Inequality and govt failure Flashcards
What is allocative efficiency
A situation where the combination of goods and services produced maximises total economic welfare of society
What is equity and why is there inequity in distribution of output?
equity refers to fairness in the distribution of output.
There are 2 reasons for inequity which are prices of essential goods and services being to high so they are unaffordable and distribution of income being too unequal.
The reason for prices being too high is because
1. Free market economy so an individuals ability to consume goods and services and the allocation of resources depends on their dollar votes which is in turn dependent on the resource or income an individual has. Thus, goods and services are allocated according to income distribution so with more unequal income distribution comes unfair allocation of resources as free market will allocate resources to goods and services for those with ability to pay.
2. People with higher incomes are able to cast higher dollar votes for the goods and services they want. In the free market, profit-maximising firms will channel resources towards to production of goods and services demanded by the rich. However, this in turn diverts resources away from goods and services that satisfy the needs of the poor since they don’t have as much purchasing power. This means that scarce resources will be given to GAS for the rich while there is inadequate scare resources to satisfy the production of GAS the poor may require.
What is income inequality and how do you measure it? How to interpret it?
It refers to the extent to which income is distributed in an uneven manner among a population. It is measured by the GINI coefficient (vertical axis- percentage of total income earned horizontal - percentage of total population) which measures the degree of inequality in income distribution among a population.
- How it compares to other countries
2.How it has changed over time
What are the causes of income inequality
- Unequal factor endowments - In a free market where people own private properties, some individuals may own more FOPS such as land, shares in a company and capital on top of labour as compared to those only with labour. This means they receive not only a wage but also interest, rent and profits. Additionally, those who are more wealthy are likely to send their children to get better education which allows them to earn a higher wage in the future as well as leave them with inheritances with jumpstarts their wealth accumulation process.
- Difference in prices of FOPS - While the type of FOP may be the same, there could be a difference in quality such as in the labour market with skilled workers earning a higher wage over unskilled workers
What is the relationship between wage rate and Qd for workers. For labour market, what are the axis?
There is an inverse relationship between wage rate and Qd of labour. As the wage rate increases, the MCOP of production a unit of output increases making it less profitable. This leaves firms with a decision to either produce less output or replace labour with other cheaper FOPs.
Vertical axis - Wage rate
Horizontal axis - Quantity of labour/t
What factors causes the market demand of labour to shift
- Change in price of an output due to increased demand for the good - Since labour is a derived demand, the demand for a particular good increasing will in turn affect the demand for labour. Given the rise in price of a good, this means that each worker is generating more revenue for the firm which raises market demand for healthcare workers.
- Change in labour productivity - An increase in labour productivity leads to a rise in output per worker which in turn increases the workers revenue contribution to the firm. With a higher revenue contribution per worker, rational firms will increase their market demand for cleaners at the same wage rate
- Change in capital productivity - An increase in capital productivity leads to capital being more attractive for companies looking to cut down on their cost of production by replacing workers with capital. This reduces the firms need for labour in turn affecting demand
What is the relationship between wage rate and Qs. What affects the market supply for labour?
Positive relationship.
1. Change in how many people get qualifies - change in number of appropriately skilled workers for specific industry affects labour supply as they are determined by govt policies and innate abilities
2. Change in population demographic whether to ageing population or immigration
3. immigration policy - for open economies, immigration is allowed in order to increase price competitiveness and allow for global companies to invest so a welcoming immigration policy can allow for influx of migrant workers
4. attractiveness of the jon
What can the govt do to address inequity?
Max price, Min price, Min Wage, Income redistribution (transfer payments, direct taxation and indirect taxation) and production subsidies
How does maximum price address inequity? What is good or bad abt it?
- A price is set below the market equilibrium for it to be effective
- Max price used to make good more affordable but leads to shortage of goods and services in the market
- Normally would lead to an upward pressure in price but now js persistent shortage which can be addressed by rationing or first come first serve as well as random allocation
Positives - relative ease of implementation and not costly
Negatives - welfare loss as no longer producing at socially optimal level, hard to enforce in some countries which may cause BM to emerge where good is sold above price ceiling and not addressing root cause
How does minimum price address inequity and what is good/bad abt it?
- Minimum price is done by either legislation or the govt agreeing to buy the good at a stipulated price
- Producers are prohibited from selling below the price to protect low-income producers by preventing their revenue from falling and in turn their income
good - lower costs compared to giving subsidies to producers
bad- loss for consumers and producers if good is price elastic, consumers may switch to other subs which results in a fall in revenue as well as loss in consumer surplus. Dynamic and productive inefficiency - dynamic cos firms lack incentive to improve their production methods while there is less pressure to minimise COP leading to productive inefficiency as they know they cans sell at that price no matter what
good/bad things about wage control
good - increased productivity as firms are incentivised to raise productivity to reduce their reliance on labour same for workers
bad- increased unemployment, allocative inefficiency and ineffectiveness as a desperate worker may offer to work below min wage in order to stay emplyed
How do transfer payments redistribute income? good/bad abit it
- Define transfer payments - expenditure by govt for which it receives no goods and services in return. It usually involves the transfer of income from taxpayers to a group of individuals which the govt has given the criteria to be in the group
- Explain what it does - govt provided lump sum payments to these individuals in order to raise their purchasing power and enable them to buy more goods and services, usually basic necessities
Another type will be govt vouchers which are given to a specific group of people. This is preferred so that they will purchase more of these goods and services instead of on other things. It increases consumers ability to purchase goods in a particular market, improving equity and SOL. However, this may come at the cost of welfare loss.#
good - effectiveness compared to subsidies where producers take a cut and cost effectiveness as it is not a long-term commitment
bad - crutch mentality, high costs and ineffective due to the criteria picked
How does direct taxation solve inequity?
- Define direct taxation - taxes levied by the govt directly on the income, wealth and profits of individuals and firms including income and corporate tax
- Name what kind of tax - progressive tax
- Define progressive tax - A progressive tax is a tax where those with higher incomes are taxed more than those with lower incomes and aims to reduce inequity by bridging the income gap between the 2 when tax revenue is redistributed in the form of transfer payments
This is bad because it may stifle work incentives since workers might not produce at full capacity since any additional work they do which garners a promotion is just going to get taxed so there is productive inefficiency.
Another reason it is bad is because it stifles investment incentives. Since the ppl with high income are more likely to invest, they act as a source for loanable funds, however if they have less income after tax, they will be less likely to invest which in the long-run leads to stagnation in economy and SOL.
How does indirect taxation solve inequity?
- State how the poor spend their money - usually on consumption
- Explain how indirect taxes work - discourage consumption and raise tax revenue. This allows for cheaper goods which the poor need while gaining more tax revenue from the riches luxury goods
good - enhances affordability of goods and services for the poor and is flexible
bad - trade off between efficiency and equity
How does production subsidy improve equity?
- Define production subsidy - It is a payment made by the govt to producer to encourage them to produce more of a certain good or service
- How does it improve equity - This decreases the MCOP of goods and services which incentivises firm to produce more of the good resulting in lower prices of essential goods and services, increasing affordability
good - enhances affordability of goods and services and flexible
bad - incurs govt expenditure, trade off between equity and efficiency and distortion in other markets
