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$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 $75,000 or more?
29.6%.
If everyone’s income was doubled, would everyone then move into higher income
brackets? Yes (Yes, No). However, if this were the case, would the degree of inequality
change? No (Yes, No).
Look at the quintile distribution. What percentage of total income is earned by the bottom 20%?
4.3%. What percentage of income is earned by the top 20%? 47.4%. Does this indicate an
equal distribution of income? No (Yes, No). What is the difference between an equal
distribution and an equitable distribution of income? An equal distribution of income means
that everyone receives exactly the same income equal to the total GDP divided by the
population. An equitable distribution of income means that everyone get their “fair
share.” Thus, with an equitable distribution of income, a physician might earn more
because he/she “deserves” more. Is the determination of an equal distribution of income based
on fact, i.e. is there only one right answer? Yes (Yes, No). Does the concept of an equitable
distribution of income involve a value judgment? Yes (Yes, No).
Click “Continue.” You will see “How Do You Want to Change the Distribution.” Select
“Economic Disturbance.” You will see “Choose an Economic Disturbance Tool.” Select
“Change Wealth Distribution.” Enter the following amounts for the new distribution of wealth.
New Distribution of Wealth
Bottom 20%
-0.05
2nd 20%
-0.05
3rd 20%
-0.05
4th 20%
-0.05
Top 20%
100.2
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$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
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$Distribution Exercise #5 Answers
Page 3
Click “Results.” Click “See Graph” and draw the resulting graph. Indicate the old Lorenz
Curve, the new Lorenz Curve, the 45-degree line, and label all axes.
Percent of
Families
0
20
Percent of Income
40
60
80
100
Thick Line = New Lorenz Curve; Dashed Line = 45-Degree Line; Thin Line = Old Lorenz Curve
What is the Lorenz Curve and what is it purpose? The Lorenz Curve is a plot of the quintile
distribution. The purpose of the Lorenz Curve is to graphically depict the equality or
inequality of the distribution of income in a given economy. What does the 45-degree line
depict? The 45-degree line indicates an exactly equal distribution of income, where
everyone gets an equal share of income. Compare the old Lorenz Curve with the new Lorenz
Curve. Has the share of the income pie increased for the lower and middle classes? Yes. (Yes,
No). How can you determine this by looking at the above Lorenz Curves? The new Lorenz
Curve, indicated by the solid line, is closer to the 45-degree line for the lower and middle
classes. This indicates that the share of total income has increased for these classes. If the
Lorenz Curve is stretched out further away from the 45-degree line, does that indicate a more
equal or more unequal distribution of income? That indicates a more unequal distribution of
income. If the Lorenz Curve is located closer to the 45-degree line, does that indicate a more
equal or a more unequal distribution of income? That indicates a more equal distribution of
income.
How is the Gini Coefficient computed? The Gini Coefficient equals the area between the
Lorenz Curve and the 45-degree line divided by the total area of the triangle formed by the
45-degree line and the horizontal and vertical axes.
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$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
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$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).