### Class Room Experiment

```EC 100 Class 9
Sixth Class Exercise
- This week: Measuring Inequality
- Lorenz curve: Being on 45 degree line is
perfect equality – 1% of population earns 1%
of total income.
- A very flat curve that rises steeply reflects high
income inequality.
Question 1
• +
• Which of them represents the higher level of
inequality?
Question 1
- A very flat curve that rises steeply reflects high
income inequality.
- So Curve A has higher inequality
Question 2
- If Sweden has a lower Gini coefficient than the
UK, does Sweden have higher or lower income
inequality than the UK?
- Gini coefficient measures inequality
- Higher Gini coefficient means higher
inequality
- Gini = 0 (no inequality)
- Gini = 1 (complete inequality)
Question 2
- Gini coefficient = A / (A+B) in graph
- With low inequality, area A is very small
- So Sweden’s Lorenz curve will be higher than
UK (smaller area A)
Question 3
• Suppose the government provides a benefit of
£100 per week to people with no other source of
income. But, for every extra £1 in income they
earn, the government reduces their benefit by
75p. Assume for simplicity, there are no other
taxes and benefits. If an individual earns £100
how much benefit will they receive:
Question 3
• Note: Person receives £100 in benefits if does
no work
• Receives £25 if earns £100
• So overall, person only gains £25 from working
• Problem: As you earn more, your benefits start
to fall (Why?)
• Losing benefits is like an additional tax on
working
Question 3
• As you earn more, your benefits start to fall
(Why?)
• “Iron triangle”
• Want to achieve 3 things:
– raise the living standards of low-income families
– provide incentives to work
– keep costs low
Question 4
• If individual in previous question
earns £100, what is their average tax
rate?
market income  final income
average tax rate 
market income
Question 4
• The persons total income when working and
earning 100 Pounds is 125
• She is still a net recipient of transfers, so her
tax rate is negative
Question 5
• If individual in previous question earns
£100, what is their marginal tax rate?
• Marginal tax rate: effective tax rate on additional
income
• “Effective” means we are including lost benefits
• Can see that this is 75% without the formula from
lectures, but you can also use it if you wish:
Change in final income
1  m arg inal tax rate 
Change in market income
• (Just re-arrange to get marginal tax rate on its own – see
board).
Question 5
• For every pound she is earning through work,
she has to give up 75 pence of transfers…
• This is a common problem amongst lowincome households
What are effects of taxes on labour
supply?
Why do we care about labour supply?!
Question 6
• If the average tax rate increases with the level
of market income how do you think the Gini
coefficients of final and market income will
compare?
Question 6
• Final income: market income – taxes + benefits
• Average tax rate increases with income – this
implies that rich pay a higher tax rate than the
poor.
• Hence after-tax Lorenz curve moves closer to line
of equality, and thus Gini coefficient falls
Question 7: When working doesn’t pay
off…
• Who has highest marginal tax rate?
• Why?
Question 8
• Suppose I believe that the impact of marginal
and average tax rates on the amount people
work is very small. Other things equal, am I
likely to favour:
Question 9
• Suppose the economy is doing really badly
and there now fewer rich people than before
and more poor people. Other things equal,
am I likely to favour:
Question 10
• Suppose average level of income in the
economy is the same as before but the
economy is becoming more unequal and there
now both more rich people than before and
more poor people. Other things equal, am I
likely to favour:
Discussion Question: Inequality and
Inter‐Generational Mobility
Inequality over Time
• Horizontal axis measures Gini coefficient
• Vertical axis is a measure of how much your wealth depends on
• So graph shows:
• Countries with high current inequality (Latin American countries)
also have low intergenerational mobility (if you come from a poor
background, you will also be poor)
• Krueger: Suggests that high inequality is associated with low
equality of opportunity
• Do you agree with this conclusion? And if this is a problem, what m
ight you think could be done about it?
Inequality over Time
• Krueger: Suggests that high inequality is
associated with low equality of opportunity
• Do you agree with this conclusion?
• Is this a problem?
• What can be done about it?
Inequality over Time
• Krueger: Suggests that high inequality is
associated with low equality of opportunity
• Do you agree with this conclusion?
- Difficult not to agree!
- Could argue that rich parents are more talented, so their children
will be more talented…
- So we might expect some intergenerational persistence of income
even with complete equality of opportunity
- Could also argue that with very high average taxes, Gini coefficient
will be low – lots of redistribution from rich to poor
- But does this really imply equality of opportunity?! May still only be
powerful families taking best jobs etc.
Inequality over Time
• Krueger: Suggests that high inequality is
associated with low equality of opportunity
• Is it a problem?
- See next slides…
• Positive:
– It may be inefficient. Maybe a lot of talent is not
that could activate their talents (hidden Einsteins).
– Maybe the reason why relationship is so strong is
in India)
– ….
• Normative: arguments along the line of…
– Equality of opportunity ought to exist in a fair
society
– The only way to create equality of opportunity is
is an empirical question that needs to be proven).
–…
Inequality over Time
• Krueger: Suggests that high inequality is associated with
low equality of opportunity
• What can be done about it?
-
Relatively easy to affect Gini coefficient (difficult part is doing it in a way
that doesn’t seriously damage the economy or cause political unrest)
How do you increase intergenerational mobility?
Avoid ghettos – mixed tenancy housing
Lots of schooling options
-
-
Sure Star in UK seems to have been effective
Grammar schools?
Ban private schools?
School assignment by lottery?
(Heavily) subsidised further & higher education?
Others…
```