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20
PRINCIPLES OF
MICROECONOMICS
F OURT H E DITIO N
This is the third of three chapters on the economics of labor markets. In Chapter 18, students learned that equilibrium wages equal the value of the marginal product of labor. In Chapter 19, students learned about various factors that affect equilibrium wages, as well as discrimination. In Chapter 20, students will learn about the extent of inequality and poverty in the U.S. The chapter also introduces some of the leading political philosophies on the role of government in redistributing income. Finally, the chapter discusses some policies designed to help the poor. This chapter is shorter than average. Most students find it less difficult than average. Therefore, most instructors are able to cover it in 60-75 minutes of class time.
N. G R E G O R Y M A N K I W
PowerPoint Slides by Ron Cronovich
2007 Thomson South-Western, all rights reserved
In this chapter, look for the answers to these questions: How much inequality and poverty exist in our
society?
What are the problems measuring inequality? What are some of the leading philosophies
on the proper role of government in altering the distribution of income?
Introduction
Recap of the previous two chapters:
equilibrium wages equal the value of workers marginal products differences in equilibrium wages result from differences in
worker characteristics:
education, experience, talent, effort
job characteristics:
extent to which a job is pleasant and safe
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In this chapter, we examine indicators of inequality and poverty philosophies about income redistribution policies designed to help the poor
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Source: Table 1, Chapter 20. Original source: U.S. Bureau of the Census.
Annual family income Under $24,117 $24,117 $42,057 $42,057 $65,000 $65,000 $98,200 $98,200 and over $170,082 and over
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Each point is the ratio of two numbers: The share of U.S. income received by the top 20%, relative to the share of U.S. income received by the bottom 20%. As the graph shows, this indicator of inequality fell from the Great Depression until 1970, and then rose. Source: Table 2, Chapter 20. Original source: U.S. Bureau of the Census.
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At least for this sample of countries, the U.S. is roughly in the middle with respect to inequality. Source: Table 3, Chapter 20. Original source: World Development Report, 2005
Income Income share share of of the the top top 20% 20% divided divided by by income income share share of of the the bottom bottom 20% 20%
In 2003 in the U.S., median family income = $52,680 poverty line for family of four = $18,810 poverty rate = 12.5%
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The poverty rate appears correlated with business cycles. For example, 1992-2000 was the longest economic expansion on record, and it coincided with a gradual fall in the poverty rate. In the early 2000s, the U.S. experienced a recession, and the poverty rate rose. Source: Figure 1, Chapter 20. Original source: U.S. Bureau of the Census.
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Poverty Rate 12.5% 8.2 24.4 22.5 11.8 17.6 10.2 5.4 28.0
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Source: Table 4, Chapter 20. Original source: U.S. Bureau of the Census.
2. The Life Cycle: the regular pattern of income variation over a persons life
People can borrow and save to offset life-cycle changes in income ( e.g., saving for retirement). Life-cycle income variation causes inequality in income, but not inequality in living standards.
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Utilitarianism Utility: a measure of happiness or satisfaction Utilitarianism: argues that govt should choose
policies to maximize societys total utility Founders: Jeremy Bentham, John Stuart Mill
Govt should enforce individual rights, should try to equalize opportunities. If the income distribution is achieved fairly, govt should not interfere, even if unequal.
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Students will recall the effects of the minimum wage from Chapter 6, which covered price floors and ceilings. A few additional notes about the minimum wage: Yes, it helps the poor at no cost to the government. But theres no such thing as a free lunch. The minimum wage transfers income to workers from firms (or rather, their owners) and from consumers, who will end up paying higher prices for goods made with unskilled labor. Some people think of the minimum wage as a law that prohibits people from working if they arent able to find a job that pays at least $5.15 an hour.
helps the poor without any cost to the govt little impact on employment if demand for unskilled labor is relatively inelastic In the long run, demand for unskilled labor is likely elastic, so minimum wage causes substantial unemployment among the unskilled. Those helped by minimum wage are more likely to be teens from middle-income families than low-income adult workers.
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Arguments against:
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3. Negative Income Tax Negative income tax: a tax system that collects
revenue from high-income households and gives transfers to low-income households
With a negative income tax, the marginal tax rate is as low for low income persons as it is for high income persons. This is in sharp contrast to other welfare-type programs, which take away benefits as income rises, thus creating very high effective marginal tax rates.
If earnings = $90,000, taxes owed = $20,000 If earnings = $60,000, taxes owed = $10,000 If earnings = $30,000, taxes owed = $0 If earnings = $15,000, taxes owed = $5,000 i.e., would receive $5000 payment from govt
A cash payment would let workers buy whatever they think they most need. Many economists believe that the government cannot know what people need better than the people themselves. Regarding the argument that the recipients could spend the money on drugs: Suppose the choice is giving the person $50 cash or $50 worth of food. If you give them $50 cash, they could buy drugs. If you give them $50 worth of food, then they have $50 that would otherwise have been used to buy food which they can now use to buy drugs.
soup kitchens food stamps, govt vouchers redeemable for food at grocery stores Medicaid , govt-provided healthcare for the poor would allow people to buy what they most need but critics argue could be used for drugs, alcohol
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CONCLUSION Poverty is one of societys most serious problems. One of the Ten Principles from Chapter 1:
Governments can sometimes improve market outcomes. Public policy can help reduce poverty and inequality.
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