Chapter 9 - the distribution of income and wealth

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Chapter 9 The distribution of income and wealth

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Learning Objectives At the end of this chapter you will be able to Demonstrate knowledge of the distribution of household income and wealth in the UK Understand the various factors which influence the distribution of income and wealth and the possible costs and benefits of more equal and unequal distributions Demonstrate knowledge of the policies available to influence the distribution of income and wealth Discuss the economic consequences of such policies and be able to evaluate the various approaches Understand the difference between relative and absolute poverty and discuss the causes and effects of poverty Understand the effects of a national minimum wage upon labour markets

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Wealth This chapter outlines what is meant by income and wealth and what tends to determine who in society gets what Wealth is a stock of valuable assets Marketable wealth – wealth that can be transferred to others e.g. property, shares, art, bank deposits, cash etc Non-marketable wealth – wealth specific to a person that cannot be transferred e.g. life insurance, pension fund holdings The distribution of wealth is how the wealth is shared between the population Wealth tends to be more unequally distributed than income in the UK The table below shows that the UK’s distribution of wealth has become more unequal between 1986 and 2003 The wealthiest 1% own around 1/5 of the nation’s entire marketable wealth The least wealthy own 10% of the countries wealth

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Sources of Wealth Inheritance the main route to wealth Assets accumulate with each successive generation Saving Easier for high income earners Older people generally have more savings than younger ones for obvious reasons! Entrepreneurship Increasing incidence of people being self made Chance Instant millionaires with the national lottery or via premium bonds

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Wealth inequality Causes of wealth inequality Inheritance Wealthy families pass from one wealthy family to the next Marriage Wealthy people tend to marry wealthy people Income equality Higher earners are more able to save Chance If you have more wealth you might be more willing to take a risk

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Income Income is a flow of money to a factor of production. It is a flow of money generated and received over a period of time The majority of income comes from wages/salaries Other sources can be seen in the pie chart Examiner’s tip - Remember that income is a flow concept whilst wealth is a stock concept

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Measuring the distribution of income A method of measuring and illustrating the degree of inequality in the distribution of income and wealth is the Lorenz curve The horizontal axis measures the cumulative percentage of the population The vertical axis measures cumulative percentage of income The 45 degree line is the line of perfect equality (50% of the population would have 50% of the income) The actual share of income is shown by the curve ( the Lorenz curve ) The greater the decree of inequality the further the curve will be from the 45 degree line Country X is more unevenly distributed than country Y

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Measuring the distribution of income A statistical measure of the degree of inequality shown on a Lorenz curve is known as the Gini Coefficient It is the ratio of the area between the line and the curve and the total area beneath the 45 degree line ( a/(a+b) ) Perfect equality would give a ratio of zero and perfect inequality would give 1 The closer to 1 the more unequal the distribution of income Examiner’s tip – know how to interpret Lorenz curves and Gini coefficients

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Measuring the distribution of income The table below shows Gini coefficient data for the UK from 1980 to 2003 for both gross income and disposable income Both show reduced inequality between 1990 and 2003 The 2003 figures are considerably worse than in 1980

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The distribution of household income in the UK Income distribution has got more unequal in recent decades Reasons Reduction in top rates of income tax Large scale privatisation led to a rise in executive pay For low earners the real value of benefit fell The percentage of single parent families who are often not in work or only in part time jobs more than doubled Insert table 9.3 P99

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The causes of income inequality between households Impact of the state A pure free market system would lead to large inequalities Government intervention should narrow inequalities Wealth inequality Wealthier households will be able to earn more income such as dividends and interest from their asset holdings Household composition Individual households will contain different numbers in employment Levels of skills and qualifications Individuals with skills or qualifications that are in high demand will tend to earn more Lifetime earnings of graduate are often considerably higher than those of non graduates Differences in earnings Full time earns more than part time workers with opportunities to work overtime will earn more

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The geographical distribution of income The average disposable income per head has tended to be considerably higher in London than in the North East of England and Northern Ireland Similarly West and East Germany and the South and North of Italy have considerable differences in levels of income

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The geographical distribution of income Throughout Europe there are significant differences in income per header The low GDP per head are seen in the agriculturally dependent Mediterranean countries and the former Eastern Bloc The better off are the north and west of Europe

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Insert table 9.4 P100

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The geographical distribution of income Throughout Europe there are significant differences in income per headere are big Insert table 9.4 P100

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Reasons for geographical distribution of income Differences in industrial structure Unemployment rates The proportion of the population claiming benefits Deindustrialisation - move to service sector employment Regions in the UK that were historically dependent on manufacturing and heavy industry have suffered from lower incomes Qualifications have not been appropriate for changes (structural unemployment) Examiner’s tip - the fact that the widest variations in income per head can often be within individual regions is an important point often not realised by some students

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Government Policy Keynesians argue in favour of government intervention because market forces may not ensure an equitable allocation of income and wealth cause social division and an ‘underclass’ Others argue that income and wealth can act as signals providing important incentives and the market should be left alone Methods of intervention Taxation – government takes money and redistributes Progressive tax such as income tax The more you earn the higher the percentage of tax Regressive tax such as VAT Takes the same amount from everyone regardless of how much you earn making distribution of income more unequal

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Government Policy – methods of intervention Monetary benefits Means tested – available to only those that an prove their income is below a certain level Universal – available to everyone e.g. child benefit Direct provision of goods and services Provision of health care, education, school meals Free at point of consumption but funded through taxation Legislation and labour market policy E.g. national minimum wage, anti-discrimination legislation and government subsidising of training all serve to reduce income inequality Complete activity P102

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Poverty Economists discuss inequality in terms of absolute poverty and relative poverty Absolute poverty occurs when people’s income is too low for them to afford basic necessities such as food, shelter, warmth and clothing In the first quarter of 2010, there were around 65,000 unintentionally homeless households in temporary accommodation in Great Britain Absolute poverty is fairly rare in the UK and more common in less developed countries

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Poverty Relative poverty is when people are poor in comparison to others Using this definition there will always be relative poverty in society Someone that judged to be poor in the UK might be regarded as relatively rich in Somalia A rise in a country’s income will result in a fall in absolute poverty but relative poverty may rise if those on high incomes benefit more than those on low income There is no official measure of poverty The Joseph Rowntree Foundation (a charity set up for social research) define a household in poverty as one where disposable income is less than 60% of the UK median

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Poverty The labour government in 1997 established a target to eradicate poverty within a generation It regularly carries out a poverty audit which compares the government’s performance against a set of targets The targets include An increase in the proportion of working age people with a qualification Improve literacy and numeracy at age 11 Reduce the proportion of older people unable to afford to heat their homes properly Reduce the number of households with low incomes Reducing homelessness Reduce the number of children in workless households Groups that are more likely to suffer poverty are the elderly, the disabled, the sick, single parents, the unemployed and ethnic minorities

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Causes of Poverty Unemployment – workless households are especially prone to poverty Low wages Sickness and disability – dependency on sickness and disability benefits gives people relatively low incomes Old age – state benefits are still the major source of income for the elderly The poverty trap – getting higher wages will increase tax paid and may result in benefits being withdrawn Imperfect information – some people are just not aware of their entitlements to benefits or do not claim payments because of their fear of social stigma Read the case study and then complete the activity P104

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Government policy measures Policies used will depend whether the intention is to tackle absolute or relative poverty Absolute poverty may be addressed by introducing measures to raise the income of the very poorest groups in society Relative poverty implies using measures to reduce the gap between the rich and the poor Measures used National minimum wage to increase the wages of low income earners Cutting the bottom rate of income taxes – allows more disposable income for the lower paid and gives an incentive to work Tackling unemployment Training and education – increases productivity , improves long term job prospects and earning potential

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Government policy measures Exploiting trickle down effects – this is a controversial argument that higher spending by the rich will create employment for the poor Increasing benefits to increase the wages of low income earners Free market economists believe this will increase voluntary unemployment Keynesians think this will stimulate aggregate demand and create jobs The very poorest members of society dependent solely on sickness or disability benefits or the state pension may be unable to raise their standard of living in any other way Tax credits – rather than receiving cash benefits the benefit is received by reducing the amount of tax paid A supply side policy that creates an incentive to work

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Minimum Wage Legislation Minimum wage must be set above the market equilibrium wage rate The diagram shows that raising the minimum wage to W2 increases the supply to QS but reduces the amount of labour demanded to QD Free market economists argue that setting a minimum wage will distort the forces of supply and demand. This will increase firm’s costs and lead to higher levels of unemployment The extent of the unemployment will depend upon the relative elasticities of supply and demand

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Minimum Wage Legislation Some economists argue that the minimum wage may not necessarily lead to unemployment The low paid may have little bargaining power compared to their employers (especially if they are monopsonists) Setting a minimum wage could increase both the wage and employment level in such cases Increasing wages will increase overall demand for goods and services leading to an increase in demand for labour Those receiving higher wages may feel a boost in morale and become more productive If employers seek to gain higher returns from the now higher paid workers by providing more training productivity will increase further Increases in productivity and demand will shift the MRP to the right eliminating any excess supply of labour Examiner’s tip – this analysis is very similar to that of the introduction of a trade union Activity P 106