What you'll learn
Markets determine not only what is produced but who gets it. A competitive market can be perfectly efficient and still leave large numbers of people poor, because efficiency is about using resources well, not about distributing the results fairly. That gap between efficiency and equity is what this topic is about, and it is where economics most obviously meets value judgement.
Two distinctions organise everything. Income is a flow received over a period — wages, profits, rent, transfers. Wealth is a stock owned at a moment — property, savings, shares. Wealth is far more unequally distributed than income in almost every economy, and it generates income, so inequality in one reinforces inequality in the other.
Absolute poverty means lacking the resources for basic needs — food, shelter, safe water, health care. Relative poverty means falling far below the standard normal in one's own society. A country can eliminate absolute poverty while relative poverty persists, because the second is defined against a moving benchmark.
By the end you should be able to measure inequality using a Lorenz curve and Gini coefficient, distinguish the causes of inequality, evaluate redistribution policies, and handle the equity–efficiency trade-off without collapsing into assertion.
Key terms and definitions
Income — a flow of earnings received over a period.
Wealth — a stock of assets owned at a point in time.
Lorenz curve — a curve plotting the cumulative share of income received against the cumulative share of the population, ranked from poorest to richest.
Line of equality — the 45-degree diagonal a Lorenz curve would follow if every household received an identical share.
Gini coefficient — a number between 0 and 1 summarising inequality: 0 is perfect equality, 1 is one household receiving everything.
Absolute poverty — lacking the resources to meet basic needs.
Relative poverty — having far less than the standard regarded as acceptable in that society, often set at a fraction of median income.
Poverty line — the income threshold below which a household is counted as poor.
Head count ratio — the proportion of the population below the poverty line.
Progressive tax — one taking a rising proportion of income as income rises. A regressive tax takes a falling proportion.
Transfer payment — a payment made without any good or service in return, such as a pension or benefit.
Core concepts
Measuring inequality: the Lorenz curve in words
Rank every household from poorest to richest and ask what share of total income each successive group receives. Plot the cumulative share of the population along the horizontal axis and the cumulative share of income up the vertical.
Perfect equality would produce a straight diagonal: the poorest 20% would receive 20% of income, the poorest 40% would receive 40%, and so on. Real distributions bow below that diagonal, because the poorest fifth receives far less than a fifth.
The further the curve sags away from the diagonal, the greater the inequality. Comparing two countries is then a matter of seeing which curve lies further out — and if two curves cross, neither is unambiguously more unequal, which is a limitation worth knowing.
The Gini coefficient
The Gini summarises the Lorenz curve as a single number: the area between the curve and the diagonal, divided by the whole area beneath the diagonal.
A value of 0 means the curve sits on the diagonal — perfect equality. A value of 1 means one household receives everything. Real economies fall between, and higher values mean more inequality.
Its strengths are that it is a single comparable figure and it uses the whole distribution. Its weaknesses are that it compresses a complex distribution into one number, so two very different distributions can share a Gini; it says nothing about where in the distribution the inequality sits; and it typically measures income rather than wealth, understating overall inequality.
Why incomes differ
Several causes combine, and naming which apply to a case is what earns marks rather than listing all of them.
Differences in skills and education feed through to marginal revenue product and therefore to wages. Inherited wealth generates income and compounds across generations. Ownership of capital means returns flow to those who already have assets. Immobility — occupational and geographical — prevents people moving to better-paid work. Discrimination produces differentials unexplained by productivity. Household composition matters, since one earner supporting six people is in a different position from two earners supporting two. And regional differences within a country can be large.
Absolute and relative poverty
Absolute poverty is measured against a fixed basket of basic needs, so economic growth can reduce it directly. Relative poverty is measured against the society's own median, so it can persist through growth if the gains go disproportionately to those already well off — and it can even rise while everyone becomes better off.
The head count ratio — the share of the population below the line — is the simplest measure, and its weakness is that it says nothing about how far below the line people fall. A policy lifting many people just over the line would show a large improvement while doing little for the very poorest.
Policies to reduce inequality and poverty
Progressive income tax takes a rising proportion as income rises. Transfer payments — pensions, child benefit, unemployment support — raise the incomes of those at the bottom directly. Free or subsidised provision of education and health raises real living standards and, in the case of education, raises future earning power. Minimum wages raise pay at the bottom of the labour market. Regional policy addresses spatial inequality.
Each is evaluated the same way: does it reach the intended people, what does it cost, and what behavioural effects does it create?
The equity–efficiency trade-off
The standard argument is that redistribution reduces incentives: high marginal tax rates may discourage effort and enterprise, and generous benefits may weaken the incentive to seek work. That is a real consideration and an answer that ignores it is incomplete.
But the trade-off is not absolute, and the strongest answers say why. Spending on education and health raises productivity, so some redistribution increases output rather than reducing it. Extreme inequality can itself damage growth through wasted talent and social instability. And the size of any incentive effect is an empirical question that varies with the level of the tax and the design of the benefit.
The conclusion an evaluate question wants is therefore conditional: redistribution financed through investment in people is more likely to be growth-compatible than redistribution through high marginal rates alone.
Worked examples
Example 1 — Reading a quintile distribution (6 marks)
In a country, the five income quintiles receive 4%, 8%, 13%, 22% and 53% of total income.
The shares sum to 100%, confirming the data is complete.
Cumulative shares, from poorest to richest: 4%, 12%, 25%, 47%, 100%.
Under perfect equality those cumulative figures would be 20%, 40%, 60%, 80% and 100%. Every actual figure falls well below, so the Lorenz curve lies far beneath the diagonal — substantial inequality.
The richest fifth receives 53% while the poorest fifth receives 4%, a ratio of 13.3 to 1. Quoting that ratio is a quick way to convey the scale of inequality without any diagram.
Example 2 — Interpreting Gini coefficients (4 marks)
Two countries report Gini coefficients of 0.28 and 0.52.
The second is considerably more unequal, since a higher Gini means the Lorenz curve bows further from the diagonal.
But the comparison needs qualifying. The figures cover income rather than wealth, so both understate total inequality. They say nothing about where the inequality sits — one country's may come from a very poor bottom decile and the other's from an exceptionally rich top decile, with quite different policy implications. And if the two Lorenz curves cross, the single number conceals that neither is unambiguously more unequal.
Example 3 — Absolute against relative poverty (5 marks)
A country's average income doubles over twenty years. The proportion unable to afford basic food, shelter and health care falls from 24% to 6%, while the proportion earning below half the median rises from 15% to 18%.
Absolute poverty has fallen sharply — growth has lifted people over a fixed threshold of basic needs.
Relative poverty has risen — the gains went disproportionately to those already better off, so more people now fall far below the society's own median even though they are absolutely better off than before.
Both statements are true simultaneously, and recognising that is the point of the distinction. Which matters more is a normative judgement, and an answer should say so rather than asserting one.
Example 4 — Evaluating a progressive income tax (6 marks)
A government raises the top marginal rate of income tax to fund transfer payments.
For: it reduces post-tax inequality directly; it funds transfers reaching those at the bottom; and where revenue funds education and health it raises future productivity as well as current living standards.
Against: high marginal rates may reduce the incentive to work or take entrepreneurial risk; high earners may be internationally mobile, which is a serious constraint for small open Caribbean economies; avoidance and evasion rise with the rate; and collection costs are real.
Conclusion: the policy is more defensible where the revenue is spent on education and health, which raise productivity, than where it funds transfers alone. The mobility of high earners places a practical ceiling on the rate in a small open economy, so the design of the tax matters as much as its level.
Note that the conclusion states conditions rather than declaring the policy simply good or bad.
Common mistakes and how to avoid them
Confusing income with wealth. Income is a flow; wealth is a stock, and it is more unequally distributed.
Saying a higher Gini means a lower income. It measures distribution, not level — a rich country can be highly unequal and a poor one relatively equal.
Treating absolute and relative poverty as the same. Growth reduces the first directly and may leave the second unchanged or worse.
Using the head count ratio as a complete measure. It ignores how far below the line people fall.
Assuming redistribution always reduces output. Spending on education and health can raise productivity.
Presenting a normative judgement as a finding. Whether inequality is too great is a value judgement; say so.
Forgetting that a Lorenz curve can cross another. Where they do, neither distribution is unambiguously more unequal.
How this links to your Internal Assessment
Income distribution offers a strong Internal Assessment topic because published data usually exists, and because the analysis leads naturally to policy.
If national quintile data is available, compute cumulative shares and describe the Lorenz curve in words as Example 1 does. Comparing two periods, or your country with a neighbour, gives you something to explain rather than merely report.
Where national data is unavailable, a survey of a defined local group can still be informative, provided you are honest about what it covers. A sample of forty households in one district tells you about that district, and saying so while still computing the distribution is better analysis than generalising to the country.
Poverty is best handled by choosing a line and justifying it. Whether you use a basic-needs basket or a fraction of median income, state which and why — that choice is itself an analytical decision, and defending it demonstrates the absolute-versus-relative distinction in practice.
Avoid concluding simply that inequality is unfair. State the normative premise you are working from, then argue from evidence to a policy conclusion.
Exam technique for income distribution and poverty
Where quintile data is given, compute the cumulative shares — that is almost always the first required step, and it is what a Lorenz curve plots.
Describe Lorenz curves in words with precision: which curve lies further from the diagonal, and therefore which distribution is more unequal. Mention the crossing case if two curves are compared, since it is a genuine limitation.
Always qualify a Gini comparison. One sentence on what the single number conceals — income not wealth, no information on where the inequality sits — converts a statement into analysis.
Command words follow the pattern. Define relative poverty wants the comparison with the society's own standard. Calculate cumulative shares wants the running totals. Explain why inequality persists wants mechanisms applied to the case. Discuss progressive taxation wants both sides. Evaluate wants a conclusion stating conditions, not a verdict.
Where the question concerns a Caribbean economy, the mobility of skilled high earners is a genuine and locally relevant constraint on tax policy, and examiners reward its use.
Quick revision summary
- Income is a flow; wealth is a stock, and wealth is more unequally distributed.
- A Lorenz curve plots cumulative income share against cumulative population share, poorest first.
- Perfect equality is the diagonal; real curves bow below it, and further out means more unequal.
- Where two Lorenz curves cross, neither distribution is unambiguously more unequal.
- Gini runs from 0 (perfect equality) to 1 (one household has everything).
- Gini weaknesses: one number for a whole distribution, silent on where inequality sits, usually income rather than wealth.
- Absolute poverty is measured against basic needs; relative poverty against the society's own median.
- Growth can cut absolute poverty while relative poverty rises.
- The head count ratio ignores how far below the line people fall.
- Causes of inequality: skills and education, inherited wealth, capital ownership, immobility, discrimination, household composition, region.
- Policies: progressive tax, transfers, free education and health, minimum wages, regional policy.
- The equity–efficiency trade-off is real but not absolute — spending on people can raise productivity, and mobility of high earners limits tax rates in small open economies.