Inequality

Question 1

What is income and wealth?

Answer 1

Income - How much money has come in throughout the year.
Wealth - How much is all of your assets worth
Income and wealth are mutually reinforcing. This is because having a high income can buy assets, increasing wealth, which can generate further income.

Question 2

What are the reasons for differentials between income and wealth?

Answer 2

• Age - The greater the age, the more skilled and experienced, increasing their earning potential, allowing them to demand higher wages.
• Education - The more qualifications can change the earning potential, changing their income and wealth.
• Ownership of financial assets - Often inherited, further worsening the inequality
• Ownership of property - Also inherited
• Wage differentials - The greater the differential, the greater the inequality in the distribution of income. This can lead to the state intervening, providing state benefits.

Question 3

What is the Lorenz curve?

Answer 3

Lorenz Curve - Gives a visual representation of income inequality within an economy
An economy with little inequality will have a Lorenz curve close to the line of equality. However, a very unequal distribution of income will be shown by a vast difference between the two curves.
This analysis can be used to show the impact of government policies, with a policy aimed to reduce inequality shifting the Lorenz curve close to the line of equality.

Question 4

What is the Gini Coefficient?

Answer 4

Gini Coefficient = Area A / Area A+B (taken from the Lorenz curve).
A gini coefficient of 0 is perfect equality, with Area A being 0.
A gini coefficient of 1 is perfect inequality, with Area B being 0.
For example, Norway, an equal economy, has a gini coefficient of 0.25, whereas South Africa, an unequal economy, has a gini coefficient of 0.65.

Question 5

What is poverty?

Answer 5

Absolute poverty - Incomes below a threshold to access the most basic, life sustaining goods and services (e.g. food, water, shelter). Living on under $2/day.
Relative poverty - Income below a given average in society.
Equity - Fair distribution of income
Horizontal equity - Equal treatment of equals. Those with the same incomes are taxed the same.
Vertical equity - Higher income earners pay more tax (progressive taxes)
Equality - Distribution of income must be equal

Question 6

What are the causes of poverty?

Answer 6

• Unemployment - Cyclical unemployment in a recession may lead to a fall in AD, resulting in workers losing their job. Structural unemployment (lack of skills) due to transfer of firms from heavy manufacturing industries towards service sector, leading to workers not having the skills to get a job in the new firms. Also, if there is no training available, these workers will be left unemployed for a long period of time.
• Poor education/skills - Those that lack qualifications to have a high MRP may be left in poverty
• Poor healthcare - Limits productivity and earning potential, due to it limiting the amount people can work and what jobs are available, further limiting them to low wages.
• Wage differentials
• Born into poverty - Evidence shows being raised by a single parent will reduce an individual’s earning potential
• Tax cuts for well off
• Subsistence agriculture - Very common in LEDCs where families will want to maintain their farm and prioritise their children working on the farm over education.

Question 7

What is the Laffer curve?

Answer 7

Increasing taxes will increase tax revenue up to a point. Increasing taxes beyond this point (the efficient tax rate), there will be a fall in tax revenue for 3 reasons:
Disincentives to work and be entrepreneurial - No point in working more/hard if more of an individual’s income will be taxed.
Emigration - Workers will move to another country in order to benefit from lower taxes, resulting in higher disposable income. 
Tax Evasion (Illegal)/Avoidance (Legal) - Reduces overall tax revenue to the government.

Question 8

What are the policies to redistribute income and wealth?

Answer 8

• Taxation:
  
  • Increase progressive taxes - Increase the tax free allowance or increase tax rates on high tax brackets. This could distort incentives, reducing the incentives to be entrepreneurial and earn more money, resulting in lower tax revenue (Laffer Curve)
  • Reducing regressive taxes - This could reduce government revenue
• Increasing benefits - Directly giving payments to the poor. This could lead to the poverty trap, whereby people in poverty have no incentive to work and, thus, end up living in poverty for life. Also, it could harm government finances, with welfare payments being a high percentage of government spending.
• Minimum / Maximum Wages - Directly change wages in labour markets. This could reduce incentives to work and may lead to workers only working part-time. Also, minimum wages could lead to further unemployment and poverty (especially for the youth who have low MRP and little experience).
• Legislation - Anti-discrimination laws, reducing wage differentials; hiring/firing laws; minimum wages; amount of leave. This could have significant costs to businesses and could also be very hard to enforce. There is also risk of government failure, with businesses possibly being forced to shut down or move to another country where legislation is not as strict.
• Supply-Side Policies:
  
  • Government spending on education/training - Increase skills/qualification leads to increased MRP and wages.
  • Government spending on healthcare
  • However, these policies are expensive and will have a time lag, with it taking time to train workers.

Question 9

Evaluation of policies to redistribute income and wealth

Answer 9

• Incentives to work?
• State of government finances
• Equity vs Efficiency - All policies to reduce inequality are equitable but not very efficient
• Normative judgements
• Risk of government failure
• Is inequality always bad? - Could provide an incentive to work and be entrepreneurial