4.2.2 Inequality

• Income & wealth inequality are two different concepts
  • Income inequality refers to the unequal distribution (flow) of income to households i.e rent, wages, interest & profit
  • Wealth inequality refers to differences in the amount of assets that households own
    
    
• The two main measures of income inequality are the Lorenz Curve & the Gini coefficient

The Lorenz Curve

• The Lorenz Curve is a visual representation of the inequality that exists between households in an economy
• Data is commonly presented in quintiles (population divided into 5 groups i.e 20%) or deciles (population divided into 10 groups i.e 10%)
  • E.g. in 2021 42% of the income flow in the UK went to the top 20% of households while only 7% went to the bottom 20%
    
    
• Perfect income distribution is not the goal (20 % of the population get 20% of the income; 40% get 40% percent of the income etc.)
  • That would equate to socialism & completely remove incentives for work as everyone would be paid equally
    
    
• More equal income distribution is desired as it reduces poverty & social unrest
  • What constitutes acceptable income equality is a normative economic issue
    
    

An illustration of Income Inequality for the UK (green line) & Sweden (red line) using a Lorenz Curve Model. The income distribution in the UK is more unequal than that of Sweden

Diagram Analysis

• The line of equality represents perfect income distribution (not desirable)
• In the UK the bottom 20% of households receive 5% of the income flow while in Sweden they receive 9% of the income flow
• In the UK the top 10% of households receive 45% of the income flow while in Sweden they receive 25%
• Sweden has a more equal distribution of income than the UK
  
  

The Gini Coefficient

• The Lorenz curve can be used to calculate the Gini Coefficient

The Gini Coefficient is calculated using the area beneath the line of equality

Diagram Explanation

• 
• A represents the area between the line of equality & the UK Lorenz curve
• B represents the area under the Lorenz curve
• A value of 0 represents absolute equality (socialism) & 1 represents perfect inequality
• In 2022, the USA coefficient was .41 as compared with the UK value of .35
  • The distribution of income in the UK was more equitable than in the USA
    
    
    

• Numerous factors cause wealth & income inequality
• It is generally true that developed countries have a larger tax base & are able to provide a better level of support to the poorest households the economy, than developing countries are able to
  
  

Cause of Wealth & Income Inequality

• In the 1950's Simon Kuznets developed a hypothesis that described how income inequality changed as an economy went through stages of industrialisation & development
  • This hypothesis was explained using the Kuznets Curve
• Industrialisation results in increased inequality as some workers move from the lower productivity, lower paid agricultural sector into the higher productivity manufacturing sector
  • There is now greater income inequality with the workers left behind
    
    
• However, at some point, inequality starts to decrease
  • This is most likely due to government intervention/support funded by increased state tax revenue brought about as a result of the increased production in the economy
    
    

The Kuznets Curve illustrates how income inequality first increases with industrialisation before then decreasing

Diagram Analysis

• As a country changes sectors from primary (farming) to secondary (manufacturing), productivity increases & the per capita income increases
• However, inequality is also increasing as the gap in wages between the primary & secondary sector is significant
• At some point, the economy will reach a turning point of income where inequality begins to fall
  • This often occurs as the primary sector diminishes while the secondary & tertiary (services) sectors increase
  • Developed economies tend to generate more income from secondary & tertiary sectors
    
    

• Capitalism is at the heart of free market economics
• Under Capitalism, inequality is inevitable
  • Workers with higher skills receive higher wages
  • Workers with little to no skills receive little to no wage
  • Individuals with higher income will acquire more assets leading to higher levels of income
    • In turn, they can keep on acquiring assets
  • Individuals with lower income will find it hard to acquire assets
    
    
• The principles of capitalism are considered important as the incentive to acquire income raises productivity & output
• The long-term cost of capitalism is that the factors of production become concentrated in ownership with relatively few individuals developing extreme wealth, at the expense of many who lose out
• It has been argued that capitalism needs checks & balances to limit the income & wealth inequality that will naturally develop
  • This calls for government intervention