Lecture Principles of Microeconomics: Chapter 16 - James D. Miller

Lecture Principles of Microeconomics - Chapter 16 Challenge to market effectiveness 6: Inequality. After reading this chapter, you should be able to answer the following questions: Why do we face income inequality? How does inequality affect a nation? What are the problems of reducing inequality? Should the government reduce inequality? How can one make very high income? Why is there income inequality between men and women?...

Chapter 16

Challenge To Market Effectiveness 6:

Inequality

Learning Objectives

• Why do we face income inequality?

• How does inequality affect a nation?

• What are the problems of reducing inequality?

• Should the government reduce inequality?

• How can one make very high income?

• Why is there income inequality between men and

Inequality

• People are not equal before markets.

• Income inequality may be due to differences in choice of careers, education, skills and abilities, amount of hard work or opportunities.

• One reason why people object to income

inequality is fairness.

• Whether fairness is important is a moral issue lying outside the boundaries of economics.

U.S Income Inequality

Population

Income in 2001

fifth Second fifth

Poorest fifth

Richest fifth

• Inequality is a different type of market challenge

It does not lower a nation’s wealth.

• Government's efforts at reducing inequality often lower a nation’s wealth.

• When the government transfers wealth to the

poor it actually encourages more people to

become poor.

• When the government gives money to the poor,

it reduces poor peoples’ incentives to work

Choice and Inequality

• A key lesson of economics is that

tradeoffs are everywhere

• One tradeoff is choosing between free

time and income

• Some professionals must put in long work hours Other jobs pay less but also require less time

• However, not everyone has comparable

choices.

Problems of Reducing Inequality

• Reducing income inequality could be unfair because

some people with relatively low incomes might, overall,

be no less happy than those with high incomes

• Reducing income inequality creates incentives for

people to stop working and become poor so they can receive welfare from the government

• Reducing income inequality punishes the rich,

reducing incentives for people to work hard to become rich

• Reducing income inequality empowers politicians and

so increases the amount of resources citizens spend lobbying politicians

Should the Government

even though significantly reducing income

inequality causes some problems, the

government should still do it

• Many people believe that excessive wealth

acquisition is socially destructive For them, the case for wealth redistribution is very strong.

Paths to Great Wealth

To make an extremely high income while working for other people, you first need to

be one of the best in your field as well as:

• Get very wealthy people to value your

work highly.

• Excel at running a large organization

• Get millions of people to value your work

Sex and Income Inequality

• In the U.S full-time working women make about 76% as much, on average, as full-time working men

• There is discrimination against women

• Child-rearing decisions made by women significantly

contribute to male/female disparity

• Women are far more likely than men to stop working for

a few years to raise children

• Women often prefer lower paying professions than men

• Even though parents don’t get paid for taking care of

their children, economists consider parenting a

• By teaming up high-income individuals,

assortative mating has increased household

income inequality

Racial Discrimination

• If a restaurant, law firm or athletic team refuses

to hire people from a given racial group then that firm’s quality will suffer

• Therefore, if customers care only about quality, then profit-maximizing firms won’t discriminate

• But if customers care about both quality and the racial makeup of employees, then racial

discrimination may be profit maximizing, e.g

South African miners, Baseball Leagues in

Jim Crow Laws in American History

• Jim Crow Laws are racially segregated seating

on public transportation in the American South.

• Private owners of streetcar, bus, and railroad

companies in the South lobbied against the Jim Crow laws.

• This resistance was not based on a desire for

civil rights, but on a fear of losing money if racial segregation caused black customers to use

public transportation less often

• The incentives of the economic system and the incentives of the political system were not only different, they clashed

Educational Premiums

• Colleges probably teach people useful information, so that will likely make them more productive workers

• Many highly intelligent people go to college and so

naturally earn more when they graduate than other

Generational Mobility

• Being born to a poor parent is a significant but surmountable obstacle to earning a

high income as an adult.

• 20% of kids who grew up in households

that were among the 20% poorest of the U.S population ended up in the richest

40% of the U.S population

• There is generational mobility in the U.S.

High Fixed Costs Goods

• But the prevalence of high fixed costs goods has still not given us total consumption equality

• There are many inequalities in life besides inequality of income, e.g inequality of

good looks.

• Inequality creates envy and a negative

“mental” externality for the have-nots.

• Radically eliminating inequality can be

very brutal

Do You Know?

• Many people have a choice of how much to

work How does this affect the fairness of

Do You Know?

• What problem can occur when the government takes

money from the rich?

When the government takes wealth from the rich it

reduces peoples’ willingness to work hard to become

rich

When do markets punish racists who refuse to hire

members of some racial groups?

When a firm refuses to hire people from a given racial group, then that firm’s quality will suffer If customers

care only about quality, markets will punish the racists

Summary

• People are not equal before markets

• Income inequality may be due to differences in choice of careers, education, skills and abilities, amount of hard work or opportunities

• Inequality does not lower a nation’s wealth

• Government's efforts at reducing inequality often lower a nation’s wealth

• When the government gives money to the poor, it

reduces poor peoples’ incentives to work

• When the government takes wealth from the rich it

reduces peoples’ willingness to work hard to become

rich

Summary

• Child-rearing decisions made by women significantly

contribute to male/female income inequality

• By teaming up high-income individuals, assortative

mating has increased household income inequality

• Markets punish racial discrimination only when

customers care only about quality

• The cost structure of many goods has created a

significant level of consumption equality between the

rich and middle class

• There are many inequalities in life besides inequality of income

Coming Up

How can we apply economics

everywhere?