“The Economic Way of Thinking” 11 th Edition

1. “The Economic Way of Thinking”11th Edition Chapter 11: The Distribution of Income

2. Chapter 11 Outline • Introduction • Suppliers and Demanders • Capital and Human Resources • Human Capital and Investment • Property Rights and Income • Actual, Legal and Moral Rights

3. Chapter 11 Outline • Expectations and Investment • People or Machines? • The Derived Demand for Productive Services • Who Competes Against Whom? • Unions and Competition

4. Chapter 11 Outline • Poverty and Inequality • Why Inequality is Increasing • Redistributing Income • Changing Rules and Social Cooperation

5. Introduction • Our money incomes come from other people. • We supply what other people want. • Thus, the distribution of income simply results from supply and demand.

6. Suppliers and Demanders • Income • Is not actually distributed • Is the outcome of numerous interacting decisions • Decisions can be unfair • The Distribution of Income • Is the product of the supply and demand for productive services

7. Suppliers and Demanders • Productive Services • Productive means the same as demanded. • Services does not necessarily mean that effort has been expended. • The distribution of income depends on the prior distribution of wealth.

8. Suppliers and Demanders • Question • What is wealth? • Wealth includes ownership of human capital.

9. Capital and Human Resources • Capital is produced goods that can be used to produce future goods. • This includes machinery, and the knowledge and skills of labor.

10. Capital and Human Resources • US Income Inequality • Arises primarily from unequal abilities to supply valuable human services. • US Income • Most is earned by supplying the services of human resources.

11. Human Capital and Investment • People add to their stock of human capital by investing in their personal skills.

12. Property Rights and Income • Productive resources are owned, individually and jointly, by many people using a variety of arrangements • Property rights depend on the reigning rules of the game.

13. Property Rights and Income • Questions • Do you “own” your driveway even if you cannot prevent someone from blocking its entrance? • What value does an education have if you cannot use it due to lack of a license to practice the skill?

14. Property Rights and Income • Questions • Does the owner of an apartment complex whose rents are controlled actually own the apartments? • Does a mayor own any of the city’s facilities?

15. Actual, Legal and Moral Rights • Actual Rights – control expectations and behavior • Legal Rights – government regulated • Moral Rights – what one believes one ought to enjoy

16. Expectations and Investment • Decisions about the use of resources depend upon expectations. • Investment Decisions • Based on the assessment of the relative values expected from consumption and investment.

17. Lawyers Mechanic Expectations and Investments Lifetime Income Profiles Annual Income 20 30 40 50 60 70 80 Age of Income Recipient

18. People or Machines? • Questions • Do machines “destroy” jobs? • What does it mean to say “machines are more productive”? • When will a machine replace a person? • If the marginal revenue from the machine’s use relative to its marginal cost is greater than the ratio for a person.

19. People or Machines? • Are wage rates relevant? • Technology innovations release labor to do other tasks • Some people do experience a loss in wealth after a reallocation of labor.

20. The Derived Demand for Productive Services • Derived Demand • The demand for productive services is derived from the demand for the goods they produce. • Quantity of services demanded depends upon: • The demand for the good being produced. • The wage rates of the service providers.

21. The Derived Demand for Productive Services • Demand as a Constraint • The income of owners of productive resources is limited by the demand for those services. • Demand as a Constraint • The income of owners of productive resources is created by the demand for the services of those resources.

22. Who Competes Against Whom? • OPEC (and similar organizations) • Argues that their association will allow them to better compete with Buyers. • However, Buyers and Sellers do not compete. • Buyers compete to obtain what Sellers produce. • Sellers compete to sell their product to Buyers.

23. Who Competes Against Whom? • Example • Assigning the exclusive right to an athlete’s services through the draft. • Question • This arrangement is designed to reduce competition between whom?

24. Unions and Competition • Questions • Are workers at the mercy of employers regarding pay? • Do we need unions to even the playing field?

25. Unions and Competition • Wages • Employers bid for workers’ services. • Workers cannot insist on receiving higher wages if other similar workers will work for less.

26. Unions and Competition • Unions attempt to control competition among workers. • Contract wages will exclude those who would work for a lower wage. • May limit competition by limiting membership.

27. Unions and Competition • Unions • History does not support the argument that unions arose to counter the power of the large corporations.

28. Poverty and Inequality • Employment opportunities are eliminated by enforcement of high wages. • Income cannot be greater than output. • Reducing poverty is not the same as reducing inequality.

29. Poverty and Inequality It should be noted that the families in the top quintile supply four times as many weeks as families in the bottom quintile. Percentage of Aggregate Income Earned by Each Quintile--Families 1950 1960 1970 1980 1990 2000 4.5 4.8 5.4 5.3 4.6 4.3 12.0 12.2 12.2 11.6 10.8 9.8 17.4 17.8 17.6 17.6 16.6 15.5 23.4 24.0 23.8 24.4 23.8 22.8 42.7 41.3 40.9 41.1 44.3 47.4 17.3 15.9 15.6 14.6 17.4 20.8 Lowest 5th Second 5th Middle 5th Fourth 5th Highest 5th Highest 5%

30. Poverty and Inequality • Figures • Do include money transfers. • Do not include in-kind transfers. • Do not account for differing family sizes. • Poverty • Has been substantially reduced. • Inequality has only been modestly reduced.

31. Poverty and Inequality Percentage of Families with Incomes Below the Poverty Line 2000 11.3 1990 10.7 1980 10.3 1970 10.1 1965 13.9 1960 18.1

32. Poverty and Inequality • Poverty Line • Income households of various sizes need to live decently. • Three times the income required to purchase an adequate diet. • Adjusted annually. • Economic growth has led to the decrease in the poverty rate.

33. Poverty and Inequality • Defining Poverty • Absolutely • Relatively • Family income depends significantly upon the age of the principal income earner. • As we grow older, we move into different quintiles.

34. Poverty and Inequality Family Mean Incomes in 2000 Age of Householder Mean Income 15 to 24 years $36,626 25 to 34 years 56,229 35 to 44 years 70,813 45 to 54 years 82,369 55 to 64 years 74,007 65 years and over 45,713

35. Why Inequality is Increasing • 80% of US family income = worker’s wages • The number of high school graduates exceeds the number of college graduates entering labor force. • Thus, increased wage inequality.

36. Why Inequality is Increasing • Demand for Labor • Manufacturing sector has been decreasing in size. • Pay is relatively equal. • Service sector has been increasing in size. • Pay is relatively unequal.

37. Redistributing Income • Question • Is it the same thing to say: • Too much income inequality is undesirable? • Poverty is undesirable? • Question • How much income inequality is desirable? • How to reallocate? • Taxes and subsidies?

38. Redistributing Income • Raising Taxes on High Incomes • Government must change the rules. • People adjust their behaviors to minimize the impact of the new rules. • Avoidance • Evasion

39. Redistributing Income • Raising the Income of the Poor • Government must rewrite the rules for grants. • People adjust their behavior to fit the new rules.

40. Redistributing Income • Raising the Income of the Poor • Sometimes it isn’t worth working. • Income is taxed • Day care • Clothing • Transportation to work • Loss of government subsidies

41. Redistributing Income • Marginal Tax Rate • The percentage of additional income taken by the tax collector.

42. Changing Rules and Social Cooperation • Why not keep changing the rules until the desired outcome is attained? • Who has the knowledge? • Changing rules would destroy the foundation for most social cooperation.

43. Once Over Lightly • The distribution of income is the result of supply and demand for productive services. • The production of productive resources is investment, or the creation of capital. • One important form of capital is human capital. • Property rights establish the amount and nature of the investment that will occur in a society.

44. Once Over Lightly • Lower rates of time preference encourage investment over consumption • The demand for productive services of any kind will not be perfectly inelastic. • The quantity of resources demanded is determined by comparing MR and MC. • The demand for productive services is derived from the demand for the goods they produce.

45. Once Over Lightly • Suppliers of productive services do not compete against buyers of those services. • Economic growth has dramatically reduced poverty in the US during the first ¾ of the 20th century. • The last ¼ of the century was marked by small, steady increases in income inequality. • Social cooperation requires stable property rights.

46. End of Chapter 11 Questions?