Archive for the 'Income distribution' Category

Mar 04 2013

Lesson Plan: Sources of Economic Growth and Development

Introduction: In order to understand the goals of economic development, it is useful to examine the characteristics of more economically developed countries and compare them to those of less economically developed countries. Before beginning the assignment below, watch the following TED Talk by Swedish Professor of world health Hans Rosling:

Resources: Use the following websites to find the required data for the assignment below.

Part 1 – Development Data:

Using the two websites above, locate the following for TWO COUNTRIES, one from the list of countries with “high human development” and one from the list of countries with “low human development”. Use the tables below to fill in the data for the two countries you have chosen.

Social Indicators (find and record figures for both the countries you chose below)

  • HDI ranking and value
  • Age structure
  • Population growth rate
  • School life expectancy
  • Life expectancy at birth
  • Total fertility rate
  • Education expenditures

Economic Indicators:

Part 2 – Dependency Ratio:

A nation’s dependency ratio tells us something about the ability of members of a nation’s workforce to provide necessities to him or herself and his or her dependents. Typically, less economically developed nations will have a higher dependency ratio than more economically developed countries. The lower a nation’s dependency ratio, the greater capacity for its workers to accumulate savings, which leads to investment, accumulation of capital, greater productivity, higher incomes and more economic development.

Calculation the dependency ratio: To calculate a nation’s dependency ratio, you must find demographic information on its population. You may need to do additional research beyond the two websites above to find this data.

Calculate the dependency ratios for:

      • Country with high HDI
      • Country with low HDI

Part 3 – Lorenz Curve and Gini coefficient:

The Lorenz curve is a graphical representation of the income distribution of a country. It plots the percentage of a nation’s total income (GDP) against its total population. The “line of absolute equality” is the 45 degree line, indicating a nation where each quintile (20% of the population) earns exactly the same income as each other quintile. No country is absolutely equal, therefore the line of equality is only used for comparison.

The Gini coefficient is the ratio of the area below the line of equality and above a country’s Lorenz curve and the total area of the triangle below the line of equality. A country with perfect income equality would have a Gini coefficient of 0. A country in which the top 1% had controlled all of a nation’s income would have a Gini coefficient of nearly 1.
Example: Australia’s income is distributed across its population in the following way:

      • 1st 20% – 5.9%
      • 2nd 20% – 12%
      • 3rd 20% – 17.2%
      • 4th 20% – 23.6%
      • 5th 20% – 41.3%
      • Gini coefficient = 0.352

Illustrating your countries’ Lorenz Curves: This is another activity that may require research beyond the websites provided above. Try to find data on the share of national income earned by various levels of society. If you cannot find data for the 20% ranges, use the percentage ranges you can find. Draw a Lorenz curve for the two countries you researched.

Part 4 – Conclusions:

Evaluate your findings from the two countries you researched.

  1. What conclusions can you draw about the correlation between GDP, HDI, income equality, social and economic indicators between developed and developing countries?
  2. Does a high HDI correlate with relative income equality? What about low HDI?
  3. Is a high GDP indicative of high levels of human development?
  4. What other conclusions can you draw about economic development, national income, and equality?
  5. To what extent did your country with low HD exhibit the following characteristics?
    • Low standards of living?
    • Low incomes?
    • Inequality?
    • Poor health?
    • Inadequate education?
    • Low levels of productivity?
    • High rates of population growth and dependency burdens?
    • High levels of unemployment?
    • Dependence on agricultural production and primary product exports?
    • Imperfect markets?
    • Dependency on foreign developed countries for trade, access to technology, foreign investment and aid?

One response so far

Jan 08 2013

Income Inequality and Asymmetric Information as Market Failures – student animations

The following animations were made by this year’s grade 12 IB Economics students when they were studying market failure in the 11th grade. They are meant to show scenarios that demonstrate two types of market failure that may arise in society: asymmetric information and income inequality.

Watch the videos and answer the questions that follow.

Income Inequality:

Discussion Questions: After watching your assigned video, answer the questions that follow

  1. In the animation you watched, what was the “market” that was being discussed?
  2. According to the dialogue, how does a market failure lead to the existence of income inequality?

Information Asymmetry

Discussion Questions: After watching your assigned video, answer the questions that follow

  1. In the animation you watched, what was the “market” that was being discussed?
  2. How did asymmetric information between the buyer and seller in the market lead to a market failure?

4 responses so far

Jan 08 2013

Income inequality as a Market Failure

The prevalence of income inequality in free market economies indicates that inequality may be the result of a market failure. Those who are born rich are more likely to become rich, while individuals who are born poor are more likely to live a life of relative poverty. In a “free” market, it is believed, all individuals possess an equal opportunity to succeed, but due to a mis-allocation of resources in a purely market economy, this may not always be the case.

The resources I refer to here are those required for an individual to escape poverty and earn a higher income. These include public and merit goods that those with high incomes can afford to consume, while those in poverty depend on the provision of from the state, including:

  • Good education
  • Dependable health care
  • Access to professional networks and the employment opportunities they provide

Whenever a market failure exists, it can be argued that there is a role for government in regulating the market to achieve a more optimal distribution of resources. When it comes to income inequality, government intervention typically comes in the form of a tax system that places a larger burden on the rich, and a system of government programs that transfer income from the rich to poor, including welfare benefits, unemployment benefits, healthcare for low income households, public schools and support for economic development in poor communities.

Many politicians and some economists like to argue that income inequality is not as evil as many people make it out to be, and that greater income inequality can actually increase the incentive for poorer households to work harder to get rich, contributing to the economic growth of the nation as a whole. Allowing the rich to keep more of their income, in this way, leads more people to want to work hard to get rich, as they will be able to enjoy the rewards of their hard work.

Another common argument is that higher income inequality leads to social and economic disruptions that can slow economic growth and bring an economy into a recession or a depression, since the middle and lower income groups in the nation will not benefit from a relatively equal share of the nation’s output, and over time will see their living standards drop and their overal productivity and contribution to national output decline.

The debate over inequality and what government can or should do about it is at ther root of many other economic debates today. A recent study by the Political Economy Research Institute of the University of Massachusetts, Amherst, provides support for those who support the second argument above. Here are some of the main discoveries from the study, “Searching for the Supposed Benefits of Higher Inequality: Impacts of Rising Top Shares on the Standard of Living of Low and Middle-Income Families”.

Discoveries of the study:

Some believe that increasing inequality leads to more growth, others argue that it leads to less growth.

A more interesting question is whether rising income inequality leads to a higher standard of living for everyone in society, or whether standards of living decline for those in the middle as the percentage of total income earned by the top 10% increases.

The study found that the higher the percentage of income earned by the top 10%, the incomes of those in the middle and bottom of the income distribution actually decreases. Not just the percentage of total income, but the actual incomes of these groups falls as the rich get richer.

The popular belief is that reducing taxes on the rich increases the amount of investment in the economy, creating more jobs and helping increase incomes of the middle and lower income households. This theory is sometimes referred to as “trickle down” economics, as the increased incomes and wealth at the top will “trickle down” and raise the incomes of the rest of society as well.

However, actual data shows that a 10% increase in the share of total income earned by the top 10% of income earners leads to a 2% decline in the incomes of households in the middle of the income distribution (based on data for the period between 1979 and 2005).

It’s not just that the rich get richer and the poor get poorer, rather that the rich getting richer makes the poor (and the middle income earners) poorer. This is a breakthrough discovery.

Possible explanations:

  • The rich contribute to growth abroad, rather than at home: Rich households’ higher incomes allow them to consume more domestic output and imported goods and services, but it also allows them to save more, which sometimes translates into more investment. But more investment does not always translate into domestic economic growth, since investment is now global. A rich American saving more does not mean American firms will have access to cheaper capital, as domestic savings may fuel investment in emerging markets or elsewhere abroad. Foreign investment resulting from savings among rich Americans counts as a leakage from America’s circular flow of income, leaving less income within America for the middle and low income earners. Essentially, much of the income earned by the rich is saved abroad, contributing to employment and growth overseas, reducing incomes of the middle class at home.
  • Reduced support for the provision of public goods: When examining living standards, more than just income must be considered, but also access to education, provision of health care and other public goods such as public safety and security. Richer households are less interested in things like public schools and social welfare programs, as they do not rely on these for their own well-being. Therefore, the richer the top 10% become,  the greater their incentive to work against efforts to fund public education, public health and public safety. The underprovision of these social welfare enhancing goods by govenrment further widens the gap between the living standards of the richest and the middle class. Economist Robert Reich refers to this phenomenon as “the secession of the successful”.
  • Wage competition reduces incomes in the middle: Business owners, who make up a large percentage of the richest households in America, increase their own incomes to the extent that they can drive down the wages they pay their employees. In this way a higher share of national income is enjoyed by a smaller proportoin of society. The minimum wage has barely increased over time, and workers have less bargaining power as fewer workers than ever are members of labor unions; this has allowed business owners to pay lower wages over time, concentrating an increasing share of national income in business profits, and less and less in wages for workers.

In the video below, the study’s author shares some of the findings discussed above. Watch the video and respond to the discussion questions that follow.

Discussion Questions:

  1. Summarize the argument against a government taking measures to redistribute its nation’s income to reduce the level of inequality between the rich and the poor.
  2. Summarize the argument for a government reducing inequality.
  3. Popular belief holds that “a rising tide lifts all boats”. In other words, if the total income of a nation is increasing, it does not matter if the rich are enjoying a larger percentage of the higher income than the poor and middle, because everyone is likely to be better off than if total income were not growing at all. Does the study discussed above support this popular view? Why or why not?
  4. What measures can a government take to assure that higher national income leads to higher standards of living for everyone in society, including the middle class and the poor? Why might the highest income earners be opposed to such attempts by government?
  5. Should government intervene to reduce the level of income inequality in society?

90 responses so far

Nov 08 2012

Tax progressivity in the US: Do the rich pay more than their fair share? The evidence indicates NO!

Just How Progressive Is the Tax System? – Economix Blog –

According to a blog post in the New York Times from April 2009, America’s America’s “progressive” tax system is not as progressive as many may believe it to be:

Research has found that many states and local governments have… regressive tax systems… that might offset the progressiveness of [US] federal tax rates.

The research from Citizens for Tax Justice — a liberal organization that advocates “fair taxes for middle and low-income families” — uses 2008 data for all federal, state and local taxes combined. It found that the average effective tax rate is 29.8 percent, and that including state and local taxes makes the tax curve look much less steep:

In the graph above, the horizontal axis shows the income group. The vertical axis shows the percentage of income that the average member of that group pays in taxes. Taxes include all federal, state and local taxes (personal and corporate income, payroll, property, sales, excise, estate, etc.). Incomes include cash income, employer-paid FICA taxes and corporate profits net of taxable dividends.

The article continues:

The group also finds that in 2008 the share of total federal, state and local taxes paid by each income group was relatively close to the share of income that that group brings in, at least as compared to comparable 2006 numbers for effective federal tax rates:

The horizontal axis shows the income group. Taxes include all federal, state and local taxes (personal and corporate income, payroll, property, sales, excise, estate, etc.). Incomes include cash income, employer-paid FICA taxes and corporate profits net of taxable dividends.

The research discussed above poses several interesting questions about the make-up of a nation’s tax revenues. Despite popular belief, it appears that the rich in America do not pay “more than their fair share”, as many argue is the case. Study the graphs carefully, and answer the questions that follow:

Discussion Questions:

  1. Based on the data above, do the rich in America pay an unfair proportion of the total taxes the US government collects? Why or why not?
  2. Why do the richest 5% in America actually pay a lower level of tax on average than the 5% below them?
  3. How much of America’s total income is earned by the richest 1% compared to the poorest 20%? Does America’s progressive tax system destroy the incentive for Americans to work hard and become rich? Why or why not?
  4. Use the data to construct a Lorenz Curve for the United States. Does the gap between the richest and the poorest Americans surprise you? What kinds of changes could be made to the tax system to narrow the gap between the top income earners and the middle and low income earners in America? Should this be done, why or why not?

131 responses so far

Oct 23 2012

Income Inequality’s Effects on Social and Economic Well-being

Inequality exists everywhere we look. Whether you live in a rich country or a poor one, there is inequality both within and between societies. Even a rich country like Switzerland has vast gaps between its richest and poorest households; and while there is no absolute poverty in rich countries like Switzerland, relative poverty exists as some within society earn an income and enjoy a standard of living significantly below those of others.

Is inequality a problem worth worrying about, however? There are arguments for and against making the reduction of income inequality a priority for government policy makers. To reduce inequality, argue some, the rich must be forced to give up some of their wealth in order to provide for the poor. Such ‘redistribution’ reduces incentives to work hard and therefore reduces the efficiency and productivity of society as a whole. ‘Handouts’ to the poor reduce their motivation to work, since more work and higher incomes would mean fewer government benefits and higher taxes.

Such a view is widely held among members of the Republican Party in the United States, including presidential candidate Mitt Romney, whose now infamous ‘47%’ comments reveal his lack of concern over the existence of inequality within the United States.

Romney’s 47% comments are in reference to Americans who, due to the progressive nature of America’s tax system, do not pay federal income taxes. (USA Today produced a very informative interactive graph providing a closer look at the 47%, which can be viewed here. Interestingly, of Romey’s 47%, 28% did pay federal payroll taxes which are non-progressive. Only 6.9% are the ‘working poor’ whose incomes are so low they pay no federal tax at all. The other 10% are elderly Americans who are no longer earning incomes and thus pay no income taxes).

The purpose of a progressive income tax scheme such as America’s is to place a larger burden of the total tax collections on the richest households, those who can most afford to pay taxes. When higher income earners pay a higher percentage of their income in taxes, and lower income earners pay lower tax rates, the after tax incomes earned by households will be more equal, and government is provided with a pool of tax revenues overwhelmingly paid by the rich. A large proportion of government programs intended to help the middle and lower income earners are then funded by the rich, effectively reducing the level of income inequality in society.

All forms of government spending are, essentially, forms of redistribution. Military spending redistributes income from households to defense, agricultural subsidies redistribute income from everyone to farmers and agro-businesses, spending on primary education redistributes income from all households to just those families with young children, the paving of roads redistributes income to people with cars, and so on… Fiscal policy itself is the act of collecting and redistributing income between different groups of households and firms. The extent to which fiscal policy can reduce income inequality, or SHOULD try to reduce income inequality, is the topic of much debate.

Recent studies have found that the existence of high levels of income inequality may be correlated with low levels of achievement in many social, human health, and economic indicators of well-being. Notably, the research undertaken by Richard Wilkinson, of the University of Nottingham, sheds a light on the effect that inequality has on society. Watch the TED talk below in which Wilkinson shares his research.

Inequality’s effects on social well-being

Using publicly available data, Google’s Public Data Directory allows us to create interactive graphs demonstrating the correlation between the level of inequality in nations and other social and economic indicators. The links below will take you to different charts I created while exploring the available data. Study each of the graphs and discuss with your class the relationship illustrated and possible explanations for the relationship.

Next, use Google’s software to create your own graphs exploring the relationship between income inequality (as measured by the Gini Index) and other economic or social indicators of well-being. Were you able to observe other correlations between inequality and social or economic welfare?

More reading on inequality

Last week’s Economist featured a special report on inequality, For richer, for poorerIt provides a great overview of the issue of inequality around the world, but focuses on inequality within countries, the threats it poses and the possible solutions to reducing it without undermining efficiency and economic growth.

I have selected the three most important articles from this report, which my students can access and read here.

Discussion Questions in Inequality

  1.  Identify two methods used for measuring income inequality (one used in Wilkinson’s talk and one is used in the Google Public Data Explorer). How are these two methods similar? How are they different? What are their short-comings?
  2. How have changes to nation’s economies brought about by globalization helped simultaneously reduce inequality between nations while increased inequality within nations?
  3. The existence of high levels of income inequality actually contributes to the efficiency with which an economy functions. Provide one argument for this claim and one argument against it.
  4. A highly progressive income tax system in the United States has somehow failed to reduce income inequality, which has actually grown. Besides a progressive tax system, what other elements must a nation’s fiscal policy include to promote greater equality? (Refer to the section from the Economist’s report on Sweden in your answer).

2 responses so far

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