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CHAPTER
18
I
NCOME AND
P
OVERTY
18.1
Income Distribution
18.3The Economics of Discrimination
18.2
Income Redistribution
18.4
Poverty
T
he ultimate purpose of producing goods and
services is to satisfy the material wants of
people. Up to this point, we examined the
process by which society decides which wants to
satisfy in a world characterized by scarcity; we exam-
ined the question of how goods are produced; and
we examined the question of how society can fully
utilize its productive resources. We did not, however,
look carefully into two equally important questions:
For whom does society produce consumer goods
and services? Why are some people able to consume
much more than others?
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SECTION
18.1
Income Distribution
What happened to income distribution
since 1935?
How significant is income mobility?
How much income inequality exists
in other countries?
Are income distribution statistics accurate?
In many economies, some individuals will have high
income and others will have low income. How unequal
is the U.S. income distribution? And why do some indi-
viduals earn more than others? These and other ques-
tions regarding income distribution and poverty are
topics we will address in this chapter.
Income Distribution of the
United States, 2005
SECTION
18.1
E
XHIBIT
1
Group Household Income (Average)
Bottom Fifth $10,655
Second Fifth $27,357
Third Fifth $46,301
Fourth Fifth $72,825
Top Fifth $159,583
Median H
ousehold Income
MEASURING INCOME INEQUALITY
Exhibit 1 shows a breakdown of average annual family
income by groups of five (or quintiles): the bottom fifth,
the second fifth, the third fifth, the fourth fifth, and the
top fifth.
Exhibit 2 illustrates the changing distribution of
measured income in the United States since 1935. As
you can see in this table, the proportion of income
received by the richest Americans (top 5 percent)
declined sharply after 1935 but has been edging back up
since the 1980s. The proportion received by the poorest
Americans (the lowest 20 percent) remained virtually
unchanged since 1935. Most of the observed changes
occurred between 1935 and 1950, probably reflecting
the impact of the Great Depression and new govern-
ment programs in the 1930s, as well as World War II.
From 1950 to 1980, there was little change in the over-
all distribution of income. Two significant changes
occurred since the 1980s: The lowest one-fifth of fami-
lies have seen their share of measured income fall from
5.3 percent to 4.1 percent of all income, and the top
=
$46,326
SOURCE: U.S. Bureau of the Census, 2005.
one-fifth of families have seen their share of measured
income rise from 41.1 to 47.6 percent of all income.
THE LORENZ CURVE
Economist sometimes use a graphical representation
of the distribution of income called the Lorenz curve.
The Lorenz curve gives us a visual picture of the dif-
ference between the actual distribution of income and
perfect equality. In Exhibit 3, we see that along the
vertical axis we measure the cumulative percentage of
total income and along the horizontal axis we measure
the cumulative percentage of households. Moving
along the horizontal axis from the left-hand corner to
the right-hand corner, we move from 0 percent of the
households to 100 percent of the households.
SECTION
18.1
E
XHIBIT
2
Income Inequality in the United States
Lowest
Second
Third
Fourth
Highest
Highest
Year
Fifth
Fifth
Fifth
Fifth
Fifth
5%
1935
4.1%
9.2%
14.1%
20.9%
51.7%
26.5%
1950
4.5
12.0
17.4
23.4
42.7
17.3
1960
4.8
12.2
17.8
24.0
41.3
15.9
1970
5.4
12.2
17.6
23.8
40.9
15.6
1980
5.3
11.6
17.6
24.4
41.1
14.6
1990
4.6
10.8
16.6
23.8
44.3
17.4
2000
4.3
9.8
15.5
22.8
47.4
20.8
2003
4.1
9.6
15.5
23.2
47.6
20.5
SOURCE: U.S. Bureau of the Census, 2003.
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CHAPTER 18
SECTION
18.1
E
XHIBIT
3
The Lorenz Curve
The Lorenz curve is a graphical presentation of the dis-
tribution of income. The horizontal axis measures the
cumulative percentage of households and the vertical
axis measures the cumulative percentage of income.
The 45-degree line represents the line of perfect income
equality. The further the Lorenz curve is from the line
of perfect income equality the more unequal is the dis-
tribution of income.
100
80
d
Line of perfect
income equality
60
1980
40
c
2003
c
′
b
20
a
b
′
a
′
0
20
40
60
80
100
Cumulative Percentage of Households
Households
Income 1980
Income 2003
Cumulative
Cumulative
Cumulative
Point
Percentage
Percentage
Point
Percentage
Percentage
Point
Percentage
Percentage
a
Lowest 20
20%
a
5.3%
5.3%
a
4.1%
4.1%
b
Second 20
40
b
11.6
16.9
b
9.6
13.7
c
Third 20
60
c
17.6
34.5
c
15.5
29.2
d
Fourth 20
80
d
24.4
58.9
d
23.2
52.4
e
Highest 20
100
e
41.1
100.0
e
47.6
100.0
Along the 45-degree line—the line of perfect
income equality—the poorest 20 percent of the families
would receive 20 percent of total income, 40 percent of
the families would receive 40 percent of total income,
60 percent of the families would receive 60 percent of
total income, and so on. The curved line on this
graph—the Lorenz curve—represents the actual distri-
bution of income. The greater the distance between the
Lorenz curve and the 45-degree line—the greater the
amount of inequality. In Exhibit 3, we plot some of
the points that make up the Lorenz curve from U.S.
data for 1980 and 2003. For example, in 2003, we see
the poorest 20 percent of all households received
4.1 percent of the income, point a
SECTION
18.1
E
XHIBIT
4
Gini Coefficient
100
80
Line of perfect
income equality
60
Area B
40
Area A
20
Lorenz
curve
on the graph. The
first 40 percent received 13.7 percent (4.1 percent
+
0
20
40
60
80
100
the
first 60 percent of households earn 29.2 percent of the
income. At point d
9.6 percent), point b
on the graph. At point c
Cumulative Percentage of Households
the first 80 percent of households
receive 52.4 percent of the income or flipping it
around—the richest 20 percent receive 47.6 percent
of the income. Notice that the distribution of income
was more equal in 1980 because the Lorenz curve is
closer to the line of perfect equality.
In Exhibit 4, the shaded area A between the line of
perfect income equality and the Lorenz curve measures
Area A
Area A + B
G
=
G
= 0 perfect equality
G
= 1 perfect inequality
The Gini coefficient is found by dividing area A by area
A
B. A Gini coefficient, as it approaches 1, indicates
greater inequality.
+
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MODULE 4
the amount of income inequality. We derive a Gini coef-
ficient,
G,
by dividing area A by area A
Since 1950, the proportion of individuals who are
either very young or very old has grown, meaning
that in a relative sense, more people are in lower-
income age groups.
B.
G
varies
from zero to one. If
G
is zero, it represents perfect
income equality—that is, area A would be zero and the
Lorenz curve would overlap the line of perfect income
equality.
G
+
1 means perfect income inequality—if one
household earned all the income. That is, the closer
G
is
to 1 the greater the degree of income inequality; conse-
quently, area A becomes larger. In the Unites States, the
Gini coefficient was .403 in 1980 and .464 in 2003,
indicating that the distribution of income has become
less equal over the last 20–30 years.
=
Other Demographic Trends
Other demographic trends, such as the increased
number of divorced couples and the rise of two-income
families, also cause the measured distribution of income
(which is measured in terms of household income) to
appear more unequal. For example, in the 1950s, the
overwhelming majority of families had single incomes.
Today, many households have two breadwinners instead
of one. Suppose their incomes rise from $50,000 a year
to roughly $100,000; thus, these households move into
a higher-income quintile and create greater apparent
income inequality. At the same time, divorces create
two households instead of one, lowering income per
household for divorced couples; thus, they move into
lower-income quintiles, also creating greater apparent
income inequality.
ARE WE OVERSTATING THE DISPARITY
IN THE DISTRIBUTION OF INCOME?
Failing to take into consideration differences in age,
certain demographic factors, institutional factors,
and government redistributive activities have all been
identified as elements that influence income distribu-
tion data and may suggest that we might be overstat-
ing inequality.
Differences in Age
At any moment in time, middle-age people tend to
have higher incomes than both younger and older
people. Middle age is when most people are at their
peak in terms of productivity and participate in the
labor force to a greater extent than do the very old or
very young. Put differently, if every individual earned
exactly the same total income over his or her lifetime,
we would still observe some inequality at any given
moment in time simply because people usually earn
more in middle age.
Inequality resulting from this demographic dif-
ference overstates the true inequality in the lifetime
earnings of people. A typical 50-year-old male earns
nearly twice the income of a male in his early 20s
and nearly one-third more than workers over 65.
Government Activities
Some economists argue that the impact of increased
government activity should be considered in evaluat-
ing the measured income distribution. Government-
imposed taxes burden different income groups in
different ways. Also, government programs benefit
some groups of income recipients more than others.
For example, state-subsidized higher education seems
to benefit the high- and middle-income groups more
than the poor (because far more students from the
higher-income groups go to college), as have such
things as government subsidies to airports and airlines,
operas, and art museums. Some programs, though,
clearly aid the poor more than the rich. Food stamps,
school lunch programs, housing subsidies, Medicaid,
and several other programs provide recipients with
using what you’ve learned
Demographic Factors and Income Distribution
What impact do you think higher divorce rates will have on income
inequality?
As you would probably imagine, when one family with two incomes
turns into two families with one income each, more families will
report less income per family. Often, this situation causes one high-income
household to become two middle-income households in the data. However, the
most dramatic changes in the distribution of income may occur in households
with one male breadwinner. When the breakup occurs, the woman, who may
have little previous job experience, is forced to look for a job. If she receives cus-
tody of children, her search might be limited to part-time jobs or low-paying
jobs with flexible hours. Her new household income will undoubtedly be far
lower, also increasing measured income disparities between families.
Q
A
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CHAPTER 18
in-kind transfers.
In-
kind transfers are given
in the form of goods
and services rather than
money. When in-kind
transfers are included
in income distribution
data, many economists
conclude that they have
served to reduce levels
of inequality significantly from the levels suggested by
aggregate income statistics.
On balance, the evidence suggests that inequality
of money income in the United States declined from
1935 to 1950 and then remained rather stable until
1980. Since then, the distribution of income has
become less equal. However, if we consider age distri-
bution, institutional factors, and in-kind transfer pro-
grams, it is safe to say that the income distribution is
more equal than it appears in Exhibit 2.
experience, marital status, and household composi-
tion, as well as changes in earnings.
in-kind transfers
In-kind transfers are transfers in the
form of goods and services instead
of money. In-kind transfers include
food stamps, school lunch programs,
housing subsidies, and Medicaid,
among others.
WHY DO SOME EARN MORE THAN OTHERS?
Many reasons explain why some people earn more
income than others. Some reasons for income differ-
ences include differences in age, skill, human capital
(education and training), and preferences toward risk
and leisure.
Age
The amount of income people earn varies over their
lifetimes. Younger people with few skills tend to make
little income when they begin their working careers.
Income rises as workers gain experience and on-the-
job training. As productivity increases, workers can
command higher wages. These wage earnings gener-
ally increase up to the age of 50 and fall dramatically
at retirement age, around 65.
HOW MUCH MOVEMENT HAPPENS ON THE
ECONOMIC LADDER?
A study of income mobility during the decade of
1985–1995 found that less than 50 percent of indi-
viduals who began in the poorest quintile ended up
there a decade later, and almost 30 percent of those
in the poorest quintile moved up to the top three
quintiles. Although roughly 80 percent of individu-
als in the richest quintile were still there a decade
later, the research does not show that people
moving into the top quintile tended to stay there.
The middle quintiles appear to experence consider-
able movement up and down the income ladder.
Generational studies also suggest a considerable
income mobility—that is, incomes of fathers and
sons tend to be only slightly positively correlated. If
a father had lifetime income earnings 20 percent
above his generation, his son could expect to earn
income about 8 percent above his generation.
Virtually no positive correlation could be made
between the earnings of grandchildren and grand-
parents. In short, high-income and low-income earn-
ers will always be with us, but more than likely they
will be different people.
In sum, most Americans experience significant
fluctuations in their economic well-being from one
year to the next. According to a Census Bureau study
in the mid-1990s, about three-fourths of the popula-
tion see their economic well-being go either up or
down by at least 5 percent from one year to the next.
Economic well-being can be affected by changes in
personal and family circumstances, such as work
Skills and Human Capital
Some workers are just more productive than others
and therefore earn higher wages. Greater productivity
can be a result of innate skills or of improvements in
human capital, such as training and education. In
Exhibit 5, we see that college graduates’ average earn-
ings are 81 percent greater than high school gradu-
ates. The financial rewards for attending college are
higher than ever. Why is the gap widening between
skilled and unskilled workers? One possibility is that
increasing international trade over the last 30 years
prompted an increase in domestic demand for skilled
workers and a decrease in demand for domestic
unskilled workers (unskilled workers are relatively
cheap and plentiful in developing countries). That is,
the United States tends to import goods produced with
unskilled workers and export goods produced with
skilled workers. In addition, technological changes to
more sophisticated equipment can lead to an increase
in demand for skilled workers. Other workers, such as
star athletes and rock stars, have specialized talents
that are in huge demand, so they make more money
than those with fewer skills or with skills that are in
less demand.
Worker Preferences
Aside from differences in age, skills, education, and
training, people have different attitudes about and
preferences regarding their work. Because workaholics
(by definition) work longer hours, they earn more than
others with comparable skills. Some workers earn
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