CHAPTER 8: ECONOMIC

INEQUALITY AND INCOME

DISTRIBUTION
INCOME INEQUALITY
The role of the Government in the economy is important. Sometimes, its
weight, relative to the total economy, can be more than half of the country's
GDP(PIB). Despite this, although the role it plays does not have to be the
same in all countries.

Inequality measures
The most common measure of inequality is the Gini Coefficient. This
coefficient indicates the degree of disparity that exists on a given variable (in
this case the income). If all the people in a population had the same income
(there would be no inequality), the Gini coefficient has value 0. The maximum
inequality is when the Gini coefficient has value 1 and it means that a single
individual has all the income.

The Gini coefficient is based on the Lorenz curve, Lorenz's Curve is

constructed by representing on the horizontal axis the percentage of the
population sorted from less rich and on the vertical axis the accumulated
income received by each fraction of the population.

Gini coefficient= A / (A+B)

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The level of taxation and transfers that the Government carries out, leads to
different levels of inequality of income exist in different countries. We can use
the Lorenz curve and the Gini Coefficient to compare income inequalities in
different countries and we can use the Lorenz curve and the Gini Coefficient
to compare the time evolution of the income inequalities between countries.

INCOME DIFFERENCES BETWEEN OR INSIDE

COUNTRIES

STATE INTERVENTION
The state can intervene in the market outcomes. The perfectly competitive
market structure allocates resources efficiently, but it can question whether
this allocation is or not fair. If you opt for a redistribution of income, you
should be aware that individuals’ incentives will vary, alter their decisions,
which can create losses of efficiency.

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PRICE CONTROLS
Even if the market is competitive and efficient, in order to reach income
redistribution objectives, the state may prefer to keep prices above or below
the equilibrium price by imposing:

-Maximum price (price ceiling): sets an upper price limit.

Ex:renting prices of flats/shops/businesses

-Minimum price (price floor): sets a lower price limit.

Ex: minimum wages

MAXIMUM PRICES
Maximum price at which sellers can sell the good or service (price below the
market equilibrium price in order to be binding, otherwise, no effect). The
direct consequences of this are that they produce excess demand and it
creates an unrecoverable loss of efficiency. And the effects of this are that the
goods are not assigned to those consumers who value them most (inefficient
allocation). The goods may need to be assigned by a queuing or rationing
system and the black markets appear in which goods/services are exchanged
illegally.

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Maximum prices and the efficiency loss

MINIMUM PRICES
Minimum price at which buyers pay for the good or service (the minimum
price must be above the equilibrium price,
otherwise, it has no effect). It have two
import consequences, the sellers produce
too much supply... excess supply, and It
creates a loss of efficiency. The effects of
the setting a minimum price are three, the
inefficient allocation among vendors, the
black market possibility of sale below the
legal price and there are alternative ways
to manage the surplus resources like stock
policy or direct subsidy policy.

Minimum price and the loss of efficiency

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TAX ON THE SELLING PRICE (TAX COLLECTED BY
THE SELLER)
The supply curve shifts to the left. Due to the tax, the new break-even point
occurs at a higher price and with a lower exchange rate. The income
collected from a consumption tax is equal to the area of the rectangle where
the height is the amount of the tax, and the width is the amount that is
exchanged once the tax has been introduced

C: DEADWEIGHT LOSS (LOSS OF EFFICIENCY)

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THE LOSS OF EFFICIENCY

WITHOUT TAX WITH TAX VARIATION

CS A+B+C A -(B+C)

PS D+E+F F -(D+E)

COLLECTED TAXES 0 B+D +(B+D)

BY GOVERNMENT

TS A+B+C+D+E+F A+B+D+F -(C+E)

LAFFER CURVE
The Laffer's Curve shows how tax collection/revenue (vertical axis) varies as
the tax rate (horizontal axis) varies. According to the Laffer's curve, tax
revenues are increasing to reach the maximum point, after which the tax
revenues begins to decline.

THE BURDEN OF TAXATION

The incidence on consumers (the consumer tax burden): Difference between
the price paid by the consumer (PD) after the application of the tax and the
price of the initial equilibrium (P*), i.e., before tax.

The incidence on producers (the producer tax burden): Difference between

the price of the initial equilibrium (P *); i.e., before the tax, and the price that
sellers receive after the tax (Ps).

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BURDEN OF TAXATION AND THE ELASTICITY
Most of the tax incidence/burden falls on those who have a more inelastic
function (demand or supply).

When the price elasticity of demand is greater than the price elasticity of
supply, the tax burden falls mainly on producers. When the price elasticity of
supply is greater than the price elasticity of demand, the tax burden falls
mainly on consumers.

The more elastic the demand/supply, the greater the loss of efficiency. Given
a supply function, the loss of efficiency will be greater the greater the
elasticity of demand. Given a demand function, the loss of efficiency will be
greater the greater the elasticity of supply.

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RESTRICTIONS ON INTERNATIONAL TRADE
The arguments to justify restrictions on international trade are: the national
security, the emerging industry or job creation and the unfair competition.

Policies that restrict international trade are often implemented over imports,
so they are related to the interests of the interest groups/lobbies that have
more to do with producers than consumers.

The instruments restricting international trade are the Tariff and Quotas on
imported goods, non-tariff barriers (technical, health regulations,…) and
export subsidies.

Tariffs

WITHOUT TARIFFS WITH TARIFFS WELFARE VARIATION

CS E+A+B+C+D+G E+G -(A+B+C+D)

PS F A+F A

GOVERNMENT 0 C C

TS E+A+B+C+D+G+F E+G+A+F+C -(B+D)

Quotas
An import quota is a limit on the amount of a good that can be sold in the
country. As the share raises the domestic price above the world price,
domestic buyers are worse, and producers are better.

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The results of tariffs and quotas are identical or equivalent:
- Domestic prices increase.
- They reduce the welfare of domestic consumers.
- They increase the welfare of domestic producers.
- They cause loss of welfare.