1

2
3
4
5
6

Chapter 20 - Income Inequality and Poverty

In the absence of discrimination, the income distribution in a market economy may not be equitable or
otherwise desirable
Causes for rise in income inequality:
1. Increases in international trade with low wage countries - reduce demand for unskilled labor
2. Changes in technology - raise demand for skilled labor
Quintile Ratio - Income received by the richest quintile of the population divided by the income of the
poorest quintile (quintile ratio/degree of inequality varies around world
Income Inequality Around World - Sweden and Pakistan have most equal income distribution while South
Africa and Brazil have least equal distribution (US is 5th least equal country)
Poverty rate - percentage of the population whose family income falls below an absolute level called the
poverty line
Poverty line - an absolute level of income set by the federal government for each family size below which a
family is deemed to be in poverty. The poverty line is set by the federal government at roughly three times
the cost of providing an adequate diet. This line depends on family size and is adjusted every year to account
for changes in the level of prices.
Life Cycle - the regular pattern of income variation over a person's life
Transitory change - need not affect standard of living
Permanent income - a person's normal income
In-Kind Transfers - Transfers to the poor given in the form of goods and services rather than cash

Problems in measuring inequality:

- incomplete picture of inequality
- household annual income
- doesn't account for in-kind transfers
- normal life cycle pattern
- transitory vs. permanent income
1
2
3
4
5
6

Data on income distribution and poverty rate paint incomplete picture of inequality since based on
household incomes and we care about the standard of living
1 . Measurement doesn't account for in-kind transfers - transfers to the poor in forms of goods/services
2. Normal life cycle pattern
Life cycle: regular pattern of income variation over a person's life
Causes inequality in the distribution of annual income but may not represent true inequality in living
standards - because people can borrow and save standard of living depends more on lifetime income than
yearly income
3. Transitory vs. Permanent Income (Keçici və Daimi Gəlir)
Transitory changes in income due to temporary variation do not necessarily affect standard of living - can
borrow/save to smooth out variation
Instead a family's ability to buy goods and services depends largely on its permanent income

Economic Mobility
- many people move among income class
- some reflects transitory variation in income (bəziləri gəlirdə keçici dəyişkənliyi əks etdirir)
- some reflects more persistent changes in income (bəziləri gəlirdə daha davamlı dəyişiklikləri əks etdirir)
- many of those below the poverty line are there only temporarily - persistent poverty less common
(yoxsulluq həddindən aşağı olanların çoxu müvəqqəti olaraq oradadır - davamlı yoxsulluq daha az
yaygındır)

Three Political Philosophies of Redistributing Income:

1. Utilitarianism
2. Liberalism
3. Libertarianism
1
2
3
4
5
6

1. Utilitarianism - The political philosophy according to which government should choose policies to
maximize total utility of everyone in society. The utilitarian case for redistributing income is based on the
assumption of diminishing marginal utility.
Utility - A measure of happiness or satisfaction
Utilitarianism Income Redistribution - Redistributing income from rich to poor increases the utility of the
poor more than it decreases the utility of the rich (maximizing sum of everyone/society's total utility)
Utilitarian case for redistributing income:
- Based on diminishing marginal utility
- One extra dollar of income
More utility to poor person than to rich person
- Government: redistribution of income
From rich to poor to increase total utility
Balance the gains from greater equality against the losses from distorted incentives
Maximize total utility: stops short of making society fully egalitarian
Diminishing Marginal Utility of Income - The Utilitarian argument for income redistribution that
maximizes utility of society as a whole; DMU says that as income increases utility flattens/reaches
maximum - thus taking a dollar from the rich reduces their utility by less than the gain in utility generated by
giving a dollar to the poor.

2. Liberalism - the political philosophy according to which the government should choose policies deemed
just as evaluated by an impartial observer under the veil of ignorance (hökumətin cəhalət pərdəsi altında
qərəzsiz bir müşahidəçi tərəfindən qiymətləndirilən siyasətləri seçməli olduğu siyasi fəlsəfə)
Liberalism call for - more redistribution (though still not complete equalization of incomes)
"Veil of Ignorance" John Rawls - Hypothetical situation in which individual decides which income
distribution system would be most fair without knowing their place in society (rich/poor )
Liberalism Income Redistribution - In designing public policy should aim to raise the welfare of worst-off
person in society - maximize the minimum utility (increase welfare of least fortunate)
Maximin criterion - The claim that the government should aim to maximize the well-being of the worst-off
person in society (Hökumətin cəmiyyətdəki ən pis vəziyyətdə olan insanın rifahını maksimum dərəcədə
artırmağı hədəfləməsi iddiası)
1
2
3
4
5
6

Social Insurance - Government policy aimed at protecting people against the risk of adverse events (ie.
being poor)

3. Libertarianism - The political philosophy according to which government should punish crimes and
enforce voluntary agreements but not redistribute income. Argue that society itself earns no income only
individual members of society earn income
Libertarianism Income Redistribution:
- Government should not redistribute income
- Doesn't evaluate economic outcomes -evaluates the process by which these outcomes arise (İqtisadi
nəticələri qiymətləndirmir - bu nəticələrin yaranma prosesini qiymətləndirir)
- As long as the process determining the distribution of income is just the resulting distribution is fair, no
matter how unequal
- Equality of opportunities is more important than equality of incomes (Gəlirlərin bərabərliyindən daha çox
imkanların bərabərliyi vacibdir)
Rank utilitarianism, liberalism, and libertarianism in sequence from the political philosophy that would
redistribute income the greatest to the one that would redistribute the least (Utilitarizm, liberalizm və
libertarizmi gəlirləri ən çox bölüşdürən siyasi fəlsəfədən ən az yenidən bölüşdürənə qədər ardıcıllıqla
sıralayın) - Liberalism, Utilitarianism, Libertarianism

Policies to Reduce Poverty:

1. Minimum Wage Laws
2. Welfare
3. Negative income tax
4. In-kind transfers

1. Minimum Wage Laws

Arguments for minimum-wage laws
- Helps the poor without any cost to government
- Little impact on employment if demand for
1
2
3
4
5
6

unskilled labor is relatively inelastic.

Arguments against minimum-wage laws
- In the long run, demand for unskilled labor is likely elastic, so minimum wage causes substantial
unemployment among the unskilled. (Uzunmüddətli perspektivdə qeyri-ixtisaslı əməyə tələb çox güman
elastikdir, ona görə də minimum əmək haqqı ixtisassızlar arasında əhəmiyyətli işsizliyə səbəb olur)
- Those helped by minimum wage are more likely to be teens from middle-income families than low-income
adult workers.

2. Welfare - Government programs that supplement the incomes of the needy

Examples: TANF (Temporary Assistance for Needy Families): assists families with children and no adult
able to support family
SSI (Supplemental Security Income): Assists poor who are sick and disabled
Criticism of Welfare Programs - such programs create incentives to become or remain needy; welfare
contributed to the rise of the single-parent family. (ie. break up families or illegitimate births)
Proponents of the welfare programs - inflation-adjusted welfare benefits fell as single-parent families
increased. (tək valideynli ailələr artdıqca inflyasiyaya uyğunlaşdırılmış sosial müavinətlər azaldı)

3. Negative Income Tax - Collects revenue from high-income households and gives subsidies to low-
income households
Poor families receive financial assistance without having to demonstrate their need; subsidizes lazy people
as well so certain taxes apply only to working poor (Ex. EITC: Earned Income Tax Credit)

4. In-Kind Transfers - Provides poor people directly with money/services need to raise living standard
instead of money. Examples: SNAP (Supplemental Nutrition Assistance Program), Medicaid Healthcare
Critics say poor should just get cash since gov can't know what goods/services people need

Anti-Poverty Programs and Work Incentives

Policies aimed at helping poor can have unintended effect of discouraging poor to escape poverty on their
own - very high effective marginal tax rate discourage poor from working and create culture of poverty
1
2
3
4
5
6

Solution: Reduce benefits more gradually as incomes rise

Other ways to reduce the work disincentive of antipoverty programs
Workfare - Require any person collecting benefits to accept a government-provided job
Provide benefits for only a limited period of time

1. In the United States today, the poorest fifth of the population earns about _____ percent of all
income, while the richest fifth earns about _____ percent.
a. 2, 70
b)) 4, 50
c. 6, 35
d. 8, 25

2. When income inequality is compared across nations, one finds that the United States is
a. the most equal nation in the world.
b. more equal than most nations but not the most equal.
c)) less equal than most nations but not the least equal.
d. the least equal nation in the world.

3. A utilitarian believes that the redistribution of income from the rich to the poor is worthwhile as
long as
a. the worst-off members of society benefit from it.
b. those contributing to the system are in favor of it.
c. each person’s income, after taxes and transfers, reflects his marginal product.
d)) the distortionary effect on work incentives is not too large. ??
1
2
3
4
5
6

4. Rawls’s thought experiment of the “original position” behind the “veil of ignorance” is meant to
draw attention to the fact that
a. most of the poor do not know how to find better jobs and escape poverty.
b)) the station of life each of us was born into is largely a matter of luck.
c. the rich have so much money that they don’t know how to spend it all.
d. outcomes are efficient only if everyone begins with equal opportunity.

5. A negative income tax is a policy under which

a)) individuals with low income get transfers from the government.
b. the government raises tax revenue without distorting incentives.
c. everyone pays less than under a conventional income tax.
d. some taxpayers are on the wrong side of the Laffer curve.

6. If the benefits from an antipoverty program are phased out as an individual’s income increases,
then the program will
a. encourage greater work effort from the poor.
b. lead to an excess supply of labor among unskilled workers.
c)) increase the effective marginal tax rate that the poor face.
d. cost the government more than a program that benefits everyone.