Cyberlecture

This chapter introduces you to the distribution of income and wealth in our economy, and problems that arise for society as a whole when some people have insufficient income. You will also learn what systems are used to address the problem of poverty.

What is a Lorenz curve?
A Lorenz curve shows how much of total income is earned by increasing percentages of the population. The further the Lorenz curve is from the diagonal line (perfect equality of income), the more inequality of income exists in an economy.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=gif:: ::/sites/dl/free/0070889740/39505/cyber_fig16_1_250_246.gif','popWin', 'width=266,height=262,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (50.0K)</a>

The Gini ratio measures the area between the Lorenz curve and the diagonal line of perfect income equality and compares it to the area of the triangle created by the diagonal line.

• the smaller the Gini ratio the smaller the degree of income inequality in an economy
• an accurate Gini ratio would use disposable (after-tax) income and take into account family size

Practice Activity 1 Try answering some questions about the Lorenz Curve.

What is poverty intensity?
The low-income cut-off (LICO) is the criterion used to measure poverty in Canada. It considers family size and income levels, and is sometimes referred to as the poverty line.
      The poverty rate is the percentage of Canadians whose income level falls beneath the poverty line. The poverty gap is the average shortfall of the incomes of the poor as a percentage of the poverty line. The inequality of poverty measures the gap between the poor and the very poorest.
      An index of the poverty rate, the poverty gap and the inequality of poverty gives a measure of poverty intensity, the best measure of poverty in an economy.

poverty intensity = poverty rate × poverty gap × inequality of poverty

For a discussion of the LICO and whether it accurately represents poverty line, see the Canadian Centre for Policy Alternatives Fast Facts article "Poverty: Where to Draw the Line" at http://www.policyalternatives.ca/manitoba/FastFactsMay31-00.pdf.

What is the poverty box?
The poverty box is a rectangle with poverty rate measured on the base and the poverty gap measured on the vertical sides. Poverty intensity is proportional to the area of the poverty box. Poverty boxes can be drawn for different groups in a society, i.e. the elderly, the middle-aged, or teenagers.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=gif:: ::/sites/dl/free/0070889740/39505/cyber_fig16_2_375_199.gif','popWin', 'width=391,height=215,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (50.0K)</a>

What is the difference between income and wealth?
Income is what you receive each month, and it is a flow variable. Wealth is the accumulation of your unspent income, and is a stock variable.

income – consumption = change in wealth

In general there is more inequality of wealth in an economy that inequality of income. Some people inherit wealth, while others accumulate it over a lifetime of saving.

What are some moral concerns about income equality?
The justice as fairness argument claims that if we did not know whether we would be born to an advantaged or disadvantaged group, we would want a fairer distribution of income than exists today. We would want to maximize the minimum incomes in our economy - an idea economists refer to as the maxi-min principle.
      The utilitarian argument claims that the right distribution of income would be the one that maximizes total utility among members of an economy. If the extra utility from transferring a dollar of income to a poor person is greater than the disutility of taking that dollar away from a wealthy person, the redistribution of income should proceed.
      The capabilities argument says that people need to be able to function at acceptable levels in society in order not to be considered poor. They must be able to appear in public without shame – that is, possess decent clothing. They must have the means of transportation to be able to visit friends or go to work. They must possess a level of literacy sufficient to enable them to interpret and understand the world around them. They must be able to access health care so that they can function without pain in society.

What are some practical concerns about income equality?
Children who live in poverty are less healthy and often underachieve in school. The future economic growth of an economy is dependent on children who turn into productive workers. Children of poverty face a larger challenge in becoming productive.
      Adults who live in poverty are less well nourished and thus less healthy. Their poor health not only makes them less productive workers, it also imposes a cost on society through increased health costs.
      People who live in poverty tend to be more attracted to crime as a means of raising income. Because many of these poor have not benefited from their education, it is often easier for them to commit crimes than to work at legitimate jobs.

What are some methods of redistributing income?
The Minimum Wage. The minimum wage is a way of increasing the incomes of people in low wage jobs. When the minimum wage increases, some workers will be laid off. For the workers who retain their jobs to be better off collectively, the price elasticity of demand for labour must be very low – 0.1 or below.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=gif:: ::/sites/dl/free/0070889740/39505/cyber_fig16_3_200_223.gif','popWin', 'width=216,height=239,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (50.0K)</a>

Practice Activity 2 Try answering some questions about economic surplus and the minimum wage.

The existence of a minimum wage may benefit the economy for two reasons.

• workers may stay in their higher paying jobs and become more productive than they would otherwise have been
• the private sector will play a larger part in the process of redistributing income

Economic Naturalist Why do increases in the minimum wage sometimes lead to an increase in minimum wage employment?

Social Assistance.Social assistance is provided by the government to people who have no other way of earning an income. People on social assistance must also lack assets that could be converted to income. The advantage of social assistance is that family size is taken into account in setting benefit levels.
      There are disadvantages to providing social assistance.

• the amount of income assistance usually leaves the family below the poverty line
• incentives to work decrease as at least a minimum level of income is guaranteed

Negative Income Tax. A negative income tax (NIT) plan provides an income tax credit to everyone in the economy, and then taxes it at a high rate (but less than 100%) as income is earned. People who earn good incomes lose the entire tax credit, and pay positive income taxes. People who have very low, or no incomes, keep the tax credit as cash.
      The incentive to earn an income is maintained because the loss of the NIT is less than the extra dollar earned, so there is a net benefit to the worker.

Assistance for the Elderly. Canadian social security programs, like the Canada Pension Plan (CPP) and Old Age Security (OAS) provide incomes for the elderly. CPP is paid to those people who have worked during their pre-retirement years and contributed to the CPP. OAS is paid to all elderly people who have lived 40 years in Canada, whether or not they were part of the labour market. Elderly people whose combined CPP and OAS payments still leave them below the poverty line qualify for a Guaranteed Income Supplement (GIS), which works like a negative income tax.

• since the elderly do not work, there is no effect on work incentives

A Canadian Government website (http://www.canadabenefits.gc.ca/faechome.jsp?lang=en) is a gateway to information about federally sponsored social assistance programs. If you are a student or an elderly person or an unemployed person, there are links that will tell you who is eligible for benefits and how to apply for them.

How should the government pay for social assistance programs?
One way to pay for social assistance programs would be to make the tax system more progressive. The wealthier taxpayers would pay a larger percentage of their incomes in tax. Drawbacks to this plan include:

• there might be a disincentive to work hard and earn more money
• taxpayers may spend more time looking for tax evasion possibilities than working at their jobs
• corporations may remunerate employees in goods (cars or trips) rather than money, reducing tax revenues
• too many young people may try to enter high-paying professions, reducing the number of lower paid workers, and reducing total economic surplus

Understanding Questions Do I understand this chapter? As a check to your understanding of the material in this chapter, you should be able to answer our questions.