Equality vs efficiency in market economies - IB Economics

Equality Vs Efficiency in
market economies
Command Economy: Society’s scarce resource
allocation done by visible hands of the state.
Achieved relative equality in the distribution of Nation’s
Income
Reduced Long-run economic growth and overall std of
living
Socialist Economy: Everyone equal – equally poor
Modern-market economy: Vast personal health and
unfathomable high income avail to most skilled and well-
capitalized members of the economy
Households -> Higher HC -> enjoy higher levels of
Income.
Truly free market economy -> Inc Income is an incentive
of Inc HC.
Work harder & Inc Std of Living.
3/21/2020
CPS PUBLIC SCHOOL - IB Economics
-MONICA

Equality vs Efficiency: The Big
Trade-off
 Inc in Avg Income -> Unequal
distribution of Income Inc
 UNFAIR: Some Households earn
more than others based on skill level
and education
 FAIR AND EQUAL economic system:
mkt s/m. More no of ppl out of poverty
line.
Gap between rich and poor Inc. Avg
household richer3/21/2020
-MONICA

Equity in the distribution of
Income
 Equity -> Fairness in economics
 Afford to pay high taxes -> Pay high
taxes
 More equitable – less in equality
 Free mkt economy is more equitable
than command economy
 Self interest to inc education &
professional growth
3/21/2020
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Indicators of Income Equality/
Inequality:
 The Lorenz Curve:
•Graphical representation of
Income inequality within a nation
•Shows the cumulative income
earned by each quintile (20%
chunks) of a nation’s population
•Vertical Axis-> Cumulative
percentage of Total Income
•Horizontal Axis -> Cumulative
percentage of Total population
3/21/2020
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 Line of Equality -> Every Quintile of
Population earns equal proportion of Income.
 Assumption: Entire Income of a nation is
earned by entire Nation’s population
 Total Income earned by Nobody -> Nothing
 No Rich/ Poor -> Total Equality
 No country has Income Equality
3/21/2020
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Lorenz Curve Illustration
(UK.)
Population Income (2012) Cumulative Income
(2012)
Poorest 20 % 7.51 7.51
Second 20 % 12.29 19.8
Third 20% 17.04 36.48
Fourth 20% 23.1 59.94
Fifth 20% 40.07 100
80% of the Population enjoy 60% of The Total
Income
Remaining 40% is enjoyed by the Top 20% or
the Richest 20% of the Population
3/21/2020
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 Takeaways:
 Income Equality
◦ Greater Equality -> Lorenz Curve closer
to line of equality
◦ Lesser Equality -> Lorenz Curve farther to
line of equality.
3/21/2020
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The Gini Co-Efficient:
 Quantify the Degree of Income
Equality.
Area above a Country’s Lorenz
Curve and below the Line of Equality
Total Area below the Line of Equality
= Area (A)
Area (A+B)
3/21/2020
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Gini Co-eff/
Proportion of
(A/(A+B))/ Value of
(A/(A+B))
Lorenz Curve Situation of the
Economy
Greater Further More Inequality
Lesser Lesser More Equality
GINI INDEX -> Gini Co-efficient * 100
Gini Index -> 100
 Perfect Inequality in the Income Distribution in the Nation
 1% Population -> 100% of the Income
 Extreme Impossible. Poor need some income to survive.
Gini Index -> 0
 Perfect Equality of Income Distribution in the Nation
 Lorenz curve -> Along the line of equality
 Every household -> Equal share of National Income
 Technically not possible.
3/21/2020
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Gini Index - Statistics
 Elite -> More share of NI (Political
connection/ Corruption).
 Highest Gini Index (Small group of Extremely
Rich and Large majority of extremely poor)
Sub-Saharan African Nations & other
extremely poor developing countries
 Lowest Gini Index (Greater equality. Govt
Regulates through Taxation and Govt
spending)
Sweden
Richest countries have higher Gini Index than
some of the poorest.
3/21/2020
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Indicators of Poverty:
 Exists everywhere.
 Higher Income countries -> RELATIVE
Poverty
 Poorest/ Lower Income countries ->
ABSOLUTE Poverty
Relative Vs Absolute Poverty:
Relative: experienced by ppl in a
country whose incomes are
considerably lower than higher income
groups in the same country.
3/21/2020
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 In US
Poor -> earn < 10,830$ per year
 In India
Poor -> earn -> <140$ ~ Rs 500/- per day
 Individual who is poor in US will be in the Top
20% in India
Absolute:
 Lowest per capita Income
 Relatively poor in a country where avg
Income is very low
 Cant afford basic necessities (sanitation,
shelter, clean water, nutrition and health care)
 Primarily concentrated -> 60 poorest
countries
“BOTTOM BILLION” -> Paul Collier
3/21/2020
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Avg Income Income
Distribution
Relative
Poverty
Absolute
Poverty
Increases Same Same Decreases
Absolute Poverty Decreases -> International economic development
strategies (Further Chapters)
Relative Poverty -> Macroeconomic instability. Policies aimed at re-
distribution of NI
Possible Causes of Poverty: Obvious causes
1 billion ppl -> 15% of World Population
Absolute Poverty -> earn <$2 per day.
1. Low Income:
Households-> Lowest Income -> Cant afford to buy necessities.
Households -> Higher Income -> healthy, comfortable, std of living
2. Unemployment:
country with high rate of unemployment-> Greater Poverty
Exception -> Social safety Net (Public support to individuals who
have lost their jobs)
3. Lack of HC:
Without Edn, skills, access to healthcare -> Less Productive
Producers & Consumers at a lesser level of Income.3/21/2020
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The Role of Taxation in Income
Distribution:
 The Marxist View:
“From each according to his ability to each
according to his need” – Karl Marx
 Marxist/ socialist -> output of nation shared
equally among those who contribute to its
production.
 Private Ownership of Resources and Output -
> Wholly abolished.
 Ownership, alloc of resources, goods and
services -> hands of the state
 Households income and consumption should
be same – logically same needs
3/21/2020
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 The Laissez-faire view:
free market model -> level of income
among households vary greatly
Each Individual -> free to pursue his
monetary objectives
Role of Govt -> protection of private
property rights.
Private owners pursue self interest –
unregulated marketplace
Money income determined by exchange
value of resources they own -> capital,
land, labor.
3/21/2020
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 The Modern Mixed Economy:
Govt – much more than simply protect
property rights but not too far to own
all factors of pdn
Role of govt -> collection of taxes,
provision of public goods and
services, transfer payments/
3/21/2020
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Role of Govt -> Taxes
 Tax-> fee charged by govt on a person’s
income, property or consumption of goods
and services.
Types: Direct and Indirect.
Direct
Paid directly to the govt
Eg. Income Tax -> Taken directly from earned
Income.
Corporate & Business taxes -> from revenues
/profits
Cant be legally avoided.
Borne entirely by Households/Firms
3/21/2020
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 Indirect:
Paid by households through
intermediary (retail store)
At the POS -> calculated by adding a
percentage rate to price of the item
purchased
Eg: Sales tax, VAT, GST, ad valorem
taxes (excise taxes)-> cigarette,
alcohol, petrol.
Avoided -> Less/No Consumption
Borne by both households and firms –
depending on elasticities.
3/21/2020
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Taxes based on different burden
on the Rich & Poor:
 Proportional Tax:
Percentage remains constant as
income increases.
Rich pay more than Poor. Burden of the
tax -> No greater burden on the rich
than the poor.
Uncommon in advanced economies
Eg: payroll taxes .
US -> social security tax-> 6.2% of
Income
3/21/2020
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 Regressive Tax:
Tax decreases in %age as income
increases.
Larger burden on lower income
households than on higher income
earners.
Greater % of poor’s household income is
used to pay the tax than a rich
household’s
Indirect Taxes (Sales Tax) -> Regressive in
nature. Sales Tax-> % of price of pdts
consumed.
Amt of Tax-> Income of Consumer3/21/2020
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 Progressive Tax:
% paid in taxes increases as income
increases.
Ability to pay most tax (The Rich) -> bear
larger burden of the nation’s total tax
receipts.
Lower income households-> pay less tax,
smaller % of income as tasx
Northern European countries - >
Progressive -> More equal distribution of
Income
Aligns most with Macroeconomic objective
of equity in income distribution.3/21/2020
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Arguments of a Progressive
IT:
 Creates a disincentive to work.
 Increase in taxes lesser than increase
in income.. Incentive -> work harder,
longer or more efficiently.
 Govt -> Effective means of re-
distributing nation’s income.
 Rich provide the nation with far more
of its tax revenues than the poor.
3/21/2020
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Progressive IT -Statistics
 US, 2006->
lowest 20% -> 1% of total tax receipts.
Top Quintile-> 70% of tax revenues
Top tax rate slab - >370000$ per year
 Canada -> Higher tax rate
Top tax rate slab -> 100000$ per year
Account for 50% of federal revenues.
3/21/2020
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 Impact on Income Distribution:
3/21/2020
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Type of Tax Burden placed Effect on Lorenz
Curve
Progressive IT Larger burden on
higher income
smaller on lower
Income
Shifts closer to
line of equality /
Less Inequality
Proportional IT No
disproportionate
burden
No Impact
/Change
Regressive IT Larger burden on
Lower Income
and smaller on
higher Income
Shifts Further
from line of
equality / More
Income Inequality

Other Measures to promote
Equality:
 1. Collecting Money from Pvt sector – Direct/
Indirect Tax.
 2. Re-distribution of tax revenues.
 Households-> Low Income – Less ability to enjoy
Good Quality of life
 Luxuries -> Out of reach. Necessities -> beyond
means
 Bridge the Gap of Std of living,
Govt -> Public goods and services to the nation’s
people
Transfer payments -> Welfare, Social Security and
subsidies.
3/21/2020
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Role of Govt: Provision of Public
goods.
 Free mkt -> Privatization , Public
goods -> not provided. (Education &
Healthcare)
 Edn -> High fees, Healthcare -> High
premiums
 Poor households -> More imp to basic
necessities. Rich households ->
Affordable to more extent
 Gap in Consumption of education and
healthcare bw rich & poor -> Poverty
Cycle and perpetuation of Income
3/21/2020
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Poor Households – Difficulty to escape poverty -> lower levels of
HC.
Upper Income Households – competitive advantage – afford
better & more education in the marketplace
Govt -> Provide Universal education & healthcare -> all
members of society.
Help poor escape poverty.
3/21/2020
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 Provision of public edn and healthcare ->
utmost priority to a national govt. obj ->
reduce income inequality.
 Educating the poor -> escape poverty
without infringing the rich’s propserity
 Better income -> Higher producitivty and
income.
 High Income earners -> Business
owners -> hire high-skilled, better
educated, healthier and more productive
workers.
 Collection of Taxes -> -ve effect on AS
 More productive workforce -> +ve effect
on AS
3/21/2020
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Role of Goods -> Transfer
Payments.
 Transfer payments -> Payments from
Govt to an individual where no G/S is
exchanged.
 Many forms .
 Eligibility-> fall below a certain income
threshold. Face economic hardship.
 Not accounted for in the GDP of a
nation -> non productive transactions.
No new income/ output results from
the transn. 3/21/2020
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 Transfer payments in most developing countries.
 Unemployment benefits
worker unemployed, level of compensation and duration of
payment vary from country to country. Maintain Std of Living .
Keep AD afloat during recession or Inc unemp
 Social Security benefits
Incl Retirement and disability income. Distributed through
payroll/income taxes collected from workers. Proportional tax
on income up to a certain threshold beyond which tax becomes
regressive. Eg. Us – 6.2% of Income up to $108,000
 Nutritional subsidies.
Low income -> lack access to healthy food -> diseases -> less
pdtivity. Continued poverty. Subsidized nutrition -> low income
receive coupons used to purchase certain nutritional food item.
Lowers burden on feeding children ltd disposable income spent
on other G/S narrow gap b /w rich and poor. More pdtivity. Higher
income.
 Higher education grants and tuition subsidies.
developed nations -> Post secondary education. European
nation- university education – reduced tuition fee
US-> higher edn – state govt and federal govt. Low income
students eligible for subsidized loans and govt grants based on
financial need.
 Welfare benefits.
Households income below poverty line. Subsidize income of3/21/2020
-MONICA

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