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12.5 End-of-Chapter Material

In Conclusion

Most of the time in the study of economics, we focus on efficiency. We ask if there are better or worse ways for society to organize its production of goods and services, and we ask if society has institutions in place that allow people to obtain all the available gains from trade. Although these can be complex questions, there is broad agreement among most people that efficiency is a desirable goal.

In this chapter, we tackled a rather different and more contentious set of issues: what is fair and just? Economists can (relatively) easily explain how society ends up distributing its resources, but the tools of economics do not allow us to say whether a given distribution is fair or not. People certainly seem to care about fairness and hold strong opinions about how society should share out its resources. Unfortunately, different people have very different ideas about what is fair.

The questions we address here go beyond economics; they vex philosophers and political scientists as well. They go to the heart of what we think of as right and good. They also force us to think about the appropriate role of the state and how that matters for the distribution of resources. Is the role of the state simply to provide an environment where people are free to pursue their own self-interest and to keep what they earn? Or does the existence of the state mean that we are all in a social contract, so all have some rights to the output of society as a whole?

As we have said previously, we cannot and do not want to answer these questions for you. Indeed we, as authors of this book, do not even agree among ourselves on the answers. Instead, we have given you some tools so you can think about these questions—which are some of the most important you will ever confront—yourself.

Exercises

  1. Draw a Lorenz curve for the data given in Table 12.2 "Example of Income Distribution".
  2. Often income data are reported by household. How does the US Census Bureau define a household? Is this the same as a family?
  3. Draw the Lorenz curve for the wealth of the top 10 people in the United States for 2006 and 2010 using the data in Table 12.1 "Wealthiest Individuals in the United States".
  4. Can you think of two other markets with significant winner-takes-all elements?
  5. During the past 100 years, there has been tremendous technical progress in creating machines to run in the household, such as dishwashers, washing machines, clothes dryers, and so on. How do you think these inventions have affected the labor participation decisions of women and the wages they are paid?
  6. Suppose that the cost of training is 20 chocolate bars. Assume high-ability people produce 100 bars if they get training and 50 bars if they don’t. Low-ability people produce 50 bars regardless of training. If under the social contract you decide to provide an incentive for high-ability people to train, what is the distribution of consumption in the economy? Is society better off with inequality in consumption or is it better to have equal consumption and no training by high-ability people?
  7. Start with the example of the social contract given in Question 6 but suppose that 75 percent of the people are high ability and 25 percent are low ability. What does the social contract look like for this economy? How much is produced by high- and low-ability people? What is the total amount of output per capita? What is the consumption per capita?
  8. Identify two institutions that provide equality of opportunity but not outcome. Identify two institutions that favor equality of outcome over equality of opportunity.
  9. Use college admissions to illustrate the difference between “equality of opportunity” and “equality of outcome.”
  10. Suppose a household holds a share of stock in a particular company and receives a dividend from that share. Which of these is a stock, and which is a flow? Which is part of income, and which is part of wealth?
  11. (Advanced) Consider two countries: one has a higher Gini coefficient and the other has less mobility across income groups over time. Which country has greater equality?
  12. If the return to education depends on innate ability, then what is the point of going to college?
  13. Do you think that trading in the stock market exhibits equality of opportunity? Why or why not?
  14. Can you come up with your own example of a trade-off between equity and efficiency?

Economics Detective

  1. Pick one of the wealthiest people in the United States. How did this person get his or her wealth? How much do you think this person earns each year from his or her assets?
  2. Find a list of the world’s wealthiest people. What countries are these people from? Pick one person and see how the person got his or her wealth. Are the wealthiest people in the world distributed across lots of countries or isolated in a just a few?
  3. The Rockefeller family was one of the wealthiest in the United States around 1900. How did the family accumulate its wealth? Where did the wealth go??
  4. Try to find data on the share of income of the bottom 20 percent of the income distribution in two different countries. Also try to find the Gini coefficients for the two countries. How might you explain the differences in income distribution between the two countries you chose?
  5. Go to the website of the Internal Revenue Service. Find the tax rates currently in effect for different income levels in the United States. Are these progressive?

Spreadsheet Exercise

  1. Create (or find on the Internet) data on income. Input the data into a spreadsheet and plot the Lorenz curve.
  2. Create a spreadsheet to follow the income and wealth of two households. Suppose the first household earns 50 chocolate bars each year, and the second household earns 100 chocolate bars each year. Suppose that each household saves a fixed fraction of its income (you can vary this in the spreadsheet). Follow these households for 50 years. Calculate familial wealth year by year using the equation at the beginning of Chapter 12 "Superstars", Section 12.2 "The Sources of Inequality".6. To do this, you will have to specify the interest rate (which you can also vary). In what sense is the distribution of wealth more unequal than the distribution of income? What if the high-income households also had a higher return on saving? What if households sometimes produced 50 chocolate bars and other times produced 100 bars? As a very advanced topic, can you build this uncertainty into your spreadsheet program? What happens to wealth?