Premium PowerPoint Slides by:
V.  Andreea  CHIRITESCU
Eastern Illinois University
N. GREGORY MANKIW

PRINCIPLES OF
ECONOMICS
Eighth Edition
•Income Inequality
•and Poverty
•CHAPTER
•20
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This is the third of three chapters on the economics of labor markets.  In Chapter 18, students
learned that equilibrium wages equal the value of the marginal product of labor.  In Chapter 19,
students learned about various factors that affect equilibrium wages, as well as discrimination.
In Chapter 20, students will learn about the extent of inequality and poverty in the U.S.  The
chapter also introduces some of the leading political philosophies on the role of government in
redistributing income.  Finally, the chapter discusses some policies designed to help the poor.
This chapter is shorter than average.  Most students find it less difficult than average.
Therefore, most instructors are able to cover it in about 60 minutes of class time.

Look for the answers to these questions:
•How much inequality and poverty exist in our society?
•What are the problems measuring inequality?
•What are some of the leading philosophies
on the proper role of government in altering
the distribution of income?
•What policies are used to fight poverty?  What are the problems with these policies?
2
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Introduction
•In the absence of discrimination
–The income distribution in a market economy may not be equitable or otherwise desirable.
•In this chapter, we examine:
–Indicators of inequality and poverty
–Philosophies about income redistribution
–Policies designed to help the poor
•
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From the previous two chapters: Equilibrium wages equal the value of workers’ marginal products
Differences in equilibrium wages result from differences in
- Worker characteristics: education, experience, talent, effort
 - Job characteristics: extent to which a job is pleasant and safe
- Discrimination.

The U.S. Income Distribution:  2014
4
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Group
Annual household income
Bottom quintile
Under $21,430
Second quintile
$21,430– $41,166
Middle quintile
$41,167 – $68,199
Fourth quintile
$68,200 – $112,253
Top quintile
$112,254 and over
Top 5 percent
$206,563 and over

This is an updated version of Table 1 in Chapter 20.  Source:  U.S. Bureau of the Census,
Historical Income Inequality Tables, available at:
https://www.census.gov/data/tables/time-series/demo/income-poverty/cps-hinc/hinc-05.html
There’s one key difference:  This table refers to households rather than families.

U.S. Income Inequality, 1950–2014
5
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Income share of the top 20% divided by income share of the bottom 20%

Each point is the ratio of two numbers:
The share of U.S. income received by the top 20% of families, relative to the share of U.S. income
received by the bottom 20%.
Source:  U.S. Census Historical Income ,
https://www.census.gov/data/tables/time-series/demo/income-poverty/historical-income-families.html

Inequality around the World
6
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Income share of the
top 20% divided by income share of the bottom 20%

Source:  Figure 1, Chapter 20.
Original source:  Human Development Report 2011.
This figure shows the ratio of the income of the richest quintile to the income of the poorest
quintile. Among these nations, Sweden and Pakistan have the most equal distribution of economic
well-being, while South Africa and Brazil have the least equal.

Poverty
•Poverty rate
–Percentage of the population whose family income falls below an absolute level (poverty line)
•Poverty line
–Set by the federal government (three times cost of providing an adequate diet)
•Depends on family size
•Adjusted every year to account for changes in the level of prices
7
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Poverty
•In 2014 in the U.S.,
–Median family income = $66,632
–Poverty line for family of four = $24,418
–Poverty rate = 14.8%
•
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[USEMAP]
0

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The figures on this slide are updated from the textbook.
Source for poverty figures:
https://www.census.gov/data/tables/2015/demo/income-poverty/p60-252.html
Source for median family income:
https://www.census.gov/data/tables/time-series/demo/income-poverty/cps-finc/finc-01.html

U.S. Poverty Over Time
9
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Percent of the population
below poverty line

The poverty rate appears correlated with business cycles.  For example, 1992–2000 was the longest
economic expansion on record, and it coincided with a gradual fall in the poverty rate.  The U.S.
experienced recessions in the early 2000s and 2008–2009, and the poverty rate rose in each.
In the first part of the 1960s, the fall in poverty is likely due to macroeconomic recovery.  The
“War on Poverty” in the 1960s led to a significant expansion of the government’s social safety net
beginning in the mid-1960s, which coincided with further reductions in poverty.  Safety net
programs will be discussed toward the end of this chapter.
Source of data: U.S. Bureau of the Census.
https://www.census.gov/data/tables/time-series/demo/income-poverty/historical-poverty-people.html
Table 2

U.S. Poverty Rate by Group, 2012
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Group
Poverty Rate
All persons
14.8%
White, not Hispanic
10.1
Black
26.2
Hispanic
23.6
Asian
12.0
Children
21.1
Elderly
10.0
Married-couple families
6.2
Female household,
no spouse present
33.1
[USEMAP]
0

This slide updates the data in Table 3 of Chapter 20.
Source:  U.S. Bureau of the Census,
https://www.census.gov/data/tables/time-series/demo/income-poverty/historical-poverty-people.html
Tables 3 and 4.
Additionally, as of 2014, the poverty rate among Veterans of the U.S. Armed Forces was 6.7% for
males and 9.4% for females.
Source:  U.S. Department of Veterans Affairs
http://www.va.gov/vetdata/docs/SpecialReports/Profile_of_Veterans_2014.pdf

Problems in Measuring Inequality
•Data on income distribution & poverty rate
–Incomplete picture of inequality
–Household annual income
1.Doesn’t account for in-kind transfers
•Transfers to the poor in the form of goods and services rather than cash
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Problems in Measuring Inequality
•Data on income distribution & poverty rate
2.Normal life cycle pattern
•Causes inequality in the distribution of annual income
•May not represent true inequality in living standards
•Life cycle: regular pattern of income variation over a person’s life
•People can borrow and save to offset life-cycle changes in income (e.g., saving for retirement).
•
•
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Problems in Measuring Inequality
•Data on income distribution & poverty rate
3.Transitory vs. permanent income
•Transitory changes - need not affect standard of living
•A family’s ability to buy goods and services depends largely on its permanent income
•Permanent income: a person’s normal income
13
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Economic Mobility
•Economic mobility
–Many people move among income classes
–Some reflects transitory variation in income
–Some reflects more persistent changes in income
–Many of those below the poverty line are there only temporarily
14
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The poverty and inequality measures discussed above do not distinguish between the temporarily poor
and the persistently poor.
Persistence of economic success from generation to generation: Above-average income carries over
from parents to children
Four of five millionaires made their money on their own; One in five millionaires inherited their
fortunes

Political Philosophy
•What should the government do about economic inequality?
•Political philosophies of redistributing income
–Utilitarianism
–Liberalism
–Libertarianism
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Utilitarianism
•Utility:
–A measure of happiness or satisfaction
•Utilitarianism:
–Government should choose policies to maximize society’s total utility
•Founders: Jeremy Bentham, John Stuart Mill
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Utilitarianism
•Because of diminishing marginal utility
–Redistributing income from rich to poor
increases utility of the poor more than it reduces utility of the rich.
•Yet, utilitarians do not advocate equalizing incomes
–Would reduce total income of everyone due to incentive effects and efficiency losses.
•
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Liberalism
•Liberalism:
–Government should choose policies deemed to be just by an impartial observer behind a “veil of
ignorance.”
•Founder: John Rawls
•Maximin criterion:
–Government should aim to maximize the well-being of society’s worst-off person
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Liberalism
•Liberalism:
–Calls for more redistribution than utilitarianism (though still not complete equalization of
incomes).
–Income redistribution is a form of social insurance, a government policy aimed at protecting
people against the risk of adverse events.
•
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Libertarianism
•Libertarianism:
–Government should punish crimes and enforce voluntary agreements but not redistribute income
•Advocate: Robert Nozick
–Libertarians focus on the process not outcome:
•Government should enforce individual rights,
should try to equalize opportunities.
•If the income distribution is achieved fairly,
government should not interfere, even if unequal
•
•
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At this point, you might pause the lecture for a short class discussion on the relative merits of
these alternative philosophies.  If you have the sense that your students are tolerant of opposing
viewpoints, you might ask for students to pick the philosophy with which they most identify.  If
you sense that students would feel more comfortable answering the question anonymously, consider
posing it to them using a classroom response system (“clickers”) or the internet-based equivalent,
PollEverywhere.com.

Policies to Reduce Poverty
•Poor families more likely to experience
–Homelessness, drug dependence, health problems, teen pregnancy, illiteracy, unemployment
•Most people believe government should provide a “safety net.”
•We now consider a few such policies…
•
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1.  Minimum-Wage Laws
•Arguments for:
–Helps the poor without any cost to government
–Little impact on employment if demand for unskilled labor is relatively inelastic.
•Arguments against:
–In the long run, demand for unskilled labor is likely elastic, so minimum wage causes substantial
unemployment among the unskilled.
–Those helped by minimum wage are more likely to be teens from middle-income families than
low-income adult workers.
•
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Students will recall the effects of the minimum wage from Chapter 6, which covered price floors and
ceilings.
A few additional notes about the minimum wage:
Yes, it helps the poor at no cost to the government.  But there’s no such thing as a free lunch.
The minimum wage transfers income to workers from firms (or rather, their owners) and from
consumers, who will end up paying higher prices for goods made with unskilled labor.
Some people think of the minimum wage as a law that prohibits people from working if they aren’t
able to find a job that pays at least $7.25 an hour.

2.  Welfare
•Welfare:  government programs that supplement the incomes of the needy
–Temporary Assistance for Needy Families (TANF)
–Supplemental Security Income (SSI)
–Critics: such programs create incentives to become or remain needy; welfare contributed to the
rise of the single-parent family.
–However, the severity of such incentive problems is unknown.
–Proponents: inflation-adjusted welfare benefits fell as single-parent families increased.
•
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3.  Negative Income Tax
•Negative income tax:
–Tax system that collects revenue from high-income households and gives transfers to low-income
households
•The Earned Income Tax Credit (EITC)
–Is similar to a negative income tax.
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Example: Taxes owed=(1/3 of income) – $10,000
If earnings = $90,000, taxes owed = $20,000
If earnings = $60,000, taxes owed = $10,000
If earnings = $30,000, taxes owed = $0
If earnings = $15,000, taxes “owed” = –$5,000 (would receive $5,000 payment from government)
With a negative income tax, the marginal tax rate is as low for low income persons as it is for
high income persons.  This is in sharp contrast to other welfare-type programs, which take away
benefits as income rises, thus creating very high effective marginal tax rates for the poor.
I encourage you to check out Mankiw’s January 2014 column in the New York Times contrasting the
EITC and minimum wage.  It’s clear, well-argued, and short.  Find it here:
http://www.nytimes.com/2014/01/05/business/help-the-working-poor-but-share-the-burden.html

4.  In-Kind Transfers
•In-kind transfers: goods or services provided to the needy
–Examples: homeless shelters, soup kitchens
–Supplemental Nutrition Assistance Program (SNAP): Gives low-income families a plastic card that
can be used to buy food at stores
–Medicaid, government-provided healthcare for the poor
•An alternative: cash payments
–People - buy what they most need; but critics argue could be used for drugs, alcohol
•
25
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A cash payment would let workers buy whatever they think they most need.  Many economists believe
that the government cannot know what people need better than the people themselves.
Regarding the argument that the recipients could spend the money on drugs:
Suppose the choice is giving the person $50 cash or $50 worth of food.  If you give them $50 cash,
they could buy drugs.  If you give them $50 worth of food, they spend $50 less of their own money
on food, and can now spend this $50 on drugs.  The outcome is the same in either case.

Anti-Poverty Programs
and Work Incentives
•Assistance from anti-poverty programs
declines as income rises.
–The result:  Poor families face high effective marginal tax rates (exceeding 100% in some
cases!).
–Such policies therefore discourage the poor from escaping poverty on their own.
•One possible solution:  “Workfare,”
–System requiring people to accept government jobs while collecting benefits.
26
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As noted two slides above, the negative income tax is an exception to the second bullet point:
poor families do not face high marginal tax rates under the negative income tax, so it does create
a work disincentive.

Conclusion
•Poverty is one of society’s most serious problems.
•Governments can sometimes improve market outcomes.
–Public policy can help reduce poverty and inequality
•People face trade-offs.
–Policies designed to improve equity often sacrifice efficiency, so the proper scope of policy is
the subject of ongoing controversy
•
27
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Summary
•Data on income distribution show a wide disparity in our society.  The richest 20% of families
earn about ten times as much as the poorest 20%.
•Problems in measuring inequality arise from
in-kind transfers, the economic life cycle,
transitory income, and economic mobility.
•When these factors are taken into account,
the distribution of well-being is probably less unequal than the distribution of annual income.
28
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Summary
•Political philosophers differ in their views of the proper role of government in altering the
income distribution.
•Utilitarians believe that income distribution should maximize the sum of everyone’s utility.
•Liberals believe the government should aim to maximize the well-being of the worst-off person in
society.
•Libertarians believe the government should aim for equality of opportunity, not equality of
income.
29
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Summary
•Policies such as welfare, minimum-wage laws, negative income taxes, and in-kind transfers can help
the poor.
•Since financial assistance falls as income rises, the poor face high effective marginal tax rates,
discouraging them from escaping poverty on their own.
30
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