Income Distribution and Welfare

Question 1

What is the difference between income and wealth?

Answer 1

Income refers to flows of wages and money from factors of production e.g. rent from land.
However wealth is referred to the accumulated stock of assets that a household owns e.g. owning a property or issuing bonds.

Question 2

Why might reducing income inequality be an important macroeconomic policy objective?

Answer 2

High inequality may reduce economic growth and extreme poverty needs to be tackled to allow economic growth.

Question 3

What are deciles used for?

Answer 3

Deciles are used as a measurement of income inequality when groups are divided into tenths.

Question 4

What is the first docile?

Answer 4

The poorest 10%

Question 5

What is the top decile?

Answer 5

The richest 10%

Question 6

What is the top quantile?

Answer 6

The richest 20%

Question 7

What is meant by the Ratio top Quantile: First quantile?

Answer 7

It shows by how much times the top quantile is richer than the bottom quantile

Question 8

What is the Lorenz curve?

Answer 8

A graph that shows the distribution of income in a country.
It shows the percentage of cumulative household income that different percentages of the poorest households have e.g. in the UK the poorest 20% have 6% of the income/

Question 9

What is on the X-axis of the Lorenz cure?

Answer 9

Cumulative Percentage of Households.

Question 10

What is on the Y-axis of the Lorenz cure?

Answer 10

Cumulative percentage of total income

Question 11

What is the Gini Index?

Answer 11

It measures the amount of income inequality in a society

Question 12

How is the Gini Index measured?

Answer 12

It is the ratio of the area between the line of equality and a country’s Lorenz curve to the entire area under the equality line

Question 13

What does it mean if a country were to have a Gini Index of 100?

Answer 13

It would mean that the country has extreme inequality

Question 14

What are the measurement issues that are come across when measuring income inequality?

Answer 14

There are differing sizes of households so looking at income per household may be unreliable as one income level may be deemed low for a household of 6, but more than enough for 2.

Consumption instead of income, may be a better measurement of inequality

It is important to notice inequality in wealth distribution as well as income.

Question 15

How are adjustments made to income distribution measurements in order to take into account the varying sizes of households?

Answer 15

Equivalence scales allow the income households to be judged relative to a reference household made up of a childless couple.

Question 16

What is Original income?

Answer 16

Income from earnings, pensions and investment before taxes or benefits

Question 17

What is post-tax income?

Answer 17

It takes away direct taxes and estimates of indirect tax payments (taxes on expenditure e.g. VAT), but adds benefits

Question 18

What is absolute poverty?

Answer 18

When a households income isn’t enough to allow them to buy the minimum amount of goods and services that are needed to survive.

Question 19

What is relative poverty?

Answer 19

When a household doesn’t have enough income to allow members to engage in a normal social life for that country.

Question 20

What is the poverty line, to show a household that is in relative poverty?

Answer 20

When a households income is less than 50% of the income of the median adjusted household (50% of the middle ranked)

Question 21

What is the difference between absolute and relative poverty?

Answer 21

A household in relative poverty has enough income to survive but is excluded from having a social life that is normal for that country and it can exist in any country, but absolute poverty is mainly in LDCs.

Question 22

List the causes of inequality

Answer 22

Labour Market Operations
Ownership of assets
Government actions
Demographic change

Question 23

Explain how the operation of the labour market could cause inequality in earnings

Answer 23

Wage rate is largely based on the demand and supply of labour, jobs where there is elastic supply will have lower pay and a larger amount of their wages will be transfer earnings. This is because it is easy to find workers that are willing to supply their labour at a lower wage rate.
If inelastic supply is coupled with high demand, this makes economic rent higher, however if demand is low it is unlikely the workers salary will be made up of a large proportion of economic rent.

Question 24

How does the ownership of assets influence inequality?

Answer 24

Wealth inequality can be caused when wealth accumulates in a family and then is passed down through inheritance.

Question 25

How can wealth inequality lead to income inequality?

Answer 25

Wealth (the ownership of assets) leads to a flow of income, from rents and dividends, which then feeds back into an income stream.

Question 26

How can demographic change lead to inequality?

Answer 26

An aging population due to improved medical treatments combined with low fertility rates means that there is increased pressure on state pensions.

State pensions are funded mainly by people who are in work but if the amount of economically active people falls as proportion to the whole population this funding comes under pressure and it may be reduced.

Question 27

what are the two forms of benefit that households can gain to help equalise the distribution of income?

Answer 27

Cash Benefits

Benefits in Kind

Question 28

what are cash benefits?

Answer 28

These are to protect families whose income otherwise would be very low e.g. income support, child benefit, incapacity benefit, working families tax credit.

Question 29

What are benefits in kind?

Answer 29

These help make sure that households can participate in a normal social life and include health and education.

Question 30

What are direct taxes?

Answer 30

Taxes that are levied directly on income

They tend to be progressive.

Question 31

What are the main direct taxes paid in the UK?

Answer 31

Income tax
Corporation tax (tax paid by firms on profits)
Capital Gains tax (tax paid by individuals who sell assets at profit)
Inheritance tax
Council tax

Question 32

What is the marginal tax rate?

Answer 32

Tax on additional income earnt

Question 33

How do you calculate marginal tax rate?

Answer 33

Amount of additional income earnt

Question 34

What is a progressive tax?

Answer 34

A tax where the marginal rate rises with income so the more income you earn the more you can expect to pay in tax, as a way to reduce income inequality.

Question 35

What is a regressive tax?

Answer 35

The marginal tax rate falls as income increases.

Question 36

What is a proportional tax rate?

Answer 36

The tax rate is fixed, so each person pays the same percentage of tax.

Question 37

What is an indirect tax?

Answer 37

A tax on expenditure e.g. VAT

Question 38

Why do some argue that indirect taxes are regressive?

Answer 38

VAT which is a tax on most goods and services is likely to take up a larger proportion of income for a poor person than a rich.

Also if a good is an inferior good and is consumed more by poor households e.g. tobacco the tax levied on it will impact poor households more than the rich?

Question 39

How can government actions cause inequality?

Answer 39

Through indirect taxes such as VAT which take up a larger proportion of poor households incomes

Through excise duties on inferior goods that low income households have a higher consumption of e.g. tobacco.

Question 40

How does the Kuznets curev describe the relationship between inequality and the development of a country>

Answer 40

(It is an upside down U shape)
With Gini index on the Y axis and Development on the X.
In the early stages of development income is fairly equal is most people are on a low income.

As development kicks off some people will be ahead of others, e.g. the entrepreneurs.

At the late stages of development, society will be able to redistribute income to the poor, so inequality will be low once more.

Question 41

Why do some believe that a degree of inequality is needed in a society?

Answer 41

If everyone earn the same income, there may be less incentive of households to supply labour and there would be less innovation as there wouldn’t be entrepreneurs that are willing to take risks.

Firms wouldn’t make the effort to maximise profits, possibly reducing consumer choice.

It is this that leads to good allocation of resources.

Question 42

In what ways can governments reduce inequality?

Answer 42

Cash benefits to low income household

Reducing indirect taxes such as VAT and excise duties as they arguably are regressive.

Benefits in kind (health and education) as well as providing Skills retraining to increase a workers marginal revenue product and their wage.