EuraStudy
Notes/Economics/The distribution of income and wealth: poverty and inequality
Notes · EconomicsUK · A-Levels

The distribution of income and wealth: poverty and inequality

This chapter examines how income and wealth are distributed and why the distribution matters. It distinguishes income from wealth and sets out the causes of inequality, the measurement of inequality using the Lorenz curve and Gini coefficient, the difference between absolute and relative poverty, and the policies governments use to redistribute income and reduce poverty - together with their effects on incentives.

4 sections·~17 min reading time·4 competencies·Level Standard 2 · Advanced 2

T·0777 / 14
Exam profile
AO1 · Distinguish income from wealth and absolute from relative poverty and define the Lorenz curve and Gini coefficientAO2 · Apply and interpret the Lorenz curve and Gini coefficient and poverty thresholds from dataAO3 · Analyse the causes of inequality and poverty and the effect of redistributive policyAO4 · Evaluate the effectiveness and side effects of policies to reduce poverty and inequality
Operators:defineexplainanalysecalculateevaluateassessdistinguish

basic level

AS-Level requires the income-wealth distinction, the causes of inequality, and absolute versus relative poverty.

higher level

The full A-Level adds the Lorenz curve and Gini coefficient and a critical evaluation of redistributive policy and the equity-efficiency trade-off.

Depth

Reading depth: In depth

Text

Text size: Standard

Contents · 4 sections▾
  1. The distribution of income and wealth: poverty and inequality
    • 01Income, wealth and the causes of inequality◐
    • 02Measuring inequality: the Lorenz curve and Gini coefficient●
    • 03Absolute and relative poverty◐
    • 04Policies to redistribute income and reduce poverty●
§ 01

Income, wealth and the causes of inequality#

●●○StandardLPAQA 7136 4.1.7LPDfE GCE Economics - the distribution of income and wealth

Key points

Income and wealth are distinct concepts that must not be confused. Income is a flow - the money received over a period of time, such as wages, interest, rent, dividends, profit and state benefits, usually measured per week, month or year. Wealth is a stock - the value of the assets owned at a point in time, such as property, shares, pension funds, savings and physical possessions, minus debts. The two are linked - wealth generates income (rent, interest, dividends) and income saved becomes wealth - but a person can be income-rich and wealth-poor (a high earner with no assets) or wealth-rich and income-poor (a retired homeowner). The distinction between a flow and a stock is a recurring theme in economics.
The distribution of both income and wealth is unequal in every economy, but wealth is typically distributed much more unequally than income, because wealth accumulates over time and is inherited across generations. Some inequality is inevitable, and even useful, in a market economy - differences in reward provide incentives to work, train, take risks and innovate - so the issue is not whether inequality exists but how much of it is acceptable and what causes it.
The causes of inequality of income and wealth within a country are several and reinforcing. Differences in the ownership of wealth (and the income it yields) are a major cause, magnified by inheritance. Differences in earnings arise from the labour market analysed in the previous chapter - skills, qualifications, the marginal revenue product of different jobs, and discrimination. Differences in household composition (the number of earners and dependants), in age (earnings rise then fall over a lifetime), and in access to education and opportunity all matter. Unemployment and reliance on benefits, and the structure of the tax and benefit system, further shape the distribution.
Inequality also exists between countries and has both narrowed and widened in different respects during globalisation. Causes include differences in resource endowments, capital stocks, technology, institutions, education and the terms on which countries trade. Whether inequality is a problem is partly a normative question (a value judgement about fairness) and partly positive - high inequality can be associated with lower social mobility, weaker demand, and social and political tension, while some inequality supports incentives. This tension between equity and efficiency runs through the whole chapter and is the crux of the policy debate.
Worked example

Classifying income and wealth

A retired person owns a house worth 400,000 pounds and shares worth 50,000 pounds, and receives a pension of 15,000 pounds a year. Identify their income and their wealth.

  1. 01Identify the flow

    Income is the flow received over time: the pension of 15,000 pounds per year.

  2. 02Identify the stock

    Wealth is the stock of assets owned: the house (400,000) plus the shares (50,000), giving 450,000 pounds of wealth.

  3. 03Interpret

    This person is wealth-rich but relatively income-poor, illustrating why the two measures can diverge and why both are needed to describe living standards.

Result: Their income is 15,000 pounds a year (a flow); their wealth is 450,000 pounds (a stock) - a clear case of high wealth with modest income.

Exam focus

  • Define income as a flow and wealth as a stock, and explain why wealth is distributed more unequally than income.
  • Give a structured set of causes of inequality (wealth ownership and inheritance, earnings differences, household and age factors, unemployment, the tax-benefit system).

Typical mistakes

  • Using 'income' and 'wealth' interchangeably - income is a flow over time, wealth is a stock at a point in time.
  • Treating all inequality as bad - some inequality provides incentives; the issue is its extent and causes.

Active revision

Distinguish between income and wealth, and explain two reasons why the distribution of wealth is more unequal than the distribution of income.

Active recall

Recall the key points — then reveal.

Sources: GCE AS and A level subject content for economics (Department for Education) · AQA A-level Economics 7136 specification (AQA)

§ 02

Measuring inequality: the Lorenz curve and Gini coefficient#

●●●AdvancedLPAQA 7136 4.1.7LPDfE GCE Economics - the measurement of inequality

The Lorenz curve and the Gini coefficient

The Lorenz curveGraph of line of equality, roots at x = 0, y-intercept at y = 0, increasing, on the interval x from 0 to 100, Graph of Lorenz curve, roots at x = 0, y-intercept at y = 0, increasing, on the interval x from 0 to 1002040608010020406080100poorest 50% get25%line of equalityLorenz curveCumulative % of incomeCumulative % of population
Fig. 1The Lorenz curve plots cumulative income against cumulative population. The Gini coefficient is area A (shaded, between the diagonal and the curve) divided by the whole area under the diagonal (A + B).

Key points

The Lorenz curve is a diagram that shows how equally income (or wealth) is distributed. It plots the cumulative percentage of the population, ranked from poorest to richest along the horizontal axis, against the cumulative percentage of total income they receive on the vertical axis. If income were perfectly equally distributed, the poorest 20% would receive 20% of income, the poorest 50% would receive 50%, and so on - the Lorenz curve would be the 45-degree line of perfect equality. In reality the poorest fractions receive less than their proportionate share, so the actual Lorenz curve sags below the line of equality; the further the curve bows away from the diagonal, the more unequal the distribution.
The Gini coefficient turns the Lorenz diagram into a single number between 0 and 1. It is defined as the area between the line of equality and the Lorenz curve (call it A) divided by the whole area beneath the line of equality (A plus the area B beneath the Lorenz curve): Gini = A / (A + B). A Gini of 0 means perfect equality (the Lorenz curve is the diagonal, so A = 0); a Gini of 1 means perfect inequality (one person has all the income). The larger the Gini, the more unequal the distribution - a country with a Gini of 0.45 is more unequal than one with 0.25.
The Lorenz curve and Gini coefficient are valuable because they make inequality visible and comparable - over time within a country, and between countries - and because they capture the whole distribution rather than a single ratio. A redistributive policy that helps the poorest pulls the Lorenz curve towards the diagonal and lowers the Gini coefficient, which is exactly how the effect of tax and benefit policy is often illustrated: the Gini for income before taxes and benefits is higher than the Gini after them, showing how much the state reduces inequality.
The measures have limitations that a strong answer notes. Two very different distributions can share the same Gini coefficient (Lorenz curves that cross can give equal areas), so the single number hides where in the distribution the inequality lies. The Gini says nothing about absolute living standards - a poor and a rich country can have the same Gini - and it depends on the quality of income data, which often misses the very top and the informal economy. And it is a positive measure of the extent of inequality, not a normative judgement about how much inequality is acceptable. Nonetheless, together the Lorenz curve and Gini coefficient are the standard tools for measuring and comparing inequality.
Gini coefficient=AA+B\text{Gini coefficient} = \frac{A}{A + B}Gini coefficient=A+BA​

The Gini coefficient

A is the area between the line of equality and the Lorenz curve; A + B is the whole area beneath the line of equality. Gini ranges from 0 (perfect equality) to 1 (perfect inequality).

Comparing two Lorenz curves

More and less equal distributionsGraph of equality, roots at x = 0, y-intercept at y = 0, increasing, on the interval x from 0 to 100, Graph of more unequal, roots at x = 0, y-intercept at y = 0, increasing, on the interval x from 0 to 100, Graph of less unequal, roots at x = 0, y-intercept at y = 0, increasing, on the interval x from 0 to 1002040608010020406080100equalitymore unequalless unequalCumulative % of incomeCumulative % of population
Fig. 2The lower Lorenz curve (further from the diagonal) is the more unequal distribution and has the higher Gini coefficient; a redistributive policy shifts a curve towards the diagonal.
Worked example

Interpreting Gini coefficients and a Lorenz curve

In a country, the poorest 50% of the population receive 25% of total income, and the Gini coefficient is 0.33. A new tax-and-benefit reform raises the poorest 50%'s share to 35% and lowers the Gini to 0.26. Interpret the changes.

  1. 01Read the Lorenz point

    Initially the poorest half receive only 25% of income (against 50% under perfect equality), so the Lorenz curve sags well below the diagonal - a clearly unequal distribution.

  2. 02Interpret the reform on the Lorenz curve

    Raising the poorest half's share from 25% to 35% pulls the Lorenz curve UP towards the line of equality: the distribution has become more equal.

  3. 03Interpret the Gini change

    The Gini falls from 0.33 to 0.26, confirming reduced inequality: the area between the curve and the diagonal has shrunk. The reform has redistributed income towards the poorest.

Result: The reform pulls the Lorenz curve towards the diagonal and cuts the Gini from 0.33 to 0.26, showing a fall in income inequality.

Exam focus

  • Read and draw a Lorenz curve correctly (cumulative population against cumulative income) and explain that a curve further from the diagonal, and a higher Gini, mean more inequality.
  • State a limitation of the Gini coefficient (it hides where inequality lies; crossing Lorenz curves can share a Gini; it ignores absolute living standards).

Typical mistakes

  • Putting the axes the wrong way round or failing to rank the population from poorest to richest.
  • Reading a HIGHER Gini as LESS inequality - a higher Gini means MORE inequality (closer to 1).

Active revision

Country A has a Gini coefficient of 0.28 before taxes and benefits and 0.24 after them; country B has 0.42 and 0.38. Interpret these figures and comment on which government redistributes more.

Active recall

Recall the key points — then reveal.

Sources: GCE AS and A level subject content for economics (Department for Education) · AQA A-level Economics 7136 specification (AQA)

§ 03

Absolute and relative poverty#

●●○StandardLPAQA 7136 4.1.7LPDfE GCE Economics - poverty

Key points

Poverty must be defined carefully, because the specification distinguishes two kinds. Absolute poverty is a situation where people cannot afford the basic necessities to sustain life - adequate food, clean water, shelter, clothing and basic health care. It is measured against a fixed real standard (such as the World Bank's international poverty line of a certain amount per day at constant prices), so absolute poverty can, in principle, be eliminated by economic growth that raises everyone above the line. It is widespread in the poorest developing economies and rare, though not absent, in developed ones.
Relative poverty is a situation where people's incomes are a certain proportion below the average (median) for their society - so they cannot afford the goods, services and activities considered normal in that society, even if their basic survival needs are met. In the UK and EU, the standard measure of relative poverty is having a household income below 60% of the median income. Because it is defined relative to the median, relative poverty is essentially a measure of inequality at the bottom of the distribution: it can persist even as a society grows richer, and it only falls if the incomes of the poorest rise faster than the median.
The distinction matters for both measurement and policy. Absolute poverty tends to fall with economic growth, which is why growth is central to reducing it in developing countries; relative poverty may not fall with growth alone, because if all incomes rise proportionately the relative position of the poor is unchanged - reducing it requires redistribution or faster income growth for the poorest. The causes of poverty overlap with the causes of inequality: unemployment and low pay, low skills and poor education, ill health and disability, old age, the level of benefits, and, in developing countries, lack of capital, poor infrastructure and weak institutions.
Poverty and inequality are related but not identical, a distinction worth making explicitly. Inequality describes the spread of the whole distribution; poverty focuses on those at the bottom. A society could reduce inequality without lifting anyone out of absolute poverty, or reduce absolute poverty (through growth) while inequality rises. Persistent poverty is costly not only to those who experience it but to the wider economy - through lost human potential and productivity, higher public spending on its consequences, and weaker social cohesion - which, alongside the ethical case, is the economic rationale for policies to reduce it.
Relative poverty line=0.60×median household income\text{Relative poverty line} = 0.60 \times \text{median household income}Relative poverty line=0.60×median household income

The relative poverty line (UK/EU convention)

Households with income below 60% of the median are counted as being in relative poverty. Because it is relative to the median, it measures inequality at the bottom and need not fall with growth.

Worked example

Applying the relative poverty line

In a country the median household income is 30,000 pounds a year. Using the 60%-of-median convention, find the relative poverty line, and state whether a household on 16,000 pounds is in relative poverty.

  1. 01Compute the poverty line

    Relative poverty line = 0.60 x 30,000 = 18,000 pounds a year.

  2. 02Compare the household

    The household's income of 16,000 pounds is below the 18,000-pound threshold.

  3. 03Conclude and note the relativity

    The household is in relative poverty. If general prosperity rose and the median climbed to 40,000, the line would rise to 24,000 - so the same household could remain in relative poverty even if its own income rose, unless it rose faster than the median.

Result: The relative poverty line is 18,000 pounds; the household on 16,000 pounds is in relative poverty, and the line itself rises with the median.

Exam focus

  • Define absolute poverty against a fixed real standard and relative poverty against the median (below 60% of median income), and explain why relative poverty need not fall with growth.
  • Distinguish poverty (the bottom of the distribution) from inequality (the whole spread) - they can move in different directions.

Typical mistakes

  • Treating relative and absolute poverty as the same - growth can cut absolute poverty while relative poverty is unchanged.
  • Confusing poverty with inequality - reducing one does not automatically reduce the other.

Active revision

Explain why economic growth may reduce absolute poverty but leave relative poverty unchanged.

Active recall

Recall the key points — then reveal.

Sources: GCE AS and A level subject content for economics (Department for Education) · AQA A-level Economics 7136 specification (AQA)

§ 04

Policies to redistribute income and reduce poverty#

●●●AdvancedLPAQA 7136 4.1.7LPDfE GCE Economics - policies to influence the distribution

Redistributing income shifts the Lorenz curve towards equality

The effect of redistributionGraph of equality, roots at x = 0, y-intercept at y = 0, increasing, on the interval x from 0 to 100, Graph of before tax/benefits, roots at x = 0, y-intercept at y = 0, increasing, on the interval x from 0 to 100, Graph of after tax/benefits, roots at x = 0, y-intercept at y = 0, increasing, on the interval x from 0 to 1002040608010020406080100equalitybeforetax/benefitsaftertax/benefitsCumulative % of incomeCumulative % of population
Fig. 3Progressive taxes and benefits pull the Lorenz curve up towards the diagonal (from 'before' to 'after'), lowering the Gini coefficient and reducing measured inequality.

Key points

Governments use a range of policies to redistribute income and reduce poverty, which fall into a few groups. Progressive taxation - where the average rate of tax rises with income, as with income tax - takes proportionately more from the rich and narrows the post-tax distribution. Cash benefits - state pensions, unemployment and in-work benefits, child benefit and tax credits - raise the incomes of the poorest directly and are the single most powerful redistributive tool. Benefits in kind - free or subsidised health care, education and social housing - raise the real living standards of the poor without a cash transfer. And a national minimum (or living) wage raises the pay of the low-paid at the bottom of the labour market.
Beyond direct transfers, governments attack the causes of poverty. Investment in education and training raises the skills, productivity and earning power of the low-paid, tackling poverty at its root over the long term. Policies to reduce unemployment (macroeconomic and supply-side measures) matter because worklessness is a major cause of poverty. Measures to improve the mobility of labour, to widen access to opportunity, and to reduce discrimination all work on the labour-market causes of inequality analysed earlier. These 'root-cause' policies are slower than transfers but can be more lasting.
Every redistributive policy, however, involves the central equity-efficiency trade-off, which top answers must confront. High marginal tax rates and means-tested benefits can weaken incentives: they may reduce the incentive to work, to work longer or to take a better job (the poverty trap and the unemployment trap, where losing benefits as income rises leaves people little better off, producing very high effective marginal 'tax' rates), and may reduce incentives to save, invest and take entrepreneurial risk. Generous benefits are also costly to fund and can raise government borrowing. There is thus a genuine tension between the goal of a more equal distribution and the goal of a dynamic, growing economy.
The evaluation is therefore about how, not just whether, to redistribute. Well-designed policy tries to reduce poverty and inequality while limiting damage to incentives - for example by making work pay (in-work benefits and a rising minimum wage rather than out-of-work benefits alone), by investing in education to raise earning power, and by tapering benefit withdrawal to soften the poverty trap. The right balance rests partly on positive analysis (the size of the incentive effects, which is empirically contested) and partly on a normative value judgement about how much equity is worth how much efficiency - which returns the chapter to the positive-normative distinction with which the subject began.
Worked example

The poverty trap in numbers

A worker earning an extra 100 pounds pays 20 pounds more income tax and 12 pounds more National Insurance, and loses 55 pounds of means-tested benefits. Find the effective marginal deduction rate and explain the incentive problem.

  1. 01Add up the deductions

    From the extra 100 pounds the worker loses 20 (tax) + 12 (National Insurance) + 55 (withdrawn benefits) = 87 pounds.

  2. 02Compute the effective marginal rate

    The effective marginal deduction rate is 87/100 = 87%: the worker keeps just 13 pounds of every extra 100 earned.

  3. 03Explain the incentive effect

    Because they keep so little of any extra earnings, the incentive to work more or take a better-paid job is weak - the poverty trap. Tapering benefit withdrawal more gently would lower this rate and improve incentives, though at greater fiscal cost.

Result: The effective marginal deduction rate is 87%, illustrating the poverty trap: high benefit withdrawal plus tax can leave the low-paid keeping very little of extra earnings.

Exam focus

  • Organise the policies (progressive tax, cash benefits, benefits in kind, minimum wage, education and training) and show on a Lorenz diagram how redistribution lowers the Gini.
  • For AO4, always confront the equity-efficiency trade-off and the poverty/unemployment trap (the disincentive effects of high effective marginal tax rates).

Typical mistakes

  • Listing policies without evaluating their effect on incentives and cost - the trade-off is where the top marks lie.
  • Assuming redistribution has no efficiency cost, or conversely that incentive effects are always large - the evidence is contested.

Active revision

Evaluate the use of progressive taxation and cash benefits to reduce income inequality in a modern economy.

Active recall

Recall the key points — then reveal.

Sources: GCE AS and A level subject content for economics (Department for Education) · AQA A-level Economics 7136 specification (AQA)

Contents

Section -- / 04

    • 01Income, wealth and the causes of inequality◐
    • 02Measuring inequality: the Lorenz curve and Gini coefficient●
    • 03Absolute and relative poverty◐
    • 04Policies to redistribute income and reduce poverty●

0/4 Read

From notes into training

The distribution of income and wealth: poverty and inequality

Reinforce this topic with matching tasks from the question bank.

~17
min
4
Competencies
Practise

References & sources

Sources

Department for Education

  • GCE AS and A level subject content for economics

AQA

  • AQA A-level Economics 7136 specification

Previous topic

The labour market

Next topic

The market mechanism, market failure and government intervention in markets

EuraStudy·Notes T·07·MMXXVI

Carry on to the next topic — your learning path is kept.