Income Distribution and
Poverty
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Income Distribution and Poverty
Income Distributions and Scarcity
Robert S. Rycroft,
I begin my discussion by asking students how much income
"typical" (defined as 4‑person if someone asks) American
families need to be comfortable. After averaging their estimates, I reveal what
the average
Further, most students do not have a clear idea of where they stand in the distribution of income. Ask your students to estimate what percentage of all families had incomes lower than theirs for the previous year. After showing them the actual data, ask how many underestimated the number of families they were richer than. Most will have underestimated.
Todd Steen,
In order to emphasize the point that an efficient situation is not always equitable, use the following example. After discussing the concept of efficiency, poll the students as to whether they think more concern should be given to efficiency or equity in the process of distributing goods. This usually leads to a good discussion focusing on the merits of both positions. After that distribute a piece of penny candy (different kinds) to each member of the class. and then allow them to make trades. This highlights the fact that once all the trades are made, the situation is considered efficient, but that the final distribution depends on initial "endowments." Then distribute additional pieces of candy to a selected group in the class (dark-haired students, for example). Again allow all possible trades to be completed. This highlights even more clearly how a situation that is efficient (as well as Pareto optimal) is not necessarily equitable. This exercise can bring to the forefront issues of equal opportunity and discrimination if the professor desires. Bring enough candy for everyone!
Donald M. Peppard, Jr.,
The income distribution game works in classes of 40 students or more. The instructor chooses four students (or 10 percent of the class) who own the rights to produce quiz results. These four student owners may hire as many students as they like to take quizzes for them. Students work in groups of four or five, and owners may hire enough students to operate more than one "plant." Owners do not work; they supervise the groups of workers that take the quizzes. There are usually four quizzes during the semester; the more quizzes the better the game works. The students who are hired negotiate their wages in advance of taking the quizzes; owners receive the points that the quiz earns and pay their workers out of the quiz earnings, retaining any residual profits. Owners may hire and fire employees at will, and students may organize unions, too.
After each quiz is taken, graded, and returned to owners, the class discusses the distribution of "income." Students who were unemployed receive some level of unemployment benefits (usually 50 percent of the average wage), and students who are unemployed for 2 quizzes receive a lower level of welfare benefits (determined by the class). Transfer payments are funded by taxes levied on the owners and the employed population (the form of taxes is discussed and determined by the class).
An owner who loses money, i.e., whose quizzes are not good enough to pay his workers and yield profits, can be bought out by another owner who borrows from future earnings; the new owner operates as the owner of 2 or more "plants." Students use their final totals of points to buy 20 percent of their course grades; grades A through F can be bought by the top through bottom quintiles of the income distribution, respectively. (This use of the points requires early and clear understanding of the grade jeopardy students may be in, but it provides an important incentive to take the game seriously.)
The game can be used to illustrate several aspects of income distribution: wage setting, tax and transfer structures, ownership advantages, incentives, and the effect of unions.
Miscellaneous Criteria for Distributing Income
Forrest McCluer,
Perhaps one of the more difficult concepts to convey in economics is the importance of income distribution in allocation decisions. Individuals rarely experience a drastic change in their families' relative income. The introduction to income distribution described here is an effort to have students experience a simulated change in income distribution.
First, begin by conveniently coming
to class with a shortage of handouts which describe the income distribution in
the
So the search is on to find another criteria upon which to base this allocation decision. A number of criteria could be used. I.Q. or grade point average could be used. However, these involve problems of credibility in measurement and may result in an increasingly skewed income distribution. I have used shoe size (measured strictly according to the male scale), as the basis of the allocation decision. This has worked out well, although height or weight could serve the same function. I start out at size twelve and work down until there are as many students with a specific shoe size or larger as I have handouts. If only 5 percent of the class get a handout then the shoe size that clears the market would be comparable to the income that would put a family into the top 5 percent of all families with income. In 1980 this amounted to $54,060.
There are a number of comments or situations that are bound to arise with such an allocation mechanism. For example, a petite female may say that she has a size 10 1/2 shoe. Obviously, she must be experienced in income tax evasion, welfare fraud and other comparably dubious deeds. Invariably, someone says that this system of allocation is `unfair'. This opens up a number of topics for discussion. First, one would inquire of those with big feet whether they thought the system was fair. Usually, they would say yes. This response would be consistent with wealthy families who would advocate the maintenance of the status quo.
Women would be particularly upset about this allocation system because they typically have smaller feet than men and would get few, if any, handouts. Some women may suggest that there ought to be some adjustment factor so that the distribution of women's shoe size would be comparable to the distribution of men's shoe size. While small‑footed men and women would still be excluded from receiving scarce commodities, such a proposal may receive tacit approval from the class for being a little more `fair'. Some interesting insights can be gained by tracing this shoe size analogy back to income distribution at this point. Should groups of people who, on average, have smaller feet (income) than other groups of people get a special discount so that their smaller feet (income) would not be a systematic disadvantage? Such a proposal could be translated into a program where blacks and women, who have on average less income than whites and males, respectively, would pay lower prices (or receive income subsidies) for goods than whites and males. Such a proposal unfailingly provokes some lively discussion.
The next objection to the shoe size distribution mechanism usually concerns the ability to change one's income but the inability to change one's shoe size. You can counter that people not only inherit their shoe size from their parents but also, on average, their parents' socio‑economic class. However, to suggest that there is, on average, little intergenerational mobility between socio‑economic classes is an invitation to angry class reactions. To an audience indoctrinated with the `American Dream', individuality, free will and Horatio Alger stories, such a suggestion would be tantamount to blasphemy. By stepping quickly to the side one could call upon the fallacy of composition concept to demonstrate the same point (although empirical evidence is available on intergenerational socio‑economic mobility). While one person could start out in life poor and become a millionaire, it does not follow that everyone who starts out poor in life can become a millionaire.
Before concluding this exercise in income distribution, you can suggest that there are other mechanisms for making distribution and allocation decisions other than on the bases of price and income, or shoe size for the matter. Resources could be shared, for example. However, sharing represents communism, and we can't have that.
Giving Real Meaning to the Poverty Level
Thomas E. Duston,
When students are introduced to the concept of the poverty level, it is generally viewed as a boring set of tables showing that poor people aren't really so bad off. Incomes of $10,000 or $12,000 per year seem quite a lot to students who view themselves as getting by on a few thousand a year, as many of them do.
To help get the students understand the meaning of poverty level income we go through a class exercise whereby we actually develop an annual budget for a typical student in class. Usually this is a single person but this illustration would also work with married learners. One must estimate each budget item, such as room, board, recreation, travel, clothing, etc., being careful not to include items which would be part of the investment in education such as tuition and books. Even with conservative expenditure estimates, which some students view as unacceptably low, it is quite easy to get an annual figure in the $8,000 to $9,000 range. All of a sudden the students understand the meaning of a $7,000 poverty level for a single individual!
This exercise meets several objectives, even in a large lecture class. First, it gets the students involved in their own learning, as a great deal of enthusiasm is generated during the estimating of the budget items. Second, it is a device which makes the numbers in a table come to life. And third, for most students it explodes one of their untrue precepts; that is, that living at the poverty level is no big deal. They are impressed.
Rarely have I found a device which so dramatically improves my ability to help students really understand and appreciate a particular measure of social welfare.
Ralph T. Byrns
Court cases are being brought to augment the doctrine of `equal pay for equal work' with a principle of `equal pay for comparable work'. The advocates of this position point to female secretaries who receive lower wages than male mechanics, where the mechanics work the same hours and have no more (and in some cases, less) education and training than the secretaries. Another example is nurses with college educations who are paid less than hospital janitors. Try the following argument on your students:
"Suppose that secretaries must be paid as much as mechanics. A profit maximizing employer will react to such a rule in the same way that a firm reacts to a higher minimum wage. Office procedures will be automated (through, e.g., word processing equipment), and the net result of the rule will be that many women who would like secretarial employment will be without jobs. Now suppose that nurses must be paid as much as other people with college degrees who work in hospitals (e.g., accountants or administrators). Nurses will be disemployed, and many of their functions will be performed by less well trained aides or technicians.
"Should those who practice music for years and attain graduate degrees in music receive the same incomes as medical doctors? Should training and education be dominant in determining incomes? If so, the signaling function of wages will be lost and people will follow the careers that they enjoy without regard to the rest of society's demands.
"The solution for women who want higher pay is for them to become engineers, or lawyers, or architects, or doctors (but not college professors). The doctrine of `equal pay for equal work' is justified; the idea that people should be paid equally for `comparable' work is not, and will only create: (a.) more of a government bureaucracy because one will be needed to review the cases brought by people who believe themselves underpaid; (b.) unemployment among women in typical `female' occupations; (c.) inefficiency and losses of production. "
This current issue may heat up in the very near future. We promise that if you advance the preceding argument (again, regardless of whether you believe it or not), your classroom discussion will be very lively.
Income Redistribution: Disincentive Effects
Russell Shannon,
It is often suggested that income redistribution schemes reduce the size of the economic pie, since both the people taxed to provide financing for welfare programs and those who receive the benefits may be discouraged from working. Suggest to your students the following experiment: After your next exam has been graded, each student above the median grade will have 30% of their `surplus' points removed from their exam grades; these points will then be redistributed to students with grades below the median, so that they receive roughly 30% of their grade `impoverishment', relative to the average grade. Ask the students (who by now may be wearing expressions of utter dismay on their faces) what they think will happen to the total amount of studying and the total amount of points made as a result of this scheme.
Reflecting on Income and Effort
Ralph T. Byrns
Suggest to your class that some people work only if they are
paid handsomely for doing so; others will not work more than a minimal amount
even if rewarded for their efforts, or punished for the lack thereof. Still
other people seem to be "workaholics", who labor diligently at any
task regardless of the monetary incentive structure; their work motivation
tends to be internal. Ask your class which of these groups they perceive as falling
into which income classes in the
"Many of those who make high incomes (e.g., doctors) may argue strenuously that they are too heavily taxed. But if these people are primarily self motivated, much of their income is economic rent and this heavy taxation may have little effect on their work effort. Thus, a large part of their income can be distributed to the poor without affecting total production in the economy."
An extension of this argument is to suggest that many of the people who have huge incomes are operating in negatively sloped (backward‑bending) ranges of their labor supply curves. If these people are taxed more heavily to finance income redistribution, it is conceivable that to maintain their country club memberships, two Mercedes, etc., that they would work even harder than they do.
On the other hand, there is considerable debate about whether most welfare recipients could work if work were available. Data published regularly by the Department of Health and Human Services suggests that most of those on welfare are minor children, the very old, or the disabled. This may be especially so given recent attempts to reduce welfare roles. Ask students whether people should suffer from very low incomes when they are incapable of changing their own circumstances in a major way. Follow up with a question about what this supply side policies that are designed to replace welfare with "workfare".
Continuing in this vein, you might discuss the position advanced by many supply-siders that income redistributions reduce the incentives to work of both those from whom income is taken and those who receive welfare. Point out that this argument is valid whenever the substitution effect of changes in wage rates is negative for those who are taxed (you will need to explain what this means in this context), and the income effect on the demand for leisure is positive for welfare recipients.
NOTE: Art Laffer has attempted to rebut some of the preceding lines of argument made in the preceding paragraph with the point that if high income people work harder when more heavily taxed because many are operating in a negatively sloped portion of their labor supply curve, the income effect of transfer payments on welfare recipients will still result in less labor being supplied in the aggregate.
Roy B. Levy,
To introduce applications of consumer theory, I develop an anecdote that serves to analyze the effects of a voucher scheme. At a social event I recently attended, each attendee received three marbles. Although one could not trade marbles for cash, each marble entitled the holder to one cocktail. A cash bar applied to anyone who chose to consume more than three cocktails.
To develop the effects of the voucher scheme for classroom use, one can depict consumptive optima for Consumers X and Y (Figure 31‑1). Consumer X views cocktails as economic bads. Consumer Y views cocktails as economic goods. In Figure 35‑1, A represents all other goods and C represents cocktails. Under the voucher scheme, Consumer X maximizes utility along budget constraint DEF at D. Consumer Y maximizes utility along budget constraint LMN at O.
Figure 31‑1
One can then discuss the effects of modifications of the voucher scheme. One possibility involves the sale of three marbles by Consumer X to Consumer Y. As a result of the sale, Consumer X realizes a new utility maximum along budget constraint GH at G. As a result of the purchase, Consumer Y achieves a new utility maximum along budget constraint PQR at S. The increase in utility of both consumers from U1 to U2 assumes the following: (1) Consumers X and Y agree on a price below the market price of cocktails; and (2) all goods, except cocktails for Consumer X, are either normal or superior goods. One can alter Figure 31‑1 to analyze other modifications of the voucher scheme, e.g., cash reimbursement of marbles.
The above anecdote has served as a successful springboard for analyses of the potential net benefits of alternatives to voucher programs. Examples include: 1) private education tuition tax credits vs. universal public education vouchers; 2) targeted tax relief vs. the food stamp program; and 3) child care tax allowance vs. a governmental child care voucher system.
Perceptions
of the Distribution of Income in the
Michael Vaughan,
Students normally enter the principles course with many misconceptions concerning income distribution. To help students come to grips with the actual distribution of personal income, I ask students to guess how much a family would have to earn to be in the upper 50 percent of income earners in the United States. I emphasize the nature of this question by stressing that the hypothetical family would be richer than one half of all households in the United States. Students normally guess amounts ranging from $60,000 to $100,000. I then tell students that in 1984 a family income of $26,430 would exceed the income of 50 percent of all households in the United States. I continue the exercise by asking students to estimate the level of household income necessary to be in the top 1 percent of the income distribution. Once again, student estimates are normally much greater than the actual figure. This exercise startles most students, and it piques their interest for a more complete discussion of income inequality.
Notes: