A focal point of common interest among social scientists, policy makers, and economists is whether the middle class is disappearing given the evidence of a widening gap between the rich and the poor on socioeconomic status. Income distribution is a topic in economics that warrants further attention. One of the formidable challenges in this field is to achieve an equitable, or more equal, distribution of income, in the absence of parameters that define exactly what degree of inequality is acceptable. Furthermore, consensus may be difficult to attain until there is an agreement on which underlying factors determine a worker's wages. A philosophical divide runs deep as one group of economists subscribes to the view that a self-regulating labor market determines wages and an opposing group holds the view that labor unions and other organizations create market imperfections and therefore a need for governmental interventions. Putting those philosophical foundations aside, there are some important tools available to analysts as they seek to understand and describe in a quantifiable manner trends and international comparisons with respect to income distribution. The Lorenz curve expresses the relationship of a percentage of income to a percentage of households and the Gini coefficient accompanies the curve as a measure of the degree of income equality. Though those tools have some limitations, this essay provides some methods and statistics that readers can use to compare Europe and the United States and examine domestic trends. The primary purpose of this essay is to provide readers with basic information for initiating and pursuing their own inquiries and for achieving a better understanding of income distribution and redistributive policy complexities.
Keywords Demand; Demand Schedule; Distribution of Income; Equilibrium; Equilibrium Price; Equilibrium Quantity; Gini Coefficients; Gini Index; Income Inequality; Labor Market; Law of Demand; Law of Supply; Lorenz Curve; Marginal Revenue; Market; Market Failure; Output; Price; Price Controls; Producers; Quantity Demanded; Quantity Supplied; Resource Market; Revenue; Supply; Supply Schedule; Transfer Payment
Economics: Income Distribution
Undergraduate students in economics courses learn quite early about poverty levels and income dispersions. Most undergraduate textbooks and courses introduce the notion of an equitable distribution of income alongside a few other goals for a nation's economy. Absent is a consensus on what precisely defines an equitable income distribution for any given country; a common interpretation is that equity improves with a movement toward equality over time and/or when one country exhibits a distribution closer to equality relative to other countries. Eventually, that basic information paves the way for learning how government policies attempt to redistribute income and provide relief to the poor.
Let us begin by considering some facts about income distribution. In 2002, 50 percent of the total income in the United States went to the richest 20 percent of households and 3 percent went to the poorest 20 percent; keep in mind that households differ in size and those differences lead some analysts to focus instead on individuals. Furthermore, income inequality in the United States has grown since the 1960s. In 1967, 44 percent of income went to the richest fifth of households and 4 percent went to the poorest fifth. A comparison of those two years reflected a growing inequality and suggested that the middle class might be falling to the wayside as the richest got richer and the poorest poorer. A further comparison of the years 1979 and 2007 shows that the top 1% of earners experience income growth of 275%, whereas the bottom 20% of earners saw household income growth of only 18% (Serwer, 2013). Frequently, income distribution of a given country becomes a major topic in discussions about the socioeconomic welfare of its citizens.
Income distribution essentially provides a reference point for comparing welfare and poverty across nations and over time. Casting issues of justice and fairness aside for the moment, one of the reasons many scholars and students find this topic appealing and/or fascinating is the challenges associated with securing a more equitable, or ideal, distribution of income while stopping far short of arguing for equality in the distribution of income. Consistent with that line of reasoning, Horn (1993) prefers to interpret perfect equality as a benchmark knowing it is perhaps the best target available until scholars and policy makers establish a socially-acceptable normal level of income equality.
It is uncertain whether a normative measure will ever become a reality. Nonetheless, there exists a real need for readers to become familiar with two types of income distribution:
- Personal distribution;
- Functional distribution.
Personal distribution explains that individual abilities, characteristics, and preferences and possibly discriminatory hiring practices determine income. Functional distribution describes income as a payment to resource owners. Each resource receives income in the form of a payment for its use in production as follows: Labor receives wages, capital receives interest, land receives rent, and the business owner or entrepreneur who assembles those resources receives profit. This essay's primary interest resides with the personal distribution, but a basic model depicting the flows of money and quantities and referencing these functionalities appears later.
Additional complexities make their way into the analysis as one enters the issue of whether an equal distribution of income removes incentives for entrepreneurs. Those individuals assemble the resources necessary in producing goods and services. In the absence of those incentives and presumably fewer producers, consumers may find themselves facing fewer choices, smaller quantities, and higher prices in the marketplace. Some downstream consequences of those outcomes include fewer workers, higher unemployment rates, and lower incomes. As the reader might guess, the topic can become quite complex especially when philosophies on income determination and redistribution are brought into the mix.
A natural extension of this topic delivers readers onto a discussion of methods for redistributing income after they get a better sense of whether income distributions are equitable or inequitable. As its major focal point, this essay avoids many complexities by limiting its breadth and depth. Consequently, the reader will receive practical guidance on measuring and interpreting income distributions in addition to brief coverage of some economic perspectives. We will return later in this essay to a discussion of whether wages are the result of this concept, market structure, or a combination of both. In addition, this essay offers some key explanations for income inequality and it presents a common measure that helps analysts to assess the degree of inequality in the distribution of income. Discussions of those components follow the next section, which outlines some economic concepts that facilitate mastery of the income distribution topic.
Conceptual Foundations: Markets, Employments
Economics as a field of study contains two divisions. Macroeconomics is the branch that focuses on the economy as a whole and microeconomics examines the interactions between firm actions and consumer behaviors as they pursue exchanges in a market. Physical quantities of resources, goods, services and monetary payments flow between consumers and households as they interact through their marketplace transactions.
There are two sectors (households and businesses) and two markets (goods and resources) that comprise the circular flow model. Readers are encouraged to consult their textbooks for a graphical presentation of the model. It depicts the business sector using resources such as labor, land, and capital to produce goods and services for the household sector. Each receives a physical quantity of something and issue money in payment. Respectively, businesses pay wages, rent, and interest as they acquire those resources. Households are the source of those quantities and they purchase goods and services issuing dollars from their personal incomes in exchange for an item.
Both markets contain a demand component and a supply component. In the goods market, a household demands quantities of items and pay the price for each item bought; businesses supply those quantities and receive revenues from each item sold. In the resource market, specifically the labor market, households supply quantities of labor and receive incomes in payment for those quantities; businesses demand quantities of labor and pay wages for them. More precisely, consumers are willing and able to purchase a specific amount at any given price according to a demand schedule that records various combinations of prices and quantities. Likewise, businesses are willing and able to provide a specific amount at any given price according to a supply schedule. Curves or lines in a graph, which are available elsewhere, display those schedules.
Whether one examines the resource market or the goods market, a direct relationship exists between price and quantity according to the Law of Supply; that is, large quantities will be supplied at high prices and small quantities at low prices. An inverse relationship exists between price and quantity according to the Law of Demand; in other words, large quantities will be in demand at low prices and small quantities at high prices. The intersection of the supply curve and the demand curve is the point of equilibrium for price and quantity, which establishes the market price.
Sometimes there are distortions or imperfections in the market that affect price. Occasionally, quantity demanded is higher or lower than quantity supplied resulting in prices temporarily above or below the market price. Usually, the price will adjust tending toward an equilibrium point. However, government may intervene...
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