Principles of Microeconomics Scarcity and Social Provisioning Chapter 20 Poverty and Economic Inequality

CHAPTER 20 . POVERTY AND ECONOMIC INEQUALITY INTRODUCTION TO POVERTY AND ECONOMIC INEQUALITY Figure . Occupying Wall Street . On September 17 , 201 , Occupy Wall Street began in New York City Wall Street financial district . Credit modification of work by David Creative Commons ) OCCUPY WALL STREET In September 2011 , a group of protesters gathered in Park in New York City to decry What they perceived as increasing social and economic inequality in the United States . Calling their protest Occupy Wall Street , they argued that the concentration of wealth among the richest in the United States was both economically unsustainable and inequitable , and needed to be changed . The protest then spread to other major cities , and the Occupy movement was born . Why were people so upset ?

How much wealth is concentrated among the top in our society ?

How did they acquire so much Wealth ?

These are very real , very important questions in the United States now , and this chapter on poverty and nomic inequality will help us address the causes behind this sentiment . OB I Introduction to Poverty and Economic Inequality In this chapter , you will learn about

PRINCIPLES OF ECONOMICS 549 Drawing the Poverty Line The Poverty Trap The Safety Net Income Inequality Measurement and Causes Government Policies to Reduce Income Inequality he labor markets that determine what workers are paid do not take into account how much income a family needs for food , shelter , clothing , and health care . Market forces do not worry about what happens to families when a major local employer goes out of business . Market forces do not take time to contemplate whether those who are earning higher incomes should pay an even higher share of taxes . However , labor markets do create considerable inequalities of income . In 2014 , the median American family income was ( the median is the level where half of all families had more than that level and half had less ) According to the Census Bureau , almost nine million families were by the federal government as being below the poverty line in that year . Think about a family of a single mother with two to pay for the basics of life on perhaps per year . After paying for rent , healthcare , clothing , and transportation , such a family might have to spend on food . Spread over 365 days , the food budget for the entire family would be about 17 per day . To put this in perspective , most cities have restaurants where 17 will buy you an appetizer for one . This chapter explores how the government defines poverty , the balance between assisting the poor without discouraging work , and how federal antipoverty programs work . It also discusses income economists measure inequality , why inequality has changed in recent decades , the range of possible government policies to reduce inequality , and the danger of a tradeoff that too great a reduction in inequality may reduce incentives for producing output .

DRAWING THE POVERTY LINE LEARNING OBJECTIVES By the end of this section , you will be able to Explain economic inequality and how the poverty line is determined Analyze the US . poverty rate over time , noting its prevalence among different groups of citizens of high and low incomes raise two different issues economic inequality and poverty . Poverty is measured by the number of people who fall below a certain level of the poverty defines the income needed for a basic standard of ing . Income inequality compares the share of the total income ( or wealth ) in society that is received by different groups for example , comparing the share of income received by the top 10 to the share of income received by the bottom 10 . In the United States , the official definition of the poverty line traces back to a single person Mollie . In 1963 , who was working for the Social Security Administration , published an article called Children of the Poor in a highly useful and publication called the Social Security Bulletin . idea was to define a poverty line based on the cost of a healthy diet . Her previous job had been at the Department of Agriculture , where she had worked in an agency called the Bureau of Home Economics and Human Nutrition . One task of this bureau had been to calculate how much it would cost to feed a nutritionally adequate diet to a family . found that the average family spent of its income on food . She then proposed that the poverty line be the amount needed to buy a nutritionally adequate diet , given the size of the family , multiplied by three . The current poverty line is essentially the same as the poverty line , although the dollar amounts are adjusted each year to represent the same buying power over time . The poverty line in 2015 ranged from for a single individual to for a household of four people . Figure shows the poverty rate over time that is , the percentage of the population below the poverty line in any given year . The poverty rate declined through the , rose in the early and early , but seems to have been slightly lower since the . However , in no year in the last four decades has the poverty rate been less than 11 of the is , at best about one American in nine is below the poverty line . In recent years , the poverty rate appears to have peaked at in 2011 before dropping to in 2013 . Table compares poverty rates for ent groups in 201 . As you will see when we delve further into these numbers , poverty rates are

PRINCIPLES OF ECONOMICS 551 low for whites , for the elderly , for the , and for households . Poverty rates for females , Hispanics , and African Americans are much higher than for whites . While and African Americans have a higher percentage of individuals living in poverty than others , most people in the United States living below the poverty line are white . Visit this Website for more information on poverty . I EVE ! 18 , I . A as Year Figure . The . Poverty Rate since 1960 . The poverty rate fell dramatically during the , rose in the early and early , and , after declining in the through , rose to in 2011 , which is close to the 1960 levels . In 2013 , the poverty dropped slightly to . Source Census Bureau )

552 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Group Poverty Rate Females Males White Black Hispanic 235 Under age 18 199 Ages 206 Ages 159 Ages 122 Ages 109 Ages 107 Ages 108 Ages 65 and older 95 Table . Poverty Rates by Group , 2013 The concept of a poverty line raises many tricky questions . In a vast country like the United States , should there be a national poverty line ?

After all , according to the Federal Register , the median hold income for a family of four was in and in Mississippi in 2013 , and prices of some basic goods like housing are quite different between states . The poverty line is based on cash income , which means it does not take into account government programs that provide assistance to the poor in a form , like Medicaid ( health care for individuals and families ) and food aid . Also , families can qualify for federal housing assistance . These and other government aid programs will be discussed in detail later in this chapter . Should the poverty line be adjusted to take the value of such programs into account ?

Many economists and wonder whether the concept of what poverty means in the century should be rethought . The following Clear It Up feature explains the poverty lines set by the World Bank for countries around the world . HOW IS POVERTY MEASURED IN COUNTRIES ?

The World Bank sets two poverty lines for countries around the World . One poverty line is set at an income of per person the other is at . By comparison , the . 2015 poverty line of annually for a family of three works out to per person per day . Clearly , many people around the world are far poorer than Americans , as Table shows . China and India both have more than a billion people is the most populous country in Africa and Egypt is the most populous country in the Middle East . In all four of those countries , in the , a substantial share of the population on less than . Indeed , about half the world lives on less than a day , and 80 percent of the world lives on less than 10 per day . Of course , the cost of food , clothing , and shelter in those countries can be very different from those costs in the United States , so the and figures may mean greater purchasing power than they would in the United States .

PRINCIPLES OF ECONOMICS 553 Country Share of Population below Day Share of Population below Day Brazil ( in 2009 ) China ( in 2009 ) Egypt ( in 2008 ) India ( in 2010 ) Mexico ( in 2010 ) in 2010 ) Table . Poverty Lines for Countries , Source ) Any poverty line will be somewhat arbitrary , and it is useful to have a poverty line whose basic does not change much over time . If Congress voted every few years to redefine what poverty means , then it would be difficult to compare rates over time . After all , would a lower poverty rate mean that the definition had been changed , or that people were actually better off ?

Government at the Census Bureau have ongoing research programs to address questions like these . KEY CONCEPTS AND SUMMARY Wages are by supply and demand in labor markets , which can lead to very low incomes for some people and very high incomes for others . Poverty and income inequality are not the same thing . Poverty applies to the condition of people who can not afford the necessities of life . Income inequality refers to the disparity between those with higher and lower incomes . The poverty rate is what centage of the population lives below the poverty line , which is determined by the amount of income that it takes to purchase the necessities of life . Choosing a poverty line will always be somewhat . SELF ' QUESTIONS Describe how each of these changes is likely to affect poverty and inequality ai Incomes rise for and workers , but rise more for the earners . Incomes fall for and workers , but fall more for earners . REVIEW QUESTIONS . How is the poverty rate calculated ?

What is the poverty line ?

What is the difference between poverty and income inequality ?

554 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER CRITICAL THINKING QUESTIONS . What goods and services would you include in an estimate of the basic necessities for a family of four ?

If a family of three earned , would they be able to make ends meet given the official poverty threshold ?

PROBLEMS . In country A , the population is 300 million and 50 million people are living below the poverty line . What is the poverty rate ?

In country , the population is 900 million and 100 million people are living below the poverty line . What is the poverty rate ?

REFERENCES , 2014 . IRS Announces 2015 Estate And Gift Tax Forbes . Accessed March 16 , Federal Register The Daily Journal of the United States Government . State Median Income mates for a Household Notice of the Federal Fiscal Year ( 2013 State Median Income Estimates for Use Under the Low Income Home Energy Assistance Program ( Last modified March 15 , Tami . 2014 . Income is on the rise . finally ! Accessed April 10 , Meyer , Ali . 2015 . Record Number of Women Not in Labor . Accessed March 16 , Mollie . Children of the Social Security Bulletin . 26 no . 1963 ) The World Bank . Data Poverty Headcount Ratio at a Day ( of Population ) Department of Commerce United States Census Bureau . American . Department of Commerce United States Census Bureau . Current Population Survey ( Table .

PRINCIPLES OF ECONOMICS 555 Department of Commerce United States Census Bureau . Income Table . All Races ) by Median and Mean . Department of Commerce United States Census Bureau . Poverty Poverty Last modified . Department of Health Human Services . 2015 . 2015 Poverty Accessed April 10 , Department of Health Human Services . 2015 . Information on Poverty and Income Statistics A Summary of 2014 Current Population Survey Accessed April 13 , income inequality when one group receives a disproportionate share of total income or Wealth than others poverty the situation of being below a certain level of income needed for a basic standard of living poverty line the specific amount of income needed for a basic standard of living poverty rate percentage of the population living below the poverty line SOLUTIONS Answers to Questions a . Poverty falls , inequality rises . Poverty rises , inequality falls .

THE POVERTY TRAP LEARNING OBJECTIVES By the end of this section , you will be able to Explain the poverty trap , noting how it is impacted by government programs Identify potential issues in government programs that seek to reduce poverty Calculate a budget constraint line that represents the poverty trap an you give people too much help , or the wrong kind of help ?

When people are provided with food , shelter , healthcare , income , and other necessities , assistance may reduce their incentive to work . Consider a program to fight poverty that works in this manner the government provides assistance to the poor , but as the poor earn income to support themselves , the government reduces the level of assistance it provides . With such a program , every time a poor person earns 100 , the person loses 100 in government support . As a result , the person experiences no net gain for working . Economists call this problem the poverty trap . Consider the situation faced by a family . A single mother ( earning an hour ) with two children , as illustrated in Figure . First , consider the budget constraint faced by this family in a situation without government assistance . On the horizontal axis is hours of leisure ( or time spent with family responsibilities ) increasing in quantity from right to left . Also on the horizontal axis is the number of hours at paid work , going from zero hours on the right to the maximum of hours on the left . On the vertical axis is the amount of income per year rising from low to higher amounts of income . The budget constraint line shows that at zero hours of leisure and hours of work , the maximum amount of income is ( hours ) At the other extreme of the budget constraint line , an individual would work zero hours , earn zero income , but enjoy hours of leisure . At point A on the budget constraint line , by working 40 hours a week , 50 weeks a year , the choice is to work a total of hours per year and earn . Now suppose that a government antipoverty program guarantees every family with a single mother and two children in income . This is represented on the graph by a horizontal line at . With this program , each time the mother earns , the government will deduct of its port . Table shows what will happen at each combination of work and government support .

Income PRINCIPLES OF ECONOMICS . 500 Leisure ( hours ) Labor ( hours ) Figure . The Poverty Trap in Action . The original choice is 500 hours of leisure , hours of work at point A , and income of . With a guaranteed income of , this family would receive whether it provides zero hours of work or hours of work . Only if the family provides , say , hours of work does its income rise above the guaranteed level of even then , the marginal gain to income from working many hours is small . Amount Worked ( hours ) Total Earnings Government Support Total Income 500 Table . Total Income at Various Combinations of Work and Support 557 The new budget line , with the antipoverty program in place , is the horizontal and heavy line that is flat at . If the mother does not work at all , she receives , all from the government . If she works full time , giving up 40 hours per week with her children , she still ends up with at the end of the year . Only if she works hours in the is an average of 44 hours per week for 50 weeks a household income rise to . Even in this case , all of her years work means that household income rises by only 400 over the income she would receive if she did not work at all . She would need to work 50 hours a week to reach . Indeed , the poverty trap is even stronger than this simplified example shows , because a working

553 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER mother will have extra expenses like clothing , transportation , and child care that a nonworking mother will not face , making the economic gains from working even smaller . Moreover , those who do not work fail to build up job experience and contacts , which makes working in the future even less likely . The bite of the poverty trap can be reduced by designing an antipoverty program so that , instead of reducing government payments by for every earned , payments are reduced by some smaller amount instead . The bite of the poverty trap can also be reduced by imposing requirements for work as a condition of receiving benefits and setting a time limit on benefits . Figure illustrates a government program that guarantees in income , even for those who do not work at all , but then reduces this amount by 50 cents for each earned . The new , higher budget line in Figure shows that , with this program , additional hours of work will bring some economic gain . Because of the reduction in government income when an individual works , an individual ing will really net only per hour . The vertical intercept of this higher budget constraint line is at ( hours ) The horizontal intercept is at the point on the graph where and 2500 hours of leisure is set . Table shows the total income with various choices of labor and leisure . However , this type of program raises other issues . First , even if it does not eliminate the incentive to work by reducing government payments by for every earned , enacting such a program may still reduce the incentive to work . At least some people who would be working hours each year without this program might decide to work fewer hours but still end up with more is , their choice on the new budget line would be like , above and to the right of the original choice Of course , others may choose a point like , which involves the same amount of work as , or even a point to the left of that involves more work . The second major issue is that when the government phases out its support payments more slowly , the antipoverty program costs more money . Still , it may be preferable in the long run to spend more money on a program that retains a greater incentive to work , rather than spending less money on a program that nearly eliminates any gains from working . Amount Worked ( hours ) Total Earnings Government Support Total Income 500 Table . The Tradeoff with Assistance Reduced by 50 Cents for Every Dollar Earned The next module will consider a variety of government support programs focused specifically on the poor , including welfare , SNAP ( food supplement ) Medicaid , and the earned income tax credit ( Although these programs vary from state to state , it is generally a true statement that in many states from the into the 19805 , if poor people worked , their level of income barely did not rise at the reduction in government support payments was factored in . The following Work It Out feature shows how this happens .

PRINCIPLES OF ECONOMICS 559 . Income . I I I I I I I I I I I I I I I I I I I 500 2500 Leisure ( hours ) Labor ( hours ) Figure . Loosening the Poverty Trap Reducing Government Assistance by 50 Cents for Every Earned . On the original opportunity set , the lower budget set shown by the smaller dashed line in the figure , the preferred choice is 500 hours of leisure and of income . Then , the government created an antipoverty program that guarantees in income even to those who work zero hours , shown by the larger dashed line . In addition , every earned means phasing out 50 cents of benefits . This program leads to the higher budget set shown in the diagram . The hope is that this program will provide incentives to work the same or more hours , despite receiving income assistance . However , it is possible that the recipients will choose a point on the new budget set like , with less work , more leisure , and greater income , or a point like , with the same work and greater income . CALCULATING A BUDGET CONSTRAINT LINE Jason earns an hour , and a government antipoverty program provides a of guaranteed income . The government reduces government support by for each earned . What are the horizontal and vertical intercepts of the budget constraint line ?

Assume the maximum hours for work or leisure is hours . Step . Determine the amount of the government guaranteed income . In this case , it is . Step . Plot that guaranteed income as a horizontal line on the budget constraint line .

550 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Step . Determine what Jason earns if he has no income and enjoys hours of leisure . In this case , he will receive the guaranteed ( the horizontal intercept ) Step . Calculate how salary will be reduced by due to the reduction in government income . In case , it will be reduced by one half . He will , in effect , net only an hour . Step . works hours , at a maximum what income receive ?

Jason will get the government assistance of . He will net only for every hour he chooses to Work . If he Works hours at , his earned income is plus the government income of . Thus the total maximum income ( the vertical intercept ) is . KEY CONCEPTS AND SUMMARY A poverty trap occurs when payments for the poor decline as the poor earn more income . As a result , the poor do not end up with much more income when they work , because the loss of government support largely or completely offsets any income that is earned by working . The bite of the poverty trap can be reduced by phasing out government benefits more slowly , as well as by imposing requirements for work as a condition of receiving benefits and a time limit on fits . SELF ' QUESTIONS . is a single father with one child . He can work as a server for per hour for up to hours per year . He is eligible for welfare , and so if he does not earn any income , he will receive a total of per year . He can work and still receive government benefits , but for every of income , his welfare stipend is less . Create a table similar to Table that shows Jonathan options . Use four columns , the first showing number of hours to work , the second showing his earnings from work , the third showing the government benefits he will receive , and the fourth column showing his total income ( earnings government support ) Sketch a diagram opportunity set with and without government support . Imagine that the government the welfare policy that was in question , so that for each dollar someone like Jonathan earns at work , his government benefits diminish by only 30 cents . Reconstruct the table from question to account for this change in policy . Draw opportunity sets , both for before this Welfare program is enacted and after it is enacted . REVIEW QUESTIONS . How does the poverty trap discourage people from working ?

How can the effect of the poverty trap be reduced ?

CRITICAL THINKING QUESTIONS . Question and Question asked you to describe the tradeoff for PRINCIPLES OF ECONOMICS 561 . Since , in the first example , there is no monetary incentive to work , explain why he may choose to work anyway . Explain what the opportunity costs of working and not working might be for in each example . Using your tables and graphs from Question and Question , analyze how the government welfare system affects incentive to work . Explain how you would create a government program that would give an incentive for labor to increase hours and keep labor from falling into the poverty trap . PROBLEMS Susan is a single mother with three children . She can earn per hour and works up to hours per year . However , if she does not earn any income at all , she will receive government benefits totaling per year . For every of income she earns , her level of government support will be reduced by . Create a table , patterned after Table . The first column should show Susan choices of how many hours to work per year , up to hours . The second column should show her earnings from work . The third column should show her level of government support , given her ings . The final column should show her total income , combining earnings and government support . poverty trap antipoverty programs set up so that government benefits decline substantially as people earn more a result , working provides little financial gain EXERCISES Answers to Questions . options for working and total income are shown in the following table . His diagram is shown in the figure following the table . Number of Work Hours Earnings from Work Government Total Income 900 600 300 Table . The following table shows a policy where only 30 cents in government support is pulled right back for every of income earned . diagram is shown in the figure following the table . Opportunity set after program extends from ( to ( Opportunity set before program slopes downward from ( to (

562 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Opportunity set with government support Opportunity set without government support I ' 300 600 900 Hours Leisure Hours La bor Hou Figure . Number of Work Hours Earnings from Work Government Total Income 900 600 300

Income PRINCIPLES OF ECONOMICS 300 600 900 12001500 Hours Leisure Hours Labor Hours Figure . 563 THE SAFETY NET LEARNING OBJECTIVES By the end of this section , you will be able to Identify the antipoverty government programs that compose the safety net Explain the primary goals of the safety net programs and how these programs have changed over time Discuss the complexities of these safety net programs and why they can be controversial he government has implemented a number of programs to assist those below the poverty line and those who have incomes just above the poverty line , who are referred to as the poor . Such programs are called the safety net , in recognition of the fact that they offer some protection for those who find themselves without jobs or income . TEMPORARY ASSISTANCE FOR NEEDY FAMILIES From the Great Depression of the until 1996 , the United States most visible antipoverty gram was Aid to Families with Dependent Children ( which provided cash payments to mothers with children who were below the poverty line . This program was often just called In 1996 , Congress passed and President Bill Clinton signed into law the Personal Responsibility and Work Opportunity Reconciliation Act , more commonly called the welfare reform The new law replaced with Temporary Assistance for Needy Families ( TAN ) Visit this Website to watch a video of President Bill Clinton Welfare Reform speech . brought several dramatic changes in how welfare operated . Under the old program , states set the level of welfare benefits that they would pay to the poor , and the federal government

PRINCIPLES or ECONOMICS 565 guaranteed it would chip in some of the money as well . The federal governments welfare spending would rise or fall depending on the number of poor people , and on how each state set its own welfare contribution . Under , however , the federal government gives a fixed amount of money to each state . The state can then use the money for almost any program with an antipoverty component for example , the state might use the money to give cash to poor families , or to reduce teenage pregnancy , or even to raise the high school graduation rate . However , the federal government imposed two key . First , if states are to keep receiving the grants , they must impose work requirements so that most of those receiving benefits are working ( or attending school ) Second , no one can receive benefits with federal money for more than a total of five years over his or her lifetime . The old program had no such work requirements or time limits . attempts to avoid the poverty trap by requiring that welfare recipients work and by limiting the length of time they can receive benefits . In its first few years , the program was quite successful . The number of families receiving payments in 1995 , the last year of , was million . By 2012 , according to the Congressional Research Service , the average number of families receiving payments under was decline of more than half . benefits to poor families vary considerably across states . For example , again according to the Congressional Research Service , in 201 the highest monthly payment in Alaska to a single mother with two children was 923 , while in Mississippi the highest monthly payment to that family was 170 . These payments reflect differences in states cost of living . Total spending on was approximately billion in 1997 . As of 2012 , spending was at 12 billion , an almost 28 decrease , split about evenly between the federal and state governments . When you take into account the effects of , the decline is even greater . Moreover , there seemed little evidence that poor families were suffering a reduced standard of living as a result of , on the other side , there was not much evidence that poor families had greatly improved their total levels of income , either . THE EARNED INCOME TAX CREDIT ( The earned income tax credit ( first passed in 1975 , is a method of assisting the working poor through the tax system . The is one of the largest assistance program for groups , and projections for 2013 expected 26 million households to take advantage of it at an estimated cost of 50 billion . In 2013 , for example , a single parent with two children would have received a tax credit of up to an income level of . The amount of the tax break increases with the amount of income earned , up to a point . The earned income tax credit has often been popular with both mists and the general public because of the way it effectively increases the payment received for work . What about the danger of the poverty trap that every additional earned will reduce government support payments by close to ?

To minimize this problem , the earned income tax credit is phased out slowly . According to the Tax Policy Center , for a family with two children in 2013 , the credit is not reduced at all ( but neither is it increased ) as earnings rise from to . Then , for every earned above , the amount received from the credit is reduced by cents , until the credit phases out completely at an income level of . Figure illustrates that the earned income tax credits , child tax credits , and the program all

566 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER cost the federal government in direct or in loss of tax revenues . stands for the government tax cuts for the child tax credit . so A A ) I ( I ( 51 ! I ( Year Figure . Real Federal Spending on , and , increased from more than 20 billion in 2000 to over an estimated 50 billion by 2013 , far exceeding estimated 2013 in the ( Child Tax Credits ) and TAN of over 20 billion and 10 billion , respectively . Source Office of Management and Budget ) In recent years , the has become a hugely expensive government program for providing income assistance to the poor and , costing about 60 billion in 2012 . In that year , the benefits to about 27 million families and individuals and , on average , is worth about per family ( with children ) according to the Tax Policy Center . One reason that the law worked as well as it did is that the was greatly expanded in the late and again in the early , which increased the returns to work for Americans . SUPPLEMENTAL NUTRITION ASSISTANCE PROGRAM ( SNAP ) Often called food stamps , Supplemental Nutrition Assistance Program ( SNAP ) is a federally funded program , started in 1964 , in which each month poor people receive a card like a debit card that they can use to buy food . The amount of food aid for which a household is eligible varies by income , number of children , and other factors but , in general , households are expected to spend about 30 of their own net income on food , and if 30 of their net income is not enough to purchase a ally adequate diet , then those households are eligible for SNAP . SNAP can contribute to the poverty trap . For every 100 earned , the government assumes that a ily can spend 30 more for food , and thus reduces its eligibility for food aid by 30 . This decreased benefit is not a complete disincentive to combined with how other programs reduce as income increases , it adds to the problem . SNAP , however , does try to address the poverty trap with its own set of work requirements and time limits .

PRINCIPLES or ECONOMICS 567 Why give debit cards and not just cash ?

Part of the political support for SNAP comes from a belief that since the cards must be spent on food , they can not be wasted on other forms of consumption . From an economic point of view , however , the belief that cards must increase spending on food seems . After all , say that a poor family is spending per year on food , and then it starts receiving per year in SNAP aid . The family might react by spending per year on food ( income plus aid ) or it might react by continuing to spend per year on food , but use the in food aid to free up that can now be spent on other goods . So it is reasonable to think of SNAP cards as an alternative method , along with and the earned income tax credit , of income to the working poor . Indeed , anyone eligible for is also eligible for SNAP , although states can expand eligibility for food aid if they wish to do so . In some states , where welfare spending is relatively low , a poor family may receive more in support from SNAP than from . In 2014 , about 40 million people received food aid at an annual cost of about 76 billion , with an average monthly benefit of about 287 per person per month . SNAP participation increased by 70 between 2007 and 2011 , from million participants to 45 million . According to the Congressional Budget Office , this dramatic rise in participation was caused by the Great Recession of and rising food prices . The federal government deploys a range of income security programs that are funded through such as Health and Human Services , Agriculture , and Housing and Urban Development ( HUD ) see Figure ) According to the Office of Management and Budget , collectively , these three provided an estimated 62 billion of aid through programs such as supplemental feeding grams for women and children , subsidized housing , and energy assistance . The federal government also transfers funds to individual states through special grant programs . The safety net includes a number of other programs school lunches and breakfasts for children from families the Special Supplemental Food Program for Women , Infants and Children ( which provides food assistance for pregnant women and the Low Income Home Energy Assistance Program , which provides help with home heating bills housing assistance , which helps pay the rent and Supplemental Security Income , which provides cash support for the disabled and the elderly poor . MEDICAID Medicaid was created by Congress in 1965 and is a joint health insurance program entered into by both the states and the federal government . The federal government helps fund Medicaid , but each state is responsible for administering the program , determining the level of benefits , and ing eligibility . It provides medical insurance for certain people , including those below the poverty line , with a focus on families with children , the elderly , and the disabled . About of Medicaid spending is for mothers with children . While an increasing share of the gram funding in recent years has gone to pay for nursing home costs for the elderly poor . The gram ensures that a basic level of benefits is provided to Medicaid participants , but because each state sets eligibility requirements and provides varying levels of service , the program differs from state to state . In the past , a common problem has been that many jobs pay enough to a breadwinner so that a family could lose its eligibility for Medicaid , yet the job does not offer health insurance benefits . A poor parent considering such a job might choose not to work rather than lose health insurance for

553 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Other Income ' programs VI I ( 03 ' 38888888888850 ( I ( 2012 ( est ) 2013 ( est ) Year Figure . Expenditure Comparison of TAN , SNAP , HUD , and Other Income Security Programs , Total expenditures on income security continued to rise between 1988 and 2010 , while payments for have increased from 13 billion in 1998 to an estimated billion in 2013 . SNAP has seen relatively small increments . These two programs comprise a relatively small portion of the estimated 106 billion dedicated to income security in 2013 . Note that other programs and housing programs increased dramatically during the 2008 and 2010 time periods . Source Table Section 600 Income Security , his or her children . In this way , health insurance can become a part of the poverty trap . Many states recognized this problem in the and and expanded their Medicaid coverage to include not just the poor , but the earning up to 135 or even 185 of the poverty line . Some states also guaranteed that children would not lose coverage if their parents worked . These expanded guarantees cost the government money , of course , but they also helped to encourage those on welfare to enter the labor force . As of 2014 , approximately million people participated in Medicaid . Of those enrolled , almost half are children . Healthcare expenditures , however , are est for the elderly population , which comprises approximately 25 of participants . As Figure ( a ) indicates , the largest number of households that enroll in Medicaid are those with children . income adults are the next largest group enrolled in Medicaid at 28 . The blind and disabled are 16 of those enrolled , and seniors are of those enrolled . Figure ( shows how much actual Medicaid dollars are spent for each group . Out of total Medicaid spending , more is spent on seniors ( 20 ) and the blind and disabled ( 44 ) So , 64 of all Medicaid spending goes to seniors , the blind , and disabled . Children receive 21 of all Medicaid spending , followed by adults at 15 .

PRINCIPLES OF ECONOMICS 569 Adults ( 28 ) Children ( 47 ) 15 ) I and ( 16 ) and I ( 44 ) Aged ( 20 ) Aged ( a ) enrollment ( Figure . Medicaid Enrollment and Spending . Part ( a ) shows the Medicaid enrollment by different populations , with children comprising the largest percentage at 47 , followed by adults at 28 , and the blind and disabled at 16 . Part ( shows that Medicaid spending is principally for the blind and disabled , followed by the elderly . Although children are the largest population covered by Medicaid , expenditures on children are only at 21 . KEY CONCEPTS AND SUMMARY The group of government programs that assist the poor are called the safety net . In the United States , prominent safety net programs include Temporary Assistance to Needy Families ( the mental Nutrition Assistance Program ( SNAP ) the earned income tax credit ( Medicaid , and the Special Supplemental Food Program for Women , Infants , and Children ( SELF CHECK QUESTIONS I We have discovered that the welfare system discourages recipients from working because the more income they earn , the less welfare benefits they How does the earned income tax credit attempt to loosen the poverty trap ?

I How does the attempt to loosen the poverty trap ?

QUESTIONS Who are the ?

I What is the safety net ?

I explain the differences between , the earned income tax credit , SNAP , and Medicaid .

570 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER CRITICAL THINKING QUESTIONS . Many critics of government programs to help individuals argue that these programs create a poverty trap . Explain how programs such as , SNAP , and Medicaid will affect individuals and Whether or not you think these programs will benefit families and children . Think about the business cycle during a recession , unemployment increases it decreases in an expansionary phase Explain what happens to , SNAP , and Medicaid programs at each phase of the business cycle ( recession , trough , expansion , and peak ) REFERENCES Congressional Budget Office . 2015 . The Effects of Potential Cuts in SNAP Spending on Households With Different Amounts of Accessed April 13 , 49978 . Falk , Gene . Congressional Research Service . The Temporary Assistance for Needy Families ( Block Grant Responses to Frequently Asked Last modified October 17 , Library of Congress . Congressional Research . Office of Management and Budget . Fiscal Year 2013 Historical Tables Budget of the . Tax Policy Center Urban Institute and Institution . The Tax Policy Briefing Book tion and the Family What is the Earned Income Tax Credit ?

earned income tax credit ( a method of assisting the working poor through the tax system Medicaid a joint program enacted in 1965 that provides medical insurance for certain ( not all ) people , including the as well as those below the poverty line , and focusing on families with children , the elderly , and the disabled those who have incomes just above the poverty line safety net the group of government programs that provide assistance to the poor and the Supplemental Nutrition Assistance Program ( SNAP ) a federally funded program , started in 1964 , in which each month poor people receive SNAP cards they can use to buy food SOLUTIONS Answers to Questions . The earned income tax credit works like this a poor family receives a tax break that increases according to how much they Work . Families that work more get more . In that sense it loosens the poverty trap by

PRINCIPLES OF ECONOMICS 571 encouraging work . As families earn above the poverty level , the earned income tax credit is gradually reduced . For those families , the earned income tax credit is a partial disincentive to work . attempts to loosen the poverty trap by providing incentives to work in other ways . Specifically , it requires that people Work ( or complete their education ) as a condition of receiving benefits , and it places a time limit on benefits .

INCOME INEQUALITY MEASUREMENT AND CAUSES LEARNING By the end of this section , you will be able to Explain the distribution of income , and analyze the sources of income inequality in a market economy Measure income distribution in Calculate and graph a curve Show income inequality through demand and supply diagrams levels can be subjective based on the overall income levels of a country typically poverty is measured based on a percentage of the median income . Income inequality , however , has to do with the distribution of that income , in terms of which group receives the most or the least income . Income inequality involves comparing those with high incomes , middle incomes , and low just looking at those below or near the poverty line . In turn , measuring income ity means dividing up the population into various groups and then comparing the groups , a task that can be carried out in several ways , as the next Clear It Up feature shows . HOW DO YOU SEPARATE POVERTY AND INCOME INEQUALITY ?

Poverty can change even when inequality does not move at all . Imagine a situation in which income for everyone in the population declines by 10 . Poverty would rise , since a greater share of the population would now fall below the poverty line . However , inequality would be the same , because everyone suffered the same proportional loss . Conversely , a general rise in income levels over time would keep inequality the same , but reduce poverty . It is also possible for income inequality to change without affecting the poverty rate . Imagine a situation in which a large number of people who already have high incomes increase their incomes by even more . Inequality would rise as a the number of people below the poverty line would remain unchanged . Why did inequality of household income increase in the United States in recent decades ?

Indeed , a trend toward greater income inequality has occurred in many countries around the world , although the effect has been more powerful in the economy . Economists have focused their explanations for the increasing inequality on two factors that changed more or less continually from the into the . One set of explanations focuses on the changing shape of American households the other focuses on greater inequality of wages , what some economists call winner take all labor . We will begin with how we measure inequality , and then consider the explanations for growing inequality in the United States .

PRINCIPLES or ECONOMICS 573 MEASURING INCOME DISTRIBUTION BY One common way of measuring income inequality is to rank all households by income , from lowest to highest , and then to divide all households into five groups with equal numbers of people , known as . This calculation allows for measuring the distribution of income among the five groups compared to the total . The first quintile is the lowest fifth or 20 , the second quintile is the next est , and so on . Income inequality can be measured by comparing what share of the total income is earned by each quintile . income distribution by quintile appears in Table . In 2011 , for example , the bottom quintile of the income distribution received of income the second quintile received the third tile , the fourth quintile , and the top quintile , The final column of Table shows what share of income went to households in the top of the income distribution in 2011 . Over time , from the late to the early , the top fifth of the income distribution typically received between about 43 to 44 of all income . The share of income that the top fifth received then begins to rise . According to the Census Bureau , much of this increase in the share of income going to the top fifth can be traced to an increase in the share of income going to the top . The quintile measure shows how income inequality has increased in recent decades . Year Lowest Quintile Second Quintile Third Quintile Fourth Quintile Highest Quintile Top 1967 1970 1975 1980 1985 1990 1995 2000 2005 2010 2013 51 Table . Share of Aggregate Income Received by Each Fifth and Top of Households , Source US . Census Bureau , Table ) It can also be useful to divide the income distribution in ways other than for example , into tenths or even into ( that is , hundredths ) A more detailed breakdown can provide insights . For example , the last column of Table shows the income received by the top cent of the income distribution . Between 1980 and 2013 , the share of income going to the top increased by percentage points ( from in 1980 to in 2013 ) From 1980 to 2013 the share of income going to the top quintile increased by percentage points ( from in 1980 to 51 in 2013 ) Thus , the top 20 of ( the fifth quintile ) received over half ( 51 ) of all the income in the United States in 2013 . CURVE The data on income inequality can be presented in various ways . For example , you could draw a bar

574 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER graph that showed the share of income going to each fifth of the income distribution . Figure an alternative way of showing inequality data in what is called a curve . The curve shows the cumulative share of population on the horizontal axis and the cumulative percentage of total income received on the vertical axis . 100 80 A 60 Perfect equality I 1980 , I 20 A 2011 ' 20 40 60 80 100 Income Figure . The Curve . A curve graphs the cumulative shares of income received by everyone up to a certain quintile . The income distribution in 1980 was closer to the perfect equality line than the income distribution in is , the income distribution became more unequal over time . Every curve diagram begins with a line sloping up at a angle , shown as a dashed line in Figure . The points along this line show what perfect equality of the income distribution looks like . It would mean , for example , that the bottom 20 of the income distribution receives 20 of the total income , the bottom 40 gets 40 of total income , and so on . The other lines actual data on inequality for 1980 and 2011 . The trick in graphing a curve is that you must change the shares of income for each specific quintile , which are shown in the first column of numbers in Table , into cumulative income , shown in the second column of numbers . For example , the bottom 40 of the cumulative income tion will be the sum of the first and second the bottom 60 of the cumulative income will be the sum of the first , second , and third , and so on . The final entry in the cumulative income column needs to be 100 , because by definition , 100 of the population receives 100 of the income .

PRINCIPLES or ECONOMICS 575 Income Share of Income in Cumulative Share of Income Share of Income in Cumulative Share of Income Category 1980 ( in 1980 ( 2013 ( in 2013 ( First quintile 102 144 84 116 quintile ' Third quintile 24 55 23 49 quintile ' Fifth quintile Table . Calculating the Curve In a curve diagram , a more unequal distribution of income will loop farther down and away from the line , while a more equal distribution of income will move the line closer to the line . The greater inequality of the income distribution between 1980 and 2013 is in Figure because the curve for 2013 is farther from the line than the curve for 1980 . The curve is a useful way of presenting the quintile data that provides an image of all the quintile data at once . The next Clear It Up feature shows how income inequality differs in various countries compared to the United States . HOW DOES ECONOMIC INEQUALITY VARY AROUND THE WORLD ?

The US . economy has a relatively high degree of income inequality by global standards . As Table shows , based on a of national surveys done for a selection of years in the last five years of the 20005 ( with the exception of Germany , and adjusted to make the measures more comparable ) the economy has greater inequality than Germany ( along with most Western European countries ) The region of the world with the highest level of income inequality is Latin America , illustrated in the numbers for Brazil and Mexico . The level of inequality in the United States is lower than in some of the countries of the world , like China and , or some countries like the Russian Federation . However , not all poor countries have highly unequal income India provides a . Country Survey Year First Quintile Second Quintile Third Quintile Fourth Quintile Fifth Quintile United States 2013 Germany 2000 Brazil 2009 Mexico 2010 China 2009 India 2010 Russia 2009 2010 Table . Income Distribution in Select Countries . Source data from Census Bureau Table . Other data from The World Bank Poverty and Inequality Data Base , Visit this website to watch a video of wealth inequality across the world .

576 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER CAUSES OF GROWING INEQUALITY THE CHANGING COMPOSITION OF AMERICAN HOUSEHOLDS In 1970 , 41 of married women were in the labor force , but by 2015 , according to the Bureau of Labor Statistics , of married women were in the labor force . One result of this trend is that more households have two earners . Moreover , it has become more common for one high earner to marry another high earner . A few decades ago , the common pattern featured a man with relatively high ings , such as an executive or a doctor , marrying a woman who did not earn as much , like a secretary or a nurse . Often , the woman would leave paid employment , at least for a few years , to raise a ily . However , now doctors are marrying doctors and executives are marrying executives , and ers with careers are often returning to work while their children are quite young . This pattern of households with two high earners tends to increase the proportion of holds . According to data in the National Journal , even as couples have increased , so have parent households . Of all families , were headed by single mothers the poverty rate among households tends to be relatively high . These changes in family structure , including the growth of families who tend to be at the lower end of the income distribution , and the growth of couples near the top end of the income distribution , account for roughly half of the rise in income inequality across households in recent decades . Visit this Website to watch a video that illustrates the distribution of wealth in the United States . CAUSES OF GROWING INEQUALITY A SHIFT IN THE DISTRIBUTION OF WAGES Another factor behind the rise in income inequality is that earnings have become less equal since the late . In particular , the earnings of labor relative to labor have

PRINCIPLES OF ECONOMICS 577 increased . labor markets result from changes in technology , which have increased global demand for stars , the best CEO , doctor , basketball player , or actor . This global demand pushes salaries far above productivity differences versus educational differences . One way to measure this change is to take the earnings of workers with at least a college bachelors degree ( including those who went on and completed an advanced degree ) and divide them by the earnings of workers with only a high school degree . The result is that those in the age bracket with college degrees earned about times as much as high school graduates in 2010 , up from times in 1995 , according to Census data . labor market theory argues that the salary gap between the median and the top percent is not due to educational differences . Economists use the demand and supply model to reason through the most likely causes of this shift . According to the National Center for Education Statistics , in recent decades , the supply of ers with college degrees has increased substantially for example , bachelor degrees were conferred on Americans in 1970 in , such degrees were increase of about 90 . In Figure , this shift in supply to the right , from So to , should result in a lower equilibrium wage for labor . Thus , the increase in the price of labor must be explained by a greater demand , like the movement from Do to . Evidently , combining both the increase in supply and in demand has resulted in a shift from to , and a resulting higher wage . 81 ' Quantity of Labor Figure . Why Would Wages Rise for Labor ?

The proportion of workers attending college has increased in recent decades , so the supply curve for labor has shifted to the right , from So to . If the demand for labor had remained at , then this shift in supply would have led to lower wages for labor . However , the wages for labor , especially if there is a large global demand , have increased even with the shift in supply to the right . The explanation must lie in a shift to the right in demand for labor , from Do to . The figure shows how a combination of the shift in supply , from So to , and the shift in demand , from Do to , led to both an increase in the quantity of labor hired and also to a rise in the wage for such labor , from to .

573 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER What factors would cause the demand for labor to rise ?

The most plausible explanation is that while the explosion in new information and communications technologies over the last several decades has helped many workers to become more productive , the benefits have been especially great for workers like top business managers , consultants , and design professionals . The new technologies have also helped to encourage globalization , the remarkable increase in international trade over the last few decades , by making it more possible to learn about and coordinate economic interactions all around the world . In turn , the rising impact of foreign trade in the economy has opened up greater opportunities for workers to sell their services around the world . And workers have to compete with a larger supply of similarly skilled workers around the globe . The market for labor can be viewed as a race between forces of supply and demand . education and training will tend to increase the supply of labor and to hold down its relative wage . Conversely , new technology and other economic trends like globalization tend to increase the demand for labor and push up its relative wage . The greater ity of wages can be viewed as a sign that demand for skilled labor is increasing faster than supply . On the other hand , if the supply of lower skilled workers exceeds the demand , then average wages in the lower of the income distribution will decrease . The combination of forces in the and labor markets leads to increased income disparity . KEY CONCEPTS AND SUMMARY Measuring inequality involves making comparisons across the entire distribution of income , not just the poor . One way of doing this is to divide the population into groups , like , and then late what share of income is received by each group . An alternative approach is to draw curves , which compare the cumulative income actually received to a perfectly equal distribution of income . Income inequality in the United States increased substantially from the late and early into the . The two most common explanations cited by economists are changes in the structure of households that have led to more couples and families , and the effect of new information and communications technology on wages . SELF CHECK QUESTIONS . A group of 10 people have the following annual incomes , Calculate the share of total income received by each quintile of this income distribution . Do the top and bottom in this distribution have a greater or larger share of total income than the top and bottom of the income distribution ?

Table 10 shows the share of income going to each quintile of the income distribution for the United Kingdom in 1979 and 1991 . Use this data to calculate what the points on a curve would be , and sketch the curve . How did inequality in the United Kingdom shift over this time period ?

How can you see the patterns in the in the curves ?

PRINCIPLES OF ECONOMICS 579 Share of Income 1979 1991 Top quintile Fourth Middle quintile Second quintile Bottom quintile Table 10 . Income Distribution in the United Kingdom , 1979 and 1991 . Using two demand and supply diagrams , one for the labor market and one for the labor market , explain how information technology can increase income inequality if it is a complement to Workers like salespeople and managers , but a substitute for Workers like file clerks and telephone receptionists . Using two demand and supply diagrams , one for the labor market and one for the labor market , explain how a program that increased educational levels for a substantial number of Workers could reduce income inequality . REVIEW QUESTIONS Who is included in the top income quintile ?

What is measured on the two axes of a curve ?

If a country had perfect income equality what would the curve look like ?

How has the inequality of income changed in the economy since the late ?

What are some reasons Why a certain degree of inequality of income would be expected in a market economy ?

What are the main reasons economists give for the increase in inequality of incomes ?

CRITICAL THINKING QUESTIONS Explain how a country may experience greater equality in the distribution of income , yet still experience high rates of poverty Hint Look at the Clear It Up How is poverty measured in countries ?

and compare to Table . The demand for skilled workers in the United States has been increasing . To increase the supply of skilled Workers , many argue that immigration reform to allow more skilled labor into the United States is needed . Explain whether you agree or disagree . Explain a situation using the supply and demand for skilled labor in which the increased number of college graduates leads to depressed Wages . Given the rising cost of going to college , explain why a college education will or will not increase income inequality .

580 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER PROBLEMS A group of 10 people have the following annual incomes , Calculate the share of total income received by each quintile of this income . Do the top and bottom in this distribution have a greater or larger share of total income than the top and bottom of the US . income distribution for 2005 ?

REFERENCES Frank , Robert , and Philip . Cook . The Society . New York Martin Kessler Books at The Free Press , 1995 . Institute of Education Sciences National Center for Education Statistics . Fast Facts Degrees by Sex and ?

Doris . Census More in Report Nontraditional National journal . Last May , Bureau of Labor Statistics Reports . Report 1040 Women in the Labor Force A Last modified March 26 , Department of Commerce United States Census Bureau . Income Table . Share of Aggregate Income Received by Each Fifth and Top Percent of . United States Census Bureau . 2014 . 2013 Accessed April 13 , United States Census Bureau . 2014 . Historical Income Tables Households Table Share of Aggregate Income Received by Each Fifth and Top of Income . All Accessed April 13 , curve a graph that compares the cumulative income actually received to a perfectly equal distribution of income it shows the share of population on the horizontal axis and the cumulative percentage of total income received on the vertical axis quintile dividing a group into fifths , a method often used to look at distribution of income SOLUTIONS Answers to Questions . A useful first step is to rank the households by income , from lowest to highest . Then , since there are 10 households total , the bottom quintile will be the bottom two households , the second quintile will be the

PRINCIPLES or ECONOMICS 581 third and fourth households , and so on up to the top quintile . The and percentage of total income for the data provided are shown in the following table . Comparing this distribution to the US . income distribution for 2005 , the top quintile in the example has a smaller share of total income than in the US . distribution and the bottom quintile has a larger share . This pattern usually means that the income distribution in the example is more equal than the US . distribution . Income Quintile of Total Income Total first quintile income Total second quintile income Total third quintile income Total fourth quintile income Total top quintile income Total Income Table 11 . just from glancing at the quintile information , it is fairly obvious that income inequality increased in the United Kingdom over this time The top quintile is getting a lot more , and the lowest quintile is getting a bit less . Converting this information into a curve , however , is a little trickier , because the curve graphs the cumulative distribution , not the amount received by individual . Thus , as explained in the text , you have to add up the individual quintile data to convert the data to this form . The following table shows the actual calculations for the share of income in 1979 versus 1991 . The figure following the table shows the perfect equality line and the curves for 1979 and 1991 . As shown , the income distribution in 1979 was closer to the perfect equality line than the income distribution in is , the United Kingdom income distribution became more unequal over time . Share of income received 1979 1991 Bottom 20 Bottom 40 Bottom 60 Bottom 80 All 100 Table 12 . In the market for labor , information technology shifts the demand for labor to the left . One reason is that technology can often substitute for labor in certain kinds of telephone or bookkeeping jobs . In addition , information technology makes it easier for companies to manage connections with workers in other countries , thus reducing the demand for workers in the United States . In the market for labor , information technology shifts the demand for wage labor to the right . By using the new information and communications technologies , labor can become more productive and can oversee more tasks than before . The following figure illustrates these

582 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER 100 Perfect , 80 60 en 40 curve ' curve In 1979 20 40 60 80 100 Income Figure two labor markets . The combination of lower wages for labor and higher wages for labor means greater inequality . Quantity Quantity ( a ) Low wage labor market ( labor market Figure . In the market for labor , a skills program will shift supply to the left , which will tend to drive up wages for the remaining workers . In the market for labor , a skills program will shift supply to the right ( because after the training program there are now more workers at every wage ) which will tend to drive down wages for workers . The combination of these two programs will result in a lesser degree of inequality . The following figure illustrates these two labor markets . In the market for labor , a skills program will shift supply to the right , which will tend to drive down wages for workers .

583 PRINCIPLES OF ECONOMICS ( labor market ( a ) Low wage labor Figure .

GOVERNMENT POLICIES TO REDUCE INCOME INEQUALITY LEARNING By the end of this section , you will be able to Explain the arguments for and against government intervention in a market economy Identify beneficial ways to reduce the economic inequality in a society Show the tradeoff between incentives and income equality society should expect or desire complete equality of income at a given point in time , for a number of reasons . First , most workers receive relatively low earnings in their first few jobs , higher earnings as they reach middle age , and then lower earnings after retirement . Thus , a society with people of varying ages will have a certain amount of income inequality . Second , people preferences and desires differ . Some are willing to work long hours to have income for large houses , fast cars and computers , luxury vacations , and the ability to support children and grandchildren . These factors all imply that a snapshot of inequality in a given year does not provide an accurate picture of how people incomes rise and fall over time . Even if some degree of economic inequality is expected at any point in time , how much inequality should there be ?

There is also the difference between income and wealth , as the following Clear It Up feature explains . HOW DO YOU MEASURE WEALTH VERSUS INCOME INEQUALITY ?

Income is a of money received , often measured on a monthly or an annual basis Wealth is the sum of the value of all assets , including money in bank accounts , financial investments , a pension fund , and the value of a home . In ing wealth all debts must be subtracted , such as debt owed on a home mortgage and on credit cards . A retired person , for example , may have relatively little income in a given year , other than a pension or Social Security . However , if that person has saved and invested over time , the person accumulated wealth can be quite substantial . In the United States , the wealth distribution is more unequal than the income distribution , because differences in income can accumulate over time to make even larger differences in wealth . However , the degree of inequality in the wealth can be measured with the same tools we use to measure the inequality in the income distribution , like quintile measurements . Data on wealth are collected once every three years in the Survey of Consumer Finance . Even if they can not answer the question of how much inequality is too much , economists can still play an important role in spelling out policy options and . If a society decides to reduce the level of economic inequality , it has three main sets of tools redistribution from those with high incomes to

PRINCIPLES or ECONOMICS 585 those with low incomes trying to assure that a ladder of opportunity is widely available and a tax on inheritance . REDISTRIBUTION Redistribution means taking income from those with higher incomes and providing income to those with lower incomes . Earlier in this chapter , we considered some of the key government policies that provide support for the poor the welfare program , the earned income tax credit , SNAP , and Medicaid . If a reduction in inequality is desired , these programs could receive additional funding . The programs are paid for through the federal income tax , which is a progressive tax system designed in such a way that the rich pay a higher percent in income taxes than the poor . Data from household income tax returns in 2009 shows that the top of households had an average income of per year in income and paid an average federal tax rate of . The effective income tax , which is total taxes paid divided by total income ( all sources of income such as wages , profits , interest , rental income , and government transfers such as veterans benefits ) was much lower . The effective tax paid by the top of was , while the bottom two ally paid negative effective income taxes , because of provisions like the earned income tax credit . News stories occasionally report on a person who has managed to pay very little in taxes , but while such individual cases exist , according to the Congressional Budget Office , the typical tern is that people with higher incomes pay a higher average share of their income in federal income taxes . Of course , the fact that some degree of redistribution occurs now through the federal income tax and government antipoverty programs does not settle the questions of how much redistribution is , and whether more redistribution should occur . THE LADDER OF OPPORTUNITY Economic inequality is perhaps most troubling when it is not the result of effort or talent , but instead is determined by the circumstances under which a child grows up . One child attends a grade school and high school and heads on to college , while parents help out by supporting education and other interests , paying for college , a first car , and a first house , and offering work connections that lead to internships and jobs . Another child attends a poorly run grade school , barely makes it through a high school , does not go to college , and lacks family and peer support . These two dren may be similar in their underlying talents and in the effort they put forth , but their economic outcomes are likely to be quite different . Public policy can attempt to build a ladder of opportunities so that , even though all children will never come from identical families and attend identical schools , each child has a reasonable to attain an economic niche in society based on their interests , desires , talents , and efforts . Some of those initiatives include those shown in Table 13 .

586 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER Children College Level Adults Improved day Widespread loans and grants for those in financial Opportunities for retraining and acquiring new care need skills Enrichment Public support for a range of institutions from Prohibiting discrimination in job markets and programs for community colleges to large research housing on the basis of race , gender , age , and preschoolers universities disability Improved public schools After school and community activities Internships and Table 13 . Public Policy Initiatives The United States has often been called a land of opportunity . Although the general idea of a ladder of opportunity for all citizens continues to exert a powerful attraction , specifics are often quite . Society can experiment with a wide variety of proposals for building a ladder of opportunity , especially for those who otherwise seem likely to start their lives in a disadvantaged position . Such policy experiments need to be carried out in a spirit of , because some will succeed while others will not show positive results or will cost too much to enact on a widespread basis . CE TAXES There is always a debate about inheritance taxes . It goes like this On the one hand , why should people who have worked hard all their lives and saved up a substantial nest egg not be able to give their money and possessions to their children and grandchildren ?

In particular , it would seem can if children were unable to inherit a family business or a family home . On the other hand , many Americans are far more comfortable with inequality resulting from people who earned their money by starting innovative new companies than they are with inequality resulting from income people who have inherited money from rich parents . The United States does have an estate is , a tax imposed on the value of an suggests a willingness to limit how much wealth can be passed on as an inheritance . However , according to the Center on Budget and Policy Priorities , in 2015 the estate tax applied only to those leaving inheritances of more than million and thus applies to only a tiny percentage of those with high levels of wealth . THE TRADEOFF BETWEEN INCENTIVES AND INCOME EQUALITY Government policies to reduce poverty or to encourage economic equality , if carried to extremes , can injure incentives for economic output . The poverty trap , for example , defines a situation where a certain level of income can eliminate or reduce the incentive to work . An extremely high degree of redistribution , with very high taxes on the rich , would be likely to discourage work and entrepreneurship . Thus , it is common to draw the tradeoff between economic output and equality , as shown in Figure ( a ) In this formulation , if society wishes a high level of economic output , like point A , it must also accept a high degree of inequality . Conversely , if society wants a high level of equality ,

PRINCIPLES OF ECONOMICS 587 like point , it must accept a lower level of economic output because of reduced incentives for duction . This view of the tradeoff between economic output and equality may be too pessimistic , and Figure ( presents an alternate vision . Here , the tradeoff between economic output and equality first slopes up , in the vicinity of choice , suggesting that certain programs might increase both output and nomic equality . For example , the policy of providing free public education has an element of , since the value of the public schooling received by children of families is clearly higher than what families pay in taxes . A population , however , is also an enormously powerful factor in providing the skilled workers of tomorrow and helping the economy to grow and expand . In this case , equality and economic growth may complement each other . Moreover , policies to diminish inequality and soften the hardship of poverty may sustain political support for a market economy . After all , if society does not make some effort toward reducing inequality and poverty , the alternative might be that people would rebel against market forces . might seek economic security by demanding that their legislators pass laws forbidding ers from ever laying off workers or reducing wages , or laws that would impose price and price ceilings and shut off international trade . From this viewpoint , policies to reduce inequality may help economic output by building social support for allowing markets to operate . i . A Lu ( a ) Greater always reduces output ( Equality and output ruse together but then face a tradeoff Figure . The Tradeoff between Incentives and Economic Equality . a ) Society faces a where any attempt to move toward greater equality , like moving from choice A to , involves a reduction in economic output . Situations can arise like point , where it is possible both to increase equality and also to increase economic output , to a choice like It may also be possible to increase equality with little impact on economic output , like the movement from choice to However , at some point , too aggressive a push for equality will tend to reduce economic output , as in the shift from to The tradeoff in Figure ( then flattens out in the area between points and , which reflects the pattern that a number of countries that provide similar levels of income to their United States , Canada , the nations of the European Union , Japan , different levels of ity . The pattern suggests that countries in this range could choose a greater or a lesser degree of inequality without much impact on economic output . Only if these countries push for a much higher level of equality , like at point , will they experience the diminished incentives that lead to lower levels of economic output . In this view , while a danger always exists that an agenda to reduce poverty or

583 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER inequality can be poorly designed or pushed too far , it is also possible to discover and design that improve equality and do not injure incentives for economic output by very even improve such incentives . OCCUPY WALL STREET The Occupy movement took on a life of its own over the last few months of 2011 , bringing to light issues faced by many people on the lower end of the income distribution . The contents of this chapter indicate that there is a significant amount of income inequality in the United States . The question is What should be done about it ?

The Great Recession of caused unemployment to rise and incomes to fall . Many people attribute the recession to mismanagement of the financial system by bankers and financial in the of the income those in lower bore the greater burden of the recession through unemployment . This seemed to present the picture of inequality in a different light the group that seemed responsible for the recession was not the group that seemed to bear the burden of the decline in output . A burden shared can bring a society closer together a burden pushed off onto others can polarize it . On one level , the problem with trying to reduce income inequality comes down to whether you still believe in the American Dream . If you believe that one day you will have your American large income , large house , happy family , or whatever else you would like to have in you do not necessarily want to prevent anyone else from living out their dream . You certainly would not want to run the risk that someone would want to take part of your dream away from you . So there is some reluctance to engage in a redistributive policy to reduce inequality . However , when those for whom the likelihood of living the American Dream is very small are considered , there are sound arguments in favor of trying to create greater balance . As the text indicated , a little more income equality , gained through programs like increased education and job training , can increase overall economic output . Then everyone is made better off . And the will not seem like such a small group any more . KEY CONCEPTS AND SUMMARY Policies that can affect the level of economic inequality include redistribution between rich and poor , making it easier for people to climb the ladder of opportunity and estate taxes , which are taxes on inheritances . Pushing too aggressively for economic equality can run the risk of decreasing nomic incentives . However , a moderate push for economic equality can increase economic output , both through methods like improved education and by building a base of political support for market forces . SELF CHECK QUESTIONS . Here is one hypothesis A social safety net can increase economic equality but will reduce economic output . Explain why this might be so , and sketch a production possibility curve that shows this tradeoff . Here is a second hypothesis A social safety net may lead to less regulation of the market economy . Explain why this might be so , and sketch a production possibility curve that shows this tradeoff . Which set of policies is more likely to cause a tradeoff between economic output and equality policies of redistribution or policies aimed at the ladder of opportunity ?

Explain how the production possibility frontier tradeoff between economic equality and output might look in each case .

PRINCIPLES OF ECONOMICS 589 . Why is there reluctance on the part of some in the United States to redistribute income so that greater equality can be achieved ?

REVIEW QUESTIONS . Identify some public policies that can reduce the level of economic inequality . Describe how a push for economic equality might reduce incentives to Work and produce output . Then describe how a push for economic inequality might not have such effects . CRITICAL THINKING QUESTIONS . What do you think is more important to focus on when considering inequality income inequality or wealth inequality ?

To reduce income inequality , should the marginal tax rates on the top be increased ?

Redistribution of income occurs through the federal income tax and government antipoverty programs . Explain whether or not this level of redistribution is appropriate and Whether more redistribution should occur . How does a society or a country make the decision about the tradeoff between equality and economic output ?

Hint Think about the political system . Explain what the and consequences are of not promoting equality or Working to reduce poverty . REFERENCES Board of Governors of the Federal Reserve System . Research Resources Survey of Consumer Last modified December 13 , Congressional Budget Office . The Distribution of Household Income and Federal Taxes , 2008 and Last 10 , 43373 . Huang , and Nathaniel . Myths and Realities About the Estate Center on get and Policy Priorities . Last modified August 29 , effective income tax percentage of total taxes paid divided by total income estate tax a tax imposed on the value of an inheritance income a flow of money received , often measured on a monthly or an annual basis progressive tax system a tax system in which the rich pay a higher percentage of their income in taxes , rather than a higher absolute amount

590 ERIK DEAN , JUSTIN , MITCH GREEN , BENJAMIN WILSON , AND SEBASTIAN BERGER redistribution taking income from those with higher incomes and providing income to those with lower incomes wealth the sum of the value of all assets , including money in bank accounts , financial investments , a pension fund , and the value of a home SOLUTIONS Answers to Questions . A very strong push for economic equality might include extremely high taxes on earners to pay for extremely large government social payments for the poor . Such a policy could limit incentives for the workers , lock the poor into a poverty trap , and thus reduce output . The in this case will have the standard appearance it will be downward sloping . For the second hypothesis , a social safety net might make people feel that even if their company goes bankrupt or they need to change jobs or industries , they will have some degree of protection . As a result , people may be more willing to allow markets to work without interference , and not to lobby as hard for rules that would prevent layoffs , set price controls , or block foreign trade . In this case , safety net programs that increase equality could also allow the market to work more freely in a Way that could increase output . In this case , at least some portion of the between equality and economic output would slope up . Pure redistribution is more likely to cause a sharp tradeoff between economic output and equality than policies aimed at the ladder of opportunity . A production possibility frontier showing a strict tradeoff between economic output and equality will be downward sloping . A showing that it is possible to increase equality , at least to some extent , while either increasing output or at least not diminishing it would have a that first rises , perhaps has a area , and then falls . Many view the redistribution of income to achieve greater equality as taking away from the rich to pay the poor , or as a zero sum game . By taking taxes from one group of people and redistributing them to another , the tax system is robbing some of the American Dream .