Similarly, money represents originally, in accordance with the idea of money: 1) private property for private property; 2) society for private property; 3) private property for society.
But Christ is alienated God and alienated man. God has value only insofar as he represents Christ, and man has value only insofar as he represents Christ. It is the same with money.”
Income Distribution and Poverty (Part A)
by
Charles Lamson
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What role should government play in the economy? Thus far, we have focused only on actions the government might be called on to take to improve market efficiency. Even if we achieved markets that are perfectly efficient, would the result be fair? We now turn to the question of equity, or fairness.
Somehow, the goods and services produced in every society get distributed among its citizens. Some citizens end up with a lot; others end up without enough to eat and live in shacks. The next several posts focus on distribution. Why do some people get more than others? What are the sources of inequality? Should the government change the distribution generated by the market? The Utility Possibilities Frontier Ideally, in discussing distribution, we should talk not about the distribution of things but about the distribution of well-being. In the nineteenth century, philosophers used the concept of utility as a measure of well-being. As they saw it, people make choices among goods and services and on the basis of the utility those goods and services yield. People act to maximize utility. If you prefer a night at the symphony to a rock concert, it is because you expect to get more utility from the symphony. If we extend this thinking, we might argue that if household A gets more total utility than household B, A is better off than B.
Utility is not directly observable or measurable, but thinking about it as if it were can help us understand some of the ideas that underlie debates about distribution. Suppose society consisted of two people, I and J. Next suppose that line PP' in Figure 1 represents all the combinations of I's utility and I's utility that are possible, given the resources and technology available in their society. (This is an extension of the production possibilities frontier in part 7 of this analysis.)  Any point inside PP', or the utility possibilities frontier, is inefficient because both I and J could be better off. A is one such point. B is one of many possible points along PP' that society should prefer to A, because both members are better off at B than they are at A. While point B is preferable to point A from everyone's point of view, how does point B compare with C? Both B and C are efficient; I cannot be made better off without making J worse off, and vice versa. All the points along PP' are efficient, but they may not be equally desirable. If all the assumptions of perfectly competitive market theory held, the market system would lead to one of the points along PP'. The actual point reached would depend on I's and J's initial endowments of wealth, skills, and so forth. In practice, however, the market solution leaves some people out. The rewards of a market system are linked to productivity, and some people in every society are simply not capable of being very productive or have not had the opportunity to become more productive. All societies make some provision for the very poor. Most often, public expenditures on behalf of the poor are financed with taxes collected from the rest of society. Society makes a judgment that those who are better off should give up some of their rewards so that those at the bottom can have more than the market system would allocate to them. In a democratic state, such redistribution is presumably undertaken because a majority of the members of that society think it is fair, or just. Early economist's drew analogies between social choices among alternative outcomes and consumer choices among alternative outcomes. A consumer chooses on the basis of his or her own unique utility function, or measure of his or her own well-being; a society, economists said, chooses on the basis of a social welfare function that embodies the society's ethics.  Such theoretical discussions of fairness and equity focus on the distribution and redistribution of utility. Because utility is neither observable nor measurable, most discussions of social policy center on the distribution of income or the distribution of wealth as indirect measures of well-being. It is important that you remember throughout the next several posts, however, that income and wealth are imperfect measures of well-being. Someone with a profound love of the outdoors may choose to work in a national park for a low wage instead of a consulting firm in a big city for a high wage. The choice reveals that she is better off, even though her measured income is lower. As another example, think about five people with $1 each. Now suppose that one of those people has a magnificent voice, and that the other 4 give up their dollars to hear her sing. The exchange leads to inequality of measured wealth---the singer has $5 and no one else has any, but all are better off than they were before. Although income and wealth are imperfect measures of utility, they have no observable substitutes and are therefore the measures we use throughout the next few posts. First, we review the factors that determine the distribution of income in a market setting. Second, we look at the data on income distribution, wealth distribution, and poverty in the United States. Third, we talk briefly about some theories of economic justice. Finally, we describe a number of current redistributional programs, including public assistance (or welfare), food stamps, Medicaid, and public housing. The Sources of Household Income Why do some people and some families have more income than others? Before we turn to data on the distribution of income, let us review what we already know about the sources of inequality. Households derive their incomes from three basic sources: (1) from wages or salaries received in exchange for labor; (2) from property---that is, capital, land, and so forth; and (3) from government. Wages and Salaries Hundreds of different wage rates are paid to employees for their labor in thousands of different labor markets. Perfectly competitive market theory predicts that all factors of production (including labor) are paid a return equal to their marginal revenue product---the market value of what they produce at the margin. There are reasons why one type of labor might be more productive than another and why some households have higher incomes than others.  Required Skills, Human Capital, and Working Conditions Some people are born with attributes that translate into valuable skills, such as many professional basketball players, partly because of how tall they are. They do not decide to go out and invest in height; they were born with the right genes. Some people have perfect pitch and beautiful voices; others are tone-deaf. Some people have quick mathematical minds; others cannot add two and two. The rewards of a skill that is in limited supply depend on the demand for that skill. Men's professional basketball is extremely popular, and the top NBA players make millions of dollars per year. There are some great women basketball players, too, but because women's professional basketball has not become popular in the United States, these winning skills go comparatively unrewarded. In tennis, however, people want to see women play and women therefore earn prize money similar to the money earned by men. Some people with rare skills can make enormous salaries in an unfettered market economy, such as professional musicians. Are they worth it? They're worth exactly what people will pay to hear their music. Not all skills are inborn. Some people have invested in training and schooling to improve their knowledge and skills, and therein lies another source of inequality in wages. When we go to school, we are investing in human capital that we expect to yield dividends, partly in the form of higher wages, later on. Human capital is also produced through on-the-job training. People learn their jobs and acquire "firm-specific" skills when they are on the job. Thus, in most occupations there is a reward for experience. Pay scale often reflects numbers of years on the job, and those with more experience earn higher wages than those in similar jobs with less experience.  Some jobs are more desirable than others. Entry level positions in"glamour" industries such as publishing and television tend to be low-paying. Because talented people are willing to take entry level jobs in these industries at salaries below what they could earn in other occupations, there must be other, non-wage rewards. It may be that the job itself is more personally rewarding, or that a low-paying apprenticeship is the only way to acquire the human capital necessary to advance. In contrast, less desirable jobs often pay wages that include compensating differentials. Of two jobs requiring roughly equal levels of experience and skills that compete for the same workers, the job with the poor working conditions usually has to pay a slightly higher wage to attract workers away from the job with the better working conditions. Compensating differentials are also required when a job is very dangerous. Those who take great risks are usually rewarded with high wages. High-beam workers on skyscrapers and bridges command premium wages. Firefighters in cities that have many old, rundown buildings are usually paid more than those in relatively tranquil rural or suburban areas. Multiple Household Incomes Another source of wage inquality among households lies in the fact that many households have more than one earner in the labor force. Second, and even third, incomes are becoming more the rule than the exception for U.S. families. The Minimum Wage Controversy One strategy for reducing wage inequity that has been used for almost 100 years in many countries is the minimum wage. A minimum wage is the lowest wage firms are permitted to pay workers. The first minimum wage law was adopted in New Zealand in 1894 (Case & Fair, p.334). The United States adopted a national minimum wage with the passage of the Fair Labor Standards Act of 1938, although many individual states had laws on the books much earlier. Today, the federal minimum wage is $7.25 per hour (U.S. Department of Labor).  In recent years, the minimum wage has come under increasing attack. Opponents argue that minimum wage legislation interferes with the smooth functioning of the labor market and creates unemployment. Proponents argue that it has been successful in raising the wages of the poorest workers and alleviating poverty without creating much unemployment. Unemployment Before turning to property income, we need to mention another cause of inequality in the United States that is the subject of much discussion in macroeconomics: unemployment. People earn wages only when they have jobs. In recent years, the United States has been through two severe recessions (economic downturns). In 1975, the unemployment rate hit 9 percent, and over eight million people were unable to find work; in 1982, the unemployment rate was nearly 11 percent, and over 12 million were jobless. More recently, the recovery from the mild recession of 1990 to 1991 was slow at first. by 2000, the number of unemployed dropped below 5.5 million (an unemployment rate of 3.9 percent, but by early 2003, it was back to 9 million, or 6 percent (p. 335). Today it is 6.1 percent (usatoday.com). Unemployment hurts primarily those who are laid off, and thus its costs are narrowly distributed. For some workers, the costs of unemployment are lowered by unemployment compensation benefits paid out of a fund accumulated with receipts from a tax on payrolls. Income from Property Another source of income inequality is that some people have property income from the ownership of real property and financial holdings while many others do not. Some people own a great deal of wealth, and some have no assets at all. The amount of property income that a household earns depends on (1) how much property it owns and (2) what kinds of assets it owns. Such income generally takes the form of profits, interest, dividends, and rents. Households come to own assets through saving and through inheritance. Many of today's large fortunes were inherited from previous generations. They have large holdings of property originally accumulated by previous generations. Thousands of families receive smaller inheritances each year from their parents. Most families receive little through inheritance; most of their wealth or property comes from saving (p. 335).  Income from the Government: Transfer Payments Transfer payments are made by government to people who do not supply goods or services in exchange. Some, but not all, transfer payments are made to people with low incomes, precisely because they have low incomes. Transfer payments thus reduce the amount of inequality in the distribution of income. Not all transfer income goes to the poor. The biggest single transfer program at the federal level is social security. Transfer programs are by and large designed to provide income to those in need. They are part of the government's attempts to offset some of the problems of inequality and poverty.  *CASE & FAIR, 2004, PRINCIPLES OF ECONOMICS, 7TH ED., PP. 331-335* end |
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