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The Lorenz Curve & Gini Coefficient

The two main measures of income inequality are the Lorenz Curve and the Gini coefficient

The Lorenz Curve

The Lorenz Curve is a visual representation of the income inequality that exists between households in an economy
Data is commonly presented in quintiles (population divided into five groups, i.e 20%) or deciles (population divided into ten groups i.e 10%)
- E.g. In 2020, 49% of the income flow in Bolivia went to the top 20% of households, while only 4% went to the bottom 20%
Perfect income distribution is not the goal (20 % of the population gets 20% of the income; 40% gets 40% of the income etc.)
- That would equate to socialism and completely remove incentives for work, as everyone would be paid equally
More equal income distribution is desired as it reduces poverty and social unrest
- What constitutes acceptable income equality is a normative economic issue

Diagram: Lorenz Curves for Sweden, the UK and Bolivia

3-4-1-low-unemployment---the-lorenz-curve

Diagram analysis

The line of equality represents perfect income distribution (not desirable)
In Bolivia the bottom 20% of households receive 4% 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

Diagram: How the Gini Coefficient is Determined

Graph showing cumulative income distribution with a blue shaded curve marked 'A' and a green area marked 'B', illustrating a Lorenz curve. — **The Gini Coefficient is calculated using the area beneath the line of equality**

Diagram analysis

$begin mathsize 14px style Gini space Coefficient space equals fraction numerator straight A over denominator straight A space plus space straight B end fraction end style$
A represents the area between the line of equality and Bolivia’s Lorenz curve
B represents the area under the Lorenz curve
A value of 0 represents absolute equality (socialism) and 1 represents perfect inequality
In 2017, Estonia’s coefficient was 0.3, compared with a value of 0.62 in South Africa
- The distribution of income in Estonia was more equitable than in South Africa
Governments use progressive taxation and transfer payments to shift the Gini coefficient closer to zero

Worked Example

Using a Lorenz curve diagram, explain what happened to income inequality in Bolivia between 2008 and 2016

Income Gini Coefficient Data for Bolivia

Income Gini Coefficient 2008	0.51
Income Gini Coefficient 2016	0.43

Step 1: Determine if inequality has improved or worsened

The closer to zero, the closer the country is to perfect equality

The situation in Bolivia has improved so the Lorenz curve is moving closer to the line of perfect equality

Step 2: Draw and label the Lorenz Curve for each year

Lorenz curve graph comparing Bolivia's income distribution for 2008 and 2016 against a perfect equality line, showing improvement over time.

Step 3: With reference to your diagram, explain what has happened to the income inequality between the two time periods

The closer the Gini coefficient is to zero, the more equal the distribution of income in a country. Bolivia’s Gini coefficient has moved closer to zero, indicating that there is less income inequality in 2016 than there was in 2008. This is illustrated by an inward shift of the Lorenz curve towards the line of perfect equality

Benefits & Costs of Unequal Distribution of Income & Wealth

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 and output

However, the long-term outcome 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
- This increases income and wealth inequality

Costs of Unequal Distribution of Income & Wealth

Impact	Explanation
Disincentives	Increasing levels of inequality can act as a disincentive for workers to work and be productive as there is a sense that society is unfair This can result in a decline in economic growth and an increase in unemployment payments and welfare benefits
Living standards	If the inequality gap grows, the rich get richer and the poor, relatively poorer, which will reduce the standard of living The wealthier will access better education and healthcare, creating even less opportunity for poorer households in the future
Social stability	More equal societies tend to be more stable, tolerant and considerate, with lower levels of crime and better standards of living Less equal societies tend to be characterised by political instability, strife, and social unrest, and in extreme cases this can lead to revol

Impact

Explanation

Disincentives

Increasing levels of inequality can act as a disincentive for workers to work and be productive as there is a sense that society is unfair
This can result in a decline in economic growth and an increase in unemployment payments and welfare benefits

Living standards

If the inequality gap grows, the rich get richer and the poor, relatively poorer, which will reduce the standard of living
The wealthier will access better education and healthcare, creating even less opportunity for poorer households in the future

Social stability

More equal societies tend to be more stable, tolerant and considerate, with lower levels of crime and better standards of living
Less equal societies tend to be characterised by political instability, strife, and social unrest, and in extreme cases this can lead to revol

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the-lorenz-curve-and-gini-coefficient

The Lorenz Curve & Gini Coefficient

The Lorenz Curve

Diagram: Lorenz Curves for Sweden, the UK and Bolivia

Diagram analysis

The Gini Coefficient

Diagram: How the Gini Coefficient is Determined

Diagram analysis

Worked Example

Benefits & Costs of Unequal Distribution of Income & Wealth

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