Economic Inequality: Income, Wealth, and Redistribution

Economic Inequality

Introduction

Economic inequality refers to the uneven distribution of income and wealth among individuals or households within a society. This chapter explores the measurement, sources, and trends of economic inequality, as well as government policies aimed at redistribution.

Distributions of Income and Wealth in the United States

Definitions and Key Concepts

• Income: A flow variable representing money received over a period (e.g., wages, interest, rent, profit).

• Wealth: A stock variable representing the total value of assets owned at a point in time.

• Money income: Market income plus cash payments from the government.

• Market income: Earnings from factor markets before taxes.

Measures of Central Tendency

• Mode: Most common income (e.g., $25,000–$35,000).

• Median: Income dividing the population into two equal groups (e.g., $68,703).

• Mean: Average income (e.g., $93,088).

• A distribution where mean > median > mode is positively skewed, indicating a long tail of high incomes.

Income Distribution by Quintiles

Income is often divided into five equal groups (quintiles) to analyze distribution:

Quintile	Share of Total Income (%)
Lowest	3.1
Second	8.3
Third	14.1
Fourth	22.7
Highest	51.8

Additional info: The highest quintile earns more than half of all income, while the lowest quintile earns a small fraction.

Factors Affecting Household Income

• Education

• Type and size of household

• Age of householder

• Race

• Region

• Assortative mating (like marries like)

Why Incomes Differ

• Wage differences

• Different attributes (skills, education, etc.)

• Endowments (talent, inheritance)

• Choices (schooling, work hours, bequests, marriage)

Measuring Inequality: Lorenz Curve and Gini Coefficient

Lorenz Curve

• Graphs cumulative percentage of income against cumulative percentage of households.

• The line of equality represents perfect equality.

• The further the Lorenz curve is from the line of equality, the greater the inequality.

Gini Coefficient

• Measures inequality as a ratio between 0 (perfect equality) and 1 (perfect inequality).

• Calculated as the ratio of the area between the Lorenz curve and the line of equality to the total area under the line of equality.

• U.S. Gini ratio in 2019: 0.47

Wealth Distribution

• Wealth is more unequally distributed than income.

• The richest 1% own almost 40% of total wealth; the bottom 40% own less than 1%.

• Wealth excludes human capital, making income a more accurate measure of economic inequality.

Trends in Inequality

• U.S. income inequality has increased over time, as shown by the rising Gini coefficient.

• Wealth inequality is even more pronounced and persistent.

Poverty

• Poverty: Income too low to afford basic needs (food, shelter, clothing).

• Poverty is both a relative and absolute concept.

• 2019 poverty threshold for a family of four: $25,926.

• About 10.5% of Americans lived below the poverty line in 2019.

• Poverty rates vary by race and household status (e.g., higher for female-headed households).

Inequality in the World Economy

• Global income distribution is more unequal than within any single country.

• Billions live on less than $5.50 per day; the average American has $270 per day.

• Global Gini ratio is high, but inequality is decreasing as incomes in poorer countries rise faster than in rich countries.

Sources of Economic Inequality

• Unequal labor market outcomes (human capital, discrimination, superstar contests)

• Unequal ownership of capital

• Life-cycle saving patterns and intergenerational transfers

Human Capital

• More human capital (education, skills) leads to higher income.

• High-skilled workers are in greater demand and command higher wages.

Technological Change and Globalization

• Technology substitutes for low-skilled labor, reducing demand and wages for these workers.

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

• Globalization increases competition for low-skilled jobs but raises demand for high-skilled workers.

Discrimination

• Wage differences may persist due to discrimination based on race or gender, even with equal human capital.

• Market forces may reduce discrimination over time, but social and cultural factors can sustain it.

Superstar Contests

• Some income differences are due to winner-take-all markets (e.g., sports, entertainment).

• Globalization amplifies these differences by expanding the market for top performers.

Government Redistribution of Income

Methods of Redistribution

• Progressive income taxes: Higher rates on higher incomes reduce inequality.

• Income maintenance programs: Social Security, unemployment compensation, welfare.

• Subsidized services: Education, healthcare, and other services provided below cost.

Types of Taxes

• Progressive tax: Marginal tax rate increases with income.

• Regressive tax: Marginal tax rate decreases with income (e.g., sales tax, FICA).

• Proportional tax: Constant marginal tax rate for all income levels.

The Big Tradeoff

• Redistribution can reduce incentives to work and save, potentially decreasing economic efficiency.

• Administrative costs and deadweight losses are associated with redistribution programs.

Policy Challenges and Solutions

• Balancing equity and efficiency is a major challenge.

• Long-term solutions focus on education and human capital development.

• Short-term solutions include welfare and child support enforcement.

Key Formulas and Concepts

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

Summary Table: Income and Wealth Distribution

Measure	Income	Wealth
Type	Flow	Stock
Distribution	Unequal	More Unequal
Key Determinants	Human capital, labor market	Inheritance, asset ownership

Review Questions

• What is the difference between income and wealth?

• How are income and wealth distributed in the U.S.?

• What are Lorenz curves and Gini ratios?

• What are the limitations of these measures?

• How can governments affect the distribution of income?

• What are the potential drawbacks to income redistribution?

• Why are incomes so different?