The Economics of Inequality

• A. The Gini coefficient ✓
• B. The median household income
• C. The poverty line
• D. The consumer price index

Why: The Gini coefficient summarizes the distribution of income across a population on a scale from 0, where everyone has identical income, to 1, where one person holds all the income. Median income and the CPI do not measure dispersion, and the poverty line is a threshold rather than a measure of inequality.

• A. The cumulative share of income held by cumulative shares of the population, ordered from poorest to richest ✓
• B. The change in prices over time for a basket of goods
• C. The relationship between education level and wages
• D. The projected growth rate of GDP over several decades

Why: A Lorenz curve plots the cumulative percentage of income against the cumulative percentage of population, sorting people from lowest to highest income. The further the curve bows below the diagonal line of perfect equality, the greater the inequality. The Gini coefficient is derived from the area between this curve and the diagonal.

• A. Wealth is accumulated from income saved over time and from returns on assets, which compound and concentrate among those who already hold assets ✓
• B. Income taxes are always higher than wealth taxes
• C. Wealth is measured in currency while income is measured in goods
• D. Income is only earned by the poor, while wealth is only held by the rich

Why: Wealth reflects accumulated savings and asset returns, which compound over time. People with more wealth earn more returns, allowing them to accumulate even faster, so wealth tends to be far more concentrated than the annual income flows that come from work.

• A. Surveys always overstate the incomes of low-income households
• B. Surveys often underrepresent the very wealthiest households and may underreport capital income ✓
• C. Surveys cannot collect any information about household size
• D. Surveys measure only wealth and never income

Why: Household surveys tend to miss the top of the distribution, since wealthy households may decline to participate or underreport investment and business income. This is one reason economists supplement survey data with tax records and national accounts when measuring inequality.

• A. Pre-tax inequality measures income before taxes and transfers, while post-tax inequality measures income after taxes and government transfers are accounted for ✓
• B. Pre-tax inequality is always higher than post-tax inequality in every country by definition
• C. Post-tax inequality only includes the income of the top 1 percent
• D. Pre-tax inequality measures only wages, while post-tax inequality measures only capital gains

Why: Comparing pre-tax and post-tax measures shows how much a tax and transfer system reduces inequality. Progressive taxes and transfers such as cash benefits typically narrow the gap, so post-tax inequality is usually lower, though the size of the reduction varies across countries.

• A. Karl Marx
• B. Simon Kuznets ✓
• C. Thomas Piketty
• D. Adam Smith

Why: Simon Kuznets proposed in 1955 that inequality tends to rise in early industrialization as workers shift from low-productivity agriculture to high-productivity industry, then decline as the economy matures. This hypothesis is called the Kuznets curve.

• A. The average income of the richest 10% of households
• B. The share of national income going to wages versus profits
• C. The degree of statistical dispersion in income or wealth across a population ✓
• D. The rate of inflation adjusted for purchasing power

Why: The Gini coefficient ranges from 0 (perfect equality, everyone has the same income) to 1 (one person holds all income). It summarizes how unevenly income or wealth is distributed across a population.

• A. The Gilded Age in the United States (1870s-1900s)
• B. The two World Wars and the Great Depression (roughly 1914-1945) ✓
• C. The decade following the 2008 financial crisis
• D. The period of rapid globalization after 1990

Why: Wars destroyed capital, imposed high taxes, and disrupted financial assets, while the Depression eroded wealth held by the rich. Together these forces reduced top income and wealth shares in many countries, a compression sometimes called the 'Great Compression'.

• A. The proportion of total income earned by the highest-earning individuals or households, such as the top 1% or top 10% ✓
• B. The share of a country's population that holds a university degree
• C. The ratio of CEO pay to average worker pay
• D. The percentage of households owning a home

Why: Top income shares measure how much of total national income goes to a small group at the top, such as the top 1%. Economists like Piketty and Saez use tax records to construct long-run series of these shares.

• A. A decline in technological change
• B. Universal adoption of progressive taxation
• C. Skill-biased technological change and globalization that increased returns to education and high skills ✓
• D. A sharp increase in the minimum wage across all OECD countries

Why: Many economists attribute rising wage gaps since the 1970s to skill-biased technological change, which raised demand for highly educated workers, along with trade and globalization, and declining union power. These forces widened the gap between high- and low-skill earnings.

• A. The fee a worker pays to enroll in a training program
• B. The additional wage earned by workers with higher skills or education compared to workers with less skill or education ✓
• C. The tax levied on high-income earners to fund public education
• D. The minimum wage set by the government for skilled occupations

Why: The skill premium is the wage gap between higher-skilled (or more educated) workers and lower-skilled workers. It reflects how the market rewards skills and is a central concept in analyzing wage inequality.

• A. Wages for skilled workers fall and the skill premium shrinks
• B. Wages for skilled workers rise and the skill premium widens ✓
• C. Wages for unskilled workers rise and the skill premium disappears
• D. Employment of skilled workers falls because wages become too high to sustain

Why: When demand for skilled labor rises while supply stays fixed, the market-clearing wage for skilled workers increases. Since unskilled wages are not rising by the same amount, the gap between them, the skill premium, widens.

• A. The total number of jobs that employers have available
• B. The quantity of labor that workers are willing and able to offer at various wage levels ✓
• C. The total output of goods and services produced by an economy
• D. The amount of money firms spend on hiring workers

Why: Labor supply describes how many hours or workers are offered to the market at different wage rates. Generally, higher wages attract more labor supply, which is one half of the supply-and-demand framework that determines wages.

• A. The worker's seniority alone, regardless of productivity
• B. The worker's marginal productivity, given the forces of supply and demand ✓
• C. The worker's gender and ethnicity
• D. The profits the firm earns in a given year

Why: In the competitive model, firms hire workers up to the point where the wage equals the worker's marginal revenue product, or productivity. Wages therefore reflect productivity as shaped by supply and demand conditions in the market.

• A. A rapid increase in the supply of educated workers relative to demand for them ✓
• B. A decline in the supply of educated workers while demand for them stays the same
• C. A technological change that increases demand for highly skilled workers
• D. A reduction in the cost of higher education that makes it less accessible

Why: When the supply of educated workers grows faster than demand for them, their relative wages fall and the skill premium narrows. Options B and C would widen the premium, and option D describes a barrier that would tend to keep the premium high by restricting supply.

• A. The movement of workers between different industries over a career
• B. The extent to which a child's economic outcomes, such as income or occupation, differ from those of their parents ✓
• C. The rate at which people migrate between countries across generations
• D. The change in average life expectancy from one generation to the next

Why: Intergenerational mobility measures how much a child's socioeconomic position depends on their parents' position. High mobility means parental background has little influence on a child's outcomes, while low mobility means outcomes are strongly inherited across generations.

• A. Education guarantees every graduate a high-paying job regardless of background
• B. Education provides skills and credentials that can allow children from lower-income families to earn more than their parents ✓
• C. Education reduces the cost of living, so families spend less of their income
• D. Education eliminates differences in innate ability between children

Why: Education builds human capital, skills and credentials that employers value. When access to quality education is broad, children from disadvantaged families can acquire the human capital needed to climb the income ladder rather than being constrained by their parents' circumstances.

• A. A graph showing that countries with higher income inequality tend to have lower intergenerational mobility ✓
• B. A graph showing the relationship between education spending and literacy rates
• C. A curve showing how wealth accumulates over a single lifetime
• D. A model of how tax rates change as income rises

Why: The Great Gatsby Curve, popularized by economist Alan Krueger, shows a negative relationship between income inequality and intergenerational mobility across countries. Societies with greater inequality tend to have children whose incomes are more strongly tied to their parents' incomes.

• A. Public schools only admit students whose parents pay tuition
• B. Wealthier families can invest more in extra resources such as tutoring, enrichment activities, and stable home environments ✓
• C. Children from poorer families are legally barred from attending higher education
• D. Wealthier children are naturally more intelligent on average

Why: Even with free public schooling, families differ in the additional resources they provide outside school, including private tutoring, books, enrichment, and stable housing. These investments compound over time and can widen achievement gaps that persist into adulthood.

• A. Reducing the number of schools to concentrate funding
• B. Early childhood education programs targeted at disadvantaged children ✓
• C. Abolishing standardized testing entirely
• D. Limiting university enrollment to students from high-income families

Why: Research, including studies of programs like Perry Preschool and Head Start, suggests that early childhood interventions for disadvantaged children can produce large long-term gains in education and earnings. Early investment is often considered more cost-effective because skills developed early make later learning easier.

• A. A system where everyone pays the same flat rate regardless of income
• B. A system where the tax rate increases as income increases ✓
• C. A system where the tax rate decreases as income increases
• D. A system where only corporations are taxed

Why: A progressive tax system applies higher marginal rates to higher income levels, so people with greater ability to pay contribute a larger share of their income.

• A. Income tax with graduated brackets
• B. Estate tax on very large inheritances
• C. A sales tax applied at a uniform rate on all goods ✓
• D. Capital gains tax with higher rates for long-held assets

Why: A uniform sales tax takes a larger share of income from low-income households, who spend a greater proportion of their earnings, making it regressive.

• A. Maximize total economic output regardless of how it is shared
• B. Reduce inequality by transferring resources from higher-income to lower-income groups ✓
• C. Eliminate all government spending
• D. Increase the salaries of public employees

Why: Redistributive policies, such as progressive taxation and transfer payments, aim to narrow gaps in income and wealth between different segments of society.

• A. Tax high earners at a penalty rate
• B. Supplement the incomes of low-wage workers, often phasing out as earnings rise ✓
• C. Charge fees on investment returns
• D. Fund national defense spending

Why: The EITC is a refundable credit that boosts income for low- and moderate-income working families, with benefits gradually reduced as earnings increase.

• A. Statutory incidence is who legally pays the tax; economic incidence is who ultimately bears its burden ✓
• B. Statutory incidence refers to international taxes; economic incidence refers to domestic taxes
• C. They are two names for the same concept
• D. Statutory incidence is the tax rate; economic incidence is the tax revenue collected

Why: The legal payer of a tax may pass some or all of its cost to others through prices, wages, or returns, so the final burden can differ from who writes the check.

• A. Higher inequality guarantees equal access to education for all households
• B. Unequal returns give people stronger incentives to save, invest, and work harder ✓
• C. Concentrated wealth reduces the total amount of capital available for investment
• D. Income gaps force governments to reduce taxes on all households equally

Why: The incentive argument holds that if rewards are unequal, individuals have stronger motivation to invest in skills, save, and take risks. This is the classic justification for inequality as a driver of growth, though critics argue the effect can be overstated.

• A. Lower-income households tend to have less access to credit and education, limiting human capital development ✓
• B. Wealthy households always save less than poor households
• C. Financial markets become less efficient when more people hold stocks
• D. Governments always spend more when inequality rises, crowding out private investment

Why: When many households cannot borrow to invest in education or start businesses, talent goes underused and aggregate productivity falls. Credit market imperfections are a central channel linking inequality to slower growth.

• A. Requiring all firms to be listed on public stock exchanges
• B. Ensuring that individuals and small businesses can access savings, credit, and payment services ✓
• C. Allowing foreign investors to dominate domestic banking
• D. Setting identical interest rates for all borrowers regardless of risk

Why: Financial inclusion means broad access to formal financial services. Research suggests greater inclusion can reduce inequality and support growth by letting more households invest in their futures.

• A. It eliminates the need for banks, since wealthy individuals lend directly to each other
• B. It can concentrate asset ownership and leverage among a few households, amplifying the effects of market shocks ✓
• C. It makes asset prices fully insensitive to economic conditions
• D. It guarantees that markets will always remain perfectly competitive

Why: When wealth and debt are concentrated, shocks to asset prices can have larger effects on the economy, since a small group's losses can trigger broader withdrawals of spending or credit. This linkage is studied in relation to financial crises.

• A. The Gini coefficient ✓
• B. The consumer price index
• C. The debt-to-GDP ratio
• D. The bond yield spread

Why: The Gini coefficient ranges from 0 (perfect equality) to 1 (one person holds all income) and is the standard summary measure of income or wealth inequality. The other options measure prices, public debt, or interest rate differences.

• A. The Gini coefficient ✓
• B. The consumer price index
• C. The unemployment rate
• D. The balance of payments

Why: The Gini coefficient ranges from 0 (perfect equality) to 1 (perfect inequality) and is a widely used summary measure of how income or wealth is distributed across a population.

• A. Everyone pays the same flat percentage of income
• B. Higher-income earners pay a larger share of their income in tax ✓
• C. Only corporations are taxed
• D. Taxes are paid only on consumption goods

Why: Under a progressive tax, the average tax rate rises with income, so higher earners pay a larger proportion of their income, which is a common remedy aimed at reducing after-tax inequality.

• A. To guarantee every citizen a regular unconditional cash payment ✓
• B. To eliminate all government spending on public services
• C. To set maximum wages for all workers
• D. To restrict immigration to reduce competition for jobs

Why: A UBI provides every individual with a regular, unconditional payment, intended to provide a income floor, reduce poverty, and offer economic security regardless of employment status.

• A. A minimum wage ✓
• B. A corporate tax holiday
• C. A reduction in estate taxes
• D. Deregulation of financial markets

Why: A minimum wage sets a legal floor on hourly pay, directly targeting the earnings of the lowest-paid workers, though economists debate its employment effects and optimal level.

• A. Eliminate all wealth inequality immediately
• B. May discourage saving and reduce incentives to build assets across generations ✓
• C. Increase the income of the poorest households by law
• D. Have no effect on economic behavior whatsoever

Why: A common objection is that inheritance taxes may reduce the incentive to save and accumulate wealth and could affect family businesses, though supporters argue they reduce the intergenerational transmission of large fortunes.