Tuesday, 16 November 2010

Economics - equity and inequality

Efficiency refers to the maximization of TSS in resource allocation, but equity refers to the fairness in society. There's trade off between efficiency and equity. Also, efficiency and inequality is positive statements while equity is normative and we don't have definite meaning for it.
Measures in income distribution
-          Income share: % of population VS different income groups
-          Decile groups: divide population into ten groups in increasing household income, e.g. the first decile group has the lowest 10% household income. If the household income is evenly distributed, then each group shares 10% of the total income.
-          Lorenz curve: cumulative % of population VS cumulative % of income
-          Gini coefficient Draw a line the 45-degree line in the graph, then
Gini coefficient = Area between Lorenz curve and 45-degree line / Area below 45-degree line
If Gini coefficient = 0, then the Lorenz curve is actually the 45-degree line, so it's absolute income inequality.
If it's 1, it's complete income disparity, where all income is occupied by one household unit.
If it's between 0 and 1, it's unequal income distribution, the larger coefficient, the larger income disparity.
Limitations in measuring income inequality
1)       Different in household size (e.g. $20000 for a 2-people family VS $30000 for a 8-people family)
2)       Imperfect market information / difficulty in collecting information
3)       Different definitions of income (some of the income is not recorded)
4)       Ignoring lifetime income (experienced worker was offered higher wages)
5)       It's calculated before transfer payments, exaggerating the income inequality.
Sources of income inequality
1)       Labour quality differs: better skilled labour has less supply but higher demand, hence the equilibrium price (wages) is higher.
2)       Working condition differs (e.g. policeman VS office lady)
3)       Difference in human capital (productivity)
4)       Geographical / age / sex difference or discrimination
5)       Unequal ownership of land, capital and business
6)       Monopoly and political power (e.g. professional membership as the entry barrier)
7)       Discrimination in labour, however it costs somehow, so discrimination is not common in the free market.
Solutions to income inequality
1)       Policies that equalizing income, such as transfer payments and legislation on minimum wages.
2)       Policies that equalizing opportunities, such as education and training, enhancing market competition, donations and foreign aid
What we have to consider about the policy is the different aspects / principles of equity, as well as balancing efficient and equity.

Up to now, the topic of "Efficiency and Equity" is completed, the next economic topic will be macroeconmics which concerns national income. If possible, I will try to put the topic into a deeper sight, with some light AL material (such as Coase's analysis) into a seperate set of notes.

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