Inequality

Question 1

Give the timeline of inequality

Answer 1

Wealth/ National income ratios

-1870-1910: very high
-> Wealth was because of land
-> Passed between families

1910-1950: Fell dramatically
-> War caused redistribution

1950 - Now: Increasing

Question 2

What are the 2 general ways to measure inequality?

Answer 2

1) Divide population into equal sized groups and measure how much income each group has.
2) Divide incomes into equal sized and ask how many people fit into each group

Question 3

What are the 2 sources of inequality?

Answer 3

• Characteristic
  -> Education
  -> initial conditions
  -> motivation

-Remuneration depends on:
-> Tech production environment
-> Demand and supply of different characteristics

Question 4

What are Piketty’s 4 conclusions from “Capital in the 21st Century”?

Answer 4

• Capital/output ratio increased over last decades
• Capital/output ratio will further increase in the future (Theoretical based on Solow)
  -If tech growth and population growth slow to zero, then capital/output ratio will skyrocket (to infinity)
  -As capital ownership is very skewed across the population, wealth inequality will rise further in the future.

Question 5

What 2 assumptions did Piketty make that differ from standard Solow?

Answer 5

1) Behavior: net instead of gross saving rate is constant (net investment is always positive, individuals save a fraction of income after replacing capital.

2) Production function: Inada conditions are applied to net output instead of gross output.

Question 6

Explain why Piketty’s assumptions cannot be correct

Answer 6

net investment always being positive, even when the cost of depreciation exceeds to marginal gain from investment implies that consumption tends to 0 as investment tends to 1. This cannot be explained under a household utility maximization framework, meaning that a similar result cannot be found in a more sophisticated economic model such as the endogenous romer model.

Question 7

Explain the process of finding the Gini coefficient

Answer 7

1) arrange households from lowest -> highest income
2) Determine what fraction of total income is earned by poorest 1%, then 2%, etc. until you each 100%
3) Graphing gives Lorenz curve
4) Lorenz curve would be straight line with slope of 1 if perfectly equal
5) Area between perfect Lorenz curve and line of perfect equality divided by area under the line of perfect equality
6) get Gini-coefficient between 0 and 1 (0 perfect, 1 bad)

Question 8

Give 4 reasons for todays inequality

Answer 8

1) Tech advances (Kutznets curve/ job polarisation)
2) Increases in international trade (Opening trade lowers ROR if something is scarce at home but plentiful in rest of world.)
3) Superstar dynamic (Number 1 paid so much more than number 2)
4) Economic reforms in 80s (Thatcher)

Question 9

Give 3 reasons why redistribution could be good for growth

Answer 9

1) If human capital ROR > capital return
2) Avoids political instability
3) Reduces crime, protection of property

Question 10

Give 3 reasons why redistribution could harm growth

Answer 10

1) Discourages incentives for investment/ working
2) Transaction costs
3) If return to physical capital > human capital