth from rich to poor? ( WHAT IS THE UNDERLYING ASSUMPTION HERE)

Answer 33

Hence concave ultity basically states that redistubting income from rich to poor is the thing to do because we care about sum of utilies ( WE ARE UTLITARIAN

Question 34

We are going to show the implications of diminishing marginal utility more formally, here shows sum of utilities with equal distrubtion and sum of utilities with unequal distrubtion, now if we work out what sum of ulties are ( m tilda drops out ( don’t need to learn this slide but yh)

Answer 34

Question 35

Can utility be measured, what is one popular approach to economics?

Answer 35

It is to use surveys of life satisfaction

Question 36

What is a social welfare function? Adding some of ultites is what?
What is another feature of social welfare function?

Answer 36

It is a function that takes utility of members in society and assigns value( number( , we are in a world of interpersonal comparability which is assumed so cardinality)

Jeremy benetham- social welfare function of utltites

Question 37

What is the Pigou-Dalton Princple of transfers?

Answer 37

If there is a fixed sum of utltiy and you transfer from a richer to a poor individual( lump sum redistribution) then social welfare should be higher, hence you are inequality averse ( you believe in fairness and resist inequalities.

Question 38

Lets look at a class of social welfare functions where the sum of utlites are raised to a power 1 - thy then normalise them by dividing by 1/1-ty.
As we let thy vary what are the special cases.
e.g. thy = 0
thy >0
thy — infinity.
What are the shapes?

Answer 38

thy = 0 ( we just look at some of utilities) - shape we get straight lines.
thy > 0 preference for equality ( what we mean by inequality aversion which satisfies the pigou dalton principle of transfers) ( higher curvature the function becomes convex like cobb-douglas preferences)
thy - infinity ( maxmin, the only thing that matters is that of the lowest level of utility in society) - L shaped function W = Min{U^A,U^B)

Question 39

What is a Utility possibility frontier?

Answer 39

snaps out all the utility possibilities that we would get, as we change the underlying disturbtion of endownments and talents. so a point on the right after equal resources would show B having more resources than A

Question 40

We want to show the case of prefence for equality ( thy > 0), first of all draw a diagram where ultity of A and b on axis, a 45* degree line and a UPF.
On the diagram show the point of equal resources with maximum ultity ( where the 45* line touches upf) , also in general equilibrium does this point arise?

Answer 40

In general equilibrium, depending on initial conditions when we maxmise ultity we can be at a point where it is equal or unequal
Where the 45 degree line touches UPF thats pareto optimal ( or anywhere on ray, or else if you were in the UFP you can make both people better off.

Question 41

Now we want to rank different utilities allocation ( thats the point of having a SWF tells us in this case which pair of utltiy is better than the other). First of all draw the social welfare contour ( it is opposite to the Social welfare function which is concave) same princple as a Indifference curve ( equal points of social welfare.

Answer 41

Question 42

What are the 2 pareto efficient points on the social welfare contour that cuts the UPF?

Answer 42

They are points of equal social welfare

Question 43

How can we show that this kind of social welfare function satisfy the Dalton principle of transfers and has a preference for equality?
What would be the case if the SW Contour was concave to origin?

Answer 43

1) Lets look at a pareto efficient point e.g. when A has more resources than B
2) if i can redisturbte resources from A to B so travel in a south east direction i can increase social welfare, NOT MAKING A PARETO IMPROVEMENT AS I AM TAKING FROM A AND GIVING TO B, but moving to a point of higher social welfare. As if i was to draw a SW contour when moving in a south west direction, it will be higher then starting point. This is because the SW Contour is convex to origin
If social welfare contour was concave to origin, i would of been to increase SW by making disturbtion more unequal not equal.

Question 44

What is the social welfare maximising outcome, by having a whole set of possibiltes available to us by redistubting resources, which one of the resources would you have maximum social welfare?

Answer 44

We would redistrubute to the SW contour is tangential to the UPF ( the point of equality in resources)

Question 45

Why is the social welfare function important?

Answer 45

For policy interventions.

Question 46

Here us a very simple example to illustrate how this might help
Consider a two person economy
Each individual produces a single good
Government has the resources to invest to raise the productivity of one
type of worker using a training program
Which worker should it focus on?
Will the Pareto principle help?
What about income?
So what will allow us to decide which worker to focus on?

Answer 46

Pareto princple is not much helps as the training in investment is not likely to make either worker worse off and you cannot make both better off.
Not income - we would focus on the worse off individual.
Biggest increase in social welfare function.

Question 47

Here us a very simple example to illustrate how this might help
Consider a two person economy
Each individual produces a single good
Government has the resources to invest to raise the productivity of one
type of worker using a training program
Which worker should it focus on?
Why is looking at the biggest increase in social welfare function the best thing to do?

Answer 47

We could introduce a welfare weight which could be higher for the poor and that policy that raises income need not be the one that increases the social welfare most. ( due to the diminishing marginal utility of income or swf with a preference for equality.)

Question 48

Should redistribution be focused on certain groups in society rather than everyone, what types of poverty( poor) that this can be argued that matter?

Answer 48

1) Absolute poverty -those with income below a cutoff level of income
2) Relative poverty - those below half median income
3) Poverty can also be about consumption of specifc goods e.g. energy, health care or food.

Question 49

What are the properties of an egalitarian social welfare?

Answer 49

An egalitarian favors equality of some sort: People should get the same, or be treated the same, or be treated as equals, in some respect.
45 * LINE

Question 50

Is looking at utilities the best way to make comparisons across societies?

Answer 50

TBH

Question 51

Whenever given a question about welfare what do we have to talk about?

Answer 51

1) PARETO PRINCPLE
2) Maxmin
3) SOCIAL WELFARE FUNCTION OF PREFERENCE OF EQUALITY
4) Possibly sum of benefits

Question 52

What are 2 papers that relate to this topic and what are the authors?

Answer 52

Why people prefer unequal societies - Christina Starmans et al ( 2017)
Why inequality matters? - Branko Milanovic ( 2018)

Question 53

What is why people prefer unequal societies about by Christina Starmans et al(2017)?

Answer 53

This reading argues that humans naturally favour fair distributions, not equal ones i.e. there is a trade-off between fairness and inequality. Moreover, when fairness and equality clash, people prefer fair inequality over unfair equality
Also when people are asked to distrubte resources among a small number of people in a lab study, they insist on an exactly equal distubtion. But when people are asked to distrubte resources among a large group of people in the actual world, they reject an equal distubtion and prefer fair inequality. This is because people care about economic unfaireness not economic equality.

Question 54

What does it mean to have a preference for equality - Why do people prefer unequal societies - Christina Starmans et al (2017)?

Answer 54

Idea of a concave social welfare function and diminishing marginal utility. ( taking money from rich and transferring to the poor, so everyone has equal stake of pie)
OR
When subjects in laboratory studies are asked to divide resources among unrelated individuals, they tend to divide them equally. If a previous situation has led to a pre-existing inequality, people will divide future resources unequally in order to correct or minimize the inequality between others.

Question 55

Can you provided a reasoned argument for preferring more equality or is it “just a matter of taste”? - Why people prefer unequal societies - Christiana starmans et al ( 2017)

Answer 55

There are psychological forces that lead to an equality preference, One of these forces is a worry about consequences of an unequal society. TFor example, as inequality increases, self reported happiness diminishes, especially among the bottom 40% of income earners therefore effects productivity of these workers. Especially if they know where they stand.

Question 56

What was the reason why in lab experiements with small amount of people compared to those with real world yielded a different result? Christiana starmans et al ( 2017)

Answer 56

. This is because in lab experiements, as people prefer faireness, not equality, this is not stated in lab experiements, hence people are made to think fair = equal.

Question 57

How is a preference for fairness distinct from a preference for equality - Why people prefer unequal societies - Christiana starmans et al ( 2017)

Answer 57

Economic equality means that everyone gets the same level of resources ( the whole idea of diminishing marginal utlity of income)
Economic fairness - means that resources should be distributed based on who deserves them more, e.g. those who work hard and work longer hours in harder jobs deserve more resources. also this can consitute to imparital procedures such as random assignments e.g. coin flips and lotteries.

Question 58

Should reducing inequality be a conscious objective of the government? - Why people prefer unequal societies - Christiana starmans et al ( 2017)

Answer 58

People have an aversion towards unfairness. As we see in the real world, people prefer fair unequal distributions vs unfair unequal distubtions. One needs to focus not on whether the system results in a relatively equal or unequal distribution of wealth, but whether its viewed as fair.

Question 59

When might there be a preference for equality by a social planner lead to a egailtarian outcome?

Answer 59

If the supply of effort is completely inelastic, and the social planner can reach the egalitarian outcome by redistubting income.

Question 60

Can there be too much equality? - Why people prefer unequal societies - Christiana starmans et al ( 2017)

Answer 60

E.g. there is a strong relationship between economic growth and inequality, without high profits and savings of rich using their money for investments, there will be no growth, despite high profits mean inequality. ( NOT FAVOURING INEQUALITY HERE)- RICH SHOULD BE RICH, IF THEY USE THEIR MONEY RIGHT.
ALSO: if there is equality, it leads to a lack of incentives, e.g. if everyone has same resources, lse applications wont be many, as differences in resources motitvate others to work harder and get to the best unis.

Question 61

Why do governments produce official inequality statisitcs? - Why people prefer unequal societies - Christiana starmans et al ( 2017)

Answer 61

1) To rank societies or to assess policies.
2) GDP is not a good indicator to assess income inequality, as it focuses on the mean.
3) people have exaggerated views about the current market system and underestimate inequality.

Question 62

What are the 3 reasons why inequality matters according to Branko Milanovic ( 2018)?

Answer 62

1) Insturmental reasons having to do with economic growth.
2) Reasons of fairness
3) Reasons of politics

Question 63

What are the instrumental reasons having to do with economic growth?- in the paper Why inequality matters? - Branko Milanovic?

Answer 63

Here there is an assumption that there is a positive relationship between inequality and economic growth ( e.g. rich use their money for investments and hence growth). However evidence shows this ain’t true, in fact it’s negatively correlated. Inequality is good for rich but not the poor. Why does inequality have a bad effect on the growth of the poorest? - because it leads to low education achievements among the poor who are excluded from good jobs.

Question 64

What are the reasons of fairness- in the paper Why inequality matters? - Branko Milanovic?

Answer 64

Those who are relatively poor cannot provide for their children as much as someone who is relatively rich, imply that inequality tends to persist across generations which in turns mean that opportunities are vastly different for those at the top of the pyramid and those at the bottom. Hence issue of fairness.

Question 65

What are the reasons of politics in the paper Why inequality matters? - Branko Milanovic?

Answer 65

The rich have more political power and they use that to promote own interests and to entrench their relative position in society. Leads to also corruption.

Question 66

PROBLEM SET

Answer 66

Question 67

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Question 68

4 5 and 6)

Answer 68

Question 69

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Question 70

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Question 71

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Question 72

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Question 73

How can we check if something is not pareto efficient?

Answer 73

If we can make a pareto improvement, then it isn’t pareto efficient.

Question 74

In Starmans ( 2017 why people prefer unequal societies) What governmnet interventions could be done to increase economic fairness rather than economic inequality?

Answer 74

Training schemes, more education to ensure upward mobility ( facility for rising to a higher social or economic position.)

Question 75

A utilitarian SWF is?

Answer 75

A STRAIGHT LINE

Question 76

What is the paper about?