1.7.1a Income, wealth, equality and equity

Income Is a Flow, Wealth Is a Stock

1. Income is a flow of money received over a period of time.
2. It comes from wages, interest, rent, profit and transfer payments.
3. Wealth is a stock of assets held at a point in time.

Income and Wealth Reinforce Each Other Over Time

1. Wealth generates income, such as rent or interest.
2. Income can be saved to build up wealth.
3. So the two reinforce each other over time.

Living Standards Depend on Both Income and Wealth

1. Living standards depend on both income and wealth.
2. Wealth inequality is usually wider than income inequality.
3. So policy must look at both when judging fairness.

Flag Income as a Flow and Wealth as a Stock

Worked Example: Turning Income Into Wealth

1. A worker earns a monthly income of £2,500\pounds 2{,}500£2,500, a flow received each month.
2. Saving $20\%$ of this income each month sets aside £500\pounds 500£500 as a monthly flow of savings.
3. £500\pounds 500£500 saved every month for $36$ months ($3$ years) accumulates to £500×36=£18,000\pounds 500 \times 36 = \pounds 18{,}000£500×36=£18,000, with no interest included.

Equality Means Sameness, Equity Means Fairness

1. Equality is an even, identical distribution of income or wealth.
2. Equity is a fair or just distribution, which is a normative judgement.
3. An equal distribution is not necessarily an equitable one.

Equity Can Be Horizontal or Vertical

1. Horizontal equity treats those in the same circumstances the same way.
2. Vertical equity treats those in different circumstances differently.
3. For example, vertical equity supports taxing higher earners more.

A Perfectly Equal Distribution Can Still Seem Unfair

1. A perfectly equal split may still strike people as unfair.
2. Judging fairness means making a value judgement.
3. So economists can agree on the facts yet differ on what is equitable.

Separate Fairness From Sameness in Your Answer

Pay, Assets and Inheritance Drive Income and Wealth Inequality

1. Income and wealth inequality has several linked causes.
2. Differences in skills, education and productivity feed wage differentials.
3. Ownership of assets and inheritance widen the gap further.

Unemployment, Discrimination and Policy Also Shape the Gap

1. Unemployment and discrimination push some groups towards the bottom.
2. The tax and benefit system can narrow or widen the gap.
3. Inequality also varies between regions and between countries.

UK Application: Measuring How Unequal Income and Wealth Are

1. The Office for National Statistics estimates the UK income Gini coefficient at around $0.35$, where $0$ is perfect equality and $1$ is perfect inequality.
2. The UK wealth Gini coefficient is much higher, at around $0.63$, confirming that wealth is far more unequally distributed than income.
3. The National Living Wage and Universal Credit both aim to raise incomes at the bottom of the distribution.
4. HMRC's progressive income tax system, with higher marginal rates on higher earnings, is designed to narrow post-tax income inequality.

Some Inequality Gives Incentives, but Extremes Are Self-Reinforcing

1. Some inequality rewards effort and gives incentives to work and invest.
2. But extreme inequality can be self-reinforcing through inherited wealth.
3. So the causes shape both fairness and the economy's long-run health.

Separate Income Causes From Wealth Causes

Evaluate the Trade-off Between Equity and Efficiency

1. Reducing inequality through taxes and benefits can improve social cohesion and raise aggregate demand, since lower-income households have a higher marginal propensity to consume.
2. However, higher taxes on income and wealth may reduce the incentive to work, save or invest, potentially slowing economic growth.
3. This equity-efficiency trade-off means redistributing income can shrink the total size of the economic pie even as it is shared more evenly.

1.7.1b Measuring and evaluating distribution

The Lorenz Curve and Gini Coefficient Measure Inequality

1. The Lorenz curve plots the cumulative share of income against the cumulative share of the population.
2. The diagonal line of perfect equality is the benchmark.
3. The further the curve bows away from the diagonal, the greater the inequality.

The Gini Coefficient Runs From $0$ for Perfect Equality to $1$ for Perfect Inequality

1. The Gini coefficient is the area between the Lorenz curve and the line of equality, over the total area beneath the line.
2. It runs from $0$ for perfect equality to $1$ for perfect inequality.
3. You interpret and compare Gini values; calculating it is generally not required.
4. One limitation is that the Gini reduces the whole distribution to a single number, so it can hide where in the distribution the inequality lies.

A Curve Nearer the Diagonal Shows a More Equal Distribution

1. A curve nearer the diagonal shows a more equal distribution.
2. A curve further out shows a less equal one.
3. So two curves let you rank countries or years by inequality.

Read Inequality From the Bow of the Curve

Worked Example: Reading the Lorenz Curve and Gini Coefficient

1. On the diagram, the horizontal axis shows the cumulative % of the population, ranked from the poorest to the richest, and the vertical axis shows the cumulative % of income.
2. The $45$-degree diagonal is the line of perfect equality, where any given % of the population always earns that same % of income, for example the poorest $40\%$ earning exactly $40\%$ of income.
3. The actual Lorenz curve bows below this diagonal, because in practice the poorest groups always hold a smaller share of income than their share of the population.
4. The Gini coefficient equals the area between the Lorenz curve and the line of equality, divided by the total area under the line of equality, giving a value between $0$ and $1$.

Both More Equal and More Unequal Distributions Bring Gains and Losses

1. There are gains and losses from moving towards a more equal or more unequal distribution.
2. The case for equality rests partly on the diminishing marginal utility of income.
3. The case for tolerating inequality rests on incentives.

Greater Equality Can Raise Welfare, Cut Poverty and Support Demand

1. Diminishing marginal utility means redistribution can raise total welfare.
2. Less poverty and social tension can follow.
3. Lower earners spend more of their income, supporting demand.

The Right Degree of Inequality Is a Trade-off, Not a Fixed Answer

1. For equality: higher welfare, less poverty and stronger demand.
2. For tolerating inequality: incentives to work, save, take risks and innovate.
3. Those incentives can raise growth that lifts everyone over time.
4. On balance, some inequality supports incentives and growth, but beyond a point it lowers welfare, so the right degree is a trade-off, not a fixed answer.

Build a Two-Sided Judgement on the Equity and Efficiency Trade-off

Inequality Reaches Individuals, Firms and the Whole Economy

1. For individuals, the chance of higher pay can sharpen effort and enterprise.
2. For firms, very low incomes can mean low productivity and weak demand.
3. For the economy, wide gaps can strain social cohesion and long-run growth.