2.13 - Inequality, Poverty & Distribution of Income - notes

Definitions of income and wealth

Income refers to the money an individual or household receives over a specific period, such as a week or a year. Wealth, on the other hand, represents the total monetary value of assets owned at a particular time.

Sources of income

Income can come from various places, including:

• Wages earned from employment
• Interest generated from savings in bank accounts
• Dividends paid out from share ownership
• Rent collected from owned properties

Key features of wealth

Wealth includes items with financial value, such as:

• Property and land
• Cash holdings
• Shares in companies
• Other valuable possessions

In economies like the UK, both income and wealth are not distributed evenly among the population.

Distribution of income and wealth

The way income and wealth are spread across society varies, with several influences shaping these patterns. Wealth tends to be distributed more unevenly than income due to how it accumulates over time.

Factors affecting income distribution

• Skill demand - Individuals with high-demand skills often command higher wages, while others earn less.
• Reliance on benefits - Those without wages, such as the unemployed or pensioners, depend on government support, which is typically lower.
• Taxation system - A progressive tax structure means higher earners pay a greater percentage, helping to redistribute funds.
• Redistribution through benefits - Taxes fund support for groups like the unemployed or disabled, aiming to balance incomes.
• Sector differences - Public sector employees generally earn more weekly than those in the private sector.
• Regional variations - Wages are often higher in urban areas compared to rural ones due to economic opportunities.

Reasons wealth is more unevenly distributed than income

• Income generation from wealth - Assets like investments can grow in value and produce additional income.
• Accumulation cycle - People with wealth can reinvest earnings, leading to further increases.
• Asset value growth - The worth of assets often rises faster than typical income increases.
• Tax differences - Income faces taxation, but wealth is not always taxed directly, making wealth harder to redistribute.

Measuring inequality with Lorenz curve and Gini coefficient

Tools like the Lorenz curve and Gini coefficient help visualise and quantify how unequally income or wealth is distributed in a society.

Features of the Lorenz curve

The Lorenz curve is a graph that shows income distribution:

• The horizontal axis represents the cumulative percentage of the population, starting from the poorest.
• The vertical axis shows the cumulative percentage of total income.
• A diagonal line (45 degrees) indicates perfect equality, where each percentage of the population receives the same percentage of income.
• The actual curve bows below this line; the further it is from the diagonal, the greater the inequality.

Calculating the Gini coefficient

The Gini coefficient measures inequality based on the Lorenz curve.

$\text{Gini coefficient}=\frac{\text{area A}}{\text{area A}+\text{area B}}$

Where:

• Area A = Space between the equality line and the Lorenz curve
• Area B = Space under the Lorenz curve

A value of 0 means complete equality, while 1 indicates total inequality (one person has everything). For example, a country's income Gini coefficient might have risen from approximately 0.25 in 1980 to 0.35 in 2020, indicating increasing inequality.

Equality versus equity

Equality and equity both relate to fairness in distribution, but they differ in approach. Equality treats everyone identically, while equity considers individual needs for a fair outcome.

Key differences between equality and equity

• Equality - Involves giving everyone exactly the same resources or treatment, regardless of circumstances. It is objective and fact-based (positive).
• Equity - Focuses on fairness by providing what people need based on their situations. It is subjective and opinion-based (normative).

Types of equity

• Horizontal equity - Ensures people in similar situations are treated the same way.
• Vertical equity - Allows different treatment for those in varied circumstances to achieve fairness.

Effects of inequality and types of poverty

Unequal distribution of income and wealth can have mixed impacts on society and the economy. It often leads to poverty, which comes in different forms and has specific causes.

Positive effects of inequality

• Economic incentives - Inequality can motivate people to work harder and develop skills to improve their position.
• Investment and innovation - Wealthy individuals may invest in businesses and new technologies, driving economic growth.
• Specialisation - Different income levels can lead to specialisation in various economic roles.

Negative effects of inequality

• Social problems - High inequality can lead to increased crime, social unrest, and reduced social cohesion.
• Limited opportunities - Those with lower incomes may have reduced access to education and healthcare.
• Economic inefficiency - Extreme inequality can reduce overall economic demand and growth.

Types of poverty

• Relative poverty - Occurs when someone's income is low compared to the average in their country, affecting their ability to participate in society.
• Absolute poverty - Involves not having enough income to meet basic needs like food and shelter. The World Bank sets a global poverty line at $1.90 per day.
• Poverty line - The minimum income level required for essentials, used to identify those in absolute poverty.

Causes of poverty

• Unemployment - Pushes people to the lowest income brackets without earnings.
• Low wages - Affects those with limited skills or qualifications, keeping incomes minimal.
• Slow benefit increases - When benefits rise slower than wages, it widens relative income gaps.

The poverty trap

The poverty trap describes a situation where low-income individuals face disincentives to earn more. It mainly impacts those on benefits or low wages with means-tested support.

How it works:

• Earning more can lead to higher taxes, national insurance, and reduced benefits, resulting in little net gain.
• The marginal tax rate (the percentage deducted from the next unit of income) can be very high in this trap, discouraging extra work or hours.