Eaton Micro 6e Ch12

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© 2005 Pearson Education Canada Inc.12.1

Chapter 12

The Distribution of Income




The Lorenz Curve

The Lorenz Curve measures income distributionby ranking individuals by income and thenplotting their cumulative number against the

cumulative percentage of income received. A perfectly equal distribution of income would

be 45 degree line.

The more unequal the distribution of income,the more “bowed” the Lorenz Curve becomes.




Figure 12.1 A Lorenz curve




Product Exhaustion

If any measure of productivity is to serveas a distributional principle, it must fulfillthe product exhaustion criterion.

The product exhaustion criterion statesthat if owners of all resources receivewhat their resources produce, then the

individual shares of the total product piemust sum to 1.




Product Exhaustion

Consider a firm in long-run equilibriumusing 2 inputs to producing y* of output.

The value of the firm’s output (py*), isthe sum of the firm’s input payments(w1z1*) + (w2z2*).

If, at the firm level, the product is justused up, the two must be equal.

Therefore: py*=w1z1*+w2z2*




Product Exhaustion

Re-writing gives:

p=(w1z1*+w2z2*)/y=LAC(y*)

This equality follows from the price beingequal to minimum average cost in long-run perfectly competitive equilibrium.

The product-exhaustion criteria istherefore satisfied in a competitiveequilibrium.




The Redistributionist Principle

The redistribution principle is at oddswith the productivity principle.

Redistributionists find significanteconomic inequalities unacceptable.

They argue that wealth and incomein the real world should beredistributed from rich to poor.




Redistribution of Income

Regardless of why income distributiontakes place, some methods are betterthan others.

Many of the schemes inevitable result ina conflict between equity and efficiency.

The challenge is to design economic

institutions that achieve the desireddistribution and minimize the resultinginefficiencies.




Minimum Wage Legislation

The real question regarding minimumwage legislations is, “do they help theworking poor?”

- Does it achieve the desired redistributionof income?

- Are workers in the industry better-off?

- Whose income falls to make up for therise in minimum wage income?

- Is inefficiency an invariable side effect?




Figure 12.2 Minimum-wage legislation

in a competitive labour market





In a competitive market, inefficiencyis a necessary by-product of aneffective minimum wage law.

As labour services are no longer putto there most productive uses, eitherunemployment or underemployment

will signal that inefficiency.




Figure 12.3 Minimum wage and a

monopsonist’s marginal factor cost




Monopsonistic Labour Markets

Once a minimum wage is brought into amonopsony, the marginal factor cost willchange.

From Figure 12.3, if the monopsonist hires anamount of labour less than z’, its marginalfactor cost is w’.

If it hires beyond that point, its marginal factor

cost is segment BC of its original marginalfactor cost function because it can hireadditional workers only at a wage rate higherthan w’.




Figure 12.4 Minimum wage and monopsony




Minimum Wage and Monopsony

Does a minimum wage increase workersincomes?

Yes, if wage is not higher than w”’ someworkers are better off and none worse off

because:- At w* or below, it has no effect.

- At above w* but below w’’’ workers hiredbefore the introduction of the minimum

wage will paid more and new workers will behired at the new (minimum) wage.

- If the rate is w”’, no new workers are hired,but existing workers will be paid more.





The attractiveness of minimum wage legislationdepends upon whether labour markets arecompetitive or a monopsony.

Empirical evidence suggests that labour

markets covered by minimum wage laws arecompetitive, and the laws are problematic.

Workers who remain employed are better off.Its is not clear at whose expense the gain is

made (we do not know who pays). By creating un/underemployment the

legislation will hurt some people it wasintended to help.




Figure 12.5 Title




Figure 12.5: The Underemployment

Equilibrium

Imposing the wage floor means that someworkers are reallocated from sector 1 tosector 2 and as a result the wage rate in

sector 2 falls. Because $6 is less than the competitive

wage of $9, workers are not allocated totheir most productive jobs.

The wage floor yields an equilibrium withunderemployment.




Figure 12.6 Wage floors and search

unemployment in a two-sector model




Figure 12.6: The Unemployment

Equilibrium

The equilibrium wage in sector 2 of theunderemployment model is lower than thesector 2 wage of the unemploymentmodel.

In unemployment model, some non-unionized workers will leave sector 2 tochase union jobs in sector 1.

As a result, the smaller number on non-unionized workers remaining in sector 2will earn a higher wage.




Figure 12.6: The Unemployment

Equilibrium

Two sources of inefficiency arise inthis model:

1. There is unemployment equal to uin quadrant I of Figure 12.6.

2. The allocation of workers who areemployed is inefficient because thewage floor exceeds the equilibriumwage.




The Efficient Transfer Mechanism

Although the lump-sum mechanismis efficient, it is not practical.

There is no systematic way of

choosing a target indifference curveor identifying individual preferencesand budgets to pinpoint recipients.

As a result, maintenance policies areformulated in terms of income ratherthan utility (income-maintenance).




Income-Maintenance Programs

Income-maintenance programs havethe objective of raising the income of anyone below a targeted level of

income, up to that level. In practical income-maintenance

schemes, the amount of the incometransfer is conditional upon theamount of the recipient’s earnedincome.




Figure 12.8 An inefficient

income-transfer mechanism




Figure 12.9 A negative income tax

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