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Table of Contents
Labor
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The share of the US economy’s output that flows to corporate profits has almost doubled since the mid-1970s, while the share flowing to workers’ compensation has fallen. Or consider this chart:
As you can see, stock prices and family incomes tracked each other somewhat closely in the decades after World War II - but no longer do. |
Labor, The Economy and Monetary Policy
Sectoral bargaining is the future of American labor unions.
Fresh Proof That Strong Unions Help Reduce Income Inequality
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Transfers and Taxes
I. Income: payment for labor services or payment for ownership of a factor of production … Labor is the most valuable resource sold by most households.
Measuring Income Distribution: The Lorenz Curve: A geometric representation of the distribution of income. A Lorenz curve that is perfectly straight represents perfect income equality. The more bowed a Lorenz curve, the more unequally income is distributed.
Criticisms of the Lorenz Curve:
The Lorenz curve is typically presented in terms of distribution of money income only.
The Lorenz curve does not account for differences in family size and effort.
It does not account for age in income differences.
The Lorenz curve is typically given for money income before taxes.
It does not measure unreported income from the underground economy.
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The Hidden Costs of Low Wages
II. Determinants of Income Differences:
Age: With age comes more education training and experience, which affects earnings. The Age-Earnings Cycle is the regular earnings profile of an individual throughout his or her lifetime. It usually starts with low earnings at 18 and increases to a peak at around age 50, when earnings gradually fall until they approach zero at retirement age.
Marginal Productivity: Workers can expect to be paid their marginal revenue product (assuming that there are low cost information flows and the labor and product markets are competitive). In a competitive situation, workers who are being paid less than their marginal revenue product will bid away to better employment opportunities. It is likely that some persons are paid more or less than their marginal revenue product because information is costly.
Determinants of Marginal Productivity:
Talent: These are factors that cannot be acquired if one does not have them.
Experience: Experience can be linked to the well-known learning curve that applies when the same task is done over and over. The worker repeating a task becomes more efficient.
Training: Much of a person’s increased productivity is due to on-the-job training.
Investment in Human Capital: Department of Labor data show that on average high school graduates make more than grade school graduates and on average college graduates make more than high school graduates. The average the rate of return to investment in human capital of a college education is between 6 and 10 percent, which is on a par with the rate of return to investment in other areas.
Inheritance: An endowment can consist of an inheritance of cash, jewelry, stocks, bonds, houses, and other real estate. Only about 10 percent of inequality of income can be traced to differences in inherited wealth.
Discrimination: Economic discrimination occurs whenever workers with the same marginal revenue product receive unequal pay due to some non-economic factor such as race, gender, or age. It also occurs when there is unequal access to labor markets.
Access to Education: Minorities have faced discrimination in the acquisition of human capital. The amount and quality of schooling offered, has often been inferior to that offered whites.
The Doctrine of Comparable Worth: The belief that women or minorities should receive the same wages as men if the levels of skill and responsibility in their jobs are equal or equivalent.
III. Theories of Desired Income Distribution: There are two normative standards for the distribution of income that have been popular with economists.
Productivity: “To each according to what he produces” is a contributive standard. It is based on the principle of rewards based on the contribution to society’s total output.
Equality: “To each exactly the same” means that everyone gets the same amount. The problem with this concept is that the incentive of higher rewards would be eliminated. Productivity and growth would decline.
IV. Poverty and Attempts to Eliminate It: There are a number of welfare programs set up for the purpose of redistributing income from the better-off to the poor and for that purpose alone, but these programs have not been entirely successful.
Defining Poverty: The US government defines the poverty line as income at or below three times the amount of money needed to buy basic, nutritionally sufficient food for all family members. The threshold income has been revised upward annually by the increase in the Consumer Price Index.
Absolute Poverty: Because the low-income threshold as an absolute measure never changes in real terms, poverty will be reduced even if nothing is done since real income levels have been growing.
Relative Poverty: Poverty has generally been defined in relative terms — in terms of the income levels of individuals relative to the rest of the population. It is based on income considerably below the average in a society. Income qualifying for poverty status in a rich country may exceed average income in a poorer country.
Causes of Poverty
Lack of Education: The median income of high-school dropouts in 1997 was $16,818, which was just above the poverty line for a family of four.
Location: On average, people who live in the inner city earn less than people living outside the inner city.
Shifts in Family Structure: Increased divorce rates result in more single-parent families and more children living in poverty.
Economic Shifts: Workers without college-level skills have suffered from the ongoing decline of manufacturing, and the rise of service and high technology jobs.
Racial and Gender Discrimination: Some inequality exists in wages between whites and minorities, and men and women.
Transfer Payments as Income: The official poverty level is based on pretax income, including cash but no in-kind subsidies. If corrections are made for such benefits then the percentage of the population that is below the poverty line drops dramatically.
Attacks on Poverty: Major Income-Maintenance Programs:
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The Earned Income Tax Credit Program: In 1975 the EITC was created to provide rebates of Social Security taxes to low-income workers. Since benefits are reduced by 17.68 cents for every dollar earned above $11,000, the incentive to make more than $11,000 is reduced. The typical EITC recipient works 1,700 hours per year compared to a standard work year of 2,000 hours.
Nickel and Dimed: On Not Getting By in America (13:58)
One view: PBS Video, Income Inequality (24:15)
What it’s like to live on $2 a day in the United States (PDF)
Try your skills at playing SPENT. (It's not easy being poor!)
Nickel and Dimed: On (Not) Getting By in America is a book written by Barbara Ehrenreich, from her perspective as an undercover journalist investigating the impact of welfare reform on the working poor in the US. If you were intrigued by the clip above, this longer and more in-depth video by Democracy Now will really make you think.
V. Reduction in Poverty Rates: The officially defined rate of poverty in the US has shown no long-run tendency to decline. It reached its low of around 11% in 1973, peaked at over 15% in 1983, and fell steadily to 13.1% in 1990 and has since fallen no lower than 12%.
VI. Health Care: Sometimes people become poor because of inadequate (or no) health insurance. They deplete their wealth paying for the expenses of an illness. Some workers may remain in a job because of the health insurance benefits.
The US Health Care Situation: Spending for health care in the US accounts for 16% of US real GDP. The US per person cost is greater than anywhere else in the world.
Why Have Health Care Costs Raised So Much?
The Age-Health Care Expenditure Equation: The top 5% of health care users incur over 50% of all health expenditures. The bottom 70% of users accounts for only 10%. The aging population stimulates the demand for health care and elderly make up most of the top users.
New Technologies: High technology is another reason health care costs have raised dramatically. For example a CT scanner costs around $100,000, an MRI scanner can cost over $4 million, and a PET scanner costs around $4 million. Fees for using these machines can cost between $300 and $2,000.
Third-Party Financing: Medicare, Medicaid and private insurance companies are third parties. When they pay for medical costs, demand for services increases. Medicare and Medicaid are the main providers of hospital and other benefits to 35 million Americans, most over 65. Medicaid, a joint state-federal program, provides long-term health care (nursing homes). There is an inverse relationship between the price and quantity demanded of medical services. Third-party payment simply decreases the net price to the consumer, thus increasing the quantity of services demanded. The more a third party pays, the greater is the likelihood that a consumer will substitute medical services for a healthier lifestyle.
Price and Quantity Demanded: Because of third-party payment, the effective price facing each consumer of medical services is often zero, or close to it. Thus, at the “low” price, it is not surprising that the quantity of medical services demanded has increased greatly.
Moral Hazard as it Affects Physicians and Hospitals: Because patients do not pay much, if any, of their health care costs themselves, they do not have an incentive to question the need for medical tests and procedures. Doctors and hospitals get paid by the number of services they render. They have no incentive to try to keep costs to the patient and third party payer down. Instead, their incentive is to increase the number of services and thus costs.
Is National Health Insurance the Answer? Proponents argue in favor of a Canadian style system, where the government sets the fees paid to a physician, prohibits private practice, and sets a yearly income cap on the amount a doctor can receive. A specified amount of funding is provided to hospitals. Using the Canadian model, people would receive fewer health services, stay in hospitals longer, and have fewer tests and procedures.
Countering the Moral Hazard Problem: A Health Savings Account: A health savings account (HSA) allows individuals to save money in a tax-exempt account that they could use to pay medical bills. Then a family or employer could buy major medical insurance with a high deductible at a relatively low price.
Combating Moral Hazard: Contributors who do not use their MSAs could keep the money as a supplemental retirement account. The moral hazard problem is reduced because patients would have to pay for minor medical expenses up to the high deductible on major medical insurance. Thus they would have an incentive to live healthier lifestyles and physicians would not order expensive tests without first consulting with their patients.
The Critics’ Responses: Critics say that people will avoid visits to a doctor for minor problems that could turn into major ones if left untreated. In addition HSAs would sabotage managed care plans that limit patients’ choice of physicians and hospitals in exchange for low or no deductibles.
US Census Bureau's Poverty Statistics
We, the Economy Films: Chapter 5: What causes inequality?
Is inequality growing? In a magical land inhabited by long lashed, multi-colored Alpacas who love lollipops, rainbows and friendship, there's a yawning divide in wealth distribution ... what's behind the inequality gap?
Why is the minimum wage important? In 2013, Seattle became ground zero for the heated national debate about increasing the minimum wage to $15 per hour. "The Value of Work" gives voice to supporters and the opponents, including the mayor, an activist city councilwoman, small business owners, and minimum-wage workers affected by the unprecedented legislation.
Why is healthcare so expensive? "This Won't Hurt a Bit" is a short film that tells the all too familiar tale of American healthcare. A patient enters a hospital with a migraine headache, unaware of the costs his visit will incur on the path to a diagnosis. He learns much more than he bargained for in this comedy on unaffordable care.
What are the causes of inequality? In "Monkey Business," economists from across the political spectrum help explain the causes of economic inequality, with help from a couple of mammalian friends.
I. Forms of Industry Regulation:
There are two basic types of government regulation: 1) economic regulation, 2) social
regulation.
Economic Regulation: Initially this was regulation to control prices that natural monopolies were allowed to charge. Over time federal and state governments have sought to regulate the characteristics of products or processes in industries without monopolistic characteristics.
Regulation of Natural Monopolies: The regulation of natural monopolies has emphasized regulation of product prices to prevent monopoly profits that is also called rate regulation.
Regulation of Non-Monopolistic Industries: All state governments regulate prices that the insurance companies can charge. Most other government regulation establishes rules that pertain to production, product features, and entry and exit within a number of specific non-monopolistic industries.
Social Regulation: The aim of social regulation is to improve the quality of life through improved products, a less polluted environment, and better working conditions. Social regulation affects all firms in the economy and not just certain industries.
II.
Regulating Natural Monopolies
Natural Monopolies Revisited: Whenever a single firm has the ability to produce all of the industry’s output at a lower per-unit cost than any other firm, a natural monopoly arises. The long-run average costs are falling over such a large range of production rates (relative to demand) that only one firm can survive in such an industry.
The Pricing and Output Decision of the Natural Monopolist: The natural monopolist will produce to the point where marginal cost equals marginal revenue and set price on the demand curve. Price will be greater than marginal cost.
Regulating the Natural Monopolist: The Problem of Marginal Cost Pricing: The government determines the price that the natural monopolist can charge. If regulation forces a natural monopolist to set price equal to marginal cost, then the monopolist would incur losses because price would be less than average cost.
Practical Regulation of Natural Monopolies: Because regulators cannot force a natural monopolist to charge a price equal to marginal cost and make it stay in business, regulation has often taken the form of average cost pricing. This can take the form of only allowing prices equal to the actual cost of service called cost-of-service pricing. Rate-of-return regulation allows the firm to set a price equal to average cost where average cost includes what regulators deem a normal or competitive rate of return on investment.
III. Regulating Non-Monopolistic Industries: Protecting consumer interests has been the main rationale for government regulatory functions.
Rationales for Consumer Protection in Non-Monopolistic Industries: At one time the rule of “caveat emptor,” or “let the buyer beware” was the rule in market transactions. Today federal regulations require sellers to meet certain minimum standards in their dealings with their customers.
Reasons for Government-Orchestrated Consumer Protection: There are two major reasons: (1) market failure and (2) asymmetric information.
Asymmetric Information and Product Quality: In extreme cases asymmetric information can lead to a situation where most of the products are of low quality. This is called the lemons problem with used cars.
The Lemons Problem: The possibility that asymmetric information will lead to a general reduction in quality in an industry. This is particularly a potential problem with credence goods.
Market Solutions to the Lemon Problem: Market solutions to the lemons problem are sellers offering warranties, setting industry standards, and seeking of external product certification.
Implementing Consumer Protection Regulation: Governments implement legal remedies for consumers, licensing, and have a regulatory apparatus for overseeing all aspects of an industry’s operations when they consider private market solutions insufficient for the lemons problem and asymmetric information.
Liability Laws and Government Licensing: Some liability laws specify penalties for product failures that provide consumers with protections similar to warranties. Governments also issues licenses that grant only qualifying firms the legal right to produce and sell certain products.
Direct Economic and Social Regulation: A government may determine that the lemons problem is so severe in a given industry such as banking, that it establishes a regulatory apparatus to maintain public confidence in that industry.
IV. Incentives and Costs of Regulation: Because abiding by regulation is costly for businesses, they engage in activities that are intended to avoid the true intent of regulations or to change established regulations.
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A. Creative Response and Feedback Effects: This is a firm’s behavioral modification that allows it to comply with the letter of the law, but violate the spirit of the law, significantly lessening the law’s effects. Sometimes there is a feedback effect in which the individual’s behavior changes in undesirable ways after the regulation is implemented.
B. Explaining Regulator Behavior: The two best known explanations of regulator behavior are the capture hypothesis and the “share the gains, share the pains” theory.
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The Benefits and Costs of Regulation: While there are many potential benefits of regulation it is difficult to measure the actual benefits of regulation.
The Direct Cost of Regulation to US Taxpayers: Currently the federal government spends $30 billion per year to fund the staff and activities of federal regulatory agencies. In addition businesses spend money complying with the regulations.
The Total Social Cost of Regulation: The estimated total social cost of complying with federal regulations is estimated at $800 to $900 billion per year. When the costs of complying with state regulation are added the estimates exceed $1 trillion.
V. Antitrust Policy: The logic behind antitrust legislation is that if the courts can prevent collusion among sellers of a product, monopoly prices will not result and there will be no restriction of output. There will be no economic profits in the long-run.
Antitrust Policy: Congress has enacted four key antitrust laws.
The Sherman Antitrust Act of 1890: This act was the first attempt by the federal government to control the growth of monopoly in the US. The most important provisions of the act are Section 1 (prohibits every contract, combination in the form of trust or otherwise or conspiracy, in the restraint of trade or commerce among the several states, or with foreign nations) and Section 2 (makes it illegal to monopolize, or attempt to monopolize, or combine or conspire with any other person or persons to monopolize any part of trade or commerce).
Other Important Antitrust Legislation: The Sherman act was so vague that in 1914 a new law was passed —the Clayton Act of 1914. It legally prohibited a number of very specific business practices. Federal Trade Commission Act of 1914 and Its 1938 Amendment: The Federal Trade Commission Act was designed to stipulate acceptable competitive behavior. It was supposed to prevent overly aggressive competition. The Federal Trade Commission is charged with the power to investigate unfair trade practices. In 1938 the Federal Trade Commission Act was amended to allow the FTC to regulate advertising and marketing practices. The Robinson-Patman Act of 1936 was designed to protect independent retailers from specified unfair competitive acts by chain stores.
Exemptions from Antitrust Laws:
All labor unions
Public utilities-electric, gas and telephone companies
Professional sports, especially baseball
Cooperative activities among American exports
Schools and hospitals
Public transit and water systems
Suppliers of military equipment
Joint publishing arrangements in a single city by two or more newspapers
International Discord in Antitrust Policy: A major issue is different antitrust laws in the US and the EU. Under EU antitrust laws any business combination that “creates or strengthens a dominant position” significantly reducing or impeding competition is prohibited. It does not matter how or why competition is significantly reduced. In the US it does matter.
VI. Enforcement of the Antitrust Laws: Most antitrust enforcement today is based on the Sherman Act. The Supreme Court has defined the offense of monopolization as “(1) possession of monopoly power in the relevant market and (2) the willful acquisition or maintenance of the power as distinguished from growth, or the development as a consequence of a superior product, business acumen, or historic accident.”
Monopoly Power and the
Relevant Market: The Market Share Test is the primary measure of
market power and is the percent of the relevant market that the firm controls.
Generally a firm is considered to have monopoly power if it has a 70 percent
or greater market share. The relevant market consists of (1) a relevant product
market and (2) a relevant geographic market.
Product Packaging and Antitrust Enforcement: In US antitrust enforcement it is important to determine whether a firm has engaged in “willful acquisition or maintenance” of market power. Two actions, versioning and bundling are presented.
Product Versioning: Versioning is selling an item in slightly altered forms to different groups of consumers at different prices. In the US versioning is not viewed as illegal price discrimination.
Product Bundling: The joint sale of two or more products as a set. If it is only offered as a set and not individually, then US antitrust authorities view it as a form of price discrimination known as tie-in sales. Tie-in-sales requires consumers who wish to buy one of its products to purchase another item the firm sells as well.
Diverging International Enforcement Perspectives: While US courts ruled that Microsoft had to unbundle Internet Explorer and Windows, the EU’s antitrust enforcers also required Microsoft to unbundle Windows and Windows Media Player as well. This action has yet to be resolved.
I. Private vs Social Costs: Private (internal) costs are costs incurred by individuals when they use scarce resources. Social costs are the full costs that society bears when a resource-using action occurs. For example, the social cost of driving a car equals all the private costs such as buying gasoline plus any additional cost that society bears, such as air pollution and traffic congestion. The air in many cities is heavily polluted from automobile exhaust fumes because when automobile drivers drive their cars they bear only the private costs of driving. They cause air pollution, which is a cost because it causes harm to other individuals. Drivers are not forced to take into account the cost of air pollution when they make the decision to drive.
II. Externalities: A situation in which a private cost or benefit diverges from a social cost or benefit, that is, the cost or benefits of an action are not fully borne by the two parties engaged in exchanges or by an individual engaging in a scarce resource-using activity.
III. Correcting for Externalities: The signals in the economy must be changed so that decision-makers will take into account all the costs of their actions.
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A. The Polluter’s Choice: Faced with a cost of polluting, polluters will be induced to (1) install pollution abatement equipment or otherwise change production techniques so as to reduce the amount of pollution, (2) reduce pollution-causing activity, or (3) simply pay the price to pollute. Each polluter is faced with the full social cost of his or her actions and makes a decision accordingly. B. Is A Uniform Tax Appropriate? The taxes imposed should be set equal to the economic damages or externalities caused by the pollution-creating activity. |
IV. Pollution: The by-products of an economic activity. There is no correct answer to how much pollution should be in an economy because when the question is asked, a value judgment is being requested. There is no way to disprove a value judgment scientifically. The optimal quantity of pollution is determined when pollution is reduced up to the point where the marginal benefit from further reduction equals the marginal cost of further reduction. The optimal quantity of pollution is the level of pollution for which the marginal benefit of one additional unit of clean air equals the marginal cost of that additional unit of clean air.
V. Common Property: Common Property is property that is owned by everyone and, therefore, owned by no one. Air and water are common property resources. Pollution occurs where there are no well-defined private property rights as in air and common bodies of water.
A. Voluntary Agreements and Transactions Costs:
1. Voluntary Agreements: Under some circumstances voluntary contracting will occur to internalize externalities.
2. Transaction Costs: One major condition for successful voluntary contracting is that the transaction costs — all costs associated with making, reaching, and enforcing agreements — must be low relative to the expected benefits of reaching an agreement.
B. Changing Property Rights: Assume that many property rights and many resources are not defined. Only when and if a use is found for a resource or the supply of a resource is inadequate to meet the quantity demanded at a zero price, does a problem develop. The problem requires that something be done about deciding property rights. If not, the resource will be wasted and possibly even destroyed. There are three ways to fill the gap between private and social costs: taxation, subsidization, and regulation.
C. Are There Alternatives to Pollution-Causing Resource Use? Some people cannot understand why we do not use non-pollution-causing sources to generate electricity, such as solar power. The fact is that generating solar power is generally more expensive relative to other alternatives. The technology does not exist yet to use solar power cost-effectively in most cases.
VI. Wild Species, Common Property and Trade-Offs: Wild species of animals are common property resources in that no one owns them and thus no one has an economic interest in protecting them. The Endangered Species Act involves restricting the use of habitats even if on private property. For example, in an attempt to save the spotted owl, logging in the Pacific Northwest was restricted and thousands of logging jobs were lost. There is thus an economic trade-off between protecting endangered species and economic activity.
VII. Recycling: The benefits of recycling are straightforward. Fewer natural resources are used. Recycling may not save total resources, however, because decreased demand for the resource (trees used for paper) may cause a decrease in supply.
A. Recycling’s Invisible Costs: Labor resources involved in recycling are often more costly than the potential savings in scarce resources. Net resource use with recycling may be greater than without it.
B. Landfills: In some areas, such as major cities, there may be a solid waste disposal crisis. In the rest of the US the data do not indicate a crisis. The disposal price per ton of city garbage has actually fallen.
C. Should We Save Scarce Resources? Virtually every natural resource has fallen in price over the last few decades, arguing against the claim that we are running out of resources.
You should conclude from this section that neither government nor markets can be asserted as a good solution to environmental problems. Of the two, government is likely the best option.
Environmental Economics and Policy (PDF)
Cap-and-Trade (PDF)
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