IB DP Economics - Unit 3 - Measuring economic inequality-Study Notes - New Syllabus

Measuring Economic Inequality

Economists use different methods to measure the degree of economic inequality within a country.

The two most important measures are:

• Lorenz curve
• Gini coefficient (Gini index)

These measures help governments and economists analyse how evenly or unevenly income or wealth is distributed.

The Lorenz Curve

The Lorenz curve is a graphical representation of income or wealth distribution in an economy.

It compares:

• The cumulative percentage of the population
• The cumulative percentage of income or wealth received

Structure of the Lorenz Curve

The graph contains:

• Horizontal axis:
  • Cumulative percentage of population
• Vertical axis:
  • Cumulative percentage of income or wealth

Line of Perfect Equality

The Lorenz diagram includes a straight 45° line called the line of perfect equality.

Under perfect equality:

• Each percentage of the population receives the same percentage of income.

Example:

Actual Lorenz Curve

In reality, income is usually distributed unequally.

The Lorenz curve therefore lies below the line of perfect equality.

Interpretation of the Lorenz Curve

• The farther the Lorenz curve is from the line of perfect equality, the greater the inequality.
• A curve closer to the equality line indicates more equal distribution.

Greater distance from equality line → Greater inequality

Example of Interpretation

If:

• The poorest 50% of the population receive only 20% of income

then income inequality is relatively high.

Uses of the Lorenz Curve

• Comparing inequality between countries
• Comparing inequality over time
• Evaluating effects of government policies

Limitations of the Lorenz Curve

• Provides a graphical measure only.
• Different curves may sometimes cross, making comparison difficult.
• Does not explain causes of inequality.

The Gini Coefficient (Gini Index)

The Gini coefficient is a numerical measure of inequality derived from the Lorenz curve.

It measures the degree of inequality in income or wealth distribution.

Range of the Gini Coefficient

The Gini coefficient ranges from:

\( \mathrm{0} \rightarrow \mathrm{1} \)

or sometimes:

\( \mathrm{0} \rightarrow \mathrm{100} \)

Meaning of Values

• \( \mathrm{0} \) represents perfect equality.
• \( \mathrm{1} \) (or 100) represents perfect inequality.

Perfect Equality

Under perfect equality:

• Everyone receives exactly the same income or wealth.

Result:

\( \mathrm{Gini = 0} \)

Perfect Inequality

Under perfect inequality:

• One person receives all income or wealth.
• Everyone else receives nothing.

Result:

\( \mathrm{Gini = 1} \)

Calculation of the Gini Coefficient

The Gini coefficient is calculated using areas within the Lorenz curve diagram.

\( \mathrm{Gini\ Coefficient = \dfrac{Area\ between\ equality\ line\ and\ Lorenz\ curve}{Total\ area\ under\ equality\ line}} \)

Interpretation of the Gini Coefficient

• A higher Gini coefficient indicates greater inequality.
• A lower Gini coefficient indicates more equal distribution.

Example of Interpretation

• A country with a Gini coefficient of \( \mathrm{0.60} \) has greater inequality than a country with \( \mathrm{0.30} \).

Advantages of the Gini Coefficient

• Provides a single numerical measure.
• Easy to compare between countries.
• Useful for analysing changes over time.

Limitations of the Gini Coefficient

• Does not show where inequality occurs within the distribution.
• Different distributions may produce the same Gini value.
• Does not explain causes of inequality.
• Data collection methods may differ between countries.

Relationship Between Lorenz Curve and Gini Coefficient

The Gini coefficient is derived from the Lorenz curve.

• More curved Lorenz curve → Higher Gini coefficient
• Lorenz curve closer to equality line → Lower Gini coefficient

Government Use of Inequality Measures

Governments use these measures to:

• Design tax and welfare policies
• Monitor poverty and inequality
• Evaluate redistribution programs
• Assess social and economic conditions

Comparison Between Lorenz Curve and Gini Coefficient

Aspect	Lorenz Curve	Gini Coefficient
Type	Graphical measure	Numerical measure
Purpose	Shows distribution visually	Measures degree of inequality
Equality Indicator	Closer to equality line	Lower Gini value
High Inequality Indicator	Large curve deviation	Higher Gini value

Key Ideas:

• The Lorenz curve graphically represents income or wealth distribution.
• The Gini coefficient numerically measures inequality.
• Greater distance from the equality line indicates greater inequality.
• A higher Gini coefficient means more unequal distribution.