Chapter 15: Distribution

1. Chapter 15: Distribution May 20, 2009

2. Pareto optimality • Economics defines efficiency as the Pareto optimal allocation of resources by the market • Assumption? • Efficient allocation = best satisfies individual wants weighted by the individual’s ability to pay (by income and wealth) • Issue of distributive equality is avoided • Economics assumes certain cultural values • (1) objective efficiency • (2) redistribution efficiency not considered

3. Distribution of income and wealth • Wealth = stock of assets, measured at a point in time (eg?) • Income = flow of earnings from these assets + earnings of your own labor power (or human capital) over a period of time • Income and wealth: two different magnitudes, measured in different units, and distributed differently over the population (eg: $ vs $/time) • Wealth: usually more concentrated than income; financial wealth even more concentrated • Why the distribution of wealth among individuals? • Historical result of whose ancestors got there first + individual ability and effort + luck

4. Measuring distribution • Lorenz curve: plots the % of total income going to each % of income recipient (income on the Y axis, and income recipients on the X axis) • The closer the curve to the 45-degree line, the more equal the distribution; the farther away, the less equal. The shaded area (between the curve and the line) measures inequality • Gini coefficient: ratio of the shaded area to the total triangular area under the 45-degree line; used to measure the inequality of the distribution of wealth or income across a population • Gini coefficient of 1 = perfect inequality; coefficient of 0 = equal distribution • Also concerned with wealth and income *between* countries and not only *within* countries

5. Measuring distribution • Is there a legitimate range of inequality, beyond which further inequality becomes either unfair or dysfunctional? What do *you* think? • Plato: richest citizen should be 4 X wealthier than the poorest • Ecological economics: since real total output cannot grow forever, then the total is limited, then the maximum for one person is implicitly limited • Functional distribution of income: What about paying for nature’s contribution? Who would collect?

6. Consequences of distribution for community and health • Inequality of income distribution has a substantial effect on rates of death and sickness – regardless of the absolute level of income of the poor. How? • Less control over the circumstances of your life • Greater risk of job loss • Lower level of social standing and respect • More frequent experiences of disrespect and shame • More threatening life – and the threat comes from those above the hierarchy • Indirect social effects on health (see Table 13.1)

7. Intertemporal Distribution of Wealth • What about the distribution of resources between generations and not only within a generation? • Should we try to make the future better off than the present? Do we have an obligation to make sure it is not worse off than the present? • 2 alternative approaches •  ecological economics approach – based on ethical judgments concerning obligations to future generations (intergenerational justice) •  more mainstream economics approach – based on an ‘objective’ decision-making rule (intergenerational allocation)

8. The normative approach of ecological economics • Since you didn’t choose to be born in this generation, there is no moral justification for claiming your generation has more right than another • Therefore: future generations have an inalienable right to sufficient resources to provide a satisfactory quality of life, and we have a corresponding duty to preserve an adequate amount of resources • What is adequate? Depends on technological and ecological change. Both characterized by ignorance. • Ethical decisions affect our actions. • Practically, what does this mean?

9. The ‘positive’ approach of neoclassical economics • Not an ethical problem, but a technical problem. How? • Comparing future benefits and costs w/ those that occur in the present. How? • Intertemporal discounting -> valuing the future less than the present; people preferring things now rather in the future. Why? • (1) impatience -> pure time rate of preference • (2) opportunity cost -> if money is fungible, then it gets more weight to any resource today than the same resource tomorrow • (3) expectation of future riches -> richer future argument • Net present value: what present and future costs and benefits are worth to us today. Implication? • Box 15-2

10. The ‘positive’ approach of neoclassical economics: discounting reconsidered • Intertemporal discounting: makes sense for the individual and for market goods. Does it make sense for society and for nonmarket goods? • How are societies different than individuals? • Immortal (relatively) -> therefore, all economists agree that social discount rates < individual discount rates • Social discount rates: rate of conversion of future value to present value that reflects society’s collective ethical judgement as opposed to an individualistic judgment • No agreement on opportunity cost of capital…

11. The ‘positive’ approach of neoclassical economics: opportunity cost of capital • Financial capital: we can invest it if we have it now. But a social discount rate into the indefinite future may be inappropriate because • (1) the real value of $ can only grow if the production of goods and services that $ can acquire also grows. What is the problem here? • (2) many investments are ‘profitable’ because we ignore many of the costs of production • (2b) if we consider that natural capital must be treated separately from manmade capital (why?) then the decline in natural capital + law of diminishing marginal utility -> negative discount rate to natural capital, or positive discount rate only to highly fungible goods and services • (3) only finite opportunities for productive investment in an economy • (4) technology – at best – can complement resources and can never replace them

12. So – what can we say about discount rates? • Make sense for individuals – in the short run, and for some small-scale, short-term social projects • Intertemporal allocation: apportionment of resources across different stages in the lifetimes of basically the same set of people (same generation) • Intertemporal distribution: apportioning of resources across different generations • Distribution is different from allocation  therefore – justice replaces efficiency as the criterion for policy when time periods become intergenerational

13. Big Ideas to Remember • Pareto optimality • Role of scale and distribution in defining Pareto optimal allocation • Income distribution vs. wealth distribution • Functional vs. personal distribution • Social limits to range of inequality • Lorenz curve • Gini coefficient • Inequality and health • Intertemporal distribution vs. intertemporal allocation • Discounting and net present value • Pure time rate of preference • Individual vs. social discount rate

14. Exam: May 22nd • Material on the exam • Environmental Economics • Chapters 6, 7, 8, 13, • Ecological Economics • Chapters 10 and 15 • GDAE • Extra reading • Including Chapter 13 in Ecological Economics • Including material in Valuing Earth