Income, wealth and their distribution
Income is a flow of money over time: wages, salaries, profit, rent, interest and government benefits. Wealth is a stock of things you own at a moment: houses, land, savings, shares, gold.
Wealth produces income (rent, interest), and income can be saved to build wealth. So wealth inequality is usually much higher than income inequality.
In a market economy most income comes from selling the services of factors of production: labour earns wages, land earns rent, capital earns interest and enterprise earns profit. The functional distribution is how income splits between these factors; the personal (size) distribution is how it splits between people or households.
Measuring inequality: quintiles, Lorenz curve and Gini coefficient
Quintile shares: rank households by income, split them into five groups of 20%, and find each group's % of total income. The 20:20 ratio = share of the richest 20% ÷ share of the poorest 20%.
The Lorenz curve has the cumulative % of people on the x-axis and the cumulative % of income on the y-axis. The diagonal is the line of perfect equality. The more the curve bows below it, the more unequal the distribution.
The Gini coefficient = A ÷ (A + B), where A is the area between the line and the curve and B is the area under the curve. It goes from 0 (everyone equal) to 1 (one person has all income). It is often shown as a % (0–100). Rough values: Nordic countries about 0.25–0.28; India about 0.33–0.35 (consumption-based); USA about 0.39–0.41; South Africa about 0.6.
Worked idea
Since A + B is half the square, if B = 0.3 (of the whole square = 1) then A = 0.5 − 0.3 = 0.2 and Gini = 0.2 ÷ 0.5 = 0.4.
Limits: the same Gini can come from different curve shapes; it says nothing about how rich the country is; data from surveys may miss the very rich and the informal sector.
Poverty, causes and effects of inequality
Absolute poverty: not having enough for basic needs such as food, water, shelter and clothes. The World Bank international line is about US$3 a day per person (2021 prices). Relative poverty: having much less than others in your society, often below 50% or 60% of the median income.
Causes of inequality
- Differences in education, skills and health.
- Inherited wealth and land.
- Technology and globalisation that raise pay for high-skilled work.
- Discrimination by gender, caste, race or region.
- Unemployment, informal jobs and weak bargaining power.
- Tax systems that favour income from wealth.
Effects
- Some inequality gives incentives to work, study and take risks.
- Too much can lower social mobility, health and trust, increase crime, and let the rich gain more political power.
- Poorer people spend a larger share of extra income, so very high inequality can weaken demand.
Different communities feel inequality differently: rural and urban areas, Indigenous peoples, women, migrants and people with disabilities often face extra barriers.
Policies to reduce poverty and inequality
- Progressive income tax: higher earners pay a higher percentage, so after-tax incomes are closer together.
- Transfers (benefits): pensions, child benefits, unemployment pay, cash transfers (for example India's PM-KISAN for farmers).
- Public services: free schools, health care and housing raise living standards of the poor.
- Minimum wage and job guarantees (for example MGNREGA in India: 100 days of paid work for rural households).
- Wealth and inheritance taxes, land reform.
- Equal-opportunity laws against discrimination.
Trade-offs: very high taxes may reduce the incentive to work or invest, and some money can be lost in administration. Benefits that stop when you earn more can create a poverty trap. Good policy balances equity (fairness) and efficiency.
Try it
Ask 5 friends how many pages they read last week. Rank them, find each one's share of the total and sketch a Lorenz curve on squared paper. Is your class 'equal readers'?
Key formulas and definitions
- Gini coefficient G = A ÷ (A + B), with 0 ≤ G ≤ 1
- A + B = 1/2 (on a unit square), so G = 1 − 2B
- 20:20 ratio = income share of richest 20% ÷ income share of poorest 20%
- Relative poverty line = 50% or 60% of median income
Worked examples
1. Quintile shares are 4%, 9%, 15%, 22%, 50%. Find the 20:20 ratio.
Ratio = 50 ÷ 4 = 12.5. The richest 20% receive 12.5 times as much income as the poorest 20%.
2. On a Lorenz diagram drawn on a unit square, the area under the curve is B = 0.32. Find the Gini coefficient.
A + B = 0.5, so A = 0.5 − 0.32 = 0.18. G = 0.18 ÷ 0.5 = 0.36.
3. Use the quintile shares 5%, 10%, 15%, 25%, 45% to find the points of the Lorenz curve.
Cumulative: 20% → 5%, 40% → 15%, 60% → 30%, 80% → 55%, 100% → 100%. Plot (20,5), (40,15), (60,30), (80,55), (100,100) and join them from (0,0).
4. Median income in a country is ₹30,000 a month. Find the relative poverty line at 60% of the median.
0.6 × 30,000 = ₹18,000 a month. Households below this are in relative poverty.
5. Country X has Gini 0.28 and Country Y has Gini 0.52. Which is more unequal and how will their Lorenz curves look?
Y is more unequal. Its Lorenz curve bends much further from the line of equality; X's curve stays closer to the diagonal.
6. A tax takes 10% of incomes up to ₹5 lakh and 30% of income above ₹5 lakh. How much tax does a person earning ₹8 lakh pay, and is the tax progressive?
Tax = 10% × 5 lakh + 30% × 3 lakh = 0.5 + 0.9 = ₹1.4 lakh. Average rate = 1.4 ÷ 8 = 17.5%, higher than 10% for a ₹5 lakh earner, so it is progressive.
Common mistakes
- Mixing up income and wealth. Income is a flow (per month or year); wealth is a stock (owned at one time).
- Thinking a higher Gini means a richer country. Gini measures how equally income is shared, not how much there is.
- Drawing the Lorenz curve above the line of equality. It always lies on or below the diagonal.
- Thinking absolute and relative poverty are the same. A person can be above the absolute line but still relatively poor.