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Course Course Number University or College Professor’s Name Student Name:________________________ Section: ______________________________ $Distribution Exercise #5 Answers ( points) Please limit your answers to the spaces provided. If necessary, write on the back of the page. Do not attach printout or additional pages. All questions pertain to the $Distribution module in the SimEcon® software package. Make sure that you have read the “$Distribution Manual” and “SimEcon® Operation Instructions.” These materials may be found at the Class Web site prior to beginning the exercise. For many of the exercise’s questions, it will be necessary to refer to those instructions. For many of the exercise’s questions, it will be necessary to refer to your text. Open the $Distribution module. You will see the “Initial Income Distribution.” Print out or copy this table for future reference. Look at the distribution of income by family. What family. What percentage of families earns less than $25,000? 21.1%. What percentage of families earns between $25,000 and $74,999? 49.3%. What percentage of families earns $75,000 or more? 29.6%. If everyone’s income was doubled, would everyone then move into higher income brackets? Yes (Yes, No). However, if this were the case, would the degree of inequality change? No (Yes, No). Look at the quintile distribution. What percentage of total income is earned by the bottom 20%? 4.3%. What percentage of income is earned by the top 20%? 47.4%. Does this indicate an equal distribution of income? No (Yes, No). What is the difference between an equal distribution and an equitable distribution of income? An equal distribution of income means that everyone receives exactly the same income equal to the total GDP divided by the population. An equitable distribution of income means that everyone get their “fair share.” Thus, with an equitable distribution of income, a physician might earn more because he/she “deserves” more. Is the determination of an equal distribution of income based on fact, i.e. is there only one right answer? Yes (Yes, No). Does the concept of an equitable distribution of income involve a value judgment? Yes (Yes, No). Click “Continue.” You will see “How Do You Want to Change the Distribution.” Select “Economic Disturbance.” You will see “Choose an Economic Disturbance Tool.” Select “Change Wealth Distribution.” Enter the following amounts for the new distribution of wealth. New Distribution of Wealth Bottom 20% -0.05 2nd 20% -0.05 3rd 20% -0.05 4th 20% -0.05 Top 20% 100.2 Course $Distribution Exercise #5 Answers Page 2 Click “Results.” Look at the quintile distribution. What percentage of total income is earned by the bottom 20%? 4.3%. What percentage of income is earned by the top 20%? 52.4%. Have these results significantly changed? Yes (Yes, No). What is the difference between wealth and income? Wealth represents your net worth at a point in time. Income represents the amount of money that you are taking in over a period of time. Notice that the figures for all but the top 20% are negative. What does this mean? This means that the typical family below the top 20% has more debts than assets. If the distribution of wealth was made more unequal, would there be an immediate change in the distribution of income? Yes (Yes, No). Click the “Back” button twice. Select the button entitled, “Economic Disturbance.” The program will automatically respond. Select “Change Unemployment Rate.” Enter a rate of 0.04 and click “Results.” If there was economic prosperity and many unemployed were able to find jobs, the status of which group would be most improved. The status of the lower income group would be most improved. Look at the quintile distribution. What percentage of total income is now earned by the bottom 20%? 4.7%. What percentage of income is now earned by the top 20%? 47.2%. Has the bottom of the income distribution gained at the expense of the top of the distribution? Yes (Yes, No). Click the “Back” button twice. Select the button entitled, “Economic Policy.” Then, select “Change Income Tax Rates.” Fill in the amounts below for the current tax rate schedule. Current Tax Rate Schedule Bottom 20% 0.12 2nd 20% 0.15 3rd 20% 0.20 4th 20% 0.25 Top 20% 0.35 Does the current tax rate schedule represent a progressive, proportional or regressive system? This current schedule represents a progressive system. Given that the goal is a more equal distribution of income, would this government want the system to be more progressive, more regressive or proportional? This government would want to make the system more progressive. Would a progressive tax system be more supported by the wealthy classes or the low income and working classes? (Give reasons for your answer.) A more progressive tax system increases the tax burden on those with high incomes and reduces it on those with low incomes. Thus, this type of system would tend to be more supported by the lower and working classes. Enter into the program the amounts below for the new tax rate schedule. New Tax Rate Schedule Bottom 20% 0.05 2nd 20% 0.07 3rd 20% 0.10 4th 20% 0.29 Top 20% 0.49 Course $Distribution Exercise #5 Answers Page 3 Click “Results.” Click “See Graph” and draw the resulting graph. Indicate the old Lorenz Curve, the new Lorenz Curve, the 45-degree line, and label all axes. Percent of Families 0 20 Percent of Income 40 60 80 100 Thick Line = New Lorenz Curve; Dashed Line = 45-Degree Line; Thin Line = Old Lorenz Curve What is the Lorenz Curve and what is it purpose? The Lorenz Curve is a plot of the quintile distribution. The purpose of the Lorenz Curve is to graphically depict the equality or inequality of the distribution of income in a given economy. What does the 45-degree line depict? The 45-degree line indicates an exactly equal distribution of income, where everyone gets an equal share of income. Compare the old Lorenz Curve with the new Lorenz Curve. Has the share of the income pie increased for the lower and middle classes? Yes. (Yes, No). How can you determine this by looking at the above Lorenz Curves? The new Lorenz Curve, indicated by the solid line, is closer to the 45-degree line for the lower and middle classes. This indicates that the share of total income has increased for these classes. If the Lorenz Curve is stretched out further away from the 45-degree line, does that indicate a more equal or more unequal distribution of income? That indicates a more unequal distribution of income. If the Lorenz Curve is located closer to the 45-degree line, does that indicate a more equal or a more unequal distribution of income? That indicates a more equal distribution of income. How is the Gini Coefficient computed? The Gini Coefficient equals the area between the Lorenz Curve and the 45-degree line divided by the total area of the triangle formed by the 45-degree line and the horizontal and vertical axes. Course $Distribution Exercise #5 Answers Page 4 Looking at the above graphs, does it appear that the Gini Coefficient has increased or decreased? The Gini Coefficient appears to have decreased. Looking at the Gini coefficient indicated on the graph page has it decreased? Yes (Yes, No) Has the distribution of income has become more unequal or more equal? The distribution has become more equal. Click the “Back” button three times and select “Economic Policy.” Select “Change Welfare Budget.” What percent of total GDP is currently being spent on welfare? 1% is being spent on welfare. Suppose that public opinion in this nation clamored for a dismantling of the welfare system. Enter 0.02, meaning that 0.02% of GDP will now be spent on welfare. Click “Results.” What is the difference between earned income and spendable income? Earned income represents the gross income before taxes are paid and before any welfare benefits are received. Spendable income represents income that you can actually spend after paying your taxes and after receiving any welfare benefits to which you are entitled. Is it possible for spendable income to be greater than earned income? Yes (Yes, No). Click “Quintile Results.” What was the old percentage of income enjoyed by the lowest 20%? 4.8%. What is the new percentage of income enjoyed by the lowest 20%? 4.26%. Has the share of income enjoyed by the lowest quintile gotten bigger or smaller? It has gotten smaller. What was the old percentage of income enjoyed by the top 20%? 46.2%. What is the new percentage of income enjoyed by the top 20%? 46.84%. Do the upper classes now enjoy a bigger or smaller share of income? They now enjoy a bigger share. Click “See Graph”, and draw the resulting graph below. Label all axes, the Lorenz Curves and the 45-degree line. Percent of Families Solid Line = Lorenz Curve Dashed Line = 45-degree line 0 20 Percent of Income 40 60 80 100 Course $Distribution Exercise #5 Answers Page 5 Has the Gini Coefficient has changed much? No (Yes, No). How much did it change? It went from 0.596 to 0.598. By looking at this Lorenz Curve, does it appear that the distribution of income has changed all that much? No (Yes, No). Do you think that the upper and middle classes have gained much as a result of this change in the welfare budget? No (Yes, No). The welfare budget was changed from 1% of GDP to 0.02% of GDP. This means that the welfare budget was reduced by 98%. Would this change have a devastating impact on those currently on welfare? Yes (Yes, No).