Economics 2023-02

1. Economics 2023-02 Class 24

2. Today’s class • We will start by looking at some broad trends in distribution of income in the US • We will then discuss some of the structural changes in the economy and labor markets that contribute to these trends • Assuming enough time, we will finish with a brief discussion of some aspects of the economics of health care.

3. Key Facts • 13 percent of all Americans and 18 percent of America’s children are in poverty • the poverty rate is higher now than it was in the 1970s • the current federal poverty level is $15,700 for a family of three • the years since 1979 have seen large increases in income for those at the top of the income distribution, modest increases for those in the middle, and almost no change at all for those at the bottom

4. Changes in the Before-Tax Distribution of Income 1949-1979. 1979-1999

6. These trends have continued since 1999. Earnings change pattern for virtually every labor market group: Bottom quintile [20%]: Absolute earnings decline Middle quintile: Negligible earnings growth Top quintile: Substantial growfth

7. 2005 IRS Income Tax Data These are preliminary data from income tax returns; they show continued growth in the highest incomes at much faster rates than for lower incomes. In 2005 compared to 2004, average incomes of the top 1% grew 14%, $139,000 each on average. Average incomes of the bottom 90% fell by 0.6% or $172, on average. Per person, the top 300,000 received 440 times as much as the average person in the bottom half.

8. Distribution of wealth is even more skewed … • http://www.youtube.com/watch?v=EDx8G8Z-PFM

9. Earnings of CEOs of largest U.S. corporations 1980: 42 x average worker’s earnings 2001: 531 x average worker’s earnings

10. Why increased inequality? • Changes in the distribution of human capital? • Foreign competition at the low end? • Technical change favoring more educated workers?

11. Survey: Which is the most important cause of increasing income inequality? • Changes in the distribution of human capital? • Foreign competition at the low end? • Technical change favoring more educated workers? • Illegal immigration of unskilled workers? • Something else completely?

12. Winner-Take-All Markets Markets in which reward depends not just on absolute performance but also on relative performance.

13. Why did Steffi Graf earn twice as much in 1993 as in 1994?

14. Sources of the Winner-Take-All Effect Economic factors:

15. "Cloning," or the ability to reproduce the best performer's product at low marginal cost.

16. The Music Industry 1300 opera houses in Iowa in 1900 Thousands of tenors earned a living as touring musicians

17. Placido Domingo Jose Carreras Luciano Pavorotti

18. The market for tax advice

19. Leverage: Effect of change in quality of performance for General vs. corporal CEO vs production worker

20. Suppose Jeff Lehman is 2% better at fundraising than Cornell’s 2nd-best candidate. The market for university presidents Bottom-line difference: (0.02)x($2 billion) = $40 million

21. •Network Economies VHS vs Betamax IBM's MS-DOS Books, plays, movies, sports, etc.

22. •Reward by contest Regulatory and anti-trust consultants Premier personal injury lawyers

23. Behavioral factors: •Natural limits on the size of the agenda Mental and physical shelf space limitations: 272-5936 487-896-4762-0534

24. •Economies of repetition in consumption: Restaurant chains New melodies Cigarettes Beer, Scotch whiskey Brand loyalties

25. Law of diminishing marginal utility [the utility from the last unit declines as you consume more of something] implies diversification of consumption. Economies of repetition [if you know something already, you don’t have to expend resources to risk finding out about it] implies specialization of consumption. Increased mobility may make economies of repetition more important

26. •Avoidance of Regret. Premium tires Consulting firms

27. The desire to consume the best product •Pure Positional Concerns

28. Technologies that extend the reach of top performers have greatly benefited consumers – now we can all hear the Rolling Stones. But they have also led to increased inequality. High inequality in US is often said not to matter because of the high degree of economic mobility here. Is that true?

30. The evidence suggests that: U.S. Socioeconomic Mobility Is Low and Declining

31. Correlations between earnings of fathers and sons: US: 0.41 – 0.54 Sweden: 0.14 Canada: 0.17 - 0.19 Finland: 0.22 Germany: 0.10 - 0.36 Malaysia: 0.33 – 0.37 Source: Bjorkland and Jantti, 1999

32. Source: Thomas Hertz

33. Source: Thomas Hertz

34. Source: Inequality.org

35. Winner-Take-All Markets as Tragedies of the Commons Example 26.1. A small island nation has five identical individuals, each of whom must choose between two occupations:

36. 1. Make pots for export in the world market. Wage = $12/yr

37. 2. Compete for a recording contract that pays some uncertain amount V, where V >$12/yr, to the winner, $0 to the losers

38. All contestants are equally likely to win. Work one year, then live one year in retirement. Winner's payment increases with the number of contestants – i.e. it is a ‘tournament’

40. If villagers are risk-neutral, how many will compete for the recording contract? Individual decision rule: Compete if expected reward is at least $12; otherwise make pots.

42. Total income = 48 + 12 = 60, (winning singer) (potter) exactly the same total income as if the singing opportunity did not exist.

43. Example 26.2. In the preceding example, what is the socially optimal number of contestants? “socially optimal”  “surplus maximizing” Rule for optimal allocation: Send another contestant into the singing contest only if the payment to the winning singer goes up by at least as much as 12 (the opportunity cost of competing).

45. Maximum total income = $32 + $36 = $68 (winning singer) (potters) The total is $8 more than before. Under unregulated competition, the quality of the winning singer is "too high“ – too many people enter the contest.

46. A second reason for overcrowding in winner-take-all markets is that contestants for top positions tend to be “naively optimistic” about their odds of winning. “The contempt of risk and the presumptuous hope of success, are in no period of life more active than at the age at which young people choose their professions.” Adam Smith

47. Survey: Compared to other FSU students, are you: • Smarter than average • About average • Less smart than average • Don’t know

48. “Lake Wobegon Effect” – “where all the children are above average”

49. More than 60 percent of NCAA Division I college basketball starters believe they will eventually start for an NBA team. Actual proportion is less than 5 percent.

50. Most people think they are more intelligent than the average person, and also better drivers.