6.6 Income inequality and the Lorenz curve

Income inequality is a hot topic in economics, reflecting how money is spread out in society. It's not just about who's rich and who's poor – it's about understanding the whole picture of how income is distributed.

Economists use tools like the Lorenz curve and Gini coefficient to measure inequality. These help us see how income is shared and compare different countries or time periods. It's crucial for policymakers trying to create a fairer economy.

Income inequality and its measurement

Defining and quantifying income inequality

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• Income inequality represents uneven distribution of income across a population or society
• Reflects disparities in economic well-being among individuals or households
• Measurement compares income shares of different population segments (quintiles or deciles)
• Analyze income distribution using statistical measures:
  • Range of incomes
  • Variance in income levels
  • Standard deviation of incomes
• Relative inequality measures compare top and bottom segments:
  • 90/10 ratio (income of 90th percentile vs 10th percentile)
  • Palma ratio (income share of top 10% vs bottom 40%)
• Absolute inequality measures consider monetary differences:
  • Absolute Gini coefficient
• Time-series analysis examines trends in income distribution over different periods

Advanced analytical techniques

• Income mobility studies track changes in individual incomes over time
• Decomposition analysis breaks down inequality by source (labor income, capital income)
• Intersectionality examines how different demographic factors interact to affect inequality
• Wealth inequality measures complement income inequality analysis:
  • Net worth Gini coefficient
  • Wealth-to-income ratios
• International comparisons of inequality use purchasing power parity (PPP) adjustments
• Multidimensional inequality indices incorporate non-monetary factors (education, health)

Lorenz curve and Gini coefficient

Understanding the Lorenz curve

• Graphical representation of income distribution
• Plots cumulative percentage of income against cumulative percentage of population
• Perfect equality represented by 45-degree diagonal line
• Greater inequality shown by more curved line deviating from diagonal
• Allows visual comparison of income distributions:
  • Between countries
  • Over time within a country
• Area between Lorenz curve and equality line indicates degree of inequality
• Can be used to analyze distribution of other variables (wealth, land ownership)

Calculating and interpreting the Gini coefficient

• Summary statistic of income inequality derived from Lorenz curve
• Calculated as ratio of area between Lorenz curve and equality line to total area under equality line
• Ranges from 0 (perfect equality) to 1 (perfect inequality)
• Higher values indicate greater income inequality within population
• Allows for quantitative comparisons across different distributions
• Limitations of Gini coefficient:
  • Cannot distinguish between different types of inequality
  • Sensitive to changes in middle of distribution
  • Does not capture demographic differences in population
• Comparative analysis across countries or time periods provides insights into relative inequality levels
• Complementary measures often used alongside Gini:
  • Theil index
  • Atkinson index

Factors contributing to income inequality

Educational and skill-based factors

• Educational attainment significantly influences income potential
• Higher education levels generally associated with higher earnings
• Skill-biased technological change exacerbates inequality:
  • Increases demand and wages for highly skilled workers
  • Potentially displaces lower-skilled workers
• Returns to education vary across fields and occupations
• Access to quality education often correlated with socioeconomic background
• Lifelong learning and skill adaptation affect income trajectories
• Educational policies impact long-term income distribution:
  • Public education funding
  • Higher education accessibility
  • Vocational training programs

Structural and institutional factors

• Labor market discrimination contributes to wage gaps:
  • Based on race, gender, ethnicity, or other characteristics
• Globalization and international trade alter relative labor demand:
  • Can benefit high-skilled workers in developed countries
  • May negatively impact low-skilled workers in certain industries
• Institutional factors impact wage structures:
  • Strength of labor unions
  • Minimum wage laws
  • Collective bargaining rights
• Intergenerational wealth transfers perpetuate inequality:
  • Inheritance
  • Access to social networks
  • Educational opportunities
• Social mobility (or lack thereof) affects long-term income distribution
• Market concentration and monopoly power in industries:
  • Lead to higher profits and wages for select groups
  • Contribute to overall income inequality
• Financialization of the economy can exacerbate inequality:
  • High returns to financial assets
  • Executive compensation structures

Government policies and income inequality

Redistributive policies and their effects

• Progressive taxation reduces after-tax income inequality:
  • Tax rates increase with income levels
  • Redistributes income from higher to lower earners
• Transfer payments provide income support:
  • Unemployment benefits
  • Social security
  • Welfare programs
• Measure policy effectiveness by comparing:
  • Pre-tax and post-tax Gini coefficients
  • Other inequality metrics before and after government intervention
• Tax expenditures have varying effects on inequality:
  • Deductions often benefit higher-income taxpayers
  • Refundable credits can support lower-income households
• Social safety net program design influences inequality impact:
  • Funding mechanisms
  • Eligibility criteria
  • Benefit levels and duration

Long-term strategies and considerations

• Policies improving education access potentially reduce long-term inequality:
  • Universal early childhood education
  • Affordable higher education
  • Skills training and retraining programs
• Labor market policies affect income distribution:
  • Minimum wage adjustments
  • Worker protections
  • Anti-discrimination enforcement
• Consider unintended consequences of policies:
  • Potential disincentives to work or invest
  • Administrative costs of complex programs
• Balancing equity and efficiency in policy design
• International cooperation on tax policy to address global inequality:
  • Efforts to reduce tax avoidance and evasion
  • Coordination on capital taxation
• Technological changes require adaptive policies:
  • Addressing automation-induced displacement
  • Promoting inclusive innovation