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Income Inequality

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Income Inequality

What seems to be the connection between income inequality and things such as spikes in crime, under-funding of education for children, and lower levels of inter-generational mobility? The answer is that there seems to be a positive correlation between income inequality and all of the things just listed. But how does income inequality cause those effects on crime, education, and inter-generational mobility? What even causes income inequality in the first place and is there a way to track it or measure it? All of the answers to these questions are provided below. To learn more about these topics, read on!

Income Inequality Definition

When the topic of a conversation is money, something that gets brought up often is income inequality. This is when income is dispersed unequally across a society. This is sometimes mixed up with wealth inequality, which is a similar idea, but in terms of unequal dispersion of general wealth rather than income.

Income inequality refers to how unevenly distributed income is throughout a society.

Wealth inequality is the unequal dispersion of wealth throughout a society.

Many other types of inequality, such as wealth, political, and social standing, have an influence on income inequality. But why should people be concerned with income inequality? Well, for starters, it hinders economic development. By transferring resources more towards people who are rich savers rather than low or middle-income spenders, growth within the economy is inhibited. Also, when wealthy people hold onto significant amounts of money and don't spend it, it will cause a suppression of demand within the economy.

It's important to note that income and poverty rates differ widely among and within separate categories like age and ethnicity, and countries as well. Also, all factors of production obtain the marginal product value, which can add to income disparity.

Causes of Income Inequality

There are typically a few things most often accepted as being causes of income inequality:

  • Labor outsourcing - Companies in India and China pay their workers a lot less money than American companies pay theirs. Since American companies are typically wanting to make as much of a profit as possible, a lot of them outsource jobs overseas so that they can get production done for a far cheaper price. Whereas factory jobs may have paid well before, now that these jobs can be outsourced for cheaper, they either will be outsourced or the workers who are working in the factories will not be well-paid.

  • Technological advances - While technological advances seem like a positive addition to the workplace, they can actually be detrimental to the workers. For example, self-checkout lanes are replacing actual cashiers. These cashiers now either have to get a different position within the company or they're let go because their services are no longer needed.

  • Education - Americans with college educations make 84 percent more than people with just a high school diploma during their lifetime.1

  • Inflation - If wages remain the same or don't go up as much as inflation does, then people are having to spend more with less money.

Measuring Income Inequality

Measuring income inequality is extremely important to economists. The Gini coefficient, which is closely related to the Lorenz curve, is the most often used measurement to determine the level of economic inequality. While both are used to compare and illustrate distributions across nations, policies, and historical periods, the Gini coefficient is the one that's focused on most.

The Gini coefficient is a measurement of the distribution of income throughout a society.

The Lorenz curve depicts the distribution of income in a society wherein money is not distributed evenly.

Income Inequality Gini coefficient StudySmarter OriginalsFigure 1. Gini coefficient, StudySmarter Originals

Figure 1 above shows the Lorenz curve and the Gini coefficient. The Gini coefficient is determined by taking the area between the Lorenz curve and the 45-degree line of equality (area A) and dividing it by everything beneath the 45-degree line (area A+B). Written out in formula form, this would be:

This will result in an answer between 0 and 1, with 0 meaning no inequality (such as where everyone makes the same amount of money) and 1 meaning full inequality. Basically, the closer to 0 a society is, the closer it is to being fully equal income-wise. If a society were to have completely equal incomes, then the line would follow the equality line on the diagram. But since that's not the case, inequality is creating the curve underneath the equality line which we recognize as the Lorenz curve.

Problem of Income Inequality

Whenever there is income inequality, there are bound to be problems associated with it. Higher inequality reduces growth by limiting lower-income families' capabilities to stay healthy and acquire wealth. For example, inequality can lead to under-funding of education for kids since disadvantaged students end up in lower-quality institutions and are less likely to go on to college. Consequently, future labor productivity might be lower due to this.

Along with that, it's been noticed that nations with greater rates of income inequality have lower levels of inter-generational mobility, and the income of the parents actually becomes a more important indicator of children's future earnings. Also, due to the fact that the wealthiest spend a smaller proportion of their incomes than middle- and lower-income groups, increasing income concentration might weaken demand and hinder growth.

There also tends to be a spike in crime when the income inequality is high. Property crime particularly increases in richer locations when the economic difference with the poorest nearby block becomes greater. When poorer households look for nearby crime chances, they are more likely to pick places with higher incomes than locations with lower incomes.

Better salaries, job stability and job availability, and family resource services can help get rid of the hopelessness that drives most low-income individuals to commit crimes and inspire them to aim for an improved way of living life.

Income inequality directly influences the rate at which growth allows poverty to be reduced. Growth is less effective in reducing poverty in nations with high rates of inequality right from the beginning, or when the growth distribution benefits the people who aren't poor. Furthermore, because economies are regularly prone to various types of shocks that impair growth, increased inequality causes a larger portion of the population to be prone to poverty.

Income inequality is an issue because it gives the rich almost all of the power, leaving many people with very little economic or social mobility. It can lead to decreased living costs for many, more hardship, and spikes in crime, mental issues, and social instability.

Examples of Income Inequality

Let's talk about some of the examples of income inequality issues that have been taking place in the United States.

Between 2016 and 2019, groups of people with low income historically (like Black and Hispanic families) saw improvement in their median wealth. These improvements ranged from 25%-60% for Black and Hispanic families, and families with a high school diploma.1

Groups with traditionally larger incomes, such as white families as well as families with a minimum of a bachelor's degree, obtained 4% to 5% more money throughout the same period of time.1 However, because these families were already wealthy, these tiny increases translated into enormous cash benefits. As a result, large wealth inequalities persisted, and wealth levels among Black, Hispanic, and other households with only high school diplomas remained low, making it harder for them to maintain financial stability.

In 2019, 39% of households had at least one person that had a four-year college degree, which is an increase from the 36% it was in 2016. Highly educated households continue to have far more money than families with less education. Families with bachelor's degrees (minimum) controlled 77 percent of wealth in 2019 and had a median worth of $310,000. This is an increase from 2016 when they had 75% of the wealth and $293,000 in median wealth.2

Yet, the average household without a bachelor's degree was earning only $66,000 in 2019 in comparison, slightly higher compared to the $54,000 it was earning in 2016.2 The inequality between these categories widened by roughly $5,000, despite a percentage-wise decrease.2 Essentially, while less educated families' wealth expanded faster in percentage terms, more educated families had more wealth to begin with, therefore their actual gain in terms of dollars was bigger.

Also, it's important to note that employers seldom provide medical coverage, sick leave, or pension plans to low-wage workers. These workers typically can't take time off if they become sick, and they can't even fathom retiring. These inequalities contribute to inequalities within the health-care field which raises the overall cost of medical treatment for everyone, not just the low-wage workers.

Let's go through an example of income inequality and the wealth gap between black and white families from about 30 years ago and compare it to 2019. Data presented is accurate according to the Federal Reserve Bank of St Louis and all dollar amounts are adjusted to 2019 dollar amounts.

Black families White families
1989$9,000$143,000
2019$23,000$184,000

Table 1. Income inequality example - StudySmarter. Source: Federal Reserve Bank of St Louis2

Generally, it appears that black families have gained the most with about a 2.5X increase in their median income from 1989 to 2019. White families, on the other hand, only increased their wealth by about 1.28X. However, this can be deceiving. Although black families seem to have gained more and white families seem to have gained less, white families had more to start with. Their increase, although smaller than that of black families, still stands to show the large wealth gap that is present between the two.


Income Inequality - Key Takeaways

  • Income inequality refers to how unevenly distributed income is throughout a society.
  • The Gini coefficient is a measurement of the distribution of income throughout a society.
  • Higher inequality reduces growth by limiting lower-income families' capabilities to stay healthy and acquire wealth.
  • Income inequality is an issue because it gives the rich almost all of the power, leaving many people with very little economic or social mobility.
  • Nations with greater rates of income inequality have lower levels of inter-generational mobility.

References

  1. Georgetown University, The College Payoff, 2022
  2. Federal Reserve Bank of St. Louis, Has Wealth Inequality in America Changed over Time?, 2020

Frequently Asked Questions about Income Inequality

Income inequality refers to how unevenly distributed income is throughout a society.

Labor outsourcing, technological advances, education, inflation, etc.

A good example of income inequality is the income inequality between families within the US that have college degrees and those with only high school diplomas.

The challenges of income inequality are: it reduces growth, creates lower levels of inter-generational mobility, leads to spikes in crime, negatively influences the rate at which poverty can be reduced, etc.

Income inequality is measured by using the Gini coefficient.

Final Income Inequality Quiz

Question

What is the link of the Gini coefficient with the Lorenz curve?

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Answer

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


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What is the Lorenz curve?

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Lorenz Curve is a graphical representation of the distribution of income or wealth within an economy.


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Why is the Lorenz curve important?

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The Lorenz curve is an important inequality metric since it allows economists to measure income and wealth inequality in an economy and compare across countries or regions. 


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The further the Lorenz curve is to the line of equality the higher the income or wealth inequality in an economy. 

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True

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What is the other name of the 45° straight line in the Lorenz curve?

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The line of equality

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The 35° straight line in the Lorenz curve shows perfect equality in income where everyone in the economy receives the same income. 

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False

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What does it mean when the Lorenz curve moves closer to the 45° straight line?

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It means that income or wealth inequality decreases in an economy.


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When comparing two Lorenz curves, if two Lorenz curves intersect, we cannot compare the inequality level across both.

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True

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Which one is not a limitation of the Lorenz Curve?

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The Lorenz curve ignores the life cycle effect.

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What is measured on the x-axis of a Lorenz curve?

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The x-axis on a Lorenz curve shows the percentage of the total population.

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What is measured on the y-axis of a Lorenz curve?

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The y-axis on a Lorenz curve shows the percentage of total income or wealth.

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Why do economists use the Lorenz curve?

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Answer

to show the population growth rate

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Question

Assume that country A has a Gini coefficient of 0.8, and Country B has a Gini coefficient of 0.4. Which of the countries has more equally distributed income?

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Answer

Counrty A

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Question

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

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True

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The larger the gap between the Lorenz curve and the perfect equality line, the bigger the amount of income equality.

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True

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What is the Gini coefficient?

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Gini coefficient is an index that measures income distribution across a population.


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What does it mean that the Gini coefficient is 1?

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If the Gini is 1, it means perfect inequality

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What does it mean that the Gini coefficient is 0?

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If the Gini is 0, it means perfect equality

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A Gini coefficient closer to 0 means that there is less income inequality in the society

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True

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If the Gini coefficient is 1, it means every individual receives the same amount of income.

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True

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Gini coefficient measures how far the Lorenz curve is from the 45° line of equality.

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True

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What does a lower Gini coefficient illustrate? 


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Answer

The lower Gini coefficient illustrates more equally distributed income or wealth across populations in the economy. 


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If the Lorenz curve goes further from the 45° line of equality, how does the Gini coefficient change? 

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Answer

The Gini coefficient rises closer to 1.

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If the Lorenz curve is closer to the 45° line of equality, the Gini coefficient would be close to 0.

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True

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Which one is not a limitation of the Gini coefficient? 

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Answer

Through the conversion of the Lorenz curve to a number, we might lose some important information.

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US's Gini coefficient is around 0.4 and 0.45, which is higher than Europe and less than Africa on average.

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True

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Assume Country A's Gini coefficient is 0.9 and Country B's coefficient is 0.3. Which country has a more equal distribution of income?

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Country A

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Question

What is poverty?

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Poverty is the state of not having the financial resources available to afford basic expenses such as food, housing, and clothing.

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What is a poverty trap?

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A poverty trap is a means by which those who are impoverished are unable to escape poverty.

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What's the definition of the poverty line?

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The poverty line is the minimum amount that is thought to be sufficient for survival in a particular country.

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List at least three causes of poverty traps.

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  • Insufficient job opportunities
  • No health insurance to cover costs of medical expenses
  • Expensive goods/services
  • Conflict within the country
  • Being unable to afford education

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What are the four poverty traps?

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  • Conflict
  • Natural resource
  • Landlocked with bad neighbors
  • Poor governance of a small country 

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What's a landlocked country?

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A landlocked country is a country that is surrounded by land, and that does not have access to water (for trade).

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What's Brain Drain?

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This is when highly educated people and professionals move to another country so they can get a better income and better living conditions.

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Name the three main effects of poverty traps.

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Poverty traps cause resource issues, lack of education, and increases in crime.

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Fill in the blank:


The more well-off someone is when they're younger, the ____ _____ it is that they will fall into poverty or poverty traps. 

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Less likely. If people have access to funds and education when they're younger, they have a better chance of excelling and getting good jobs compared to those that did not have the same opportunities.

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Explain the natural resource trap.

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The natural resource trap is when a country and their economy become overly dependent on the natural resources. They profit and the economy improves until their currency becomes too strong for the international market and so their exports also become more expensive. This makes them no longer competitive in the market and they begin to lose money.

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What do landlocked countries lack?

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They lack ports which would allow them to trade via the water with other countries. Unless they have the possibility to trade by air, this could become problematic. Also, they (usually) lack good relationships with their neighbors which results in the the neighboring country not wanting to share their port. 

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What are the two things that can be done to help overcome poverty traps?

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Slowly weaning people off of unemployment benefits instead of completely cutting them off, and delaying paying taxes for a period of time to let them get back on their feet.

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Why is poor governance of a small country considered to be a type of poverty trap?

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It's considered to be a trap because smaller countries usually have a higher dependance on their government. If these governments become corrupted, then there can be no development within the country. 

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What usually happens to the people who have just gotten a job and are no longer eligible for government assistance? 

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They get sucked back into the poverty trap. This happens because their expenses increase significantly as opposed to their income, but they no longer have the benefits they were getting before to help them out. 

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Why is education so important when it comes to escaping poverty traps?

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The more educated someone is, the higher likelihood they have to find a well-paying job. By doing so, they will be well above the poverty line and able to afford their basic needs on their own without government assistance. This could break generational poverty. 

Show question

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What is income inequality?

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Answer

Income inequality refers to how unevenly distributed income is throughout a society.

Show question

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What's wealth inequality?

Show answer

Answer

Wealth inequality is the unequal dispersion of wealth throughout a society.

Show question

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What causes income inequality?

Show answer

Answer

Labor outsourcing, technological advances, education, inflation, etc.

Show question

Question

Income inequality example?

Show answer

Answer

The income inequality between families within the US that have college degrees and those with only high school diplomas.

Show question

Question

What are the challenges of income inequality?

Show answer

Answer

It reduces growth, creates lower levels of intergenerational mobility, leads to spikes in crime, negatively influences the rate at which poverty can be reduced, etc.

Show question

Question

How to measure income inequality?

Show answer

Answer

The Gini coefficient

Show question

Question

Define the Gini coefficient 


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Answer

The Gini coefficient is a measurement of the distribution of income throughout a society.

Show question

Question

Define the Lorenz curve

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Answer

The Lorenz curve depicts the distribution of income in a society wherein money is not distributed evenly.

Show question

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