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## 18.4 Review and Practice

### Summary

In this chapter, we looked at three issues related to the question of fairness: income inequality, poverty, and discrimination.

The distribution of income in the United States has become more unequal in the last four decades. Among the factors contributing to increased inequality have been changes in family structure, technological change, and tax policy. While rising inequality can be a concern, there is a good deal of movement of families up and down the distribution of income, though recently mobility may have decreased somewhat.

Poverty can be measured using an absolute or a relative income standard. The official measure of poverty in the United States relies on an absolute standard. This measure tends to overstate the poverty rate because it does not count noncash welfare aid as income. Poverty is concentrated among female-headed households, minorities, people with relatively little education, and people who are not in the labor force. Children have a particularly high poverty rate.

Welfare reform in 1996 focused on moving people off welfare and into work. It limits the number of years that individuals can receive welfare payments and allows states to design the specific parameters of their own welfare programs. Following the reform, the number of people on welfare fell dramatically. The long-term impact on poverty is still under investigation.

Federal legislation bans discrimination. Affirmative action programs, though controversial, are designed to enhance opportunities for minorities and women. Wage gaps between women and white males and between blacks and white males have declined since the 1950s. For black males, however, most of the reduction occurred between 1965 and 1973. Much of the decrease in wage gaps is due to acquisition of human capital by women and blacks, but some of the decrease also reflects a reduction in discrimination.

### Concept Problems

1. Explain how rising demand for college-educated workers and falling demand for high-school-educated workers contributes to increased inequality of the distribution of income.
2. Discuss the advantages and disadvantages of the following three alternatives for dealing with the rising inequality of wages.

1. Increase the minimum wage each year so that wages for unskilled workers rise as fast as wages for skilled workers.
2. Subsidize the wages of unskilled workers.
3. Do nothing.
3. How would you define poverty? How would you determine whether a particular family is poor? Is the test you have proposed an absolute or a relative test?
4. Why does the failure to adjust the poverty line for regional differences in living costs lead to an understatement of poverty in some states and an overstatement of poverty in others?
5. The text argues that welfare recipients could achieve higher levels of satisfaction if they received cash rather than in-kind aid. Use the same argument to make a case that gifts given at Christmas should be in cash rather than specific items. Why do you suppose they usually are not?
6. Suppose a welfare program provides a basic grant of $10,000 per year to poor families but reduces the grant by$1 for every $1 of income earned. How would such a program affect a household’s incentive to work? 7. Welfare reform calls for a two-year limit on welfare payments, after which recipients must go to work. Suppose a recipient with children declines work offers. Should aid be cut? What about the children? 8. How would you tackle the welfare problem? State the goals you would seek, and explain how the measures you propose would work to meet those goals. 9. Suppose a common but unfounded belief held that people with blue eyes were not as smart as people with brown eyes. What would we expect to happen to the relative wages of the two groups? Suppose you were an entrepreneur who knew that the common belief was wrong. What could you do to enhance your profits? Suppose other entrepreneurs acted in the same way. How would the wages of people with blue eyes be affected? 10. The Case in Point on Income Inequality in the United States versus continental Western Europe argues that people get, in effect, what they expect. People in the United States attribute success to hard work and skill, while people in Continental Western Europe attribute success to connections, luck, and corruption. With what set of views do you agree? Explain. 11. The Case in Point on welfare reform in Britain versus that in the United States argues that the British system, before it could be adopted in the United States, would require a change in attitudes in the United States. What sort of change would it require? Do you prefer the British approach? Why or why not? 12. James Heckman of the University of Chicago advocates a program of early intervention targeted at low income families. What are the advantages of such an approach? The disadvantages? 13. Give five reasons that the income distribution in the United States has become more unequal in the last several decades. Do you regard this as a problem for society? Why or why not? 14. Suppose that all welfare aid were converted to programs of cash assistance. Total spending on welfare would remain unchanged. How would this affect the poverty rate? Why? ### Numerical Problems 1. Here are income distribution data for three countries, from the Human Development Report 2005, table 15. Note that here we report only four data points rather than the five associated with each quintile. These emphasize the distribution at the extremes of the distribution. Poorest 10% Poorest 20% Richest 20% Richest 10% Panama 0.7 2.4 60.3 43.3 Sweden 3.6 9.1 36.6 22.2 Singapore 1.9 5.0 49.0 32.8 1. Plot the Lorenz curves for each in a single graph. 2. Compare the degree of inequality for the three countries. (Do not forget to convert the data to cumulative shares; e.g., the lowest 80% of the population in Panama receives 39.7% of total income.) 3. Compare your results to the Lorenz curve given in the text for the United States. Which country in your chart appears closest to the United States in terms of its income distribution? 2. Looking at Figure 18.11 "Prejudice and Discrimination" suppose the wage that black workers are receiving in a discriminatory environment, WB, is$25 per hour, while the wage that white workers receive, W, is $30 per hour. Now suppose a regulation is imposed that requires that black workers be paid$30 per hour also.

1. How does this affect the employment of black workers?
2. How does this the wages of black workers?
3. How does this affect their total income? Explain.
3. Suppose the poverty line in the United States was set according to the test required in the European Union: a household is poor if its income is less than 60% of the median household income. Here are annual data for median household income in the United States for the period 1994–2004. The data also give the percentage of the households that fall below 60% of the median household income.

Median Household Income in the U.S. Percent of households with income below 60% of median
1994 40,677 30.1
1995 41,943 30.4
1996 42,544 29.9
1997 43,430 29.1
1998 45,003 27.8
1999 46,129 27.1
2000 46,058 26.4
2001 45,062 27.4
2002 44,546 27.8
2003 44,482 28.3
2004 44,389 28.3
1. Plot the data on a graph.
2. Is this a relative or an absolute definition of poverty?
3. Why do you think the percent of households with incomes below 60% of the median fell from 1994 to 2000 and has risen since?
4. Discuss the measurement issues involved in the data you have presented.
5. Discuss the elements of the system of counting the incomes of low income people in the United States and explain how it relates to your answer in (d).
4. Consider the following model of the labor market in the United States. Suppose that the labor market consists of two parts, a market for skilled workers and the market for unskilled workers, with different demand and supply curves for each as given below. The initial wage for skilled workers is $20 per hour; the initial wage for unskilled workers is$7 per hour.

1. Draw the demand and supply curves for the two markets so that they intersect at the wages given above.
2. How does increased demand for skilled workers and a reduced demand for unskilled workers affect the initial solution?
3. How is the Lorenz curve for the United States economy affected by this development? Illustrate the old and the new Lorenz curves.
4. Suppose there is an increase in immigration from Mexico. How will this affect the two markets for labor?
5. Suppose Professor Heckman’s recommendation for early intervention for low income children is followed and that it has the impact he predicts. How will this affect the two markets today? In 20 years? Illustrate and explain how the demand and/or supply curves in each market will be affected.
6. What would the impact of the change in (d) be on the Lorenz curve for the United States 20 years from now?
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