Select your language

Suggested languages for you:
Log In Start studying!
StudySmarter - The all-in-one study app.
4.8 • +11k Ratings
More than 3 Million Downloads
Free
|
|

All-in-one learning app

  • Flashcards
  • NotesNotes
  • ExplanationsExplanations
  • Study Planner
  • Textbook solutions
Start studying

Lorenz Curve

Save Save
Print Print
Edit Edit
Sign up to use all features for free. Sign up now
Economics

How do we calculate inequality in society? How do we know if inequality is improving or worsening in a specific country? This article helps answer those questions by explaining the Lorenz curve.

The Lorenz curve graphically shows the degree of income or wealth inequality in an economy. It was developed by economist Max O. Lorenz in 1905.

Interpreting the Lorenz curve graph

To interpret the Lorenz curve, we need to first understand how it is represented on the diagram. There are two curves in Figure 1 below.

We first have the 45° straight line, known as the line of equality. It has a slope of 1 which illustrates perfect equality in income or wealth.

The Lorenz curve lies beneath the 45° line of equality. The further away the curve is from the 45° line, the greater the income or wealth inequality in an economy. We can see that in the diagram below.

The x axis shows the percentage of the total population. The y axis shows the percentage of total income or wealth. The word ‘cumulative’ in both axes means up and including.

Lorenz Curve Graph of the Lorenz curve StudySmarterFigure 1. The Lorenz Curve - StudySmarter Originals.

Interpreting the data from the Lorenz curve is quite simple. Pick a point from the x axis and read off the y axis. For example, reading off the diagram, 50% of the population has access up to and including 5% of the country's national income. In this example, income is distributed very unequally as half of the population has a very small share of the country’s national income.

Shifts of the Lorenz curve

The Lorenz curve can shift closer or further away from the 45° line of equality. In the diagram below, the Lorenz curve has moved closer to the line of equality. This means that inequality in this economy has decreased.

Lorenz Curve Shifts in Lorenz Curve StudySmarterFigure 2. Lorenz Curve shifts - StudySmarter Originals.

According to the diagram above, initially, only 90% of the population had access to 45% of the country’s national income. After the curve shifted, 90% of the population has access to 50% of the country’s national income.

The Lorenz curve and the Gini coefficient

The Lorenz curve is linked to the Gini coefficient. You can calculate the Gini coefficient using this curve.

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

Graphically, the Gini coefficient measures how far the Lorenz curve is from the line of equality. It quantifies the level of economic inequality in an economy.

Lorenz Curve Gini coefficient StudySmarterFigure 3. Gini coefficient calculated from Lorenz Curve - StudySmarter Originals.

In the diagram above, the shaded area is Area A. The remaining white space is Area B. Plugging the values for each area into the formula gives us the Gini Coefficient.

The Gini coefficient is calculated with the following formula:

A coefficient of 0 means that there is perfect equality. This means that every 1% of a population has access to 1% of national income, which is unrealistic.

A coefficient of 1 means that there is perfect inequality. This means that 1 individual has access to the entire country’s national income.

A lower coefficient indicates that income or wealth is distributed more equally across the population. A higher coefficient indicates that there is severe income or wealth inequality and is mainly due to political and/or social disruption.

Why is the Lorenz curve important?

The Lorenz curve is important because it helps economists measure and understand income or wealth inequality.

Economists are interested in how income and wealth inequality changes over time in an economy. It also allows them to compare the level of economic inequality between different countries.

Both the US and Norway are high-income countries. However, they have very different Lorenz curves and Gini coefficients. Norway's Lorenz curve is much closer to the line of equality than the United States’. By comparison, income is distributed more equally in Norway than in the US.

Limitations of the Lorenz curve

While the Lorenz curve is helpful for economists to make comparisons on the level of income and wealth distribution, it does have some limitations. Most of these limitations lie with the data.

For example, the Lorenz curve doesn't take into account:

  • Wealth effects. A household may have a low income compared to the rest of the population, thus lying in the bottom 10%. However, they may be ‘asset rich’ and possess assets that are appreciating in value.
  • Non-market activities. Activities such as education and healthcare make a difference to a household’s standard of living. In theory, a country could have a Lorenz curve close to the line of equality, but have poor education and healthcare standards.
  • Lifecycle stages. An individual’s income changes throughout their lifetime. A student may be poor due to the early stages of their career, but may later earn more than the average person in that country. This variation in income is not considered when analysing inequality with the Lorenz curve.

Lorenz curve example

The Lorenz curve below has been plotted to fit the data describing England’s income distribution.

Lorenz Curve England's Lorenz curve StudySmarterFigure 4. England's Lorenz Curve - StudySmarter Originals.

Thanks to the curve, we can see that wealth is unequally distributed across England. The top 10% hold 42.6% of the country’s total net wealth. Those in the bottom 10% hold 0.1% of England’s total net wealth.

To find the Gini coefficient, divide the area between the line of equality by the sum of the total area under the line of equality. In 2020, England’s Gini coefficient reached 0.34 (34%), a slight decrease from the previous year.

Now you have seen how economists show graphically how income and wealth are distributed in an economy with the Lorenz Curve. Go to 'Equitable Distributions of Income' to learn how income can be distributed equitably.

Lorenz Curve - Key takeaways

  • The Lorenz curve depicts graphically the income or wealth inequality of an economy.
  • On the graph, there is a 45° straight line known as the line of equality, which shows perfect equality. The Lorenz curve lies beneath that straight line.
  • The closer the Lorenz curve is to the line of equality the lower the income or wealth inequality in an economy.
  • The Gini coefficient can be calculated from the Lorenz Curve using the formula A/(A+B).

  • The Lorenz curve is important as it allows economists to measure income and wealth inequality in a country and compare it to different countries.

Lorenz Curve

The Lorenz Curve is a graph that shows income or wealth inequality in an economy.

Any factor that improves income or wealth distribution, such as high levels of education, will shift the Lorenz curve closer to the line of equality. Any factor that worsens income or wealth distribution shifts the curve further from the line of equality.

It is important because it helps economists measure and understand income and wealth inequality, which they can use to make comparisons between different economies.

The area between the line of equality and the Lorenz curve is Area A. The remaining space between the Lorenz curve and x axis is Area B. Using the formula Area A/(Area A + Area B), you can calculate the Gini coefficient.

Final Lorenz Curve Quiz

Question

What is the Lorenz curve?

Show answer

Answer

The Lorenz curve is a graph that shows income or wealth inequality in an economy.

Show question

Question

Why is the Lorenz curve important?

Show answer

Answer

It is important because it helps economists measure and understand income or wealth inequality. 


Show question

Question

What shifts the Lorenz curve?

Show answer

Answer

Any factor that improves the income or wealth distribution, such as high levels of education and a small family composition, will cause the Lorenz curve to shift closer to the line of equality.

Show question

Question

What does the Gini Coefficient measure in the Lorenz curve?

Show answer

Answer

It measures how far away the Lorenz curve is from the line of equality.

Show question

Question

What does an inward shift of the Lorenz curve mean?

Show answer

Answer

It means that income or wealth inequality has fallen in an economy.

Show question

Question

What are some limitations of using the Lorenz curve?

Show answer

Answer

It doesn't include non-market activities such as education, and healthcare.

Show question

Question

What does a Gini coefficient of 0 mean?

Show answer

Answer

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

Show question

Question

What does a Gini Coefficient of 1 mean?

Show answer

Answer

Perfect inequality. It means that 1 individual has access to the entire country’s national income.

Show question

Question

A low Gini coefficient means income or wealth is distributed unequally.

Show answer

Answer

True

Show question

60%

of the users don't pass the Lorenz Curve quiz! Will you pass the quiz?

Start Quiz

Discover the right content for your subjects

No need to cheat if you have everything you need to succeed! Packed into one app!

Study Plan

Be perfectly prepared on time with an individual plan.

Quizzes

Test your knowledge with gamified quizzes.

Flashcards

Create and find flashcards in record time.

Notes

Create beautiful notes faster than ever before.

Study Sets

Have all your study materials in one place.

Documents

Upload unlimited documents and save them online.

Study Analytics

Identify your study strength and weaknesses.

Weekly Goals

Set individual study goals and earn points reaching them.

Smart Reminders

Stop procrastinating with our study reminders.

Rewards

Earn points, unlock badges and level up while studying.

Magic Marker

Create flashcards in notes completely automatically.

Smart Formatting

Create the most beautiful study materials using our templates.

Sign up to highlight and take notes. It’s 100% free.