Explaining the Changes

How are we to explain these changes in terms of the functional distribution of income? There are at least three possible explanations:

The distribution of wage income may have become more unequal.
The distribution of income from property may have become more unequal.
The functional distribution may have shifted, so that property incomes are a larger fraction of total incomes.

The last one, a shift of the functional income distribution so that property income is a larger fraction of the total, would make the personal distribution of income more unequal because property incomes are the more unequal component. Increasing the weight on the more unequal component will increase overall inequality.

When we look at the record in detail, it seems that both the first and the last of the three things seems to have happened. We have to distinguish between the markets for unskilled and skilled labor. This is a little more complex that the John Bates Clark model, which thinks in terms of homogenous labor, but the same principles can be applied without much difficulty. One explanation that fits the facts pretty well is that there has been a big decrease in the demand for unskilled labor. It's easy to see how that would cause an increase in the inequality of wage income. Unskilled workers were already being paid less, then a drop in the demand for their labor depresses their wages, and they make even less, relative to skilled labor. The John Bates Clark model helps out by showing us how this would also tend to shift the functional distribution of income.

Take a look at Figure 13:

Figure 13: A Decrease in the Demand for Unskilled Labor

The demand for unskilled labor is, again, the value of the marginal product. Before the decrease in demand, the supply and demand for unskilled labor are S₁ and D₁, and the market wage is c. The unskilled workers earn an amount visualized by the rectangle cbd0, and profits on their work amount to the triangle abc. Now there is a big decrease in the demand for unsilled labor, to D₂, partially offset by a slight decrease in the supply, to S₂. The new wage for unskilled labor is h, much lower than before, as we anticipated. Now, in addition, unsilled workers are earning a much smaller share -- hkg0 by comparison with profits akh. Since the share of unskilled workers is less, if nothing has changed the share of skilled workers, the overall share of labor in the functional distribution of income will have declined.