Family income issues

The tri-annual Survey of Consumer Finances by the Federal Reserve Board is out. AP summarizes some of the results:

WASHINGTON (AP) -- The average income of American families, after adjusting for inflation, declined by 2.3 percent in 2004 compared to 2001 while their net worth rose but at a slower pace.

The Federal Reserve reported Thursday that the drop in inflation-adjusted incomes left the average family income at $70,700 in 2004. The median, or point where half the families earned more and half less, did rise slightly in 2004 after adjusting for inflation to $43,200, up 1.6 percent from the 2001 level.

Matt Yglesias responds with:

Read a bit down in the article and you'll see that median family income, which matters more, has gone up during the same time period. I'm a bit baffled by the result, which suggests that the Bush economy is curbing income inequality and appears to contradict every other economic indicator I've seen, but that's what the survey says.

The fact that the median income rose slightly while the average income fell does NOT necessarily mean that income inequality is decreasing. This can be easily proven through a simple counter example. Suppose we have a three family economy. At the beginning the three families are earning $100,000, $40,000, and $20,000, respectively. That gives the economy a median income of $40,000 (the middle family's income) and an average income of $53,333. Now, suppose the incomes change to $110,000, $40,500, and $5,000. The median income has increased by $500, and the average income has fallen to $51,833, but no one would say that income inequality was lessened when the rich family got richer but the poor family got poorer.

For whatever that's worth.