Market FailuresMarket Failures

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Review1. Define Market Failure.2. Identify the three market failures we have

learned so far in this unit. 3. Explain why are public goods a market failure.4. Explain why are externalities a market failure.5. Explain why are monopolies a market failure.6. Use a graph to explain the remedy for positive

externalities.7. Use a graph to explain the remedy for negative

externalities.

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Market Failure #4

Unfair Distribution of Wealth

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Net Worth

over $3.1 billion

1. What percent of American’s are living in poverty?

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Income Inequality In 2013, the average American family made

$51,939. Everyone is obviously rich.

What’s wrong with using the average?

Averages reveal absolutely nothing about how income is distributed.

How does the government measure distribution of income?

(Based on 2013 Information) 5

THE LORENZ CURVE

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Measuring Income Distribution Reviewing the process:• The government divides all income earning

families into five equal groups (quintiles) from poorest to richest.

• Each groups represents 20% of the population.• If there was perfect equality then 20% of the

families should earn 20% of the income, 40% should earn 40% (and so on).

• The government compares how far the actual distribution is from perfect distribution then attempts to redistribute money fairly.

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20 40 60 80 100

100

80

60

40

20

0

Percent of Families

Per

cen

t of

In

com

e

Perfect Equality

The Lorenz Curve

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100

80

60

55

40

30

2015

5 0

Percent of Families

Per

cen

t of

In

com

e

Perfect Equality

Lorenz Curve (actual distribution)

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The Lorenz Curve

20 40 60 80 100

100

80

60

55

40

30

2015

5 0

Percent of Families

Per

cen

t of

In

com

e

Perfect Equality

Lorenz Curve (actual distribution)

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The Lorenz Curve

The size of the banana showsthe degree of

income inequality.

20 40 60 80 100

100

80

60

55

40

30

2015

5 0

Percent of Families

Per

cen

t of

In

com

e

Perfect Equality

After Distribution

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The Lorenz Curve

The banana gets smaller when the government re-

distributes income

20 40 60 80 100

The Lorenz Curve is related to the Gini Coefficient

The Gini coefficient is usually defined mathematically based on the Lorenz curve, which plots the proportion of the total income of the population (y axis) that is cumulatively earned by the bottom x% of the population (see diagram). The line at 45 degrees thus represents perfect equality of incomes.

The Gini coefficient can then be thought of as the ratio of the area that lies between the line of equality and the Lorenz curve (marked A in the diagram) over the total area under the line of equality (marked A and B in the diagram); i.e., G = A / (A + B)

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13Inequality is calculated based on the Gini Index, which measures inequality on a scale of 0 to 1. A score of 1 indicates that one person has all the wealth and a score of 0 indicates that wealth is distributed evenly.

Welfare provides a safety net for citizens(retirement, unemployment, workers comp, health, etc.)

BUT, what are some possible downsides?

Where does the government get the money for welfare?

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Taxes

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What are Taxes?

Why does the government tax?Two purposes:1. Finance government operations.

• Public goods-highways, defense, employee wages• Fund Programs- welfare, social security

2. Influence economic behavior of firms and individuals.

Ex: Excise taxes on tobacco raises tax revenue and discourages the use of cigarettes.

Taxes – mandatory payments made to the government to cover costs of governing.

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Three Types of Taxes1. Progressive Taxes -takes a larger percent of

income from high income groups (takes more from rich people).

Ex: Current Federal Income Tax system

3. Regressive Taxes –takes a larger percentage from low income groups (takes more from poor people).

Ex: Sales tax; any consumption tax.

2. Proportional Taxes (flat rate) –takes the same percent of income from all income groups.

Ex: 20% flat income tax on all income groups

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What kind of taxes are these? (THINK % of Income)

1. Toll road tax ($1 per day) 2. State income tax where richer citizens pay

higher % 3. $.45 tax on cigarettes4. Medicare tax of 1% of every dollar earned 5. 6% Michigan sales tax

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Three Types of Taxes

Regressive

Progressive

Regressive

Proportional

Regressive

Federal Income Tax DebateFederal Income Tax Debate Equal Tax of $350 per week (Regressive Tax)Equal Tax of $350 per week (Regressive Tax) Income Amount of Tax % Amount to live on• $200 $350 175% -$150)[crime?]

• $350 $350 100% $0 • $500 $350 70% $150• $1,000 $350 35% $650• $5,000 $350 7% $4,650

TTaxax of 20% per week (Proportional Tax) of 20% per week (Proportional Tax) Income Amount of Tax Amount to live on• $200 $40 $160

• $350 $70 $280• $500 $100 $400 • $1,000 $200 $800 • $5,000 $1,000 $4,000

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Federal Income Tax DebateFederal Income Tax Debate

This is our current system. Is it fair?The Progressive tax system is the most

effective way to fight this market failure

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Rate Single Filers Married Joint FilersHead of Household Filers

10% $0 - $9,075 $0 to $18,150 $0 to $12,950

15% $9,075 - $36,900 $18,350 - $72,800 $12,950 - $49,400

25% $36,900 - $89,350 $73,800 -$148,850 $49,400 - $127,550

28% $89,350 to $186,350$148,850 - $226,850

$127,550 -$206,600

33%

35%

$186,350 - $405,100

$405,100 - $406,750

$226,850 - $405,100

$405,100- $457,600

$206,600 -$405,100

$405,100 - $432,200

39.6% $406,750 and up $457,600 and up $432,200 and up

There is a proposal to increase the income tax rate above 39.6% for the highest earners. Is it a good idea?

The Laffer CurveShows relationship between tax rate

and tax revenue.What would happen if the highest tax

bracket was 75%?

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The LAST micro graph to learn!!!!

THINK ROBIN HOOD!!!!!!

What did Robin Hood do?Steal from the rich and give to the poor.

What would happen to the amount of travelers through Sherwood forest if he took 95% instead of 39% of their money?

What would happen to the total amount of money he collects?

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The Laffer Curve

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% Tax Rate

Tax Revenue

If the government increase taxes rates

tax revenue will increase

If the tax rate becomes too high, tax revenue will fall since

workers have no incentive to work

harder

GREAT NEWS…

YOU ARE DONE WITH MICRO!!!!

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Practice FRQs

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272005, #2

282003, #1