Economics of Inequality and Poverty
Lorenz curve, Gini coefficient, poverty, causes of inequality, taxation, and redistribution policies.
- Distinguish between equality and equity
- Draw and interpret a Lorenz curve
- Construct a Lorenz curve from income quintile data HL
- Define the Gini coefficient and relate it to the Lorenz curve
- Distinguish absolute and relative poverty
- Identify causes of income and wealth inequality
- Distinguish progressive, regressive, and proportional taxes
- Evaluate policies to reduce poverty and inequality
This section is pending teacher review.
Equality vs Equity
Equality means equal shares — everyone receives the same amount. Equity means fairness — distribution may be unequal but is considered just. What counts as equitable is a normative judgement. Economists typically focus on equity rather than equality.
Measuring Income Inequality: Lorenz Curve and Gini Coefficient
The Lorenz curve plots the cumulative share of income (y-axis) against the cumulative share of the population (x-axis), ordered from lowest to highest income.
- The line of perfect equality is the 45° diagonal — each x% of the population earns x% of income
- The further the Lorenz curve bows away from the diagonal, the greater the inequality
The Gini coefficient = Area A ÷ (Area A + Area B), where A is the area between the line of equality and the Lorenz curve, and B is the area below the Lorenz curve.
- Gini = 0: perfect equality
- Gini = 1: perfect inequality (one person has all income)
- A higher Gini indicates more inequality
Poverty
A fixed standard of living below which a person cannot meet basic needs. Measured against international poverty lines (e.g., World Bank $2.15/day at PPP).
A standard of living below what is considered acceptable in a given society — typically defined as below a percentage (e.g., 60%) of the median income. Reflects inequality within a country.
Measuring poverty
- Single indicators: international poverty lines, minimum income standards, income measures
- Composite indicators: Multidimensional Poverty Index (MPI) — captures health, education, and living standards dimensions together
Causes of Inequality and Poverty
- Inequality of opportunity — unequal access to education, healthcare, and social mobility
- Different levels of resource ownership (capital, land)
- Different levels of human capital (skills, qualifications)
- Discrimination (gender, race, and others)
- Unequal status and power — political influence of wealthy groups
- Government tax and benefit policies
- Globalisation and technological change — replacing low-skill labour
- Market-based supply-side policies — reducing welfare state
Taxation
| Tax type | Definition | Effect on inequality |
|---|---|---|
| Progressive tax | Tax rate rises as income rises — higher earners pay a larger percentage | Reduces inequality (redistributive) |
| Regressive tax | Tax rate falls as income rises — lower earners pay a larger percentage of income | Increases inequality (e.g., flat-rate indirect taxes hit lower incomes harder) |
| Proportional tax | Same tax rate for all income levels (flat tax) | No change in relative distribution |
Average tax rate (ATR) = Total tax paid ÷ Total income × 100
Marginal tax rate (MTR) = Additional tax paid ÷ Additional income × 100
A progressive tax system has MTR > ATR — each additional dollar of income is taxed at a higher rate than the average.
Indirect tax rate calculation: Indirect tax rate = Tax per unit ÷ Price excluding tax × 100. The amount of indirect tax from a given expenditure can be calculated using the tax-inclusive and tax-exclusive prices.
Policies to Reduce Poverty and Inequality
| Policy | How it works |
|---|---|
| Investment in human capital | Education and training programmes raise productivity and wages for low-income groups, reducing inequality of opportunity |
| Transfer payments | Direct cash transfers from the government to households (e.g., unemployment benefits, pensions) — redistribute income to the poorest |
| Targeted spending | Free/subsidised provision of healthcare, education, and housing for low-income groups |
| Universal basic income (UBI) | A flat payment to all citizens regardless of income — eliminates poverty trap; debated in terms of cost and work incentives |
| Minimum wages | Raises income floor; helps working poor but may reduce employment if set too high |
| Anti-discrimination policies | Legislation and enforcement to reduce wage gaps by gender, race, etc. |
- Lorenz curve: further from diagonal = more inequality
- Gini = 0 (perfect equality) to 1 (perfect inequality)
- Absolute poverty: below fixed basic needs threshold
- Relative poverty: below a share of median income
- Progressive tax: higher % on higher incomes → reduces inequality
- Regressive tax: lower % on higher incomes → increases inequality
- Key policies: human capital investment, transfers, minimum wage, targeted spending
Worked examples are pending teacher review.
Worked Example — Progressive Tax Calculation HL
A country has the following income tax bands: 0% on the first $20,000; 20% on $20,001–$50,000; 40% on income above $50,000. A person earns $70,000.
Total tax paid
Band 2: $30,000 × 20% = $6,000
Band 3: $20,000 × 40% = $8,000
Total tax = $0 + $6,000 + $8,000 = $14,000
Average tax rate
Marginal tax rate on the last dollar
MTR (40%) > ATR (20%) — confirms this is a progressive tax system.
Practice questions are pending teacher review.