Macro Unit 2 Flashcards
How is income inequality measured primarily?
When measuring income inequality it is important to decipher between market income (all earnings from employment, investments etc) and disposable income (earnings after tax etc).
Using the Gini coefficient which is the average difference in income between all members of the population, divided by the population and multiplied by 0.5.
The Lorenz curve is used as a diagrammatic observation of inequality which has cumulative share of population on the x axis and cumulative share of income on the y axis.
The Gini coefficient is related to the Lorenz curve, Gini = A/A+B where A is the area between the line of perfect equality and the Lorenz curve and B is the area below the Lorenz curve.
How is the WS-PS model related to inequality?
The WS-PS model shows the division of the economy’s output between workers and employers.
Workers produce a constant amount of output per day, lambda, which is divided into the profit share for owners and the wage share for workers.
In an economy with 10% unemployed, 80% workers and 10% owners and a wage share of 0.6 lambda for example, a Lorenz curve can be drawn next to the WS-PS model to show income distribution at equilibrium:
0-10% that are unemployed earn 0% of income
10-90% workers earn 60% of income
90-100% owners earn 40% of income
Assuming no unemployment benefits, each worker earning the same wage
What is the impact of increased competition in the product market on inequality using the WS-PS model?
We start at equilibrium (WS=PS) with a Gini of 0.36.
Competition in the market increases.
The markup charged by firms will decrease.
The price setting curve shifts up, forming a new equilibrium.
At this new equilibrium there is a higher real wage and level of employment.
As a result, weaker market power means the profit share decreases and consequently the wage share increases.
Inequality falls.
What is the impact of education and training on inequality using the WS-PS model?
Education and training quality improves, increasing labour productivity
The markup chosen is determined by competition so is unaffected by improved productivity.
When average product of labour rises but the profit and wage shares remain the same, the PS curve shifts up.
A new equilibrium forms and workers benefit from a higher real wage and structural unemployment decreases.
On the Lorenz curve, this moves the first kink of unemployed people to the left and everything else stays the same.
Thus the Lorenz curve is closer to the line of perfect equality and income inequality decreases.
What is the effect of a wage subsidy on income inequality using the WS-PS model?
Government pays a subsidy to firms in proportion to the wages it pays its workers.
The costs of the firm have fallen (not due to higher productivity).
The markup the firm will use has not changed, so with lower costs it will set a lower price.
When all firms do this, the price level falls and real wages rise.
The PS curve shifts upwards and structural unemployment falls.
Income inequality falls.
What is the impact of unemployment benefits on income inequality using the WS-PS model?
We relax the assumption that the income of unemployed people is 0.
Government introduces an unemployment benefit.
Initially the Nash equilibrium is where WS=PS. Here, neither worker nor firm could be better off by stating a different wage or price.
In the short run, the reservation wage of employed workers increases, shifting the WS curve upwards.
Employers must pay more to recruit and motivate workers.
Unemployed and employed receive a higher income.
In the long run, a new Nash equilibrium forms where the new WS=PS.
Here, there is higher structural unemployment and income inequality is higher.
This outcome is not consistent across all countries however.
How do trade unions affect the WS-PS model?
A trade union is a membership organisation of workers that aims to improve pay and conditions of work for members.
Unions use the threat of strike action and collective bargaining power to negotiate wages with employers.
Thus, the wage is not set by HR, and rather a new wage curve, the bargaining curve, lies above the wage curve.
In the short run, the WS curve essentially shifts upwards so the employed receive a higher wage.
In the long run, a new Nash equilibrium forms where there is higher structural unemployment and an unchanged wage for the employed.
The unintended consequences are that fewer workers are employed and the wage is no higher than in the absence of the union.
However, this outcome varies between countries. Powerful unions often restrain from increasing wages as they understand the consequences
What is a segmented labour market?
A labour market with two or more distinct segments that function as separate labour markets.
Typically, there is a primary labour market of higher earners and stable jobs, and a secondary labour market where jobs are temporary, unstable, low pay, zero hour contracts etc
On the Lorenz curve, this forms a new section where the employed is divided into 2 sections (primary and secondary labour markets)
Reducing labour market segmentation reduces income inequality.
How is tax incorporated into the WS-PS model?
We now factor in that taxes in the economy change and the percentage rate of tax is denoted t, ie tv or td.
Tax on consumption means the price received by firms, P, is lower than the price paid by the consumer, Pc (=P(1+tv))
Tax on income means the workers’ take home pay, W, is lower than the total wage cost to the employer, Wg (=W(1+td))
We write the WS and PS curves in terms of the real post-tax consumption wage, w = W/Pc
If we put real post-tax consumption wage on the y axis, the WS curve is unaffected.
The PS curve is affected: Wg/P = (1-sigma)lambda written in terms of W and Pc gives the PS curve in terms of the post-tax real wage w = W/Pc:
, w = (1-sigma)lambda/(1+td)(1+tv)
The overall effect of taxes is to reduce the real output available to be shared between the worker and firm from lambda to lambda/(1+td)(1+tv). The firm receives sigma, worker receives 1-sigma and the rest of lambda goes to the government
What is the effect of an increase in tax on income inequality using the WS-PS model?
If tax on income or consumption increases, this leaves less output per worker for real wages and profits to be shared between firms and workers.
Since competition hasn’t changed, the profit and wage shares are unaffected.
Higher tax reduces the PS real wage and so the PS curve shifts down.
This increases structural unemployment.
How are imported input materials factored into the WS-PS model?
When we allow for imported raw materials, the marginal cost is higher by a factor of (1+tau) than in the model where labour is the only input.
The price will also be higher by the same factor, and the price-setting real wage is: W/P=(1-sigma)lambda/(1+tau)
We can model an increase in the price of raw materials as an increase in tau which will reduce the price setting real wage
The PS curve shifts down as firms pass on the higher costs in the price of their products.
Real output per worker is shared between workers, firms and foreign suppliers.
Competition is the same so firms continue to get a markup of sigma and an increase in the price of imported materials leaves the profit share unaffected.
If the same amount of output per worker goes to owners and more goes to foreign suppliers, there is less that goes to workers and so real wage decreases and structural unemployment increases.
