Utility Functions

• Economists usually work with utility functions that are curved.

• Typically, they mean that an x% income loss “hurts” more if you make $20,000/year than if you make $1,000,000/year.

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• (Behavioral economists have found strong reference point effects, too.)

  • $50,000/year feels different if you used to earn $20,000/year than if you earned $1,000,000/year

Inequality

Wealth or Income Setup:

• 10 poor people, each $1,000.

• 1 rich person, $100,000.

  • PS: likely will be you.

• Inequality Ratio: 100-to-1

Questions

• Does inequality have intrinsic negative externalities?

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• Should society redistribute wealth?

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• Does it matter whether it’s inherited? “Earned”?

What If?

(Base: 10 x $1,000. 1 x $100,000)

 

• Take $50,000 from rich. Give $5,000 each to poor.

• Greatly reduced inequality.

  • 10 poor people, each $6,000.

  • 1 rich person, $50,000.

  • Inequality Ratio: 100-to-12, not 100-to-1

Better?

What If?

(Base: 10 x $1,000. 1 x $100,000)

 

• Take $50,000 from rich. Give $2,500 each to poor. Lose $2,500 in process.

• Greatly reduced inequality.

  • 10 poor people, each $3,500.

  • 1 rich person, $50,000.

  • Inequality Ratio: 100-to-7, not 100-to-1

Better?

What If?

(Base: 10 x $1,000. 1 x $100,000)

 

• Take $50,000 from rich. Lose all in process.

• Still greatly reduced inequality.

  • 10 poor people, each 1,000.

  • 1 rich person, $50,000.

  • Inequality Ratio: 100-to-2, not 100-to-1

Better?

Incidentally…

• Almost all wealth statistics are quoted before redistributive activities.

• In real life, not all redistribution is from rich to poor.

Fighting CC

Setup:

• 10 poor people, each earning $1,000/year.

• 1 rich person, earning $100,000/year.

Choices:

• #1: Reduce income of poor people by 1% each

• #2: Reduce income of rich person by 1% each

• #3: Reduce income of poor and rich alike by 0.5%

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(What would most economists propose?)