DISTRIBUTION OF INCOME AND WEALTH: AQA Economics Specification Topic 4.1

Topic 4.1 - Individuals, firms, markets and market failure

Snapshot of the AQA syllabus topic area we’ll be covering in this post.

DISTRIBUTION OF INCOME AND WEALTH:

The distribution of income and wealth: poverty and inequality

AQA students must understand the following content [taken from the syllabus]

• The difference between income and wealth.

• The various factors which influence the distribution of income and wealth.

• The difference between equality and equity in relation to the distribution of income and wealth.

• The Lorenz curve and Gini coefficient.

• The likely benefits and costs of more equal and more unequal distributions.

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ESSENTIAL INFORMATION

[NOTE: supplementary knowledge, supporting diagrams and questions at the end]

INTRODUCTION

We are now discussing the topic of income and wealth distribution, under the poverty and inequality. In this post, we will carefully exam what it is you need to know for your AQA Economics exam.

Distribution of income and wealth is a key factor in how countries' economies develop. While wealth distribution includes the distribution of assets, savings, and accumulated wealth, the term "income distribution" relates to how incomes are allocated across people or households. The goal of this page is to study the ideas of income and wealth distribution, investigate the causes of their discrepancies, look at inequality metrics, and talk about the potential advantages and disadvantages of more equal or uneven distributions.

1. Understanding the Difference between Income and Wealth:

• Income: Flows of money or earnings over a certain period are referred to as income, and examples include wages, salaries, dividends, and rental income.

• Wealth: Contrarily, wealth is the total amount of assets that a person or household owns, such as their savings, investments, real estate, and other priceless possessions. Wealth is the accumulation of prior earnings and financial assets, whereas income is a measure of one's ability to earn.

2. Factors Influencing the Distribution of Income and Wealth:

The distribution of income and wealth within a society is influenced by a number of factors.

These include:

• the degree of education attained

• skill sets

• employment trends

• technology developments

• inheritance laws

• rights over property ownership

• tax laws

• wage laws

• equality of opportunities

• the level of discrimination towards certain groups

• institutional issues

Income and wealth inequality can be dramatically impacted by economic and social policies such as minimum wage regulations, progressive taxation, and access to high-quality education.

3. Equality vs. Equity in Income and Wealth Distribution:

When talking about the distribution of income and wealth, equality and equity are two different ideas.

• Equality: Equality entails an equitable distribution of wealth and income among all people, regardless of their circumstances.

• Equity: Contrarily, equity describes justice in the distribution while taking into account the various needs and circumstances of each individual. Equity takes into account the possibility that some people will need more resources or help in order to reach a comparable degree of economic well-being.

4. Measures of Inequality: Lorenz Curve and Gini Coefficient:

Economists analyse the distribution of income and wealth using tools like the Lorenz curve and the Gini coefficient. The cumulative share of income or wealth owned by various population segments is contrasted with the total share of the population using a graph called the Lorenz curve.

The Lorenz curve is used to calculate the Gini coefficient, which has a single value between 0 and 1. Greater income or wealth inequality within a society is indicated by a higher Gini coefficient.

Therefore, a Gini coefficient of 0 means perfect income equality throughout society.

A Gini coefficient of 1 means perfect inequality of income (meaning 1 person earns 100% of the income and everyone else earns nothing)

[Lorenz Curve diagram is drawn below]

5. Benefits and Costs of More Equal and More Unequal Distributions:

Supporters of equality argue there are benefits to having a more equal distribution of income throughout society.

Benefits of Greater Equality

• greater social cohesion

• higher social mobility

• improved economic stability

• decreased poverty rates.

Costs of Greater Equality

• diminished incentives for innovation

• reduced entrepreneurship

• productivity losses as harder working people get compensated less

6. Is Having a More Equal Society the Best Outcome in Terms of Equity?

• less inequality can improve equity as it usually means that more people have greater access to opportunities and thrive within the country

• however, it’s important to realise that equality and equity are not the same thing as it really depends on a person’s value judgements on the subject

  • for example, one might believe it important to be able to earn more money if you work harder, earn more skills, achieve greater productivity and output compared to other workers

  • is it fair to pay higher earners less purely to compensate others for earning less than them?

  • if this is forced excessively on higher earners (through high taxes for example) then a likely consequence is that higher earners will emigrate to other countries to avoid higher taxes

  • the outcome of high progressive taxes might be a more equal society but a worse-off one overall

7. How is Income Inequality both a Cause and Consequence of Market Failure?

• Cause of Market Failure

  • lack of equal access to opportunities e.g. quality education throughout the country is not the same, healthcare disparities, wealth disparities

  • monopoly powers mean entrepreneurs can achieve higher earnings relative to workers - this widens the income gap

• Consequence of Market Failure

  • imperfect information

  • externalities such as pollution

  • inadequate competition such as monopolies and monopsonies cause prices to rise and incomes to fall due to excessive market power

  • diminished social cohesion: for example, social tensions between income groups or classes, higher crime rates - leads to economic and social instability

Conclusion:

Distribution of income and wealth affects societal economic, social, and political processes in a variety of ways. Analysing the scope and effects of inequality requires understanding the distinction between income and wealth, looking at the causes affecting their distribution, separating equality from equity, and using tools like the Lorenz curve and Gini coefficient.

In order to create societies that are both sustainable and affluent, it is important to carefully weigh the advantages and disadvantages of working towards a fair and equitable distribution of wealth and income.

Policymakers can strive towards developing more inclusive and equitable economic systems that are beneficial to individuals, create social well-being, and support long-term economic growth by tackling the underlying causes and effects of income and wealth inequality.

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SUPPLEMENTARY KNOWLEDGE

From the Equality Trust website

“The UK has a very high level of income inequality compared to other developed countries.

The majority of households in the UK have disposable incomes below the mean income (£32,300 as of 2022). This includes wages and cash benefits, and is after direct taxes like income tax and council tax, but not indirect taxes like VAT. The median income was rising by 2.2% on average for the last five years before the pandemic. However, in 2022, incomes for the poorest 14 million people fell by 7.5%, whilst incomes for the richest fifth saw a 7.8% increase.[1]

In 2022, households in the bottom 20% of the population had on average an equivalised disposable income of £13,218, whilst the top 20% had £83,687. As can be seen from the graph below when original incomes are compared, the difference is even more striking: the richest fifth had an income more than 12 times the amount earned by the poorest fifth.[2]”

the two charts above allow you to visualise the level of income inequality - splitting the total income earned in the UK into 20% segments, you can see that the bottom 20% of people earn only 8% of the total income, whereas the top 20% of people earn 36% of the total income

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SUPPORTING DIAGRAMS

lorenz curve diagram - the diagram shows the level of inequality thoughout society - you can use this diagram to calculate the Gini coefficient - to calculate the Gini, coefficient, the formula is Area A / Area A+B. This means if Area A is large, there is a greater degree of inequality throughout society

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SUPPORTING QUESTIONS

Question 1: What factors contribute to income inequality?

Answer:

Different educational levels, skill levels, labour market conditions, technological breakthroughs, globalisation, tax policies, social assistance programmes, and institutional variables like minimum wage regulations and collective bargaining power all have an impact on income inequality.

Question: What is the difference between income and wealth?

Answer:

The term "income" refers to the flow of funds or resources that people or families get over a certain time period, typically measured annually. It consists of pay, benefits, profits, dividends, interest, and transfers from the government.

Contrarily, wealth is defined as the total amount of assets and property that a person or household owns at any given moment, including their savings, investments, real estate, stocks, and other kinds of financial and material possessions. Wealth also takes into account liabilities somebody might have such as debts that must be repaid or expenses due.

The value of assets - liabilities is what determines somebody’s net worth.

Question: How do economists measure income and wealth inequality?

Answer:

To measure the disparity in income and wealth, economists employ a variety of metrics.

The Lorenz curve and the Gini coefficient are two frequently employed instruments. The cumulative share of income or wealth possessed by various population segments, listed from lowest to highest, is depicted graphically by the Lorenz curve.

The Lorenz curve is used to calculate the Gini coefficient, a number that ranges from 0 to 1, with 0 denoting perfect equality and 1 denoting excessive inequality. Greater income or wealth inequality within a society is indicated by a higher Gini coefficient.

To calculate the Gini coefficient, the formula is Area A/Area A+B.