Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.
PART 6 The Economics of Labor Markets
Chapter 20 of 36 Income Inequality and Poverty
Section 8 of 20
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A study of 2006 data by Michael Cox and Richard Alm shows how different inequality measures generate very different results
They compared American households in the top fifth of income distribution to those of the bottom fifth.
They found for U.S. households
· the richest fifth has an average income of $149,963
· the poorest fifth has an average income of $9,974
· the top group has about 15 times more income than the bottom group
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When accounting for taxes paid, the gap shrinks somewhat because the tax system is progressive, meaning the higher the income the higher percentage tax paid on it.
The top group pays a higher percentage of income in taxes
After taxes, the richest fifth has 14 times more net income than the poorest fifth.
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Looking at consumption rather than income the gap shrinks substantially.
They found the consumption of the richest fifth is only 3.9 times more than of the poorest fifth.
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The consumption gap becomes smaller when correcting for the number of people in households.
Because larger families are more likely to have two earners they are more likely to be in a higher income distribution group.
They found households
· in the top fifth have an average of 3.1 people
· in the bottom fifth have an average of 1.7 people
As a result, consumption per person in the richest fifth of households is only 2.1 times as much as consumption per person in the poorest fifth.
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Overall, these data show inequality of material standards of living is much smaller than inequality of annual income.
This means most of the after-tax higher income of the richest fifth is invested.
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Are purchases of homes and automobiles considered consumption?
ChatGPT:
In Mankiw’s framework, purchases of homes and automobiles are not treated as “consumption.”
Consumption includes spending on goods and services that are used up quickly—such as food, clothing, travel, and entertainment.
Durable goods like automobiles and investment goods like houses are classified differently.
Automobiles are considered consumption of durable goods in some contexts.
Homes (new houses) are treated as investment, not consumption, because they add to the economy’s capital stock.
So, in national accounting terms:
New homes = investment
Cars = durable consumption
Everyday goods/services = nondurable consumption
In Mankiw’s discussion, when comparing consumption inequality, economists focus on actual spending on goods and services used for living, not on large, infrequent investments like homes.
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What about purchase of a house that is not new (used, had previous owner)?
ChatGPT:
The purchase of an existing house (used home) is not counted as consumption or investment in GDP.
When a home is newly built, it adds to the nation’s capital stock and is counted as investment.
When an existing house is resold, it is simply a transfer of ownership of an existing asset.
No new production takes place, so it doesn’t add to GDP.
However, any services related to the sale — such as real estate agent fees, legal services, or home renovations — do count as part of GDP, since they involve current production of goods or services.
Summary:
Buying a new house = investment.
Buying a used house = not counted, except for service fees involved in the transaction.
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after-tax income
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