Economic Inequality: Income and Wealth Distributions, Trends, and Government Redistribution

Economic Inequality

Overview and Learning Objectives

Economic inequality refers to the differences in the distribution of income and wealth among individuals and households within a society. This chapter explores the measurement, trends, and sources of economic inequality, as well as the role of government in income redistribution.

• Describe the distributions of income and wealth and the trends in economic inequality in the United States.

• Describe the distributions of income and the trends in inequality in selected countries and the world.

• Explain the sources of economic inequality and its trends.

• Describe the scale of government income redistribution in the United States.

Economic Inequality in the United States

Distribution of Income

The distribution of income in the United States is measured across households, revealing how income is spread among the population.

• Mode income: The most common income level, which in 2016 was between $15,000 and $20,000.

• Median income: The income that divides the population into two equal groups; in 2016, the median was $59,036.

• Mean income: The average income, which was $83,143 in 2016.

Positively skewed distribution: In the U.S., the mean income exceeds the median, and the median exceeds the mode, indicating a long tail of high-income values. This is known as a positively skewed distribution.

Income Shares by Quintile

Income distribution can also be analyzed by dividing the population into quintiles (five equal groups). Trends from 1970 to 2018 show persistent differences in income shares among these groups.

Quintile	Share of Income (1970-2018)
Lowest quintile	Consistently lowest share
Second quintile	Low share, slightly increasing
Third quintile	Moderate share, relatively stable
Fourth quintile	High share, slightly increasing
Highest quintile	Largest share, increasing over time

Distribution of Wealth

Wealth refers to the value of all assets owned by a household at a point in time. Wealth is distributed even more unequally than income in the United States.

• Wealth is a stock of assets, while income is a flow resulting from a given stock of wealth.

• Wealth distribution excludes human capital, whereas income reflects human capital.

• Wealth is a less accurate measure of economic inequality compared to income.

Lifetime Income and Wealth

Household income and wealth change over the life cycle:

• Young households: Moderate income, low wealth, accumulating assets.

• Middle-aged households: Highest income and wealth levels.

• Older households: Lower income, consuming accumulated wealth.

Measuring Inequality: The Gini Ratio

The Gini ratio is a common measure of inequality, ranging from 0 (perfect equality) to 1 (maximum inequality).

• In 2012, the U.S. Gini ratio was 0.47.

• A higher Gini ratio indicates greater inequality.

Trends show that income distribution in the United States has become more unequal over time.

Poverty

Poverty is defined as a situation in which a household's income is too low to afford basic necessities such as food, shelter, and clothing.

• Poverty is a relative concept, varying by society and time.

• In 2016, the poverty level for a four-person family was $24,424.

• 12.5% of Americans (41 million) lived below the poverty level in 2016.

• Poverty rates vary by race and household status:

  • White Americans: 11%

  • Hispanic-origin Americans: 19%

  • Black Americans: 22%

  • Female-headed households (no husband): >27%

Inequality in the World Economy

Global Income Distributions

Income inequality is more pronounced globally than within individual countries.

• 50% of the world population lives on $2.50 a day or less.

• 30% live on $2.50 to $10 a day.

• 80% of the world population is considered very poor.

• The average American has $115 a day.

Global Gini Ratio and Trends

The global Gini ratio shows that worldwide income distribution is becoming less unequal, as incomes in poorer countries rise faster than those in richer countries.

The Sources of Economic Inequality

Human Capital

Human capital refers to the skills, education, and experience possessed by an individual, which affect their earning potential.

• More human capital generally leads to higher income.

Demand, Supply, and Wage Rates

Labor market dynamics influence wage inequality:

• High-skilled workers have a higher value of marginal product and earn more.

• Acquiring human capital is costly, requiring higher wages to compensate.

Trends in Wage Inequality

Technological change and globalization have affected wage inequality:

• Technological advances (e.g., computers) substitute for low-skilled labor, reducing demand and wages for these workers.

• High-skilled labor is complemented by technology, increasing demand and wages.

• Globalization has lowered prices of manufactured goods and decreased demand for low-skilled labor in developed countries, while increasing demand for high-skilled labor.

Discrimination

Discrimination based on race, gender, or other factors can contribute to economic inequality, even when human capital is equal.

• Prejudices among customers or employers can result in wage differentials.

• Market pressures may eventually reduce discrimination, but differences in specialization (e.g., time spent in the labor force) can explain some wage gaps.

Contests Among Superstars

The top 1% of earners often receive incomes far above what can be explained by human capital alone, due to winner-take-all markets and contests for top positions.

• Large differences in prizes (income) induce high effort among competitors.

Wealth Inequality

Wealth inequality is greater than income inequality, arising from life-cycle saving patterns and intergenerational transfers.

• Marriage and inheritance can concentrate wealth within families.

Income Redistribution

Government Redistribution Mechanisms

Governments redistribute income through:

• Income taxes

• Income maintenance programs

• Subsidized services

Prosperity vs. Equality

Capitalist societies tend to be more prosperous but not necessarily more unequal than socialist societies. The tradeoff between prosperity and equality is a central issue in economic policy.

The Big Tradeoff

Redistributing income involves a tradeoff between equity and efficiency:

• Redistribution uses resources that could be used for production.

• Taxes required for redistribution create deadweight losses.

• Supplemental income programs may reduce incentives to work.

Key Formula:

• Gini Ratio: $G = \frac{A}{A+B}$, where A is the area between the Lorenz curve and the line of equality, and B is the area under the Lorenz curve.

Example: If the Gini ratio is 0.47, this indicates a moderate level of income inequality.