Income Distribution Basics
This article was derived from Episode 4 of Everything Economics, published on June 18, 2018. Everything Economics is a bi- A weekly podcast hosted by Tahlia Murdoch, on the Cave Goblin Network.
Income distribution refers to the way all income in a country, is shared among the population. It is a measure of equality within a country, and can often indicate whether a country is more socialist or capitalist from an economic and political perspective.
The Lorenz curve is used to plot income distribution within a country. It can also be used measure wealth distribution, which includes things like an individual’s net worth based on property and stocks value, superannuation or 401K net worth, taking in to account more than just income earned. It really doesn’t matter which indicator you use, just be aware of what it is, if you do decide to go and find out more about this stuff in your country. Today, while going through the theory, I’m just going to be using the word income as this is less complex.
The Lorenz curve is a graph that shows what percentage of a country’s population, shares what percentage of the income. As it plots percentages, it is confined to a nice, clean area, which makes it a pretty handy tool.
Now, in the podcast, I have to try and explain what this graph looks like, but as you can see below, I have drawn a really cool sketch of a Lorenz curve that is far easier to explain.
In this graph, the x-axis, is population percentage, starting at 0% and ending at 100% percent, and the y-axis, is income percentage, also starting at 0% and ending at 100%. Starting at 0 and running all the way up to the top right corner, is a 45 degree line. This is known as the line of perfect equality where 100% of the population shares 100% of its income, evenly. It also acts as a control to compare your own Lorenz curve against.
The Lorenz curve then, is the curve below the line equality. This curve, obviously shows that income is not distributed equally, as it is not 45 degrees. To compare, if you find the point on this Lorenz curve for 20% of the population, it looks like that this bottom percent of the population, only shares about 10% of income, compared to the line of equality. If you then move higher, to say the top 20% of the population (from finding 80% on the x-axis) it may be that this portion of the population shares 60% of the income, which is not perfectly equal.
The further away the Lorenz curve gets from the line of equality, the less equal the income distribution. As it gets closer to that line, income is shared more evenly across a population.
So how can we use this curve to calculate income distribution in a country? We find the Gini Coefficient.
The Gini Coefficient is the ratio of the area between the line of equality and the Lorenz curve, to the area between the line of perfect equality and the line of perfect inequality, which is where 1 of the population controls all of the income.
So looking back at the graph, we can get super mathematical here to calculate it, but I don’t want to do that. One of my tutors felt very strongly about the fact that you don’t need to be good at math to be an economist which I can appreciate. So we calculate area A, the space between the line of equality and the Lorenz curve that looks a bit like a half moon, and then divide that by the area A+B which is the entire space below the line of equality. This gives us the Gini Coefficient.
A value of 0, means that the country has perfect equality of income. It exists along the line of perfect equality and 100% of the population shares 100% of its income. A value of 1 represents maximum inequality, where 1 person controls all the country’s income. I think that either options are not ideal.
We can use this indicator to analyze income equality of any country, to make comparisons, conduct research, and inform policy.
Across OECD countries, the top 5, most unequal countries are as follows:
- Mexico, with a coefficient of 0.459
- Chile, with 0.454
- Turkey, with 0.398
- United States, at 0.39
- And Lithuania, with 0.381
As expected, Russia, Australia, the UK, and Canada are among the top 20, and Norway, Denmark and Iceland are in the bottom 5 (meaning their income is distributed more equally) where their gini coefficient is smaller than 0.3. Note, that the OECD does not include every country in the world, rather a collective who work together to achieve economic outcomes. So there may well be less income equal countries out there.
Other than just calculating income distribution, the Gini Coefficient can also be used to compare how wages have grown or shrunk in a country, or what has happened to the population and employment rate, for a more comprehensive overview of a nation’s equality. It is definitely on its own, a useful indicator, but as we know, economic models often rely on the rest of the economy being fixed, so this is just something to mindful of if you explore further. But that is for another article.
I acknowledge that the land I work, live and play on is the unceded territory of the Coast Salish peoples, including the territories of the Səl̓ílwətaʔ/Selilwitulh (Tsleil-Waututh), the xʷməθkwəy̓əm (Musqueam), and the Skwxwú7mesh (Squamish) Nations.
