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Summary Economic Analysis of Inequality
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LES 1: AN ECONOMIC ANALYSIS OF INEQUALITY: FROM PRINCIPLES TO POLICY1. What is inequality?
What is inequality for you?
• Look at questionnaire and think
• People differ in their ethical (normative) intuitions. So, there are no “right” or “wrong”
answers
• Anything goes? →No!
• In these lectures we study how ethical principles translate into practical measures and policy
advice = normative side of economics.
3 concepts:
• (Social) welfare: Evaluation of (income) distribution according to its size and inequality (see
lecture 3-4) → overall desirability of a distribution? In which distribution do you want be
born?
• Inequality: Evaluation of (income) distribution according to its inequality (see lecture 5-6) →
which is the more equal of the 2 distributions?
• Poverty: Evaluation of lower part of (income) distribution (see lecture 7)
• Different concepts! (think of China nowadays → poverty is going down but inequality is
rising!)
• Creating conceptual clarity is one of the main aims of the course
What is welfare for you?
9
8 8
currency of "Hypothesia"
currency of "Hypothesia"
7 7
6
6
5
5
4 Programme X
3 Programme X 4
Programme Y
2 Programme Y 3
1 2
0 1
0
Ann Bob Charlotte Danny
1
, What is inequality for you?
6
6
currency of "Hypothesia"
currency of "Hypothesia"
5 5
4 4
3 3
Programme X programme X
2 2
Programme Y Programme Y
1 1
0 0
❖ Grey in the first graph is an completely equal distribution
❖ Pigou-Dalton transfer: when you take one block from Ann and give it to Danny = when you take
money from the poor and give it to the rich = a more unequal distribution.
6 6
currency of "Hypothesia"
5 5
currency of "Hypothesia"
4 4
3 3 programme X
programme X
2 Programme Y
Programme Y 2
1
1
0
0
Ann Bob Charlotte Danny
❖ In the second graph we have two different sizes of distributions: to measure the inequality
between two distributions of a different size = not easy
❖ Economist would say these two distributions are both equal to each other (thinking in shares) =
relative position
❖ Others might say this isn’t true because the difference between the poor and the rich is higher
for Y. = absolute position
→ if you believe in the pigou-dalton
6 position, you cannot take a relative
currency of "Hypothesia"
5 ànd absolute position at the same
time. (see lesson 5)
4
3
programme X
2
Programme Y
1
0
2
,2. Why should we care about inequality?
Why inequality matters:
o Instrumental reasons (because of the consequences of inequality on other outcomes)
• Recent epidemiological insights (Wilkinson & Pickett, 2009
❖ Always income
inequality on the X-axis
and any other problem, in
this example homicides
per million, on the Y-axis.
❖ “Conclusion”: more
inequality leads to more
homicides.
❖ But what we see here
is at best a correlation!
Certainly not a causal
relation.
• Economists are predominantly interested in the effect of inequality on economic output
(GDP) or its growth → is it the case that more unequal countries grow less or more?
• Founding father: Simon Kuznets
→On the X-axis: poor countries
becoming richer.
→On the Y-axis: inequality (gini-
coëfficient)
→1st inequality goes up and then it
goes down.(hypothesis)
→unfortunately it is not so simple in
the real world.
3
, • Establishing the (causal) effect of inequality on economic growth is a VERY DIFFICULT
question
• Because inequality is not an exogenous variable. It is determined from within the model
= endogenous. Bv. Institutions might affect both economic growth and inequality.
• Causal empirical statements are hard to make (see your econometrics course)
• Also theoretically it is a hard question:
Monopoly effect: the rich may gain a lot by protecting their
acquired positions (rent seeking =bad for growth) → rich people want to remain rich and
protect their rents → organise the society so that the poor don’t come to their full
potential.
Clinton: fraction of total growth captured by the 1% is 45%
Bush: fraction of total growth captured by the 1% is 65% → more as half of the total
growth goes to the rich = the rich are much more able to keep the money between the
rich.
Incentive effect: Inequality creates incentives for investment and entrepreneurs. Wealth
generated by the rich trickles down to lower parts of distribution. → so a little bit of inequality
can also be good for growth.
The question now is what is the bigger effect? The monopoly effect which is bad
for economic growth or the incentive effect which is good for economic growth?
4
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