MICRO - 8. distribution of income ✅

Question 1

difference between income and wealth

Answer 1

INCOME is flow of money you receive monthly, hourly, weekly or annually which you can save and add to personal wealth (eg wages, rental income, interest from savings, profits)

WEALTH is the stock, accumulation of everything with value that you own (eg savings, ownership of property, stocks/shares, wealth held in pension schemes)

Question 2

how does distribution of income arise

Answer 2

arises from complex interaction between market workings and government intervention producing allocation of resources (efficient or inefficient)

Question 3

what creates differences in the distribution of resources in capitalist market economy (5) (differences in how people get money and how much they get)

Answer 3

• the ownership of property and how much they receive depends on the forces of demand and supply
• Workers with scarce skills in high demand = high wages but workers with lower skills in less demand = low wages
• High skilled workers however may choose not to work
• Shares in companies differ and the owners with assets of high value are likely to have a high income and those with large shares of financial capital have more income than majority of the population
• Since 1945, welfare state has been created which works towards altering the distribution of income to ensure greater equality

Question 4

what are causes of inequality in income (longer) (6)

Answer 4

EARNED INCOME (some earn more than others, determined by educational attainment as university degrees earn more. Full time also earns more than part time)
NON-WORKERS (not all work, so are likely to earn lower incomes than those in work eg pensioners or full time parents)
PHYSICAL AND FINANCIAL WEALTH (those with higher physical/financial wealth generate a higher income from assets)
HOUSEHOLD COMPOSITION (a high salary but with a large family means the income per person is low. However, household with two parents and four child wage earners with high income inequality is presented differently)
GOVERNMENT POLICY (extent to which government distributes income through taxes and benefits)
DEGREE OF COMPETITION IN PRODUCT MARKETS (perfectly competitive markets = different distribution than imperfectly competitive markets)

Question 5

what are the different forms of wealth

Answer 5

PROPERTY WEALTH = value of houses with commercial land eg farming and commercial buildings
PHYSICAL WEALTH = value of physical valuables eg antiques, furniture
FINANCIAL WEALTH = value of monetary assets eg personal savings, stocks, shares
PRIVATE PENSION WEALTH = locked in pension funds linking to occupation

Question 6

what causes inequality in wealth for individuals (3)

Answer 6

• income/wealth levels
• inheritance
• chance

Question 7

how do income/wealth levels create inequalities in wealth

Answer 7

INCOME levels:
- Higher level of income = more likely they can save and accumulate physical assets however bottom end they will probably not be able to save and so can’t accumulate wealth
WEALTH levels:
- Those owning high levels of wealth can make higher returns and income as a % of their assets than those on low incomes e.g., owning higher levels of assets takes on higher risk than owning fewer assets
- Wealthy individuals have more access to potential high return assets than poor individuals

Question 8

how does inheritance contribute to wealth inequality

Answer 8

• More a person inherits, higher their wealth will be.
• Traditionally land based - passed down through generations and most valuable thing a person can inherit is a house
• Parents also pass down education and work ethics, so UK income and wealth levels are correlated

Question 9

how does chance contribute to wealth inequality

Answer 9

• Element of chance within wealth accumulation
• Eg owner of a house in Chelsea is luckier than a house owner in Wolverhampton as house prices have rose more in Chelsea than Wolverhampton
• Chance also comes into stocks and shares and income levels and occupation with career progression

Question 10

how can inequality be measured

Answer 10

• Using the Lorenz curve with a straight line portraying total equality and the closer the other lines are to this line is how close they are to total equality
• One statistical measure is the Gini co-efficient

Question 11

what is the significance of the Gini co-efficient figures

Answer 11

The higher the Gini co-efficient the more unequal the country is and if everyone has equal income then Gini = 0 and if it = 1 then one person has all the income, and the others have none

Question 12

what is absolute poverty

Answer 12

ABSOLUTE POVERTY = necessities needed to maintain life cannot be consumed so malnourishment or homelessness is absolute poverty

Question 13

what is the relationship between poverty and development

Answer 13

In rich industrialised society absolute poverty is low and levels tend to increase as average incomes of economies fall so absolute poverty is correlated with economic development

Question 14

how can you measure poverty

Answer 14

• RELATIVE poverty is always present in society as relatively poor are at the bottom end of income scale
• however there is no exact way of measuring, but the two common ways are :
  –> to measure the number/% of households whose total income is at X% less than median income (common way in the UK/EU is measuring peoples incomes less than 60% of median income because households will find it difficult to participate in society effectively below this level)
  –> Another way of measuring poverty is finding out what necessities people might have to buy to not be considered poor

Question 15

what are the causes of poverty

Answer 15

• people without jobs are in poverty as no income and have to fall back on other ways to survive
• lack of human capital – education and training associated with poverty so with little = workers only sell skills for low wages. (Positive correlation between countries of the number of years spent in education and level of income)
• Lack of financial capital hits those retired so poverty is high among old people as they have inadequate savings
• Health problems affecting a person’s ability to work
• Being dependent on others for income = poverty e.g., % of children in poverty is above adults and those on unemployment benefits
• Inheritance is important
• Between countries/regions, physical capital and intellectual capital like patents

Question 16

what are the cycles of the rich and poor

Answer 16

• Cycle of poor means low income = borrowing which adds to personal debt = income spent on debt repayment = less disposable income = fall in consumption = any wealth disappears
• Income cycle of rich = wealthier you are = more investment income you earn adding to total income = increases ability to save and savings add to wealth so cycle repeats

Question 17

effects of poverty

Answer 17

• Absolute poverty = ill health or death
• Relative poverty ill health and death are still a hazard as are more likely to have ill health due to poorer housing, bad diets and lack of access to health care
• Relative linked to lack of access to physical goods and services
• Low self-esteem creating mental health problems and affecting quality of life

Question 18

what is horizontal and vertical equity

Answer 18

HORIZONTAL EQUITY = identical treatment of identical individuals in identical situations

VERTICAL EQUITY = everybody is different, so it is the different treatment of people with different characteristics to promote greater equity. In terms of equality = everybody should have same opportunity regardless of their background

Question 19

are inequalities unfair?

Answer 19

Inequalities aren’t necessarily unfair as a person working more is naturally going to be earning more, same with pensioners not making adequate pension provision for themselves whilst working

Question 20

what are the disadvantages of inequality

Answer 20

1. inequality arising from monopoly power
2. inequality arising from monopsony power
3. diminishing marginal utility of income
4. social problems
5. unemployment
6. inherited wealth

Question 21

what are the advantages of inequality (4)

Answer 21

1. incentive effect
2. entrepreneurs require rewards
3. trickle-down effect
4. fairness

Question 22

how is inequality arising from monopoly power a disadvantage of inequality

Answer 22

if they have monopoly power = can set higher prices for consumers = redistribution of income from consumers to shareholders. Inequality based on unfair distribution of power

Question 23

how is inequality from arising monopsony power a disadvantage of inequality

Answer 23

monopsony is when firm has market power in employing workers at a wage below competitive equilibrium, so wages are lower than marginal revenue product (MRP) of labour so unfair distribution away from workers

Question 24

how is diminishing marginal utility of income a disadvantage of inequality

Answer 24

• income has diminishing marginal utility
• with first 1k earned you can buy necessities and the next 1k has the highest utility as it is essential to maintain life and avoid absolute poverty
• if another 1k is earned then you can now buy better quality goods, but the increase is less than the second 1k. millionaires marginal utility is very limited.

THEREFORE, increasing income equality leads to overall net gain because the poor see a bigger increase in utility than the loss faced by high earners

Question 25

how are social problems a disadvantage of inequality

Answer 25

can lead to social friction, can cause higher crime levels or more riots so all members of society lose out, particularly if inequality is perceived to arise out of unfair opportunities

Question 26

how is unemployment a disadvantage of inequality

Answer 26

biggest cause as it is considered a market failure as represents an inefficient allocation of resources

Question 27

how is inherited wealth a disadvantage of inequality

Answer 27

gives people unfair advantage in life, may make them lazy as they can live off rent, dividends and profit

Question 28

how is the incentive effect an advantage of inequality

Answer 28

if someone works harder and receives higher wage this isn’t market failure.
Hopes for higher wages is essential to encourage extra effort by rewarding hard work so productivity will rise and higher GDP

Question 29

how are entrepreneurs requiring rewards an advantage of inequality

Answer 29

inequality is necessary to encourage entrepreneurs to take risks and set up a new business
Without the prospect of rewards incentives to invest in business opportunities would drop

Question 30

how is the trickle-down effect an advantage of inequality

Answer 30

extra income gained can trickle down to other people.

Eg., if an entrepreneur takes risks and sets up a business he may become a millionaire but this also creates jobs and provides incomes.
Although the gap between high and low income earners will still exist, the lowest earners are still better off than without the entrepreneur

Question 31

how is fairness an advantage of inequality

Answer 31

can be argued that people deserve to keep high incomes is their skills merit it

Question 32

how can government expenditure redistribute wealth and income

Answer 32

• Providing monetary benefits to those requiring financial support
• Governments can target specific areas by alleviating old age relative poverty by granting low rent housing or offering renovation grants or by offering free school meals or free nursery education to help children in poverty
• the provision of goods/services giving citizens equal opportunities in society

Question 33

what three approaches can be utilised for the provision of goods/services giving citizens equal opportunities

Answer 33

• Pure free market approach – arguing if high income earners can buy better education and better healthcare, they can buy better cars so individuals with neither won’t have access to these goods/services
• Middle position – all individuals have right to minimum level of healthcare and education and those on higher incomes can afford to buy higher quality services so every child is entitled to free education in a state school but some can choose to buy better education in private schools
• Interventionist approach – all individuals should have equal access to services like healthcare and education and private health care and education shouldn’t exist. This would lead to horizontal equity

Question 34

how can governments use taxation to reduce inequalities

Answer 34

• Impose inheritance taxes. The higher the rate of tax, more difficult it becomes for individuals to pass on wealth however main problem is that they can be avoided through careful tax planning
• Very high taxes on high incomes. Forces highly wealthy people to spend more on maintaining a lifestyle, however this encourages tax avoidance.

Question 35

how do progressive/regressive/proportion taxes differ

Answer 35

• Progressive tax = tax where proportion of income paid in tax rises as the income of the taxpayer rises
• Regressive tax = where proportion of income paid in tax falls as income rises
• Proportion tax = where proportion paid in tax remains the same while income of the taxpayer changes

Question 36

what type are direct taxes

Answer 36

Direct taxes on incomes tend to be progressive because of the structure (income tax where lower income pays nothing and higher incomes pay 40%)

Question 37

what type are indirect taxes

Answer 37

Indirect taxes such as VAT tend to be regressive , as income rise households tend to spend less as a proportion of income and save more

eg taxes on cigarettes and alcohol tend to be highly regressive because they form a larger % of spending for low income households than high income households

Question 38

what other policies can be used to reduce inequality and wealth

Answer 38

• Raising minimum wage will raise incomes of lowest paid workers
• Maximum wages can be fixed e.g., in a firm, highest wage is 20x more than lowest wage
• Employers forced to provide benefits free to their workers e.g., sickness benefits, pensions and medical care
• Passing equal pay legislation. Certain groups discriminated against
• Passing trade union friendly legislation as they raise average wages
• Price controls on essential goods e.g., maximum rents and maximum prices for bread, rice, petrol or electricity
• Private sector goods/services provided on the basis of income. E.g., a new housing estate might be developed where only first time buyers can buy it under planning regulations, first time buyers usually have lower incomes

Question 39

what are the disadvantage of employing taxation as a means to reduce inequality

Answer 39

• Raising income tax lowers incentives of workers so reduces growth of economy rate
• Higher taxes paid by employers on wages discourages them from employing labour
• Higher taxes on company profits reduces incentives to make profit and invest and lead to a flight of capital and labour from the country
• Individual entrepreneurs may choose to emigrate, taking money and skills with them, as well as firms to take advantage of lower tax rates = loss of domestic jobs and income
• Overall, higher the tax = more incentives for taxpayers to use legal loopholes to avoid taxes, or illegal tax evasion

Question 40

what are the disadvantage of employing minimum/maximum wages as a means to reduce inequality

Answer 40

• High minimum wages may discourage employers from taking on workers
• Low maximum wages may discourage workers from taking on difficult and responsible jobs

Question 41

what are the disadvantage of employing maximum prices as a means to reduce inequality

Answer 41

• May lead to shortages and queues
• Black markets may develop where goods bought at lower maximum prices are sold at a higher price
• Maximum prices discourage investment and production e.g., bakeries may not be able to make profits on bred because of maximum prices so production ceases in long run
• The larger the gap between the free-market price and the maximum price, the larger the inefficiencies created in the market