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Gini Coefficient

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Economics

Inequality can be difficult to measure as there are many variables to take into account. How do economists do it and how reliable are their methods? This explanation will show you how to estimate inequality through the Gini coefficient, or the Gini index.

The Gini coefficient is the measure of the distribution of income.

Statistician Corrado Gini developed the Gini coefficient in 1912. The Gini coefficient is used to quantify the level of economic inequality in an economy.

The Gini coefficient is linked to the Lorenz Curve. It measures how far the Lorenz curve is from the line of equality. Using this curve, you can calculate the coefficient with this formula:

Gini coefficient Lorenz curve StudySmarterFigure 1. Calculating the Gini coefficient from the Lorenz Curve - StudySmarter Originals.

Area A is the area between the line of equality and the Lorenz curve. Area B is the remaining area between the Lorenz curve and the 𝑥 axis. We can calculate the Gini coefficient by finding the two numerical values for Area A and B.

In the diagram above, Area A is 7, and Area B is 13. Using the formula, Gini coefficient = 7/(7+13) = 7/20 = 0.35. In this example, income is distributed quite equally, but there is still room for improvement.

Interpreting the Gini coefficient

The value of the Gini coefficient ranges from 0 to 1. A coefficient of 0 indicates perfect equality. It means that every 1% of a population has access to 1% of national income, which is unrealistic. A coefficient of 1 indicates perfect inequality. It means that 1 individual has access to 100% of the country’s national income.

Gini coefficient Gini coefficient scale StudySmarterFigure 2. Gini coefficient Scale - StudySmarter Originals.

As the figure above shows, a coefficient between 0–0.3 indicates relative equality. Relative to a Gini coefficient of 0, income or wealth is distributed quite equally. A coefficient between 0.3–0.4 indicates that there is adequate equality. This means that income or wealth is distributed in a suitable way, but can be distributed more equally. A coefficient greater than 0.4 is an important point and indicates that there is a big income gap. Inequality above this level often means that there is social and political instability or tension. A coefficient between 0.5–1 means that there is severe inequality within an economy.

Why is the Gini coefficient important?

The Gini coefficient is important because it helps economists measure income or wealth inequality. Economists are interested in how income and wealth inequality change over time in an economy as well as the difference in economic inequality between different countries.

Limitations of the Gini coefficient

Whilst the Gini coefficient has proved to be beneficial to help measure income and wealth inequality, it does have some limitations.

One significant limitation is that a lot of information can be lost. For example, in 2016, Turkey and the US had the same Gini coefficient. While both countries may experience similar levels of inequality, the Gini coefficient fails to account for the differences in population size, and how large each economy is.

Like many other measures of inequality, the Gini coefficient shouldn’t be used as the sole measure of income inequality. It could be used alongside other measures, such as the decile ratio or the Palma ratio to look at the broader scope of inequality within an economy.

Gini coefficient examples

The global Gini coefficient is estimated to be around 0.61–0.68. This estimate shows significant levels of income inequality around the world.

Taking a deeper look into the statistics, the Central African Republic has one of the highest Gini coefficients at 0.61. The country’s history of conflicts and competition over resources has contributed to that value.

Denmark, on the other side, is a country with one of the lowest Gini coefficients at 0.28. Denmark’s redistributive system and strong welfare system contribute to low income inequality levels.

The Gini coefficient in the UK

The UK experienced a sharp increase in inequality from 1978 until the 1980s. Some of the reasons that explain that rise in inequality are:

  • Reduced power of trade unions: trade unions help protect workers and strengthen their bargaining power. Weakening trade unions mean that employers are able to exploit workers through lower wages, affecting the poorest significantly.
  • Reduction in higher income taxes: income taxes became more regressive and placed a smaller burden on higher earners. The poorest in society were burdened more than the rich.

From the mid-1970s to the 1990s, the top 1% saw an increase in their access to the UK’s national income. This was largely due to:

  • Growth of the financial sector: the growth in this sector caused an increase in wages within this sector. Already high-earners earned even more while the poor saw little to no change in their wages.
  • Increase in house prices: an increase in house prices causes homeowners to feel richer due to the wealth effect. This could have increased wealth inequality.

Gini Coefficient - Key takeaways

  • The Gini Coefficient is a measure of the distribution of income.
  • It is linked to the Lorenz curve. You can calculate the Gini Coefficient of a country using the Lorenz curve.
  • A coefficient of 0 indicates perfect equality and a coefficient of 1 indicates perfect inequality.
  • A coefficient > 0.4 indicates that there is a large income gap and often means there are social and or political tensions.
  • While the Gini Coefficient helps quantify income inequality, it fails to account for the population's and economy's size.

Gini Coefficient

The Gini coefficient is the measure of the distribution of income which quantifies the level of economic inequality in an economy.

You can calculate it using this formula: Area A / (Area A + Area B), where area A is the area between the line of equality and the Lorenz curve. Area B is the remaining area between the Lorenz curve and the 𝑥 axis.

The Gini coefficient is the mathematical calculation of income or wealth inequality. The Lorenz curve is a visual representation of income or wealth inequality in a country.

Final Gini Coefficient Quiz

Question

What is the Gini coefficient?

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Answer

The measure of the distribution income.

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Question

What does a coefficient of 0 mean?

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Answer

It indicates perfect equality. This means that every 1% of a population has access to 1% of national income.

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Question

What does a coefficient of 1 mean?

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Answer

It indicates perfect inequality. This means that one individual has access to 100% of the country’s national income.


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Question

What is the difference between the Gini coefficient and the Lorenz curve?

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Answer

The Gini coefficient is a mathematical measure of the distribution of income, while the Lorenz curve is a visual representation of income or wealth inequality.

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Question

What does a coefficient > 0.4 mean?

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Answer

It indicates that there is a big income gap and there must be some level of social and political instability.

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Question

What is the range of the Gini coefficient?

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Answer

It ranges from 0 to 1.

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Question

Why is the Gini coefficient important?

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Answer

It is important because it helps economists measure income or wealth inequality which they can use to compare different countries.

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Question

What is the main limitation of using the Gini coefficient? 

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Answer

A lot of information can be lost such as the population size of a country, and how large an economy is.


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Question

How is the Gini coefficient linked to the Lorenz curve?

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Answer

You can calculate the Gini coefficient from the Lorenz curve. It also measures how far the Lorenz curve is from the line of equality.

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