Yesterday we left off by agreeing that the hypothetical two person society we created suffered neither from objectionable income nor consumption inequality (we’ll have a philosophical discussion on the whole topic in the future), despite what the various ways of looking at inequality suggested.
How would you feel, however, if you drilled down to the micro-level to understand how each person earned their income, or was able to have their consumption capacity? What if both Petey and Will each earned $50,000, and that they worked the same number of hours, but that Petey worked in a comfortable air conditioned (in summer) and heated (in winter) office while Will suffered from the extremes in temperatures (we have to assume that no compensating differential would arise in the salaries). Clearly measured inequality would be no different, but wouldn’t this world be somewhat different, perhaps morally inferior (to some), than the first world? We’d never know it from the income statistics.
Indeed, the fact that prices do work tells us something interesting. In my example above, it would have to be the case that Will’s wage would increase and Petey’s wage would decrease until the wage differential reasonably captured (there are transactions costs) the difference in convenience in the two jobs. So, Petey earns $48,000 at a climate controlled job while Will earns $52,000 at a non-climate controlled job. In this world, the well being of each person is identical, but the measured income statistics would show a degree of inequality that would be problematic for some.
Now, also in this world, the consumption measures would be distorted as well. Why? It would appear that Petey has less capacity to consume than does Will. But that it totally untrue. They each have identical capacities to consume – in this case, $50,000. It just so happens that Petey “spends” $2,000 of his income in order to be comfortable at the office, while Will “sells” some of his comfort for a price of $2,000 so that he can consume something other than a warm or cool room. The consumption statistics do NOT pick up these sorts of transactions which do not occur in a separately traded market (even though we try to capture some of this).
If Petey’s additional income happened to come from something other than a compensating differential, but involved the same kind of a choice, again the inequality statistics would tell us something was “wrong” while our common sense and moral intuition would suggest no problem at all. What if, for example, we were back to the situation where each earned $50,000 for doing identical jobs. But that each year, Petey shaves all of his hair and is able to see it for $2,000 to a wig designer. Will has the same hair, but he loves his hair and does not wish to sell it. Now we’d see Petey’s income rise to $52,000 while Will’s was “stagnant” at $50,000. But Will also had the same opportunity to sell his hair as Petey. Is this outcome “worse?”
Remember these are extreme simplifications, but there are important real-world analogs that we will discuss in due time. In future posts we’ll address the role of leisure and schooling in our story.