# 15.E: Poverty and Economic Inequality (Exercises)


## Key Concepts

### 15.2 Drawing the Poverty Line

Wages are influenced by Supply and demand in labor markets influence wages. This can lead to very low incomes for some people and very high incomes for others. Poverty and income inequality are not the same thing. Poverty applies to the condition of people who cannot afford the necessities of life. Income inequality refers to the disparity between those with higher and lower incomes. The poverty rate is what percentage of the population lives below the poverty line, which the amount of income that it takes to purchase the necessities of life determines. Choosing a poverty line will always be somewhat controversial.

### 15.3 The Poverty Trap

A poverty trap occurs when government-support payments for the poor decline as the poor earn more income. As a result, the poor do not end up with much more income when they work, because the loss of government support largely or completely offsets any income that one earns by working. Phasing out government benefits more slowly, as well as imposing requirements for work as a condition of receiving benefits and a time limit on benefits can reduce the harshness of the poverty trap.

### 15.4 The Safety Net

We call the group of government programs that assist the poor the safety net. In the United States, prominent safety net programs include Temporary Assistance to Needy Families (TANF), the Supplemental Nutrition Assistance Program (SNAP), the earned income tax credit (EITC), Medicaid, and the Special Supplemental Food Program for Women, Infants, and Children (WIC).

### 15.5 Income Inequality: Measurement and Causes

Measuring inequality involves making comparisons across the entire distribution of income, not just the poor. One way of doing this is to divide the population into groups, like quintiles, and then calculate what share of income each group receives. An alternative approach is to draw Lorenz curves, which compare the cumulative income actually received to a perfectly equal distribution of income. Income inequality in the United States increased substantially from the late 1970s and early 1980s into the 2000s. The two most common explanations that economists cite are changes in household structures that have led to more two-earner couples and single-parent families, and the effect of new information and communications technology on wages.

### 15.6 Government Policies to Reduce Income Inequality

Policies that can affect the level of economic inequality include redistribution between rich and poor, making it easier for people to climb the ladder of opportunity; and estate taxes, which are taxes on inheritances. Pushing too aggressively for economic equality can run the risk of decreasing economic incentives. However, a moderate push for economic equality can increase economic output, both through methods like improved education and by building a base of political support for market forces.

## Questions

1. Describe how each of these changes is likely to affect poverty and inequality:

1. Incomes rise for low-income and high-income workers, but rise more for the high-income earners.
2. Incomes fall for low-income and high-income workers, but fall more for high-income earners.
2. Jonathon is a single father with one child. He can work as a server for $6 per hour for up to 1,500 hours per year. He is eligible for welfare, and so if he does not earn any income, he will receive a total of$10,000 per year. He can work and still receive government benefits, but for every $1 of income, his welfare stipend is$1 less. Create a table similar to Table 15.3.2 that shows Jonathan’s options. Use four columns, the first showing number of hours to work, the second showing his earnings from work, the third showing the government benefits he will receive, and the fourth column showing his total income (earnings + government support). Sketch a labor-leisure diagram of Jonathan’s opportunity set with and without government support.

3. Imagine that the government reworks the welfare policy that was affecting Jonathan in question 1, so that for each dollar someone like Jonathan earns at work, his government benefits diminish by only 30 cents. Reconstruct the table from question 1 to account for this change in policy. Draw Jonathan’s labor-leisure opportunity sets, both for before this welfare program is enacted and after it is enacted.

4. We have discovered that the welfare system discourages recipients from working because the more income they earn, the less welfare benefits they receive. How does the earned income tax credit attempt to loosen the poverty trap?

5. How does the TANF attempt to loosen the poverty trap?

6. A group of 10 people have the following annual incomes: $24,000,$18,000, $50,000,$100,000, $12,000,$36,000, $80,000,$10,000, $24,000,$16,000. Calculate the share of total income that each quintile receives from this income distribution. Do the top and bottom quintiles in this distribution have a greater or larger share of total income than the top and bottom quintiles of the U.S. income distribution?

7. Table $$\PageIndex{1}$$ shows the share of income going to each quintile of the income distribution for the United Kingdom in 1979 and 1991. Use this data to calculate what the points on a Lorenz curve would be, and sketch the Lorenz curve. How did inequality in the United Kingdom shift over this time period? How can you see the patterns in the quintiles in the Lorenz curves?

Share of Income 1979 1991
Top quintile 39.7% 42.9%
Fourth quintile 24.8% 22.7%
Middle quintile 17.0% 16.3%
Second quintile 11.5% 11.5%
Bottom quintile 7.0% 6.6%

Table $$\PageIndex{1}$$ Income Distribution in the United Kingdom, 1979 and 1991

8. Using two demand and supply diagrams, one for the low-wage labor market and one for the high-wage labor market, explain how information technology can increase income inequality if it is a complement to high-income workers like salespeople and managers, but a substitute for low-income workers like file clerks and telephone receptionists.

9. Using two demand and supply diagrams, one for the low-wage labor market and one for the high-wage labor market, explain how a program that increased educational levels for a substantial number of low-skill workers could reduce income inequality.

10. Here is one hypothesis: A well-funded social safety net can increase economic equality but will reduce economic output. Explain why this might be so, and sketch a production possibility curve that shows this tradeoff.

11. Here is a second hypothesis: A well-funded social safety net may lead to less regulation of the market economy. Explain why this might be so, and sketch a production possibility curve that shows this tradeoff.

12. Which set of policies is more likely to cause a tradeoff between economic output and equality: policies of redistribution or policies aimed at the ladder of opportunity? Explain how the production possibility frontier tradeoff between economic equality and output might look in each case.

13. Why is there reluctance on the part of some in the United States to redistribute income so that greater equality can be achieved?

14. How is the poverty rate calculated?

15. What is the poverty line?

16. What is the difference between poverty and income inequality?

17. How does the poverty trap discourage people from working?

18. How can the effect of the poverty trap be reduced?

19. Who are the near-poor?

20. What is the safety net?

21. Briefly explain the differences between TANF, the earned income tax credit, SNAP, and Medicaid.

22. Who is included in the top income quintile?

23. What is measured on the two axes of a Lorenz curve?

24. If a country had perfect income equality what would the Lorenz curve look like?

25. How has the inequality of income changed in the U.S. economy since the late 1970s?

26. What are some reasons why a certain degree of inequality of income would be expected in a market economy?

27. What are the main reasons economists give for the increase in inequality of incomes?

28. Identify some public policies that can reduce the level of economic inequality.

29. Describe how a push for economic equality might reduce incentives to work and produce output. Then describe how a push for economic inequality might not have such effects.

30. What goods and services would you include in an estimate of the basic necessities for a family of four?

31. If a family of three earned $20,000, would they be able to make ends meet given the official poverty threshold? 32. Exercise 15.2 and Exercise 15.3 asked you to describe the labor-leisure tradeoff for Jonathon. Since, in the first example, there is no monetary incentive for Jonathon to work, explain why he may choose to work anyway. Explain what the opportunity costs of working and not working might be for Jonathon in each example. Using your tables and graphs from Exercise 15.2 and Exercise 15.3, analyze how the government welfare system affects Jonathan’s incentive to work. 33. Explain how you would create a government program that would give an incentive for labor to increase hours and keep labor from falling into the poverty trap. 34. Many critics of government programs to help low-income individuals argue that these programs create a poverty trap. Explain how programs such as TANF, EITC, SNAP, and Medicaid will affect low-income individuals and whether or not you think these programs will benefit families and children. 35. Think about the business cycle: during a recession, unemployment increases; it decreases in an expansionary phase. Explain what happens to TANF, SNAP, and Medicaid programs at each phase of the business cycle (recession, trough, expansion, and peak). 36. Explain how a country may experience greater equality in the distribution of income, yet still experience high rates of poverty. Hint: Look at the Clear It Up "How do governments measure poverty in low-income countries?" and compare to Table 15.5.1. 37. The demand for skilled workers in the United States has been increasing. To increase the supply of skilled workers, many argue that immigration reform to allow more skilled labor into the United States is needed. Explain whether you agree or disagree. 38. Explain a situation using the supply and demand for skilled labor in which the increased number of college graduates leads to depressed wages. Given the rising cost of going to college, explain why a college education will or will not increase income inequality. 39. What do you think is more important to focus on when considering inequality: income inequality or wealth inequality? 40. To reduce income inequality, should the marginal tax rates on the top 1% be increased? 41. Redistribution of income occurs through the federal income tax and government antipoverty programs. Explain whether or not this level of redistribution is appropriate and whether more redistribution should occur. 42. How does a society or a country make the decision about the tradeoff between equality and economic output? Hint: Think about the political system. 43. Explain what the long- and short-term consequences are of not promoting equality or working to reduce poverty. 44. In country A, the population is 300 million and 50 million people are living below the poverty line. What is the poverty rate? 45. In country B, the population is 900 million and 100 million people are living below the poverty line. What is the poverty rate? 46. Susan is a single mother with three children. She can earn$8 per hour and works up to 1,800 hours per year. However, if she does not earn any income at all, she will receive government benefits totaling $16,000 per year. For every$1 of income she earns, her level of government support will be reduced by $1. Create a table, patterned after the Table you created in Example 2. The first column should show Susan’s choices of how many hours to work per year, up to 1,800 hours. The second column should show her earnings from work. The third column should show her level of government support, given her earnings. The final column should show her total income, combining earnings and government support. Based on the table you created, what are the likely impacts of this kind of assistance program on Susan's incentive to work? Are there additional opportunity costs that may reduce her incentive to work? 47. A group of 10 people have the following annual incomes:$55,000, $30,000,$15,000, $20,000,$35,000, $80,000,$40,000, $45,000,$30,000, \$50,000. Calculate the share of total income each quintile of this income distribution received. Do the top and bottom quintiles in this distribution have a greater or larger share of total income than the top and bottom quintiles of the U.S. income distribution for 2005?

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