Topic 8 - Finance And Inequality Flashcards
How is the poverty line measured ?
By the income needed for a basic standard of living
What is poverty a measure of ?
Poverty is the measure of the number of people who fall below the poverty line (income needed for a basic standard of living)
What is relative poverty ?
When your income is low compared to the rest of society
How is relative poverty measured ?
When your income is measured as less than 60% of the median income of a country
What is absolute poverty ?
When someone can’t afford basic human needs (like food, water and shelter)
What are causes of poverty ?
Low income
Low wealth
Being unemployed and not having desirable (employable skills)
Wages rising more quickly then those on sate benefits
What is the poverty trap ?
Happens when there’s no net gain from working
Whatever the poor earn in income they lose in assistance
E.g. they earn £100 so lose £100 from government benefits
No incentive to work as are working to make as much as not
What are the benefits of poverty ?
Poverty can be good as it encourages (gives an incentive for) people to work so they improve their incomes and escape poverty
This can reduce absolute poverty in the long term.
Higher inequality means those at the top will do better financially (so increase in tax and derived demand for labour)
This will have a trickle down effect through higher levels of employment to the poorest in society. They will be more able to rise out of poverty
- But this may mean relative poverty will increase as the rich are gaining proportionally more then those getting the benefit of the trickle down effect. So relative poverty will rise
What are the negatives of poverty ?
Poverty will increase the level of crime
Some people have the entrepreneurial talent and drive but lack resources this is a waste as some of this innovation may have benefited society, therefore poverty causes waste in intelligent people
Entrepreneurs and labour are factors of production so economic growth will fall
If corporation taxes were lowered for the top 100 companies in the UK, what would we expect to happen to the proportion of the population in relative poverty?
Increase in relative poverty
Johnny is a low-earning graduate in poverty. He gets promoted, but his student loan increases and he is taxed more. What situation is he in?
Poverty trap
What is a commonly used threshold for the poverty line in the UK ?
60% below median income
What is income ?
A flow of money, often received monthly or annually
What is wealth ?
The sum of the value all of assets
Including pensions, money in the bank, financial investments and the value of a home
What are the factors that influence the distribution of income/wealth?
Taxation policy: regressive policies will tend to increase the income and wealth gap between different groups in a country. Progressive taxation policies will reduce the gap.
The differences in wage between low and high skilled labour.
The level of discrimination against different groups of workers.
Regional differences in earnings.
Unsalaried individuals depending on state benefits.
How does wealth inequality work ?
The money that a person does not spend is saved and accrues as wealth.
Over time the person on the higher income gains wealth quickly compared to the middle income, with the low-income person acquiring very little wealth at all.
In the UK, wealth is distributed more unequally than income. This is because differences in income can compound over years and over generations if wealth is passed on through families.
How does income inequality work ?
Incomes are the payments for factors of production. For most people, their wages are their primary incomes.
In a market economy, different people get different wages based on the jobs they have. Each person then spends money on the basic costs of survival (needs, the cost of which are the same for each person) and then spends a proportion of what is left on wants.
What’s an example on how wealth inequality can become larger in an economy ?
A 0% inheritance tax
How do some people avoid inheritance tax ?
gifting family members income each year and putting assets in trusts is a way that wealthy families try to avoid inheritance tax.
Enrique Iglesias is estimated to have $100M in stocks, bonds, cash and other real estate assets. How are all of these assets best described?
As wealth
What does equality measure ?
Equality measures the difference in income and wealth from the very richest in society to the poorest.
What does equity judge ?
Equity tries to judge whether the distribution of income and wealth is fair or not.
Why is equity hard to quantify?
Because equity tries to judge whether the distribution of income and wealth is fair or not, it’s hard to quantify. So a value judgement needs to be made.
Equity can be horizontal or vertical:
Horizontal equity would imply individuals with similar incomes/wealth paid similar amounts of tax.
Vertical equity would imply that individuals with higher incomes/wealth paid more tax.
What is likely to reduce the level of inequality of wealth in the UK ?
A 100% inheritance tax
What are the benefits of unequal income distribution?
Trickle down economics says that the poor may benefit from the success of the rich.
Unequal distributions can motivate some to work hard and can encourage entrepreneurship.
What are the negatives of unequal income distribution?
They will increase levels of absolute and relative poverty.
If poverty is high, people may not be able to afford the basic needs, leading to increased levels of crime.
If some people have a very high income, depending on the marginal propensity to import, this could lead to a worsening of the balance of trade. If income rises, people will import more.
Why might inequality worsen the balance of trade in a nation?
Wealthy people might have a higher propensity to import
What are two ways to analyse inequality between nations ?
inequality in income within a nation
average incomes (GDP per capita)
What does capitalism rely on ?
Capitalism relies on firms, individual incentives and the price mechanism to allocate resources.
Although this has led to economic growth, many people believe that government policies to manage inequality between nations and within nations is needed.
The UK allocates 0.7% of Gross National Income towards foreign aid.
How much of the UKs gross national income goes towards foreign aid ?
0.7%
In 2018 what did Joseph Stiglitz argue about ?
About Job creation or destruction
although many Western jobs were relocated to developing nations, jobs in developing nations were still destroyed faster than they were created.
Although people moved out of farming to work in higher ‘value-add’ industries like manufacturing, more people lost jobs than gained them.
But the creation of jobs in the poorest developing countries may reduce the amount of people living in absolute poverty.
In the late 1900s why did the demand for manual and factory works’ skills fall ?
Globalisation and deindustrialisation
The outsourcing of the manufacturing sector to developing nations created inequality in developed nations as the demand for manual and factory workers’ skills fell drastically in the late 1900s.
However, GDP per capita growth in nations like China has benefited hugely from this change.
Although inequality in the USA has risen in recent years, in the last three decades, inequality between nations in the world has fallen.
Over the last three decades what happened to inequality between nations ?
Inequality fell
What does the Lorenz curve show ?
A Lorenz curve shows the cumulative percentage of total income received by the cumulative share of the population.
(Income quantiles on the x axis) quantiles are just the constant increase of 20%
(Share of income on the y axis)
How can you understand the Lorenz curve and use it to find a country with a more unequal distribution of income and a country with a more equal distribution of income ?
“perfect equality” is a 45-degree line (x=y)
In a Lorenz curve diagram, a more unequal distribution of income is represented below the 45-degree line.
A more equal distribution will be closer to the 45-degree line.
What is Gini coefficient? (If not understood perfectly look online)
The Gini coefficient is a measure of inequality that can be shown on the Lorenz curve.
This is equal to Area A ÷ (Area A + Area B).
Area A is the area in between the “perfect equality” line and actual equality line
Area B is the area below the actual equality line
A coefficient of 0 represents perfect equality.
A coefficient of 1 represents complete inequality.
The Organisation for Economic Co-operation and Development (OECD) said that the UK had a Gini coefficient of about 0.35 in 2017.
What does a Gini coefficient of 0 show?
Perfect equality
Why is poverty undesirable for governments ?
as it leads to significantly reduced welfare and also has spillover effects (negative externalities) in terms of crime and health care.
What are some government policies to alleviate poverty ?
Benefits
Progressive tax
Minimum wage
State provision
Stimulate the economy
How do the government use benefits to alleviate poverty ?
Governments pay benefits to those who are unable to support themselves due to being out of work, suffering from long-term illness or for several other reasons.
Benefits are an example of transfer payments and are funded through taxes.
Benefits are designed to prevent people from living in absolute poverty by meeting the cost of needs. By providing enough to ensure food, shelter and other essentials and for those who are temporarily unemployed it means they are fit enough to return to work.
How does the government use progressive taxes to alleviate poverty ?
Progressive taxes are designed so that the higher your income is, the higher the proportion of your income you pay in tax.
So the rich pay proportionately more tax than the poor.
This reduces the inequality in income and wealth.
How does the government use minimum wages to alleviate poverty ?
A minimum wage could also be used to try to guarantee that workers receive a fair wage and can afford the basic needs.
A minimum wage can also stop monopoly employers from paying workers too little and putting them in poverty.
Or a benefits system could be used.
How does the government use state provision to alleviate poverty ?
State provision means that those goods and services which are deemed essential by the government are available for all regardless of income or wealth.
By providing schooling, children are given a more equal start in life regardless of their family background.
Without adequate schooling, the children themselves are limited in what jobs they can do when they are older which may keep them in poverty. They would also bring fewer skills to the workforce making the country less productive.
How do the government stimulate economic growth to alleviate poverty ?
Governments can generate economic growth using expansionary policies. This can be used to try to get people out of poverty.
This should also create jobs.
This should mean workers get higher wages and the government should collect higher tax revenue in return.
But this is difficult and inequality could worsen.
What are the negative effects of progressive taxation?
By increasing the tax on higher income brackets, you are discouraging workers from earning more money.
The gain from working might not be as great as the loss of benefits from moving up an income bracket.
So progressive taxation can reinforce the poverty trap
What are the negative effects of minimum wage?
In a perfectly competitive labour market, the introduction of a minimum wage can increase the levels of unemployment.
A national minimum wage underestimates the cost of living differentials across a country.
So a national minimum wage could be better for people who live in cheaper areas than for people who live in more affluent areas.
But the presence of a minimum wage could incentivise work
What are the negative effects of the benefit system ?
The benefits system can disincentivize work.
This is bad for productivity and the economy.
Benefits that are means tested can also lead to a worsening of the poverty trap.
If people think that their benefits will go down if their income increases, they may intentionally not go up an income bracket.
What are the negative effects of economic growth ?
Economic growth is not a simple way to alleviate poverty effectively. It must be carefully managed.
It can also impact the environment by using up scarce resources
What are some measure that are factors in economic development?
access to internet coverage, access to clean drinking water, years of schooling
What is the human development index ?
Human Development Index (HDI)
The most popular measure is the Human Development Index (HDI)
What is HDI a composite of ?
life expectancy, education, and income indicators
How do you calculate HDI ?
Life expectancy at birth (health).
Mean years of schooling and expected years of schooling (education).
Gross national income (GNI) per capita (PPP US$) (standard of living).
Each item is equally weighted.
What are the limitations of HDI ?
The HDI is not a comprehensive measure of human development.
It just focuses on the basic dimensions of human development, excluding factors such as political freedom.
It does not reflect the input efforts in terms of policies, nor can it measure short-term human development achievements.
HDI is an average measure and so masks inequalities within countries.
But it is important to keep it simple with minimum variables to make sure its acceptable, understandable and predictable.
What does the Indian economist Amartya Sen see development as ?
being concerned with improving the freedoms and capabilities of the disadvantaged to enhance the overall quality of life.
While the standard set of freedoms could be around hunger, for example, you can also expand it to increasing political freedom, cultural and social freedom.
For example, if a woman cannot vote or drive a car, her level of economic development is a lot lower than HDI or other measures would imply.
What’s the difference between economic growth and economic development ? (Fact)
Economic growth is measured by an increase in real GDP.
While this allows for higher real incomes, which means people can afford a higher standard of living, it is very important for economists to realise that an increase in real GDP does not equate to economic development, although it may contribute.
Supporting research & development is viewed as a huge supporter of economic growth. South Korea has grown rapidly since 1992 and its R&D has been up to 3.5% of GDP.
Where as
The United Nations (UN) defines development as “the expansion of people’s freedom to live long, healthy and creative lives; to advance other goals they have reason to value; and to engage actively in shaping development equitably and sustainably on a shared planet.”
What are common characteristics of less developed countries ?
Low investment and savings
Command and corrupt economy
Lack of education
Lack of loans and borrowing
Why should investment and saving be important and a goal for less economic developed countries ?
Increasing the quality or quantity of physical capital can increase the productivity of an economy.
A country or business needs to save money to invest the savings in capital. If a country does not save, then investment in physical capital will be lower.
Why should a free market economy and less corruption be important and a goal for less economic developed countries ?
Command economies, where the price mechanism (or invisible hand) does not allocate resources.
Corruption and infighting, where resources and investment are not directed to the place where it is intended.
For example, the Democratic Republic of Congo is resource-rich, but politics seems to have slowed economic development.
Why should better education be important and a goal for less economic developed countries ?
Education is sometimes called the accumulation of human capital.
High levels of education can make the labour force more productive and increase the output of an economy
Why should loaning and borrowing be important and a goal for less economic developed countries ?
If households or businesses cannot borrow money (get access to capital), then they won’t be able to invest in houses, capital (like machinery) or inventory. This will harm economic growth and development.
What are some barriers to development ?
Geography
Corruption
Conflict
Infrastructure
Foreign exchange gap
Savings gap
Lack of property rights
Inadequate human capital
Lack of healthcare
Primary product dependency
Debt
Human capital flight
How is geography a barrier to development ?
Issues such as climate and geographical location can restrict a country’s ability to develop through targeting certain industries or impacting their ability to trade.
For example, a landlocked country may find it more difficult to pursue export-led growth.
How is corruption a barrier to development ?
High levels of corruption and bureaucratic delays can harm growth by discouraging foreign direct investment (FDI).
Corruption also leads to allocative inefficiency because resources are allocated for personal gain rather than what is good for the economy.
Corruption makes it likely that domestic businesses will invest overseas rather than at home.
Corruption can lead to the government collecting less tax revenue, which has knock on effects for growth and anti-poverty policies
How is conflict a barrier to development ?
Physical capital is destroyed by war. This shifts the LRAS in.
Human capital is destroyed or emigrates, shifting the LRAS in.
Resources are diverted from long term capital goods to short term military expenditure, harming the long-term trend rate of economic growth.
Conflict also discourages both domestic investment and foreign direct investment (FDI) because of the huge uncertainty it creates. This reduces aggregate demand (AD) and could also shift the LRAS to the left.
How is infrastructure a barrier to development?
Infrastructure includes physical capital, such as critical energy power and water supplies, sanitation, telecommunications and transport networks, schools and hospitals.
Poor energy reliability leads to shortages and blackouts, which deters foreign direct investment (FDI) and investment and reduces efficiency and productivity.
Poor trains and roads reduce the mobility of labour and the ability to get goods to export markets.
What is the Harrod-Domar model ?
The Harrod-Domar model stresses the importance of the need for saving and investment to fund economic growth.
The higher the level of saving there is, the more money there is available for firms to borrow for investment.
The model also states that, if the productivity of capital improves, then so will the LRAS and economic growth.
Policies to improve either of the two above would help to improve the financial system to allow for savings to be channelled into funds for investment.
How is the foreign exchange gap a barrier to development ?
A lack of foreign currency may prevent businesses from being able to purchase ‘big ticket’ items, such as capital machinery, especially if the exporting country will not accept the currency being offered.
This makes investment by domestic firms more difficult and can restrict growth.
How is the savings gap a barrier to development ?
Savings are needed to provide finance for capital investment.
In many smaller low-income countries, high levels of poverty make it almost impossible to generate sufficient savings to provide the funds needed to fund investment projects.
Low savings rates and poorly developed financial markets make it more expensive for firms in less-developed economies (LDEs) to get funds for investment. Higher borrowing costs deter capital investment.
How is lack of property rights a barrier to development ?
Institutional factors include a lack of property rights, a democratic government or an independent legal system.
Property rights are defined as having four main characteristics:
The right to use the good.
The right to earn income from the good.
The right to transfer the good to others.
The right to enforce property rights (rights of ownership).
By lacking them, or not enforcing them, this discourages entrepreneurship or FDI.
How is inadequate human capital a barrier to development ?
Poor quality of human capital leads to a lack of productivity and efficiency.
This leads to the cost of production being higher than in other countries and uncompetitive exports.
In 1972, Iraq nationalised the western Iraq National Oil company. It was better to nationalise in 1972 than in 1950 because this gave the Iraqi population 22 years to build up the skills to run oil wells and oil refineries.
How is lack of adequate healthcare a barrier to development ?
The lack of adequate healthcare causes people to be ill more often and to have lower life expectancy.
Both of these factors cause workers’ productivity to be lower with more absenteeism (staying off work for no good reason).
Poor healthcare also means people try to have larger families as a way to hedge the risk of some children not surviving. This creates an added burden of high population growth and dependants.
How is primary product dependency a barrier to development ?
Primary products are commodities like iron ore, oil or agricultural products like coffee, rice and cocoa beans.
Supply in commodities is inelastic. These crops can take years or even millennia (for things like oil) to develop. When demand changes, prices can change by a large amount.
Income from exports can rise if commodity prices rise and exports can decrease rapidly if commodity prices fall.
This uncertainty may deter investment in that country.
It can also create exchange rate volatility which also discourages investment.
How is debt a barrier to development ?
If a developing nation has a lot of debts, it will spend some of its tax revenues on interest payments. Developing nations are usually riskier borrowers than developed nations, so they may pay a higher interest rate too.
Debt can reduce a developing nation’s government’s spending on infrastructure, education and healthcare.
Some people argue for debt relief for developing nations. This would involve cancelling these nation’s debts. However, the money from the debt may be embezzled by corrupt individuals and may generate moral hazard, with nations borrowing with no intention of repaying a debt.
How is human capital flight a barrier to entry ?
Poor quality of human capital leads to a lack of productivity and efficiency.
This leads to the cost of production being higher than other countries and uncompetitive exports.
Often, high skilled labour migrates to other nations to earn higher wages. This can leave developing nations with a labour shortage.
What is the Prebisch-singer hypothesis (why primary product dependency is not good for longtermgervity ?
The Prebisch-Singer hypothesis claims that, because the demand for primary products doesn’t change much with income (they are income inelastic), that rising incomes don’t lead to increased demand for primary products, unlike manufacturing and services’ products.
Therefore, if incomes rise globally, nations producing primary products won’t see much of a change in demand. Nations producing manufacturing goods would because manufactured products are income elastic.
This would suggest that primary products are not a sustainable development strategy for a country.
