Economics of inequality and poverty

· Focus of this topic: know what inequality and poverty mean, how they are measured, why they happen, their effects, and which policies can reduce them.
· Common exam skill: define carefully, use key terminology accurately, explain chains of reasoning, and apply ideas to real-world policies.

Equality and equity

· Equality = a more even distribution of income or wealth.
· Equity = fairness in the distribution of income, wealth, opportunities, or outcomes.
· A society can have more equality without necessarily being more equitable, and vice versa.
· In essays, show that equity is normative: what is “fair” depends partly on value judgments.

Economic inequality

· Economic inequality means an unequal distribution of income and/or unequal distribution of wealth.
· Income = flow of earnings over time, such as wages, rent, interest, profit.
· Wealth = stock of assets owned at a point in time, such as property, savings, shares.
· Wealth inequality is often greater than income inequality because assets accumulate over time.
· In exams, do not confuse income with wealth.

Measuring inequality

· Lorenz curve shows the cumulative percentage of income (or wealth) earned by the cumulative percentage of the population.
· The 45° line represents perfect equality.
· The more the Lorenz curve bows away from the 45° line, the greater the inequality.
· Gini coefficient (index) = numerical measure of inequality based on the Lorenz curve.
· Higher Gini coefficient = greater inequality; lower Gini coefficient = more equal distribution.
· In data response, be ready to compare two Lorenz curves or interpret a rise/fall in the Gini coefficient.

This diagram shows a Lorenz curve, the line of perfect equality, and the shaded area used to derive the Gini coefficient. It is ideal for explaining how economists measure the degree of income inequality. The further the curve lies from the equality line, the greater the inequality. Source

Poverty

· Poverty = inability to achieve a minimum acceptable standard of living.
· Absolute poverty = inability to meet basic physical needs such as food, shelter, clothing, clean water, sanitation.
· Relative poverty = being poor relative to others in the same society, often defined with reference to median income.
· Absolute poverty is more useful for cross-country comparisons of extreme deprivation.
· Relative poverty is more useful for understanding social exclusion in richer countries.

This image illustrates relative poverty by marking a poverty threshold as a share of median income. It helps show that relative poverty depends on a society’s overall income distribution, not just survival needs. This is useful for distinguishing relative from absolute poverty. Source

Measuring poverty

· Single indicators include international poverty lines and minimum income standards.
· International poverty lines are benchmark income thresholds used for global comparison of extreme poverty.
· Minimum income standards estimate the income needed for a socially acceptable standard of living in a particular country.
· Composite indicators combine several dimensions of deprivation.
· Multidimensional Poverty Index (MPI) measures poverty using deprivations in areas such as health, education, and living standards.
· MPI is useful because poverty is not only about income; it can also involve schooling, nutrition, sanitation, electricity, housing.

Difficulties in measuring poverty

· Poverty is multidimensional, so one measure may miss important forms of deprivation.
· National poverty lines differ across countries, making direct comparison difficult.
· Informal economy income may be under-recorded.
· Non-monetary deprivation is hard to quantify.
· Household data may be outdated, incomplete, or unreliable.
· Relative poverty measures can rise even when absolute living standards improve.

Causes of inequality and poverty

· Inequality of opportunity: unequal access to education, healthcare, networks, finance.
· Different levels of resource ownership: some own more land, capital, property, financial assets.
· Different levels of human capital: more education/training usually raises productivity and earnings.
· Discrimination: gender, race, ethnicity, disability and other forms can reduce access to jobs and pay.
· Unequal status and power: some groups have more influence over wages, policy, and opportunities.
· Government tax and benefits policies may either reduce or worsen inequality.
· Globalisation and technological change can increase demand for high-skilled labour and reduce demand for some low-skilled labour.
· Market-based supply-side policies may increase efficiency, but can widen inequality if gains go mainly to higher-income groups.

Impacts of income and wealth inequality

· On economic growth: inequality may reduce growth if poorer households cannot invest in education, training, health, but some argue incentives can encourage effort and investment.
· On standards of living: high inequality can leave many people with poor access to housing, healthcare, education, nutrition.
· On social stability: very unequal societies may face more social tension, crime, political instability, distrust.
· Strong evaluation: the impact depends on the degree of inequality, the country context, and whether inequality reflects opportunity gaps or incentives.

Taxation and redistribution

· Taxation can reduce poverty and income/wealth inequality by redistributing purchasing power from higher-income groups to lower-income groups.
· Progressive tax: as income rises, the percentage of income paid in tax rises.
· Regressive tax: lower-income earners pay a higher percentage of their income than higher-income earners.
· Proportional tax: everyone pays the same percentage of income.
· Average tax rate = total tax paid ÷ income × 100.
· Marginal tax rate = tax paid on the next unit of income earned.
· Direct taxes include personal income tax, corporate income tax, and wealth taxes.
· Indirect taxes are taxes on expenditure/consumption and may be regressive because poorer households spend a larger share of income.
· In evaluation, balance equity gains against possible disincentives to work, save, invest, and innovate.

This chart illustrates tax progressivity by showing how tax burden changes as income rises. It helps students distinguish progressive, proportional, and less progressive tax outcomes. Use it to explain how taxation can be used to improve equity and reduce inequality. Source

Other policies to reduce poverty and inequality

· Policies to reduce inequalities of opportunity / investment in human capital: improve education, training, healthcare.
· Transfer payments: cash support such as unemployment benefits, pensions, child benefits can reduce poverty directly.
· Targeted spending on goods and services: government spending on healthcare, housing, education, nutrition for vulnerable groups.
· Universal basic income (UBI): all citizens receive a regular payment regardless of income.
· Policies to reduce discrimination: equal pay laws, anti-discrimination enforcement, access support.
· Minimum wages can raise low incomes, but if set too high may create unemployment for some low-skilled workers.
· Strong evaluation point: effectiveness depends on government budget size, targeting accuracy, administrative capacity, and possible trade-offs with efficiency.

Evaluation points examiners like

· No single measure fully captures inequality or poverty.
· Policies often involve trade-offs between equity and efficiency.
· Progressive taxes may reduce inequality, but excessive tax rates may weaken incentives.
· Transfer payments reduce poverty quickly, but may create government budget pressure.
· Education and healthcare investment may be more sustainable long term, but effects take time.
· The best answer usually combines short-run redistribution with long-run opportunity-enhancing policies.