G H A P T E R 11 :

macroeconomic objectives It:

Economic growth + equity
in the distribution of income
 CHAPTER 11.1
Economic growth

THE MEANING OF ECONOMIC GROWTH

understanding economic growth

or Economic growth : an increase in real GDP I the real quantity of goods -1 Services produced over a period of time (typically a year )

-
is usually expressed as :

→ a % Change in real GDP over a period of time

→
a go change in real GDP per capita over a period of time
-

the distinction between growth in real GDP t real GDP per capita is important to the two measures are v different
→
whereas real GDP measures the total output produced in an economy , real GDP per capita measures total output per person

→ real GDP per capita is a better indicator of the standard of living of a population , since it measures the amount of real GDP

corresponding to each person on average

-
it's measured as the 0100 in real as opposed to nominal GDP

→ the real figures eliminate the impact of price changes , thus permitting meaningful comparisons of levels of output over time

calculating economic growth

o) calculating economic growth from a set of data

final value of real GDP

-
initial value of real GDP
-
0/00 in real GDP = # X 100
initial value of real GDP

-
ex : it an economy had real GDP of 1575.3 billion in 2010 t $81.7 in 2011 , by how much did real GDP grow in 2010 2011 ? -

81.7 75.3
÷
4
-

Yoo in real GDP ×

100 100=8.590
- -

→ - -
x
,

-
an identical formula is used to calculate the 0100 in real GDP per capita

→
ex : suppose an economy has real GDP per capita of $1402 in 2009 $1457 in 2010,4151410 ,
in 2011

1457 1402 -
55
↳ 2009 20100 in real GDP per capita : X
100=14-02×100--3.990
-

1410 -
1457
↳ 2009-20110 in real GDP per capita x 100 100 = 3.2%
- -

Ey
- -
x -

↳ economic growth was negative

01 Relating growth in real GDP to growth in real GDP per capita

-
suppose real GDP is growing in a hypothetical economy , so it has a positive growth rate ; does this mean it also has positive per capita GDP

growth ?

→
the answer depends on how fast the population is growing

→
it real GDP is growing faster than the population , then the amount of real GDP that corresponds to each person on avg increases ,

resulting in positive growth in real GDP per capita

→ it the population is growing faster than real GDP , then the amount of GDP per person on avg decreases , t the growth rate of real GDP

per capita is negative

-
it we know the 0100 in real GDP t the 060 in the population we can find the 060 in real GDP per capita in , a v simple way :

0100 in real GDP per capita = 0100 in real GDP Yoo in population
→ -

→
ex : it real GDP grew by 2% in a year y the population grew by 1.5% , then real GDP per capita growth was 0.5%
↳ it the population grew by 2.5% then the 900 in , real GDP per capita was -0.5% -
indicating that output per person tell

The significance of economic growth

01 Economic growth rates achieved by countries around the world vary widely

-
while some countries experience rapid growth , others grow much more slowly , while others contract for a period of time

01 Table 11.1 : avg annual growth rates of real GDP per capita for several countries for the period 1990 2007 -

at the bottom of the table , we see that the world growth rate over the same period was 1.6% per year on avg
-

01 Differing growth rates have enormous implications for a country 's economic performance over long periods of time

ex : consider what would happen to per capita G DPs of 3 hypothetical economies that 9 row at different rates over a period of 17 Years

→ imagine that each economy Starts out in the year 2000 W/ a GDP per capita Of $1000

→ the first one grows for 17 years at the high annual rate of 8.9% ; the 2nd country grows at the world avg rate of 1.6% ; t the 3rd
 Country contracts at the rate of -2.7%1negative growth) Average annual growth 10/01 1990 -
2007

→ results are in Table 11.2 China 8.9

→
the country that grows at 8.9% per year for 17 years succeeds in Vietnam 6.0

more than quadrupling its GDP per capita Ireland 5.8

→ the country that grows at the world avg rate of 1.6% per year India 4.5

for 17 years only adds $310 to its GDP per capita Botswana 4.3

→ in contrast the country that contracts at 2.7% per year for 17

. Greece 2.7
'
years loses 13 of its per capita GDP United Kingdom 2.4

2000 GDP per capita Annual growth rate 2017 GDP per capita United States 2.0

$1000 8.9% $4261 Argentina 1.5

$1000 1.6% $1310 Japan to

$1000 -
2.7% 15634 Switzerland 0.8

Table 11.2 Growth of real GDP per capita in hypothetical countries Kenya o.O

01 The enormous cumulative impact that rates of growth have on levels of Paraguay -
0.3

real GDP per capita explains why govt around the world focus strongly Moldova -1.3

on policies intended to increase their growth Burundi -

2.7

World 1.6

Table 11.1 Real GDP per capita percentage growth

TEST YOUR UNDERSTANDING 11 .

'

l .
Economic growth refers to an increase in real GDP 1 the real quantity of goods and services produced over a period of time typically a year )

2 . Real values in order to eliminate the impact of price changes , thus permitting meaningful comparisons of levels of output over time

3 .
Real GDP per capita is a better indicator of the standard of living of a population , since it measures the amount of real GDP corresponding

to each person on average

4 1611 1579
100--153,4×100=2.0390
-
.

la ) rate of economic growth in 2007-2008 X

:-p
1597 -
1611 -
14

100=-0.86%10
rate of economic growth in
(b)
2008-2009=-16,1×100
= x

) 2008 2009
-

5 .
His possible if the population is growing faster than real GDP -
causing the amount of GDP per person on average to decrease and therefore

leading µ a negative growth rate of real GDP per capita , even if real GDP growth is positive .

6 . growth of real GDP per capita -

-
2.2%-1.590=0.790
THE PRODUCTION POSSIBILITIES MODEL t THE CAUSES OF ECONOMIC GROWTH
Explaining economic growth in terms of the production possibilities model

01 Increases in actual output

-
ppb shows combinations of Max output that can be produced by an economy w/ fixed resources -1 tech , provided there is full Imax

employment of resources + productive efficiency

employment in this model doesn't full employment as in AD AS models ; it means that all resources are employed to
'
→ Max mean ' -

the fullest extent t there is no unemployment

-
any economy is most likely to be actually situated at some point inside its PPC , as it is v difficult ever to achieve full productive

efficiency + Max employment of all resources

the further away an economy is situated from its ppc , the greater is resource unemployment -1 productive inefficiency
-

→
therefore , by reducing unemployment + increasing productive efficiency , a country moves closer to its PPC t increases the actual

quantity of output produced

-
reductions in unemployment t increases in productive efficiency are 2 factors that can cause growth of actual output

-
Figure It Hal
. : the movement from point A to point B illustrates growth of actual output

o) Increases in production possibilities

-
reduction of unemployment t inefficiencies can only result in a limited amount of economic growth
-
as the economy moves closer to its PPC , the ability to achieve more growth can only occur if there's an increase in production

possibilities
→
outward shift of the ppo
 -
Figure 11.1lb ) : outward shift Of PPC

→
it means that the economy can produce more of both goods IN Economic growth as an increase in actual

Htb ) output caused by reductions in unemployment

→ shifts from Ppc , topper to ppc, t productive efficiency
→
increases in production possibilities are accompanied by outward 4

movements of the economy 's points of actual production

↳ from A to B to C

-
factors that lead to outward shifts of ppg increases in production
•

possibilities are :
/
•
B

→
increases in the quantity of resources If actors of productions ) in A

the economy
- -

→ improvements in the quality of resources x

↳ ex : through more educated labor, or improved physical capital (b) Economic growth as an increase in production

through tech change possibilities caused by increases in resource

-
as its production possibilities increase , an economy must make quantities 1improvements in resource quality

efforts to keep unemployment at low levels t reduce inefficiencies to b

ensure that its actual output continues to grow along w/ production

possibilities
T

I
:c
÷
→
ex : an increase in the size of the labor force will do little to increase

actual output produced it much of this labor remains unemployed

↳ the economy could remain stuck at point A even as PPC ,

shifts to ppg ,
O
PPO , PPC, PPC , x
↳ similarly the discovery of major oil reserves may do little to
,

expand actual output if these reserves remain unexploited 1 101 Decrease in production possibilities

if their exploitation is undertaken inefficiently y

-
figure 11.1101

the ppb can also shift inward indicating a decrease in production

f
→
.

possibilities 1 that less of the 2 goods can be produced

f
↳ this results a decrease in the quantity of resources 1

deterioration in resource quality

-
Figure II. Ild ) ppoz ←
ppg ,
O
→ an outward 1 inward shift need not be parallel X

→ ex : a tech change favoring the production of one good IN increases Id ) Non parallel shifts of the ppb
-

the production of that good proportionately more y

→
similarly , an influx of unskilled workers into a country results in a

larger proportionate increase in the production of goods using

relatively more unskilled labor

/
/
INVESTMENT, CAPITAL -1 PRODUCTIVITY /
The roles of physical , human 1- natural capital in economic growth

01 Capital : resources that can produce a future stream of benefits ppb , ppg ,
O
-
this future stream of benefits arises from investment Is pending x

FIGURE It using the production

'
possibilities model to illustrate
undertaken to create that stream of benefits
.

economic growth

01 The 3 factors of production : land 1 natural resources ; labor 1 human resources it physical capital can be interpreted as a type of capital :

-
physical capital :
→
standard type of capital

→ results from investments is pending to produce machines , equipment roads , etc . .

-
human capital :

→ the skills abilities knowledge t levels of health of workers

. .

→
results from investments / spending on education , training , provision of healthcare services , clean water supplies , good nutrition , t

generally anything that affects levels of education t health

 -
natural capital

includes everything that traditionally falls within ' land ' I ' natural resources
'
→

↳ includes everything under the land : mineral deposits , metals oil , natural gas , etc . .

↳ includes everything on the land : rivers lakes , oceans , forests , soils , etc
. .

↳ includes a country 's overall natural environment + ecosystem : air, wildlife biodiversity , climate, , ozone layer

whereas I land ' natural capital include the same things there's difference in how the 2 terms are interpreted
'
important
'
→ t , an

↳
land ' is assumed to be given by nature doesn't change
'
t

↳ '
natural capital ' does change bait can be destroyed : by cutting down forests polluting the air -1 water , depleting fish .

↳ it can also be improved by planting more forests improving soil quality

: .

↳ maintaining natural capital t improving its quality depend on investments that aim to preserve t improve natural resource

quantity -1 quality

habitat extended the meaning of investment apply to all 3 factors of production :

' '

By expanding the meaning of

'
01 , we have to

Factor of production Type of capital

physical capital is related to investments in physical capital

labor human resources

-
- is related to investments in human capital

land : natural resources is related to investments in natural capital

01 Investments can be undertaken by the private sector ltirmsl private indi vs ) or by the public sector 19 out )

-
there are a number of situations where govt investment are necessary particularly when there are market failures ,

→ externalities

→ need to provide merit -1 public goods

01 Investment is crucial to building capital of any type

-

physical capital , tech -1 economic growth

→
increase in the quantity of physical capital increase in the number of machines , tools , equipment road systems , ports , etc , available
-
- . .

in an economy

→ an improvement in the quality of physical capital depends on tech advances which lead to new ,
t better machines tools -1 equipment
,

↳ tech advances are usually incorporated into new capital goods

↳ ex : a new computer that's faster + more powerful incorporates within it the new tech that makes it faster -1 more powerful
↳ when a tech advance is incorporated into a capital good . it's referred to as being embodied in the new capital
'
→
improved capital goods '
: capital goods that embody a new tech

→ use of capital goods embodying new techs leads to a larger quantity of output produced

↳ ex : the use of a more powerful computer allows a worker to produce more output

→
increases in the quantity +
improvements in the quality of physical capital , arising from investments in physical capital t new tech ,

are among the most important sources of economic growth over long periods of time
-
human resources , human capital , +
economic growth

→
the quantity of labor can sometimes be an important source of economic growth

↳ ex : the influx of foreign workers into Germany in the 1960, -119705 played an important role in promoting its growth

↳ however many countries (especially less

,
developed ones ) sometimes face high levels Of unemployment + underemployment
↳ therefore , increases in the quantity of labor may not always be a source of growth

→
improvement in the duality of labor , determined by skills abilities knowledge , , , t levels of health of the workforce is far more

important than increases in the quantity of labor

↳ improved labor quality is the result of investments in human capital :

↳ spending on education building schools providing meals for schoolchildren

, , t providing vocational training
↳ spending to provide medical services, immunisation , t ensuring access by the overall population to healthcare services ,

together w/ the provision of sanitation -1 clean water supplies , t keeping the environment unpolluted
→
higher levels of skills knowledge -1 health resulting from investments in human
, , capital , are a v important source of economic

growth bo a highly skilled well educated,

-
t healthy labor force is more productive than an unskilled uneducated ,
,
t unhealthy one :

a skilled + healthy worker can produce more output than a worker who's unskilled Innhealthy

→
increased quantities of labor are unlikely to be a source of economic growth over long periods . but improvements in the quality of

labor arising from investments in human capital , are among the most important sources of growth
.
 -

natural resources natural capital, t economic growth

→
kinds of natural capital
↳
marketable commodities

↳ commodities that 're bought 1- sold

↳ ex : timber , 0091 oil minerals metals

. .
, , natural gas

↳ ecological resources

↳ generally common access resources

↳ ex : soil quality rivers clean air biodiversity the

, , , , 02 one layer

-
the role of marketable commodities

→ can contribute to growth but aren't essential

↳ ex : the US benefitted enormously from its large tracts of good quality agricultural land, oil reserves , + mineral deposits
↳ yet the evidence suggests that countries don't need to be rich in marketable commodity type natural resources to achieve
,
-

high rates of growth

↳ there are many economies , such as Israel Japan Hong Kong , Singapore South Korea , Switzerland Taiwan etc , that have achieved
, . .
. , .

high rates of growth over long periods 1- have attained high levels of GDP per capita in spite of producing few it any marketable

commodities

-
the role of ecological goods t common access resources

→ ecological goods t common access resources are crucially important to long term growth -

→ long term economic growth depends critically on the ability of countries to maintain it it possible improve environmental quality ,
+

therefore natural capital that includes common access resources

↳ bo environmental destruction on a large ( unsustainable ) scale means leaving behind fewer t lower quality resources for future

generations
→
environmental destruction can have direct effects on the amount of output produced
↳ ex : a farmer working w/ poorer quality soil produces less output ; fisheries in fish depleted seas have a smaller catch
-

→ it can also have important indirect effects

↳ ex : workers whose health is affected by environmental pollution become less productive

↳ involves depletion of human capital together w/ depletion of natural capital

→
these effects involve an inward shift of the PPO due to fewer -1 lower quality environmental t human resources (natural t human capital )

t therefore lower (or even negative ) Ebon growth in the future

↳ Figure It .
I lol

→ continued econ growth in the future requires investments in the present in natural capital for environmental preservation

→
marketable commodity type natural resources -
can contribute to economic growth but aren't , an essential source of growth

→ however maintaining the quantity -1 quality of ecological resources through investments in natural capital is critically important for
,

continued economic growth over long periods

The central importance of productivity as a source of economic growth

01 Productivity : the quantity of output produced for each hour of work of the working population
-
summarizes the contributions of resource quantities t quality to econ growth

o) For an economy as a whole , productivity can be measured as real GDP ÷ total number of hours worked

01 An improvement in productivity means that workers become more productive : the quantity of output produced in an hour of work

increases

-
Had to Pooh growth bo each hour of work. now produces more output

or improvements in productivity arise from factors that make labor more productive , so that each hour of work produces more output

01 Factors :
-
increases in quantity t improvements in quality of physical capital

→
through investments in physical capital +
tech change

-
improvements in the quality of labor
→
through investments in human capital
-
improvements in (or at least maintenance on the quantity +
quality of ecological resources
→
through investments in natural capital

01 In the production possibilities model , productivity improvements result in outward shifts of the ppb
consumption versus investment : present choices -1 future growth possibilities
-

01 The PPC model is a useful tool for illustrating how choices made by an economy in the present affect the position of its PPC in the

future

01 Ex : flatland -1 Mountain land

-
w/ identical resources -1 techs in the present t therefore identical ppos

→
p pop in Figure 11.2 for both countries

each country must make a choice in the present concerning what quantity of consumer goods to produce + what quantity of capital

goods to produce (may be physical , human 1 natural capital)

each must choose where it wants to be on its Php

-

→ consumer goods : goods that satisfy immediate consumer needs -1 Wants

↳ represent consumption in the present

↳ ex : food , clothing books , DVD players , oars

.

→
the production of capital goods depends on investment which is made possible through saving
,

↳ investment involves a sacrifice of some present consumption

→
the consumption sacrificed today is the opoost of building capital
-
Flatland chooses to produce relatively more consumer goods in the present I point Xl while Mountain land chooses to produce relatively

more capital goods I point Y)

→
for simplicity we're assuming that each country
, can produce on its PPC

ppg , showing the future PPO for both countries indicates that Mountain land expects to experience
, a larger ppc shift

→ bo it produces more I improved capital goods ,thus increasing its production possibilities more than Flatland
→
Mountainland expects greater possibilities for economic growth in the future

01 In order to have

191 Flatland Ibl Mountain land long term economic

-

consumer consumer growth itis necessary

,

goods goods
loonsumptionl to sacrifice some
lbohlnmptionl
X
- - - - - - - -
q consumption in the

t present in order to
!
make investments
I

t - - - - - - - - - - -

gab that will result in

l l
p pop ppg
I
p pop pp of the formation of new
o
y o
l

capital goods ( investment ) capital goods ( investment) capital for use in

the future
FIGURE 11.2 present choicest future growth
01 Investment is financed by saving which is that portion of income that's not consumed
,

01 Most countries particularly low income developing ones have incomes so low that most of this goes toward consumption , leaving little for
,
-
.

saving 1- investment

-
if these countries had to rely only on their own resources , it would be v difficult for them to achieve economic growth

-
what can these countries do ?

→
borrow from abroad -1 use the borrowed funds to finance investments that will help them grow

↳ either from other countries or from international financial institutions

→
accept foreign investments

↳ involve investments by foreigners in the domestic economy

ECONOMIC GROWTH +
THE IRAS CURVE
AD AS model Factors causing growth production possibilities model
-

}
{
increased resource quantity

"'M
i noreasfsnitnwatoda.Y.osnhiptotisibim.es,
µg¥¥%%%%% .
improved rnesoonnarnoegpana
.
.

}
improved efficiency
potential output )
movements of production point closer to ppg
0h14 natural ← reduced unemployment →
a, , types

institutional changes not included

TABLE 11.3 Factors that cause economic growth

 01 Table 11.3

-
improved efficiency t reduced unemployment causing points , of production to move closer to a fixed ppb . can cause the IRAs curve to shift

to the right

→
though only natural unemployment is included

→
this excludes cyclical unemployment , as red notions in this don't affect the position of the IRAS curve
-

the IRAS curve can shift to the right as a result of institutional Chan 995 , which aren't included in the ppb model

→
there are some differences between the 2 models , as each has been constructed to illustrate different principles
↳ the IRAS curve is intended to show that potential output is independent of the price level
↳ ppb doesn't deal w/ the price level t is better suited to illustrate the principles of resource scarcity top costs of economic

choices

REAL WORLD FOCUS

long term economic growth in the eurozone
-

1 . Natural unemployment : structural , frictional , and seasonal unemployment . Natural unemployment is high because there are disincentives to

work and wage inflexibility Structural unemployment

.
occurs as a result of changes in demand for particular types of labor skills , changes

in the geographical location of industries and therefore jobs , and market rigidities Frictional unemployment occurs when workers are .

between jobs and tends to be short term -

making it less serious than structural unemployment Seasonal unemployment occurs when the
.

demand for labor in certain industries changes on a seasonal basis because of variations in needs .

/ If
2 .
Id) price LRAS , IRAS , lb ) Y
level

÷ .

O -

O -

Yp ,
Ypr real GDP X

Reductions in the natural rate of unemployment lead to a Reductions in the natural rate of unemployment lead to a

rightward shift in the IRAS curve , as potential output increases movement of the production point closer to the PPC from A H B)

l RAS IRAS ,

t¥¥
3 .
Id ) price z lb) b

level

SRAS , SRA Sz T

" . . . . - . . - .
÷÷
AD , HD2
O -
o
Yp '
Ypz real GDP PPO , PPC, PPC , X

improvements in productivity cause an increase in potential output improvements in productivity result in outward shifts of ppg

from Y pi to bpr -
shifting IRAS to the right from IRAS , to IRAS 2 , from PPC , to ppa to ppb, Increases in production possibilities
.

and therefore causing long term economic growth -

are accompanied by outward movements of the

economy 's points of actual production Atom Ate B t O )

4 . The lack of 10T usage disincentives to work , wage inflexibility , lack of innovation 110-11 , long bureaucratic procedures that make it hard to start
, a

business table of competition in product markets etc

, , .

TEST YOUR UNDERSTANDING 11.2

1 ,
y 4 An increase in actual output caused by a reduction in

unemployment and an increase in productive efficiency

7 causes a country to move closer to its PPO from A to B .
Ah

I
:c
÷
increase in production possibilities lead to outward shifts of
•

/
•
B PPO from ppb , te p por te ppg due to the increase in the

quantity of resources improvements in the quality

-

A or of

resources increases in production possibilities can also be

.

- .
× PPO , PPG PPG X
accompanied by outward movements of the economy's
-
 points of actual production from A te Bt b

2 .
la ) Y lb) Y lol Y Id ) Y

→
→
• •

1B
• ⑧
IA
(

A B

ppg , ppg , PPG PPG ppg , ppg ,

O O O O
x x x x

IP ) b HI Y 191 Y 1h ) Y

t
-
•

/
•
B
c-

ppc , ppb , ppg , ppb , ppg , ppg ,

O O O O
x x x x

lil 4 lil b IN Y

←
→ →

ppg , PPC , PPC , p plz ppb , ppg ,

O O O
x x x

3 , la ) rightward shift of IRAS

lb ) rightward shift of IRAS

lol no effect on IRAS

Id ) rightward shift of LRAS

191 rightward shift of LRAS

HI rightward shift of LRAS

191 leftward shift of IRAS

tht leftward shift of IRAS

lil rightward shift of LRAS

(j) rightward shift of LRAS

IN leftward shift of IRAS

4 . Capital refers to resources that can produce a future stream of benefits This future stream of benefits arises from investment Is pending
.

undertaken to create that stream of benefits Therefore capital has . , a dependent relationship with investment as investment is needed , to build

capital of any type Physical capital results from investments is pending to produce machines , equipment roads , etc Human capital results
.
. .

from investments / spending on education , training , provision of healthcare services , clean water supplies , good nutrition , generally anything

that affects levels of education and health Maintaining natural capital and improving its quality depend
.
on investments that aim to preserve
and improve natural resource quantity and quality .

5 .
increases in the quantity and improvements in the quality of physical capital , arising from investments in physical capital and new

technology, are among the most important sources of economic growth over long periods of time , as they increase the quantity of output

produced Increased quantities

.
of labor are unlikely to be a source of economic growth over long periods . but improvements in the quality of

labor arising from investments in human capital , are among the most important sources of growth Improvements
.
.
in (or at least maintenance

ON the quantity and quality of ecological resources through investments in natural capital lead to economic growth .

6 .
la ) productivity refers to the quantity of output produced for each hour of work of the working population

(b) An improvement in productivity means that the quantity of output produced in an hour of work by workers increases -
leading to

economic growth because each hour of work

, now produces more output

lol increases in the quantity and improvements in the quality of physical capital , arising from investments in physical capital and new

technology : improvements in the quality of labor through investments in human capital ; and improvements in (or at least maintenance

ON the quantity and quality of ecological resources through investments in natural capital
 l H
(d) b Pri OP L RAS , LRA Ss
level

O O -

ppg , PPC , X
Yp ,
bpr real GDP

7 . In order to have long term economic

-

growth it's necessary

,
to sacrifice some consumption consumer
goods
in the present in order to make investments that will result in the formation of new loonsumptionl
capital for use in the future The production of capital goods depends
.
on investment which
,

×
is made possible through saving Investment involves sacrifice of -9
- -

present consumption
- -

. a some .

The consumption sacrificed today is the opportunity cost of building capital Choosing to .
t
I

produce at point Y l invest more ) leads to a greater outwards shift in ppb from p pop to pp
Gy - - -
f - - - - -

age Y
l
l
when compared to the shift from ppop to ppoyx encountered by the economy that chooses to l l
ppg ppg
's
p pop ,
l l
O
spend more at point X . This signifies that it's necessary to sacrifice some consumption to produce capital goods ( investment)

greater economic growth .

POSSIBLE CONSEQUENCES OF ECONOMIC GROWTH

01 Economic growth has many possible consequences as it affects numerous aspects of an economy

01 Some of the consequences are positive while others may be negative

-
whether these will be positive negative often depends on the particular circumstances that an economy finds itself in
 CHAPTER 11.2
Equity in the distribution of income
EQUITY 1- THE DISTRIBUTION OF INCOME
Equity + equality in the distribution of income

01 Equity : the condition of being fair I just

01 Equality the state : of being equal w/ respect to something

equality w/ respect to income would mean that each member of a society receives exactly the same income

→ this may I may not be equitable , depending on how equity is interpreted

↳ it it's believed that income distribution is equitable Hair if it's distributed equally , then equity in income distribution = income

equality
↳ however if it's believed that it is equitable Hair for
, people 's income to be in proportion to their work effort ( a different equity

principle ) . this would give rise to income inequality since . not everyone 's work effort is the same

01 Many philosophers have dealt w/ the issue of equity in income distribution t there are numerous different interpretations

01 In most countries around the world , the pursuit of equity in the distribution of income is usually interpreted as the pursuit of greater equality 1

less inequality relative to what would be achieved by the free market

'
-

for this reason , we often find writers referring to a more equitable I more equal distribution
' ' '
of income interchangeably

→
both expressions are correct , provided it is understood that in these oases , equity in income distribution is interpreted as greater

equality
→
while this idea of equity is related to equality it doesn't involve the pursuit of complete income
. equality

income distribution t the market system

)
o Every economy , regardless of its form of organization , must answer 3 basic economic questions : what to produce how . to produce , t for whom

to produce
-
first 2 relate to resource allocation

3rd deals wi the distribution of income /output

-

→ concerned w/ how much of goods -1 services different indivs I different groups in the population receive

a circular flow model Shows that in a market economy , the amount of goods t services that households receive depends on their income as this ,

determines how much they can buy

-
their income depends on payments they receive by selling the factors of production they own

01 Output + income distribution in a market economy depend on how many resources consumers ( households ) own t are able to sell in resource

markets , as well as on the prices of the factors of production they sell

01 The problem of income distribution arises bc ownership of factors of production is highly unequal t bo the prices of factors of production

determined in the market vary enormously

while most people have labor resources that they provide in labor markets for which they receive wages , some people are able to
-
.

receive v high wages bo of special skills t education natural talents , while others who 're less skilled , educated I talented may receive wages

so low that they may be unable to cover the most basic needs for themselves t their families ( food , shelter, clothing etc ) , .

there may be people who would like to work but can't do so bo they lack the kinds of skills firms want to hire , or bb they're sick told ,
-
-

or have special needs that prevent them from working , or bo there simply aren't enough jobs in the economy to provide work for everyone

-
there are some indivs who possess some of the additional factors of production of land , capital . + entrepreneurial abilities for which they ,

receive rental interest ,

t profit income

→
these additional factors of production are generally highly unequally distributed

→ as a result the market determined distribution of income in

,
-
an economy is likely to be v unequal w/ some people receiving far
,

larger shares than others

u) markets can 't ensure that everyone in a population will secure enough income to satisfy their basic needs

most societies consider this to be a disadvantage of the market 900 nomy , bo of the belief held by most people that everyone in a
-

population should be able to satisfy a min of basic human needs

-
govt around the world use a variety of methods to change the market determined distribution of income
- +
Output , t arrive at a more

socially desirable outcome

→
referred to as redistribution
TEST YOUR UNDERSTANDING 11.3
I .
Equity is the condition of being fair I just Equality is the state of being equal with respect
.
to something .
Equality with respect to income

would mean that each member of a society receives exactly the same income This may I may not be equitable , depending
. on how

equity is interpreted If it's believed that it is equitable Hair for people 's income to be
.
in proportion to their work effort this would give rise
.

to income inequality since . not everyone 's work effort is the same If it's believed that income distribution is equitable Hair if it's distributed
.

equally , then equity in income distribution is equivalent to income equality

2 .
Markets can 't ensure that everyone in a population will secure enough income to satisfy their basic needs due to the problem of income

distribution that arises because ownership of factors of production is highly unequal and because the prices of factors of production

determined in the market vary enormously While most people have labor resources that they provide in labor markets for which they
. .

receive wages some people ,

are able to receive very high wages because of special skills and education natural talents , while others

who 're less skilled , educated I talented may receive wages so low that they may be unable to cover the most basic needs for themselves and

their families ( food , shelter, clothing etc ) There also man be people who would like to work but
, .
.
can't do so because they lack the kinds of skills

firms want to hire , or because they're sick told , or have special needs that prevent them from working , or because there simply aren't enough
-

jobs in the economy to provide work for everyone There are also some individuals who possess some of the additional factors of production of
.

land , capital and entrepreneurial abilities for which they receive rental interest and profit income These additional factors of production
, , , ,
.

are generally highly unequally distributed As a result the market . ,

-

determined distribution of income in an economy is likely to be very

unequal with some people receiving far larger shares

. than others .

INDICATORS OF INCOME EQUALITY 1 INEQUALITY : INCOME SHARES, THE LORENZ CURVE 1- GINI COEFFICIENT
presenting some data on income distribution

percentage share of income Icon sumption 01 Table 11.4 : data on income

country poorest 2006 second 20% Third 20% Fourth 20% Richest 20% Gini coefficient distribution of selected

Bolivia 12008) 2.7 6.5 11.0 18.6 61.2 0.58 Countries around the world

Mexico 120061 3.8 8. I 12.4 19.3 56.4 0.48

-
shows how income is

Philippines 12006) distributed by quint les

'

5.6 9. I 13.7 21.2 50.4 0.44

Ghana 12006 ) 5.2 98 14.8 21.9 48.3 0.43 Of the population

Vietnam 12006) 7. I 10.8 15.2 21.5 45.4 0.38 →

quintile : a 20010

Pakistan 120051 9. I 12.8 16.3 40.5 0.31 portion of country 's

-

21.3 a

Belarus 120071 8.8 13.4 17 5

.
22.6 37 7-
0.28 population

TABLE 11.4 Distribution of income by quintile in selected countries

→
we can divide a population into 5 quintile , ranging from the lowest quintile ( the poorest 2090 Of the population ) to the highest

quintile ( richest 20%1

01 If income were completely equally distributed , everyone would receive exactly the same income

-
every quintile would receive 20010 Of income

-
in the real world this is, a virtual impossibility

01 In all countries in the world the presence of

. inequalities in income distribution means that the poorest quintile of the population receives less

than 2090 Of income , t the richest quintile more than 20010

-
Table 11.4 ex :

→ in Bolivia the lowest

.
quintile receives 2.7% of income t the highest quintile 61.2%
→ in Belarus , the lowest quintile receives 88% t
-

the highest quintile 37.790

-
in general the higher the percentage share of income received by the poorest quintile , t the lower the percentage share received by the
,

highest quintile , the more equal the distribution of income

01 Income shares can also be shown by deciles , which are 10010 portions of the population ( there are 10 deciles ) as well as quartiles or 250/0 portions of

the population ( there are 4 quartiles )

THE LORENZ CURVE
01 Used to show the degree of income inequality in an economy

01 Named after an American statistician Conrad Lorenz who devised this measure of income inequality in 1905
. .

01 It's a visual representation of the kind of income distribution data appearing in Table 11.4

01 Figure ii. 3

-
to construct a Lorenz curve we draw , a square box , where the vertical axis measures the total amount of income in an economy in

cumulative percentages ( runs from 0%-1000/01 ,

t the horizontal axis plots the total population in the economy , also in cumulative
 percentages I also runs from 0%-100%1
→
cumulative :
100
↳ 20 :
poorest 20% of the population
e
↳ 40 poorest 40010 5
-
-

3 80
↳ etc . . .
E
perfect
-

1-
-

diagonal line : perfect equality in income distribution , as it shows that o income → h

•
E 60 equality
it income were perfectly equally distributed 20% of the population . E
I
would receive 20% Of income 40% would receive 4006 Of income, .
t
so
d
I 40 •
In doo
10 Oh e

f-
'
>
Belarus
-
the Lorenz curve plots the actual relationship between percentages of E f
•
s
20 •
§
the shares of income they receive
o
the population 1- s e b
u
• •
f
-
also plots 2 Lorenz curves one for Bolivia .
-1 one for Belarus based on
•
a Bolivia
0
the data in Table 11.4 20 40 60 80 100

-
Bolivia 's curve cumulative percentage of population

→
point a : the poorest 20010 Of the population receives 2.7% of FIGURE 11.3 Lorient curves : Belarus achieves greater income equality
than Bolivia
income

→
point b is obtained by adding the 2.7% of income of the poorest quintile to the 6.5% Of income received by the 2nd quintile giving
,

9.20 to

↳ this is the cumulative income of the bottom 4006 Of the population

→ point o is obtained by adding the percentages of income received by the bottom 3 quintile , giving 20.2% Of income

→
point d is obtained by adding the incomes of the bottom 4 quintile , getting 38.3% of income for 80% Of the population
→
when these points are joined together starting from O t going up to 100% of the population , we obtain Bolivia 's Lorient curve

-
points at ohh , on Belarus
'
curve are calculated t plotted in exactly the same way

To plot a Lorient curve , we could use income distribution figures that divide the population into 10 deciles (or tenths) , or other convenient
-

01 any

subdivision

01 In general the closet

. a Lorient curve is to the diagonal representing perfect income equality the greater the equality ,
in income distribution

-
Fig 11.3 : Belarus clearly has greater income equality than Bolivia
.

THE GINI COEFFICIENT

01 Named after Corrado Gini , an Italian statistician

01 A summary measure of the information contained in the Lorenz curve of an economy

area between diagonal t Lorenz curve

o) Gini coefficient
-
- -

entire area under diagonal

01 Has a value between Ot '

-
it there were perfect income equality the coefficient
, would be 0 , since the numerator of the ratio would be O

-
the larger the Gini coefficient + the closer it is to z the greater the income inequality , since the further away the Lorenz curve is from
,

the diagonal

-
a perfectly unequal income distribution would be where a single household receives all the income of the economy + the numerator would

equal to the entire area under the diagonal -

making the Gini coefficient : I

01 The last column of Table 11.4 Shows Gini coefficients that correspond to each of the income distributions

-
Belarus Gini coefficient is 0.28 while Bolivia 's is 0.58 , indicating Belarus relatively more equal
'
.
'
country Gini coefficient

income distribution United States 0.41

01 The Gini coefficient is a summary measure of income inequality , t in a Lorenz diagram is the ratio United Kingdom 0.36

of the area between the diagonal t the Lorenz curve , to the total area under the diagonal Australia 0.35

01 It has a value between 0 -11 Greece 0.34

-
the closer the value is to 0 , the greater the income equality Canada 0.33

-
the closer the value is to 1. the greater the income inequality Netherlands 0.31

01 Table 11.5 lists the Gini coefficients of some economically more developed countries Germany 0.28

using Lorenz curves to illustrate income redistribution Norway 0.26

o ) Graphically this appears as

. a shift of a country 's Lorenz curve closer to the diagonal line +
is reflected Denmark 0.25

coefficient of selected
TABLE 11.5 Gini
in a lower Gini coefficient
economically more developed countries
 01 Figure 11.4

-
shows how a Lorenz curve shifts towards the diagonal after the govt
100
pursues policies to redistribute income to increase the degree of income
e

s equality in the economy

is 80
E
perfect ←
-

1-
o income →
E 60 equality
⇐
§ increased income \
£ 40 equality after
g
f
'
redistribution
) v

E
20
T y
§
s before
u
9 redistribution

0
20 40 60 80 100

cumulative percentage of population

FIGURE 11.4 Lorenz curve! t income redistribution

TEST YOUR UNDERSTANDING 11.4

I .
A quintile represents a 20010 portion of a country's population We can divide
. a population into 5 quintile , ranging from the lowest quintile

(the poorest 2090 Of the population ) to the highest quintile ( richest 20%1 . A decile represents a 10010 portion of a country 's population There are
.

10 decile5. ranging from the lowest I poorest 10901 to highest (richest 10%1 Income shares can be shown by either quintile
. or deciles If income
.

were completely equally distributed , everyone would receive exactly the same income . Every quintile would receive 20010 of income or every

decile would receive 10010 Of income In general , the higher the percentage share of income received by the poorest quintile Idea'll , and the
.

lower the percentage share received by the highest quintile 1decile the ,
more equal the distribution of income .

2 . la ) Vietnam because it has a Gini coefficient 0.38 thatis closer to 0 , the perfect income
.
equality coefficient

lb ) Pakistan , because its Gini coefficient of 0.31 is closer to 0 than Ghana 's Gini coefficient Of 0.43

3 . la ) The Gini coefficient is a summary measure of income inequality

(b) In a Lorenz diagram it is the ratio of the

, area between the diagonal and the Lorenz curve , to the total area under the diagonal

101 It has a value between 0 and I

(d) The closer the value is to 0 , the greater the income equality ; the closer the value is to 1 , the greater the income inequality

4 . Idi lb) The country with the Lorenz curve that is closest to the diagonal line
-

l l
representing perfect income equality has a more equal income distribution .

5 Thus Belarus has a more equal income distribution

.

3 SO
-
E perfect lol The country with a Gini coefficient thatis closer to o has a more equal
1- income equality
•
income distribution
E 60 I Belarus
5
b
E

E
- 40
Mexico
5 ru
f-
'

§
20
§
§

-
20 40 60 80 100

cumulative percentage of population

5 . Norway has a more equal income distribution because its Gini coefficient of 0.26 is closer to O l perfect income equality coefficient) when

compared to the UK 's Gini coefficient of 0.36 .

6 . in The Lorenz curve shifts closer to the diagonal line if the income redistribution increases income equality but shifts farther from the ,

diagonal line if the income redistribution decreases income equality

(b) An increase in income equality lowers the Gini coefficient closer to 0 While a decrease in income equality increases the Gini coefficient

closer to 1

POVERTY
Absolute t relative poverty

)
o poverty : an inability to satisfy minimal consumption needs
01 Beyond this general definition there are different perspectives
. on how best to define poverty

-
in one view , poverty refers to the inability of people to satisfy their basic in an absolute sense that is constant -1 unchanging

-
in another poverty is
. a relative concept that varies across societies t changes overtime

01 These a perspectives are reflected in 2 definitions of poverty : absolute poverty + relative poverty

01 Absolute poverty

measures of absolute poverty begin by defining level called

' '
-
a min income a poverty line

according poverty line is : that's considered minimally sufficient sustain in terms of food
→
to the OCED , a An income level family
''
to a .

housing clothing medical needs etc

"
. , , .

-
most countries have a national poverty line determined by govt authorities as an appropriate amount of income required to satisfy minimum

needs
-
in addition , there are internationally determined poverty lines such as 2 defined by the World Bank commonly used for developing
.

countries

→ living on less than $1.25 a day defined as extreme poverty

,

→ living on less than $2 a day , defined as moderate poverty

-
once a poverty line has been determined the amount of poverty is found by taking the percentage of
,
a population ' the number of indites

whose income falls below the poverty line

Extreme poverty : millions Extreme poverty : go of Moderate poverty : go -

Table 11.6 : data on extreme
of people living on HIS population living on less of population living on
Region than $1.25 a day than $1.25 a day less than $2.00 a day -1 Moderate poverty in

111 12 ) 131 141 151 161 171

1990 2005 Change 1990 2005 1990 zoos developing countries based

East Asia-Pacific 873.4 316.2 -

63.8 54.7 16.8 79.8 38.7 on a v extensive study by

lot which China) 1683.21 1207.71 f- 69.6 ) (60.21 115.91 184.6) 136.31 the World Bank

Eastern Europe +
Central Asia 9. I 17.3 90 I . 2.0 3.7 6.9 8.9 →
the study estimates

Latin America -1 Caribbean 42.9 46.1 -

7.5 98 8.4 19.7 16.6 that there are nearly

Middle East t North Africa 9.7 11.0 13.4 4.3 3.6 19.7 16.9 1.4 billion people in the

South Asia 579.2 595.6 2.8 51.7 40.3 82.7 73.9 world living in

lot which India ) 1435.51 1455.81 14.71 151.31 141.61 182.61 175.6) extreme poverty ( using

sub Saharan Africa

-

299 I .
390.6 30.6 57.9 51.2 76.2 73.0 the $1.25 a day poverty

Total 11813.4 1,376.7

-

24 . I 41.6 25.2 63.2 47.0 line

TABLE 11.6 Absolute poverty : extreme -1 moderate poverty

→ -12.6 billion people living in moderate poverty 1191 than $2 a day )

→ the total represents nearly half the fetal population of developing countries
→
columns 445 indicate that significant progress was made in reducing the 90 of ppl in extreme poverty which fell from about 42010in
,

1990 to 25% in 2005

→
columns 1+2 show that a significant decrease in terms of absolute numbers has also occurred

↳ however , progress has been highly uneven across geographical regions

↳ the greatest declines in extreme poverty occurred in the East Asia +

Pacific region

→ a region of concern is sub Saharan Africa , where half of the total population lives in extreme poverty 10014mm 51
-
t nearly 3-

quarters in moderate poverty ( column H

→
the country wi the largest number of extremely poor people is India , WI 42010 of its total population living on less than $1.25 a day

in addition to the World Bank 's poverty lines Many developing countries also have national poverty lines
-
-

→
in higher income developing countries these . are often set at a higher income level than those of the World Bank , so that a

larger percentage of people are considered poor by national standards

→ however , in lower income countries these are usually set . at a lower income level , so that a smaller percentage of people are

considered poor
→ this isn't surprising bo the World Bank 's definitions of extreme
. -1 moderate poverty are arbitrary being too low for higher
,

income countries 1- too high for lower income ones

-
more developed countries use national poverty lines to determine absolute poverty

→ ex : in the US , the poverty rate was 13.2% in 2007 , compared to 22.4010 in 1959 when poverty first began to be measured -111.1010 in ,

1973 , which was the lowest rate ever recorded

 01 Relative poverty
-
a concept that compares the income of individuals ' households in a society w/ median incomes

→ median : the number that's in the middle of a series of numbers

→
median income : income that lies in the middle of all income levels , so that half of income levels are greater -1 half are lower

→
median # average t mean

-
it's closely related to how equally I unequally society 's income is distributed among its total population

→ it income were equally distributed there would be , no relative poverty since

, no one would be poor relative to someone else
-
in general , the more unequal the distribution of income the greater is the .
degree of relative poverty

-
the idea behind relative poverty is that poverty is much more than being unable to afford a minimum of basic goods -1 services
→
even tho people may be able to buy basic necessities , they're still poor if they can't afford goods -1 services t a lifestyle that are typical

in a society
↳ the measurement of what is typical is based on a standard determined by the median income level

→ it people 's incomes fall far below this median level , they're considered poor

-
measurement of relative poverty involves specifying a particular percentage of median income below which there is poverty

→ often this is taken to be 50%

→ ex : say the median annual family income in an economy is $20000

↳ taking 50% Of this , we have $10000

↳ any family whose annual income falls below $10000 is considered poor 1in relative terms )
-

Table 11.7 : data on relative poverty in some economically country population living below 5006 Of median income 12000 20051 -

more developed countries Netherlands 4.9

01 poverty rates differ widely among social groups in a society Hungary 6.4

-
in general , older people children , single parent households
,
-
, Norway 7.1

women , t racial -1 ethnic groups that suffer discrimination Belgium g. I

face higher poverty rates than national averages German b 8.4

→
this applies to most countries in the world both more . United Kingdom 11.8

4 less developed Australia 12.2

01 Both absolute -1 relative poverty measures , on a national level t Canada 13.0

for particular social groups , are v useful to govt as guides to Greece 14.3

policies providing income support (ex : transfer payments) as well Ireland 16.2

as measures intended to combat poverty United States 17.3

possible causes of poverty TABLE 11.7 Relative poverty in economically more developed countries

01 LOW incomes

-
Obu cause of poverty , since by definition poverty is due to incomes that fall below some predefined level

-
causes of poverty
-
-
we're asking "
what are the factors that lead to low incomes
"

o ) unemployment
-
an unemployed in div receives no income but may receive some unemployment benefits
.

→ however , these are generally low relative to income received for work

→
in most countries are only provided for limited periods

it unemployment is long term Huohas w/ structural unemployment) , then an in div '

family is more likely to become poor
-

-
the risk of falling into poverty is far greater in single parent households where the parent
-
is unemployed lit both heads of a household

are unemployed over long periods

01 LOW levels of human capital

-
low levels of education -1 Skills translate into low incomes be there is generally a positive I direct ) relationship between skill 1 educational

attainment 1- income levels

-
poor levels of health also lead to low incomes bo an unhealthy person is likely to be less productive t therefore more poorly paid
-

unskilled people may rely on the min wage Which may be insufficient to support
. a family

01 LOW levels of capital I land ownership

whereas some people may inherit financial capital ( steaks -1 bonds ) / other forms of property (such as agricultural land 1 a home ) , which

gives them both an income advantage tsmthn to fall back on in case of unemployment , many others have no resources to rely on

other than their labor

 → which may not provide them wi an adequate income
-
ppl on low incomes often don't own a home -1 are forced to pay rent which may take up
,
a substantial portion of their income

-
low incomes may mean poor housing affecting health t , further lowering one 's income potential + may even lead to homelessness

01 Discrimination
-
some social groups (racial t ethnic groups, women I may face discrimination in the job market , w/ the result that then may receive lower

wages than others for the same work I may find greater difficulty finding work than the worker who doesn't face discrimination

0 ) Geography
-

some ppl may live in remote , isolated geographical regions , w/ limited possibilities for employment t WI limited possibilities to relocate (move)

to other more economically active regions ( due to poverty, aye , or lack of communication t lack of marketable skills)

-
this problem may be especially significant in some rural areas in less developed countries

01 Age
-
older people may receive pensions that 're barely enough to cover minimum needs
-
in many countries (particularly less developed ones ), older ppl may receive no pension at all if they 've been living 1- working in the

informal economy (outside the legally registered economy )

01 Limited social services (merit goods ,

-
ppl on low incomes must often rely heavily on social services (healthcare education housing ) provided I subsidised by
, , the govt , as their

incomes are insufficient to purchase these in the market

if social services are limited I reduced by the govt ppl on low incomes may be forced into poverty by having to purchase these in the
-
,

market

01 Poverty

-
poverty itself may become a cause of further poverty
-
it ppl don't have abbess to essential services such as healthcare , education 4- housing , a self -

perpetuating 04019 may be set into motion

where low incomes lead to low human capital 1- further to low incomes

→ part of the poverty cycle

possible consequences of poverty

01 LOW living standards

there is an obv consequence arising from low incomes

-

low living standards are associated w/ greater levels of psychological stress , alcoholism poor nutrition t poor levels of health
-
.

→
leading to poorer job income earning prospects
-

all t

01 Lack of access to healthcare -1 education

-
poverty results in a lower ability to access healthcare t education

leads to lower human capital formation lower productivity , , t lower incomes

→
possibly resulting in the self perpetuating cycle of poverty
-

01 Higher infant , child , t maternal mortality

-
the inability to access needed healthcare services as well as poor nutrition for mothers 1- children lead to large numbers of unnecessary
.

deaths among infants children , . -1 women due to pregnancy related causes-

01 Higher levels of preventable diseases

-
poor hygiene -1 nutrition make both children -1 adults more prone to illnesses

01 Social problems

-
these include higher crime rates, drug use family breakdowns + homelessness
,

01 Inability to realize one 's full potential

ppl in poverty are unable to realize their full potential

-
leads to a waste of human talent , t in addition to the personal costs may result in lower economic growth by adversely affecting the
.

economy 's p poll HAS curve

TEST YOUR UNDERSTANDING 11.5

la , measures of absolute poverty begin by defining minimum income level called
'

poverty line while measures of relative poverty

'
i . a a

compares the income of individuals ' households in a society with median incomes and involves specifying a particular percentage

of median income below which there is poverty .

lb ) No , because they each have individual definitions determinants , and approaches , te classifying poverty . The poverty line is not always equal

to the percentage of median income -

making absolute and relative poverty rates differ from one another .
 2 .
No, because the World Bank 's definitions of extreme and moderate poverty are arbitrary being too low for higher income, developed ,

countries Thus many developed countries use national poverty lines to determine absolute poverty , which are often set at
. , a higher income

level than those of the World Bank , so that a larger percentage of people are considered poor by national standards

3 . la ) causes of poverty include low incomes , unemployment low levels of human capital , ( low levels Of education skills and health translate
, , into

low incomes because an unskilled , unhealthy person is likely to be less productive and therefore more poorly paid ) low levels of capital I land
,

ownership (many people have no resources to rely on other than their labor which may not provide them with
, an adequate income ) ,

discrimination ( some social groups may face discrimination in the job market , with the result that then may receive lower wages than

others for the same work I may find greater difficulty finding work than the worker who doesn't face discrimination ) etc , .

lb) consequences of poverty include low living standards 110W living standards are associated with greater levels of psychological stress ,

alcoholism poor nutrition , and poor levels of health

.
-
all leading to poorer job and income earning prospects), table of abbess to healthcare
-

and education ( leads to lower human capital formation lower , productivity , and lower incomes ) , social problems ( higher crime rates, drug

use , family breakdowns and . homelessness ) higher levels of preventable diseases ( poor hygiene and nutrition make both children and adults
.

more prone to illnesses ) higher infant , child , and maternal mortality ( the inability to access needed healthcare services as well as poor
. ,

nutrition for mothers and children lead to large numbers of unnecessary deaths among infants children and women due . .
to pregnancy -

related causes ) etc ,

.

4 . If people don't have abbess to essential services such as healthcare , education , and housing , a self -

perpetuating 04019 may be set into motion

where low incomes lead to low human capital and further to low incomes Thus poverty in the present leads to lower human capital formation
.
, ,

lower productivity , and lower incomes -

causing further poverty in the future .

METHODS THAT CAN BE USED TO PROMOTE EQUITY (REDISTRIBUTE INCOME t OUTPUT )

o) poverty is a major global concern

-
it affects both more +
less developed countries

-
9 Outs around the world devise policies that attempt to reduce it

→
these policies promote equity interpreted as a greater degree of income equality lower degree of income inequality

Transfer payments

01 Payments made by the govt to indi vs specifically for the purpose of redistributing income away from certain groups x
towards other groups

they transfer income from those who work t pay taxes towards those who can 't work t need assistance
-

01 Groups of people who receive transfer payments : older ppl sick ppl . . v poor ppl , children of poor families unemployed ppl etc
,
. .

they're referred to as vulnerable groups

-

01 Include old age pensions , disability pensions unemployment benefits , war veterans ' benefits maternity benefits child allowances housing benefits
, , , .

for the poor student grants , etc

, .

01 Made possible by taxes collected by the govt

a portion of taxes paid to the govt by the working population is used to make transfer payments to vulnerable groups thereby achieving
-

some income redistribution

REAL WORLD FOCUS

The role of cash transfers

1 .
cash transfers ( both conditional and unconditional ) redistribute income by transferring the income from those who work and pay taxes towards

those who can't work and need financial support A portion of .

taxes paid to the government by the working population is used to make

transfer payments to vulnerable groups thereby achieving some income redistribution ,

100
2 . An increase in income equality lowers the Gini coefficient closer to o

§ 80
£
r perfect
t
-

- income →
E 60 equality
⇐
§ increased income \
£ 40 equality after
g
f
'
redistribution
) v

E
20
T y
§
s before
u
9 redistribution

0
20 40 60 80 100

cumulative percentage of population

 3 . Because conditional cash transfers are administratively more demanding -
requiring greater coordination of different agencies and monitoring

of compliance Unconditional cash transfers may be more effective when securing people 's abbess to food and other basic necessities that
.

are deemed to be merit goods and therefore tend to under provided and underconsumed in the free market These basic goods can be .

directly provided by the government (direct government provision in order to ensure that vulnerable groups have access to basic necessities ,

as these goods tend to be in short supply in the free market .

Subsidised provision or direct provision of merit goods

01 Merit goods : goods that're beneficial for consumers

-
often w/ positive consumption externalities

-
under provided by the market t under consumed

01 From the Pov of income redistribution the issue here concerns . low consumer incomes t poverty

-
it income distribution were left entirely to the market , 2 Of the most important merit goods that would be under consumed due to low

incomes t poverty would be education t healthcare

→
edu t healthcare are v important that they're often viewed as fundamental human rights

01 It's not enough for a outs just to provide edu t healthcare to supplement the insufficient quantities provided by the market , as they must also

ensure that these are affordable for V low income groups

-
this can be accomplished when govt offer edu Y healthcare services that 're free ( or nearly free) of charge to consumers

→
called '
subsidised provision
'
of the goods 1- services bc the govt offers them to consumers at a price ( often 01 that's far below the cost

of producing them

govt may also provide subsidies to private providers to increase supply

-
edu t healthcare can be made more affordable through transfer payments

01 other merit goods that may require subsidised 1 direct provision by the govt 1- that're esp important in developing countries that concentrate

large groups of ppl on v low income include infrastructure

-
includes numerous kinds of physical capital : clean water supplies, sanitation + sewerage

-
subSidi Sati on I direct govt provision makes these more affordable te poor ppl

or whatever the merit good , the govt uses tax revenues to provide the good in larger quantities than the market would 've provided +
additionally

to make it available at V low ( or O) prices

us The provision of subsidised merit goods offers some redistribution by making certain goods available to ppl on low incomes who wouldn't

otherwise be able to afford them

Government intervention in markets

o ) Govt s often intervene in markets in ways that change the distribution of income

or minimum wage legislation

-
by setting a legal min wage

govt raises the lowest permissible wage above the equilibrium market level

raises the wages of low income It usually unskilled ) workers

-

Food price ceilings

.

01

-
by setting Max prices for certain food products

→ prices below the market determined equilibrium price

-

-
90 Vts can make food more affordable for low -
income groups

01 price floors for farmers

-
by setting legal min prices for certain agricultural products

-
often involves govt purchases of the resulting surpluses
-
govt raise their prices above the equilibrium market price in order to support farmers incomes '

Taxation

o ) makes redistribution possible through transfer payments + subsidised provision of merit goods
-
since these are paid for out of tax revenues

01 However , overt above this important role , taxation is itself an important instrument for redistribution bo it can lower income inequalities by
,

taking more taxes from the rich than from the poor

TEST YOUR UNDERSTANDING 11.6

1 . Payments made by the government to individuals specifically for the purpose of redistributing income away from certain groups and towards other

groups They transfer income from those

.
who work and pay taxes towards those who can 't work and need assistance ( vulnerable groups ) They 're
.
 Made possible by taxes collected by the government as . a portion of taxes paid to the government by the working population is used to make

transfer payments to vulnerable groups thereby achieving some income redistribution

,

2 . For example : education and healthcare It's not enough for . governments just to provide education and healthcare to supplement the insufficient

quantities provided by the market , as they must also ensure that these are affordable for low income groups . This can be accomplished when

governments offer subsidized provision of education and healthcare

-
offering these services for free ( or nearly free) of charge to consumers .

Governments may also provide subsidies to private providers to increase supply The government uses tax revenues to provide the good in larger
.

quantities than the market would 've provided and additionally to make it available at low ( or O) prices The provision of subsidised merit .

goods offers some redistribution by making certain goods available to people on low incomes who wouldn't otherwise be able to afford them

THE ROLE OF TAXATION IN PROMOTING EQUITY (INCOME REDISTRIBUTION)

01 Taxes are the most important source of govt revenues t
provide the funds for many purposes
-
ex : public goods transfer payments
,
1- merit goods correcting externalities , providing subsidies , changing the allocation of resources changing
. ,

the distribution of income etc , .

Direct 1- indirect taxes

01 Direct taxes

-
taxes paid directly to the govt tax authorities by the taxpayer
-
types :

→ personal income taxes

↳ most important source of govt tax revenues in many countries les p more developed countries )

↳ involves taxes paid by households lindivs in households

↳ paid on all forms of income : wages , rental income, interest income t dividends l income from ownership of shares in a company

+ are income from profits )

→
corporate income taxes

↳ corporations : businesses firms that have formed a legal body that's legally separate from its owners

↳ taxes on the profits of corporations

→
wealth taxes

↳ taxes on the ownership of assets

↳ 2 most common : property taxes ( based on the value of property owned ) t inheritance taxes (based on the value of property

inherited )

-
the revenue collected from taxation is paid into the govt's budget t is used to finance a broad variety of govt expenditures

-
additional form of taxation : social insurance (social security) contributions 1payroll taxes

→ these taxes are paid by workers 1- their employers ( who pay on behalf Of their employees)
→
the revenues from these taxes aren't paid into the govt's budget , but rather into specific funds
↳ ex : pensions social insurance , t
, health care (in some countries)

earmarked taxation , bait's earmarked I identified to be spent only for specific purpose
'
'
→
called " a

01 Indirect taxes
-

taxes on spending on goods + services

-
called indirect bo while consumers are the ultimate players of
, a party all Of these taxes , they pay indirectly through the suppliers of the

good 1 service purchased

→
suppliers : producers retailers , sellers .

-
types :

→ general expenditure taxes / sales taxes

↳ taxes on spending bales of goods + services

↳ in the US (where they 're known as '

sales taxes 't , they 're a fixed 010 of the retail price of goods t services

the corresponding tax used in the EU many other countries around the world is the
'
↳ t value added tax NAT)
'

↳ VAT differs from a sales tax in that it's a tax paid on the value added by each producer in the production process

value added firm 's output minus the value of its inputs
' '
↳ : the value of a

↳ it there is more than a stage in the production process , the firm pays VAT for each stage in which value is added

↳ thus , the total VAT paid by the firm is the sum of the value added taxes paid at each stage in the production process

↳ when the good 1 Service reaches the market place , its price includes the VAT that has been paid by all the firms involved in its

production
 ↳ each country in the EU has its own particular VAT rates

↳ both sales taxes in the US t VAT in the EU t elsewhere are paid fully by the consumer but indirectly via the retailers ' firms that
,

produced the good 1 service

↳ in practice, many countries that use the VAT as well as States in the US exempt I exclude certain 900dg t services from payment of

taxes the grounds of equity

'
on

↳ ex : goods -1 Services like food, pharmaceuticals , rents on housing , -1 Others

↳ in some cases , there may be different types of goods 1- services on the grounds of equity

→ excise taxes

↳ taxes paid on specific goods + services such , as cigarettes -1 petrol (gasoline)

↳ payment is split between the consumer -1 the firm producing the good Her vice wi the relative size determined by PED -1 PES

↳ unlike expenditures sales taxes which're ultimately paid by the consumer

→
customs duties Ita rifts

↳ a type of tax applied on imports of foreign goods into a country

↳ reasons why govt levy tariffs :

⑦ to keep imports out of the country by making them more expensive to consumers

② to raise tax revenues

whereas in developed countries tariff revenues are small proportion of tax revenues lat little as I -3901 , in many less developed
-

↳ a v

countries , they're sometimes a major proportion (in some oases accounting to more than 50010 Of total tax revenues )

01 Tax systems vary enormously from country to country around the world + there are no 2 Countries that have the same tax system
-
while most countries have a mix of direct 4 indirect taxes , they vary w/ regard to the degree of reliance on each of these , as well as on

the particular mix of types of taxes within each group

addition , they enormously w/ respect to tax rates many other technical details
-
in can u t

understanding the principles of proportional progressive , . t regressive taxation

01 Taxes can be defined as being proportional , progressive 1 regressive according to the relationship between income t the fraction of income paid as

tax

01 Tax rate : the fraction of income paid as tax lolol

01 proportional taxation : as income increases, the fraction of income paid as taxes remains constant

-
there's a constant tax rate

o ) progressive taxation : as income increases , the fraction of income paid as taxes increases

-
there is an increasing tax rate

01 Regressive taxation : as income increases, the fraction of income paid as taxes decrease

-
there's a decreasing tax rate

proportional taxation progressive taxation Regressive taxation 01 Table 11.8

TAX rate TAX rate -

shows 3 possible income
Amount of
AMIT,f¥
Amount of amount of "
1h00 met lprtocfxrfiaontfn , tax # Imildly
progressive)
tax €
(strongly
progressive)
+a×€
Tax rate
levels -14 hypothetical
,

10000 1590 1500 15010 1500 1590 1500 15010 1500 taxation systems w/

20000 15% 3000 20% 4000 25% 5000 1090 2000 differing tax rates

30000 15% 4500 25% 7500 40% 12000 506 1500

TABLE 11.8 Progressive , proportional t regressive taxation

-
in each case the amount Of tax is calculated by multiplying the amount of income times the corresponding tax rate
,

in the case of proportional taxation the tax rate remains constant (at 15%1 for all income levels
,

→ the amount of tax paid increases in the same proportion as income

-
case of progressive taxation : in both the tax rate increases as income increases
.

→ the amount of tax paid increases more than in proportion to income

first ex : mildly progressive

'
→ '

↳ the tax rate increases slowly as income increases

'
in the strongly progressive ex the tax rate increases much more rapidly
→ '
.

01 Amount of tax paid in the cases of proportional VS mildly progressive vs strongly progressive taxation
-
in all 3 cases, as income increases , the amount of tax paid becomes larger
-
which of the 3 is the most ' fair ' ?
 → all 3 satisfy the principle of vertical equity , according to which those w/ greater income should pay a larger tax than those w ' less

income

→
this is impossible to answer using economic reasoning bo fairness is a normative question that depends on value judgements

o ) The more progressive a tax system , the more equal 1 less unequal the after -
tax distribution of income becomes

Table 11.8 in all 3 taxation systems , the taxpayer faces the same tax rate t the same amount of tax for income of €10000
-
:

→
however , as income increases to €20000 + then to €30000 , the amount of tax paid increases more rapidly in the mildly progressive

system t even more rapidly in the strongly progressive system

→
by shrinking the difference between high-1 low income levels progressive taxation achieves , a more equal income distribution than

proportional taxation

↳ the more progressive the tax system , the greater the income equality achieved

01 In regressive taxation , the tax rate decreases as income increases

-
the proportion of income paid in tax falls as income rises

-
regressive taxation makes income distribution less canal

Achieving progressivity through proportional taxation

01 personal income taxes in most countries are progressive , though in some countries they're proportional ( they're called '
flat taxes l 'flat rate
'

taxes
'

ol when personal income taxes are proportional they

, can achieve some progressivity by introducing exclusions

exclusion : an amount of income that is excluded from the tax

-

01 Ex : assume a hypothetical tax system w/ an exclusion of £10000

-
this means that dm income up to this amount isn't taxed at all

suppose that all incomes above this amount are taxed at 1506 I proportional taxation )
-

Income £ Taxable income £ Amount of tax Ek 15010 Of taxable income Effective tax rate -
Table 11.9 : the addition of an

10000 O O O exclusion to a proportional tax

15000 5000 750 5% System makes it progressive

20000 10000 1500 7.5% -

taxable income : income -
exclusion

25000 15000 2250 9% ↳ the amount Of tax is calculated

TABLE 11.9 A proportional income tax becomes progressive when there are income exclusions as 15% of taxable income
-
the effective tax rate : divide the amount of tax by the amount of income

→
since it's increasing, the proportional tax system has become progressive

01 Since all proportional income tax systems , where they 've been implemented , contain exclusions , it follows that virtually all personal income tax

systems around the world are in effect progressive , though they vary v much in how progressive they are

other types of taxes : why indirect taxes are regressive

01 Although progressive , proportional t regressive taxation are defined relative to income , they don't apply just to income taxes , whether direct indirect

-
this is bo taxes are paid out of income toan therefore be compared w/ income

01 To see whether a tax is progressive , proportional / regressive , it can be calculated as a fraction of the income out of which it 's paid

corporate income taxes are usually proportional

-

-
social insurance contributions are also usually proportional

→
for both workers + their employers

-
indirect taxes of all types are regressive

01 Ex why indirect taxes are regressive : consider a indi us , xx x xy

-
each one buys a car for $10000 Into tax) on which there's an indirect tax IVATI Sales tax l tariff) Of 10010 , amounting to $1000

-
in div Xb has an annual income of $10000 t indi v XX has an annual income of $20000

-
the $1000 Of tax is 10010 Ot in div Xb 's income t it 's 5010 Of in div xx 's income

as income increases from $10000 to $20000 , the fraction of income paid on the indirect tax decreases from 1090 to 5010

→
this is the definition of regressive taxation

-
since all indirect taxes work on the same principle , we can conclude that indirect taxes are regressive

→ indirect taxes are inconsistent wi the objective of a more equal distribution of income

01 In the real world , some goods -1 services considered to be necessities ( ex : food t meds ) may be exempted from general expenditure on sales taxes

-
this makes indirect taxes somewhat less regressive , though they remain regressive overall

01 Virtually all countries around the world have tax systems consisting of many different types of taxes
 -
whether the overall tax system of a country is more progressive , regressive depends on the mix of taxes + tax rates t their relative importance

as sources of govt revenue

ex : suppose a country has a system of progressive income taxes as well as a variety of indirect taxes , which are regressive
-

→ it most tax revenues come from indirect taxes , it is likely that the overall tax system tends to be regressive

→ it most tax revenues come from progressive income taxes , then it's likely that the tax system is more progressive

01 The more progressive a tax system , the more equal is the after tax distribution of income compared to the pre tax distribution of income
-
-

-
regressive tax systems tend to make the distribution of tax less equal

TEST YOUR UNDERSTANDING 11.7

i .
Direct taxes are taxes paid directly to the government and tax authorities by the taxpayer Examples include personal income taxes , corporate
.

income taxes , wealth taxes , payroll taxes Indirect taxes

.
are taxes on spending on goods and services and are called ' indirect because while '

consumers are the ultimate players of a party all Of these taxes , they pay indirectly through the suppliers of the 900 d l service purchased Examples
.

include sales taxes excise taxes , tariffs , etc

, .

2 .
proportional taxation has a constant tax rate -
meaning as income increases, the fraction of income paid as taxes remains constant For .

example , proportional taxation will cause the tax rate to remain constant at 10% for all income levels Progressive taxation has .
an

increasing tax rate -

meaning as income increases the fraction of income paid as taxes increases For example, progressive taxation will cause
, .

the tax rate to increase from 1090 to 20010 When the income of the taxpayer increases from €10000 to €20000 Regressive taxation has a .

decreasing tax rate -

meaning as income increases, the fraction of income paid as taxes decrease For example, regressive taxation will cause .

the tax rate to fall from 10% to 50 to when the taxpayer 's income increases from €10000 to €20 000 .

3 .
Income taxes can redistribute income away from certain groups and towards other groups They transfer income from those who work and pay .

taxes towards those who can 't work and need assistance ( vulnerable groups ) They can be used to lower income inequalities if the tax
.

system is progressive The more progressive

. a tax system , the more equal is the after tax distribution of income compared to the pre tax distribution
-
-

of income When . personal income taxes are proportional they

, can achieve some progressivity by introducing exclusions I an amount of income

that is excluded from the tax ) .

4 . lol ) They're regressive because the fixed tax causes the tax rate 1 the fraction of income paid as taxes to decrease as income increases .

(b) They're basic goods that are deemed as necessities Thus the government
.
, must ensure that vulnerable or low -
income groups have

access to them and that they're at an affordable price -

thereby excluding them from taxation It's also unethical and inhumane
.

to tax goods deemed to be necessary for survival , as it violates human rights laws The goods may also have positive externalities that
.

create spillover benefits to society as a whole .

lol This makes indirect taxes somewhat less regressive , though they remain regressive overall

5 . The use of taxes to redistribute income and questions regarding its efficiency is a normative issue that depends on value judgements and

the definition of equity , equality , fairness and where to draw line His very . subjective because fairness is a normative question that depend

on personal opinions and biases .

6 . I at The increase in income equality after the progressive taxation will cause the Lorenz curve to shift closer to the diagonal line

that represents perfect income equality -

lowering the Gini coefficient closer to o

lb) The decrease in income equality due to the overall regressive tax system will cause the Lorenz curve to shift farther from the perfect

income equality diagonal line -

increasing the Gini coefficient closer to 1

101 Income equality decreases due to the reduction in transfer payments -

shifting the Lorenz curve farther from the diagonal line and

increasing the Gini coefficient closer to 1

Id ) income equality may increase -

potentially shifting the Lorenz curve closer to the diagonal line and decreasing the Gini coefficient

closer to 0

calculations using marginal t average tax rates

01 Average tax rates

tax paid divided by total income

-

expressed as a Ole
-

-
all the tax rates in Table 11.8 are avg tax rates
-
can be calculated for any type of tax
-
ex : suppose a fam w/ an annual income of €50000 Spends €40000 on goods t services , which includes an indirect tax ( a VAT Halls tax) of

1890

→
therefore , 1890 Of the €40000 represents payments on the indirect tax

→ this fam must pay a total amount of E 40000×0.18--87200 on indirect taxes

 → as a 010 Of income , this amount of tax represents =
€0.144 or 14.490 of income

→
therefore , the avg indirect tax rate for this fam is 14.4010

-
suppose we have info on a family's avg income tax rate + its avg indirect tax rate , t we would like to find its total avg tax rate Hetch taxes

paid direct + indirect

, , as a % of income)

→
to calculate this , we add the 2 avg tax rates to find the sum

→
it, in the ex above , the same fam has an avg income tax rate of 22.7% , total avg tax rate
-
-
22.7%414.40/0=37 I % .

→
this means that 37.1% Of the total income of €50000 is paid as taxes , including both direct t indirect

01 Marginal tax rates

tax rate paid on additional income

-
in the real world , income taxes in a progressive tax system are calculated using successive layers of income + applying a different tax rate

to each layer

→
layers of income are called tax brackets + the corresponding tax rates are called ' marginal tax rates '
-
Table 11.10
11) 12)
→ column 1 Shows tax brackets (the layers of income) in a hypothetical economy Annual income lolol Marginal tax rate 1010)

→
column a shows the marginal tax rate that applies to each bracket O -
10000 O

-
ex :
suppose we want to calculate the amount of income tax paid on an annual income of 10001 25000
-
9

$59000 25001 -
55000 22

→ the total tax paid will be 0 in the first $10000 of this income ; 9010 on income between 55001 -
115000 40

$10001 t $25000 ; 22% on income between $25001 t $55000 ; t finally 40% on income between 115001 or more 55

$5500145159000 TABLE 11.10 calculating marginal t avg tax rates

→ we calculate the total tax paid as follows :

10×151000014/0.09×1515000) t 10.22×15300001 t
10.40×1540001--0-115135041566004151600=159550
→ what is the avg tax rate for the income of $59000

↳ total tax paid ÷ income expressed as a %

$9550
↳ - " O' 162 I 16.2%
$59000

-
Table 11.10

→
total income tax paid on income of $175000 :

( Ox $100001 -110.09×15150001-110.22×1530000) -110.40×1560000 ) -110.55×15600001=041513501-1566004152400041533000--1564950

→ avg tax rate on income of $175000 :

$64950

371=37.1%01
' O'
$175700

Comparing the avg tax rate for income of $59000116.20101 WI the avg tax rate Of income of $175000137.10101 , we see that the higher income has

a higher avg tax rate , just as expected since this is , a progressive tax system

TEST YOUR UNDERSTANDING 11.8

1 .
Idl $0

lb) 10×15100001410.09×1557001=15513

lol 10×15100001410.09×15150007410.22×1560001=041513504151320--152670

Id ) 10×15100001410.09×15150001 -110.22×15220001=01-1513504154840--156190

Ill 10×151000011-10.09×1515000 ) -110.22×15300001410.40×15600001410.55×1550001=01-1513501-156600 -115240001-152750=1534700

2 lat $513 $34700

$$÷oo
$2670 $6190
'

⑨ O ⑨ $157002 0.0327--3.2790 ⑥ $3,040 O 0861--8.6190 ⑨ $yyooo- 0.132--13.290 ⑨ $,zoooo_ 0.289=28.990

- - -
-
- - -
'
= -

(b) It increases as income increases because it's a progressive tax system

101 ⑨ 090 ④ 9010 ⑥ 22% ⑨ 2290 ⑨ 5590

3 . la) 0.20×1525000=155000

Ibl $5000

153-1000=0161--16.1%4
. 8.610/01-16.10/0=24.7106
EQUITY IN INCOME DISTRIBUTION VS EFFICIENCY : AN EVALUATION
01 While most economists -1 others would agree that a certain amount of income redistribution is necessary in any society, there are intense

disagreements over how much is appropriate -1 how this should be best achieved to avoid possible negative consequences on efficiency

Taxes and allocate've efficiency

01 Taxes affect the allocation of resources + make it different from what would 've been achieved in a free market economy w/ no govt

intervention

01 When taxes are used to correct market failures , they're intended to move the economy towards a more efficient allocation of resources

-
however, of the v large variety of taxes levied by govt , most aren't implemented w/ the intention of correcting market failures

-
most economists argue that a variety of taxes worsen the allocation of resources -
causing at locative in efficiency
→ the reason is that taxes change the after-tax relative prices of goods 1- services 1- factors of production

→
since resource allocation in the market system is guided by prices that act as signals 4 incentives , t since prices in the absence

of market failures give rise to the best allocation of resources , it follows that some taxes cause all ooativo inefficiency

01 Income taxes , equity t efficiency in resource markets

-
a relatively high degree of equality in income distribution can't be achieved w/o a highly progressive tax system , which would involve

taxing significant amounts of income away from high income earners

-

→
according to a perspective I supply side economics ) , high income taxes act as
-
a disincentive to work as well as to save , particularly among

high income earners who would be taxed more heavily

-

-
income taxes reduce after tax income - t as a result , reduce the quantity of labor offered in the market t also reduce savings

→ lower savings has a negative effect on investment t therefore on the production of new capital goods

→
therefore , in this perspective, high income taxes affect the price mechanism in the resource markets of labor to a pital -
causing at locative

inefficiency

→
lower quantities of labor toa pit at in turn translate into lower rates of growth for the economy

* this argument is usually made in terms of the disincentive effects of high marginal tax rate

01 Indirect taxes, equity -1 efficiency to product market

general expenditure taxes , sales taxes are commonly used around the world on the grounds that when a tax is levied on all goods t services
-

at the same Mo , then there's no change in relative prices -1 therefore no impact on resource allocation , bo the signals -1 incentives that prices

convey remain the same

→
therefore, general expenditure taxes are consistent w/ the goal of all 00am've efficiency

→ however , these taxes are regressive , thus leading to a more unequal distribution of income

-
in practice , we've seen different VAT rates , sales taxes are sometimes applied to different categories of goods -1 Services , while some goods -1

services are exempted from taxes altogether

→
objective : to exclude certain necessities from taxation t make them more affordable to low income earners
-

→ such exemptions are consistent w/ the principle of increasing equity in the distribution of income

→ however, at the same time , the allocation of resources is affected boot relative price changes in product markets

-
in the case of excise taxes lindirect taxes imposed on specific goods ) , the outcome again affects the allocation of resources by changing

relative prices thence the signals t incentives they convey

→
excise taxes intended to correct negative externalities have the effect of improving efficiency in the allocation of resources , though

they're regressive t make income distribution more unequal

→
it excise taxes aren't imposed in order to correct negative externalities they worsen both the allocation of resources ,
t the distribution

of income

01 Countering the idea of a trade off between income equality

-
-1 efficiency

as a counter argument to the notion that progressive income taxes negatively affect resource allocation some economists note that this
- -
,

has mainly theoretical merit , bo the empirical evidence suggests that tax increases 1 decreases don't have a v significant effect on labor

supplied , saving investment -1 Capital thence

, , on output produced by an economy

→
therefore , in practice , while there may be some negative effects on resource allocation , these may not be important enough to

significantly reduce economic growth

-
a separate argument suggesting a possible positive influence of progressive income taxes on economic growth is that these not to reduce

short term fluctuations of economic activity the business cycle)

-

→ in fact , the greater the progressivity of income taxes, the greater the potential contribution to making recessions t
inflation less severe

↳ a less severe recession means that fewer resources are wasted due to unemployment -1 hence a smaller reduction in output
 ↳ a less severe inflation means the negative effects of inflation on investment will be less pronounced

→
therefore , progressive income taxes may have positive effects on economic performance by making business cycle fluctuations milder

-
some economists argue that policies in pursuit of both equality t efficiency may actually complement each other
→
high income inequalities often mean that some groups in a population live in poverty + the poor have low levels of education t

healthcare , fewer opportunities for work , t can become discouraged from trying to find jobs t
improve their standard Of living
→ unemployment results in lower output produced

→ greater income equality could raise these people out of their poverty , provide them w/ access to education -1 healthcare , thus

increasing human capital , increase their opportunities to find employment ,

t therefore contribute to increasing output produced t

economic growth

↳ in this case, greater equality would permit a more efficient use of resources

Transfer payments and al locative efficiency

on some economists argue that transfer payments may have undesirable consequences for efficiency

supporters of supply side economic policies argue that certain transfer payments such as unemployment benefits /other benefits for the poor
-
-
, ,

are disincentives for unemployed t poor people to accept work that would shorten their period of unemployment
→
the result is an extra burden on the govt in terms of unemployment t other benefits , as well as higher unemployment rates for the

economy , causing output to be lower than it could be

01 As a counter argument Others note that while it's like lb that some people may take advantage of
-

.
a system of transfer payments for their

own personal gain at the expense of the social interest , on the whole such a system is needed to offer protection to vulnerable groups in need

who might otherwise face extreme poverty + destitution

01 In addition transfer payments like unemployment benefits act automatically to reduce the effects of short term fluctuations in economic
,
-

activity thus lessening the severity of recession I inflation

,

-
the effects are similar to those of progressive taxation

Government expenditures on merit goods and al locative efficiency

01 The subSidi Sati on I direct provision of merit goods lean , healthcare t infrastructure , including sanitation clean water
, supplies sewerage etc )
, ,
.

is a burden on the govt budget t always entails opoosts in terms of foregone alternatives

01 Beyond that , it's likely that govt expenditure on merit goods is consistent wi the achievement of all ooative efficiency

-
merit goods are under provided by the market mainly on account of their positive consumption externalities

-
the purpose of govt intervention in this case is to correct the problem of under allocation of resources through policies intended to increase

the demand I supply of the goods in question

Government intervention in markets and al locative efficiency

01 Govt intervention in markets intended to produce a more equitable distribution of income (min wage legislation , food price ceilings -1 price floors

for farmers ) clearly conflicts w/ resource allocation objectives

-
these types of intervention lead to al locative efficiency + a loss of social surplus

TEST YOUR UNDERSTANDING 11.9

I . Taxes affect the allocation of resources and make it different from what would 've been achieved in a tree market economy with no

government intervention When taxes .

are used to correct market failures they're intended to
, move the economy towards a more efficient

allocation of resources Most economists argue that

.
a variety of taxes worsen the allocation of resources -
causing at locative inefficiency -

because taxes change the after-tax relative prices of goods and services and factors of production Since resource allocation in the market .

system is guided by prices that act as signals and incentives and since prices in the absence of market failures give rise to the best
,

allocation of resources , it follows that some taxes cause all ooativo inefficiency High income taxes affect the price mechanism in the resource .

markets of labor and capital -

causing at locative inefficiency by reducing after tax income which reduces the quantity of labor offered in the
-

market and reduces savings ; lower savings has a negative effect on investment and therefore on the production of new capital goods .

G e nerd , exPe nd ith re taxes , sales taxes lindirect) levied on all goods and services at the same percentage has no impact on resource allocation ,

because the signals and incentives that prices convey remain the same , since there's no change in relative prices Hence , they're consistent
.

with the 9001 Of all 009 live efficiency However , if there 're exemptions (to exclude certain necessities from taxation and make them more affordable
.

to low income earners ) the allocation of resources will be affected due to relative price changes in product markets in the case of excise taxes
-
.
,

Iindirect taxes imposed on specific goods ) , the outcome again affects the allocation of resources by changing relative prices and hence the

signals and incentives they convey Excise . taxes intended to correct negative externalities have the effect of improving efficiency in the

allocation of resources , while excise taxes which aren't imposed in order to correct negative externalities worsen the allocation of resources

2 .
They contribute significantly towards government revenue without additional burdens on government budget, as they 're easier to implement
 than progressive tax systems ( no or less additional costs of monitoring )

3 . la, Greater income equality could raise people out of their poverty , provide them with access to education and healthcare , thus increasing

human capital increase their opportunities to find employment and therefore contribute to increasing output produced
, , and economic

growth . It also incentives workers to work harder -

increasing productive efficiency Hence in this case, greater equality would permit
. , a

more efficient use of resources

lbs income redistribution aimed at achieving greater equality is a form of government intervention that may worsen the allocation of

resources -
potentially decreasing the amount of output produced and hindering the economy from producing the greatest possible

amount of output with its resources Economist Arthur Okun argued that government intervention to redistribute income results in
.

changes in work effort 1 People don't work as hard I, in changes in investment and savings 1 people save and invest less ) , and in changes

in attitudes (people have less of an incentive to train and get new skills to become more productive ) .