INCOME

REDISTRIBUTION
Chapter 6

2016 by McGraw-Hill Education Limited.

Learning Objectives
1. Define market income, total income and income
after taxes and transfers.
2. Explain how the Lorenz curve and the Gini
coefficient can be used to measure income
inequality.
3. Summarize how the low income ratio and the
low income gap ratio can be used to measure
poverty in Canada.
4. Describe the alternative views on redistribution
that are embedded in the additive social
welfare function and the maximin criteria.
6-2

Learning Objectives
(cont)
5. Explain how distortionary taxation affects
the policy prescriptions for redistribution
given an additive social welfare function
and the maximin criteria.
6. Describe what Pareto efficient redistribution
is and how it differs rom the additive and
maximin social welfare functions.
7. Summarize the arguments made in favour
of pursuing redistribution using in-kind
transfers rather than cash transfers.
6-3

LO1, LO2

Distribution of Income
The Lorenz curve
The Gini coefficient
Market income
Income after taxes and transfers

The income share of the richest 1

percent

6-4

The Lorenz Curve: Income LO2

Inequality in Canada, 1980
and 2011

Figure 6.1
6-5

The Gini Coefficient for

Canada (based on market
income and after taxes and
transfers), 1980 to 2011

LO2

Figure 6.2
6-6

Income Share of the Top One

Percent in Canada (1920-2010)
and the United States (19202012)*

Figure 6.3
6-7

LO3

Poverty
Poverty can be defined as lacking
sufficient resources to meet current
needs
Practically, difficult to define sufficient
and needs

Low income rate

Low income gap ratio
Poverty line

6-8

Low Income Rates in Canada

(in percent)

Figure 6.4

6-9

Average Low Income Gap

Ratio, 1980 and 2011 (in
percent)

Table 6.1

6-10

Interpreting the Data

The choice of income measure is
important
Some important sources of income
are excluded from the data
In-kind transfers
Payments made in commodities or
services

The household unit

Time frame
6-11

Rationale for Income

Distribution

LO4, LO5

Utilitarianism

Utilitarian Social Welfare Function:

W = F(U1, U2, , Un)
Additive Social Welfare Function
W = U1 + U2 + + U n
Assumptions
1. Individuals have identical utility functions
that depend only on their incomes
2. Utility functions exhibit diminishing
marginal utility of income
3. Total amount of income to society is fixed

6-12

LO4, LO5
Model of the Optimal Distribution
of Income:
Peters marginal utility

Pauls marginal utility

The Additive Social Welfare Function

e
f

This is the
net gain to
society

d
c

Social welfare
maximized

MUPeter

0
Pauls income

Figure 6.5

I*

MUPaul
0
Peters income
6-13

LO4, LO5

The Maximin Criterion

Social Welfare Function
W = Minimum(U1, U2, , Un)
Maximin criterion maximize the
utility of the person with the
minimum utility
Original position
Critique of Rawls

6-14

Alternative Social LO4, LO5

Welfare Functions and
Redistribution

Panel a: Additive Social Welfare Function

Panel b: Maximin Criterion

45o line

45o line

e
f

S0
S1

W0
W1
C

Pauls utility

L Pauls utility

Figure 6.6
6-15

Pareto Efficient Income

Redistribution

LO6

Will redistribution always make someone

worse off?
Redistribution if gain in utility from
altruism exceeds loss from reduced
consumption
Government reduces cost of redistribution
Income distribution as a Public Good
Social stability

6-16

Non-individualistic Views
Fundamental principles specifying
income distribution derived
independent of tastes
Platos 4:1 ratio of highest to lowest
income
Incomes distributed equally as matter of
principle

12-17

Other Considerations
Processes versus Outcomes
Fairness of the process by which distribution is
determined
Fairness of the procedures used to redistribute
it
Robert Nozick
Society cannot redistribute income because society
has no income to redistribute

With sufficient social mobility, distribution

of income is of no particular ethical interest
6-18

Cash Versus In-Kind

Transfers
C
Y+X Z

K
E2

C2
C1

E1

I2

C2

I1
B
H1 H2

Z
H

Figure 6.7
6-19

An In-Kind Transfer that

Results in a Lower Utility Level
than
a Cash Transfer
C
Y+X Z

E3
K
I3
I2

E1

I1

Z
H

Figure 6.8
6-20

Cash and In-Kind Transfers

Under Asymmetric Information
UB

UA = C A + H
UB = C B + h T
R = CA + C B + T

b
c
e

E1

45o
d
H

R+H

UA

Figure 6.9
6-21

Reasons for In-Kind

Transfers

LO7

Commodity egalitarianism
Paternalism
Political motivations

6-22

Chapter 6 Summary
The Lorenz curve, the Gini coefficient, and the income
share of the top 1 percent are indicators of income
inequality and are sometimes used to compare income
inequality over time, across countries, or before and after
government taxes and transfers.
Recent trends indicate that the distribution of income in
Canada has become more unequal since 1980.
The low income rate, a measure of poverty, is calculated as
the percentage of a given population with income below a
certain threshold income level. A measure of the depth of
poverty is the average low income gap ratio for a given
population.
Measuring income inequality and poverty is difficult
because income is hard to measure correctly.
6-23

Chapter 6 Summary
(cont)

If (1) social welfare is the sum of identical utility functions that

depend only on income, (2) there is decreasing marginal utility
of income, and (3) the total amount of income is fixed, then
income should be equally distributed. These are quite strong
assumptions, and weakening them gives radically different
results.
The maximin criterion states that the best income distribution
maximizes the utility of the person who has the lowest utility.
The ethical validity of this proposition is controversial.
The income distribution may be like a public goodeveryone
derives utility from the fact that income is equitably distributed,
but government coercion is needed to accomplish redistribution.
The prevalence of government in-kind transfer programs may be
due to asymmetric information, paternalism, commodity
egalitarianism, or political attractiveness.

6-24