Micro CHAPTER 6.5:

CHAPTER SUMMARY

Inequality is the difference between what people have or earn. Income is the amount of money people earn each year, while wealth is the total value of the things people own (called assets). For example, if I own a home and the value of the home goes up, my wealth has increased, but it was not measured as income.

It can be difficult to measure wealth inequality because some assets are hard to measure. However, it is pretty easy to measure income inequality because we just have to know everyone's income. One way that we can represent inequality on a graph is using what we call a Lorenz curve, which is seen below.

The x-axis shows the percent of families in an economy, and the y-axis shows the percent of income. We rank all families and organize them with the lowest income families on the left and highest income families on the right. Then, we look at what percent of the total income of the economy goes to what percent of families. In the example below, we can see that the poorest 20% of families only receive 5% of the income. The poorest 80% of families receive 55% of the total income, which means the richest 20% of families receive 45% of the income.

The bigger the yellow area, the greater the income inequality in an economy. If there is no yellow area, that means all families have exactly the same income, which would mean we have perfect income equality. If the entire area under the 45 degree curve is yellow, that would mean one family has all the income, meaning we have perfect income inequality.

We measure the level of income inequality using the Gini coefficient, which ranges from 0 to 1. The Gini coefficient basically tells us what percent of the total area under the perfect curve is yellow. If we have perfect income equality, the Gini coefficient is 0, and if we have perfect income inequality, the Gini coefficient is 1. This means that, the higher the Gini coefficient, the more inequality an economy faces.

The type of taxes that a government imposes can affect inequality. There are three main types:

• Proportional (flat) taxes: Taxes that take the same percentage of everyone's income. If we have a proportional tax of 10%, a person earning $100k would pay $10k, and a person earning $50k would pay $5k.

• Progressive taxes: Taxes that take a higher percentage from people with higher income. Most national income taxes are set up this way. In this case, a person earning $100k might pay $25k in income taxes (25% of their income), while a person earning $50k might only pay $10k (20% of their income).

• Regressive taxes: Taxes that take a higher percentage from people with lower income. Many sales taxes are regressive, because people with lower income spend a higher percentage of their income. Imagine the person earning $100k spends $50k per year, and there is a 10% sales tax. They must pay $5k in sales taxes, which represents 5% of their income. Meanwhile, the poorer family earning $50k per year spends $40k per year, and pays $4k in sales tax, which represents 8% of their income. This means the poor family paid a higher percent of their income, making the tax regressive.

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