IB Economics - Equity in the Distribution of Income

This study note for IB economics covers Equity in the Distribution of Income

1. The Meaning of Equity in the Distribution of Income

• Definition of Equity:
  • Equity in income distribution refers to the fairness with which income is distributed among members of society. It considers whether people are receiving income in a manner that is just and socially acceptable.
• Definition of Equality:
  • Equality in income distribution means that everyone receives the same income, regardless of their circumstances, efforts, or contributions to the economy.

2. Difference Between Equity and Equality in Income Distribution

• Equality:
  • Implies identical income for everyone.
  • Does not consider differences in effort, talent, education, or circumstances.
  • Example: A society where every citizen receives the same annual income, regardless of their job, education, or work hours.
• Equity:
  • Focuses on fairness, which may involve differences in income that are justified by factors like effort, skill, or need.
  • Takes into account the different starting points of individuals, such as access to education and opportunities.
  • Example: A progressive tax system where higher earners pay a larger percentage of their income in taxes, which is used to support those with lower incomes.
• Key Point: Equality treats everyone the same, while equity aims to achieve fairness, which often involves treating people differently according to their needs or contributions.

3. The Market System and Income Distribution

• Unequal Ownership of Factors of Production:
  • Factors of Production: Land, labor, capital, and entrepreneurship.
  • In a market economy, individuals who own more or better factors of production (e.g., land, capital) typically earn more income.
  • Inequitable Distribution: If ownership of these factors is highly unequal, the market system can result in significant disparities in income distribution, with wealthier individuals or families accumulating more income and wealth over time.
• Real-World Example: In the United States, income and wealth distribution is heavily skewed, with the top 1% owning a significant portion of the country’s wealth. This reflects inequities in the ownership of capital and access to high-paying jobs, which are often passed down through generations.

4. Indicators of Income Equality/Inequality

4.1. Relative Income Shares

• Deciles and Quintiles:
  • Deciles: Dividing the population into ten equal groups based on income, from the lowest 10% (first decile) to the highest 10% (tenth decile).
  • Quintiles: Dividing the population into five equal groups based on income, from the lowest 20% (first quintile) to the highest 20% (fifth quintile).
  • Analysis: By comparing the income shares of different deciles or quintiles, economists can assess the degree of income inequality within a country.
• Real-World Example: In Brazil, a highly unequal country, the top 20% of the population receives a disproportionately large share of the national income, while the bottom 20% receives a much smaller share.

4.2. Lorenz Curve

• Definition: The Lorenz Curve is a graphical representation of income distribution within an economy.
• How to Draw:
  • The horizontal axis represents the cumulative percentage of households (or population), while the vertical axis represents the cumulative percentage of income.
  • The line of perfect equality (45-degree line) shows an equal distribution of income (e.g., 20% of the population earns 20% of the income).
  • The Lorenz Curve plots the actual distribution of income, typically bowing below the line of equality, indicating inequality.
• Significance:
  • The further the Lorenz Curve is from the line of equality, the greater the degree of income inequality.
  • Real-World Example: South Africa's Lorenz Curve is significantly bowed, reflecting one of the highest levels of income inequality in the world.

4.3. Gini Coefficient

• Definition: The Gini Coefficient is a numerical measure of income inequality derived from the Lorenz Curve.
• How it is Derived:
  • The Gini Coefficient is calculated as the area between the line of perfect equality and the Lorenz Curve, divided by the total area under the line of perfect equality.
• Interpretation:
  • The Gini Coefficient ranges from 0 to 1.
  • A Gini Coefficient of 0 indicates perfect equality (everyone has the same income).
  • A Gini Coefficient of 1 indicates perfect inequality (one person has all the income, and everyone else has none).
• Real-World Example:
  • Sweden has a relatively low Gini Coefficient of around 0.25, indicating a relatively equal income distribution.
  • South Africa, on the other hand, has a Gini Coefficient of approximately 0.63, reflecting significant income inequality.

5. Economists to Explore on this Topic

• Thomas Piketty:
  • Famous for his work on wealth and income inequality, particularly his book Capital in the Twenty-First Century.
• Joseph Stiglitz:
  • A Nobel laureate in economics who has written extensively on income inequality and its impacts on economic stability and growth.
• Amartya Sen:
  • Known for his work on welfare economics and the concept of equity, focusing on the capabilities approach and how income distribution affects well-being.

Glossary of Key Terms

• Deciles: Ten equal groups into which a population can be divided according to the distribution of values of a particular variable, such as income.
• Equality: The concept of treating everyone identically, with no differences in income or wealth distribution.
• Equity: The concept of fairness in the distribution of income, which may involve different treatment based on needs or contributions.
• Factors of Production: Resources used in the production of goods and services, including land, labor, capital, and entrepreneurship.
• Gini Coefficient: A numerical measure of income inequality, ranging from 0 (perfect equality) to 1 (perfect inequality).
• Income Inequality: The unequal distribution of income within a population.
• Lorenz Curve: A graphical representation of the distribution of income or wealth within an economy.
• Quintiles: Five equal groups into which a population can be divided according to the distribution of values of a particular variable, such as income.

Possible IB Economics Essay-Style Questions

1. Evaluate the extent to which the market system leads to an equitable distribution of income.
2. Discuss the use of the Lorenz Curve and Gini Coefficient as tools for measuring income inequality.
3. To what extent can government intervention reduce income inequality? Use real-world examples in your analysis.
4. Explain the difference between equity and equality in income distribution and discuss which concept should guide public policy.
5. Assess the impact of unequal ownership of factors of production on income distribution in both developed and developing countries.

Real-World Data

• Gini Coefficient:
  • Sweden: 0.25 (Low inequality)
  • South Africa: 0.63 (High inequality)
  • United States: 0.41 (Moderate inequality)
• Income Shares:
  • In the United States, the top 10% of income earners receive approximately 50% of the total national income, reflecting significant inequality.