The Lorenz Curve & Gini Coefficient (AQA A Level Economics)

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 

An illustration of income inequality for Bolivia (blue line), Sweden (red line), and the UK (yellow line) using a Lorenz Curve Model. The income distribution in Bolivia is more unequal than that of Sweden
       

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

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

Diagram analysis

• 

• 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

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