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of wealth. It was developed by Max O. Lorenz in 1905 for representing inequality of the wealth

distribution.

The curve is a graph showing the proportion of overall income or wealth assumed by the

bottom x% of the people, although this is not rigorously true for a finite population (see below).

It is often used to represent income distribution, where it shows for the bottom x% of

households, what percentage (y%) of the total income they have. The percentage of households

is plotted on the x-axis, the percentage of income on the y-axis. It can also be used to show

distribution of assets. In such use, many economists consider it to be a measure of social

inequality.

The concept is useful in describing inequality among the size of individuals in ecology[1] and in

studies of biodiversity, where the cumulative proportion of species is plotted against the

cumulative proportion of individuals.[2] It is also useful in business modeling: e.g., in consumer

finance, to measure the actual percentage y% of delinquencies attributable to the x% of people

with worst risk scores.

Explanation:

Points on the Lorenz curve represent statements like "the bottom 20% of all households have

10% of the total income."

A perfectly equal income distribution would be one in

which every person has the same income. In this case,

the bottom N% of society would always have N% of the

income. This can be depicted by the straight

line y = x; called the "line of perfect equality."

By contrast, a perfectly unequal distribution would

be one in which one person has all the income and

everyone else has none. In that case, the curve would

be at y = 0% for all x < 100%, and y = 100%

when x = 100%. This curve is called the "line of

perfect inequality."

The Gini coefficient is the ratio of the area between the

line of perfect equality and the observed Lorenz curve

to the area between the line of perfect equality and the

line of perfect inequality. The higher the

coefficient, the more unequal the distribution is. In the

diagram on the right, this is given by the ratio A/(A+B), where A and B are the areas of regions

as marked in the diagram.

The Lorenz curve is a graphical way of representing the income distribution of a population.

Consider the following table on the income distribution of families in 1994.

Proportion of Total Income Received by Various Income

Quintiles

First Secon Third Fourth Fifth

Quintile Quintile Quintile Quintile Quintile

(20%) (20%) (20%) (20%) (20%)

4.2% 10.0% 15.7% 23.3% 46.9%

This information can be put in terms of the cumulative proportion of income and cumulative

proportion of families; i.e.,

Groups

Lowest 20% Lowest 40% Lowest 60% Lowest 80% 100%

100.0

4.2% 14.2% 29.9% 53.2%

%

When the above information is plotted in a graph the result is called the Lorenz Curve.

The Lorenz curve for a completely even income distribution (every family has the same income)

would lie on the diagonal. If all of the income was received by one family the Lorenz would be a

zero for every point on the horizontal axis except 100% where it would jump to 100% on the

vertical axis. This would be the case of complete concentration of the income distribution and

would represent complete income inequality.

The Gini Coefficient for a Lorenz curve is defined as the ratio of the area between the Lorenz

curve and the diagonal to the triangle below the diagonal line. In the graph below the area

between the Lorenz curve and the diagonal is shown in green. The area of the triangle is the

green area plus the light blue area. The Gini coefficient is then a number that falls in the range

from 0 to 1. For the completely equal income distribution the area is zero and the Gini

coefficient is zero. For the completely concentrated distribution the area is the same as the

triangle so the Gini coefficent is one. For the U.S. familty income distribution for 1994 the Gini

coefficient is 0.424.

Income inequality is a pressing issue both in the United States and around the world. In

general, it is assumed that high-incomeinequality has negative consequences, so it's fairly

important to develop a simple way to describe income inequality graphically.

The Lorenz Curve is one way to graph inequality in income distribution.

The Lorenz curve is a simple way to describe income distribution using a two-dimensional

graph. To do this, imagine lining people (or households, depending on context) in an economy

up in order of income from smallest to largest. The horizontal axis of the Lorenz curve is then

the cumulative percentage of these lined up people that are being considered.

For example, the number 20 on the horizontal axis represents the bottom 20 percent of income

earners, the number 50 represents the bottom half of income earners, and so on.

The vertical axis of the Lorenz curve is the percent of total income in the economy.

We can start plotting the curve itself by noting that the points (0,0) and (100,100) have to be

the ends of the curve. This is simply because the bottom 0 percent of the population (which has

no people) has, by definition, zero percent of the economy's income, and 100 percent of the

population has 100 percent of the income.

The rest of the curve is then constructed by looking at all of the percentages of the population

between 0 and 100 percent and plotting the corresponding percentages of income.

In this example, the point (25,5) represents the hypothetical fact that the bottom 25 percent of

people have 5 percent of the income. The point (50,20) shows that the bottom 50 percent of

people have 20 percent of the income, and the point (75,40) shows that the bottom 75 percent

of people have 40 percent of the income.

Because of the way that the Lorenz curve is constructed, it will always be bowed downwards as

in the example above. This is simply because it is mathematically impossible for the bottom 20

percent of earners to make more than 20 percent of the income, for the bottom 50 percent of

earners to make more than 50 percent of the income, and so on.

The dotted line on the diagram is the 45-degree line that represents perfect income equality in

an economy. Perfect income equality is if everyone makes the same amount of money. That

means the bottom 5 percent has 5 percent of the income, the bottom 10 percent has 10 percent

of the income, and so on.

Therefore, we can conclude that Lorenz curves that are bowed further away from this diagonal

correspond to economies with more income inequality.

developed by American economist Max Lorenz in 1905. The graph plots percentiles of the

population according to income or wealth on the horizontal axis. It plots cumulative income or

wealth on the vertical axis, so that an x-value of 45 and a y-value of 14.2 would mean that the

bottom 45% of the population controls 14.2% of the total income or wealth.

The Lorenz curve is often accompanied by a straight diagonal line with a slope of 1, which

represents perfect equality in income or wealth distribution; the Lorenz curve lies beneath it,

showing the actual distribution. The area between the straight line and the curved line,

expressed as a ratio of the area under the straight line, is the Gini coefficient, a measurement

of inequality.

While the Lorenz curve is most often used to represent economic inequality, it can be used to

represent unequal distribution in any system. The farther away the curve is from the baseline,

represented by the straight diagonal line, the higher the level of inequality. In economics, the

Lorenz curve denotes inequality in the distribution of either wealth or income; these are not

synonymous, since it is possible to have high earnings but zero or negative net worth, or to

have low earnings but a large net worth.

The Gini coefficient is used to express the extent of inequality in a single figure. It can range

from 0 (or 0%) to 1 (or 100%). Complete equality, in which every individual has the exact same

income or wealth, corresponds to a coefficient of 0. Plotted as a Lorenz curve, complete equality

would be a straight diagonal line with a slope of 1 (the area between this curve and itself is 0,

so the Gini coefficient is 0). A coefficient of 1 means that one person earns all of the income or

holds all of the wealth. Accounting for negative wealth or income, the figure can theoretically be

higher than 1; in that case the Lorenz curve would dip below the horizontal axis.

Lorenz Curve

Definitions

Economics

noun

(written as Lorenz curve)

a curve developed by the economist Max Lorenz which shows the inequality of incomes,

plotting cumulative income against the cumulative variable of the population which is being

examined

Health Economics

The Lorenz curve was developed by Max Lorenz (1880-1962), a US economist who

developed it to describe income inequalities. It shows the cumulative percentage of income,

health care expenditures, etc. held by successive percentiles of the population. The

percentage of individuals or households is plotted on the horizontal axis, the percentage of

income, health care expenditures, etc. on the vertical axis. A perfectly equal distribution,

where each has the same, appears as a straight line called the line of equality. A completely

unequal distribution, where one person has everything, appears as a mirror L shape. This is

a line of perfect inequality.

The Lorenz curve was developed by an American statistician and economist named Max Lorenz

when he was a graduate student at the University of Wisconsin. His article on the topic

"Methods of Measuring the Concentration of Wealth," appeared in Publications of the American

Statistical Association , Vol. 9, No. 70 (Jun., 1905), pp. 209-219. The CBO report explains it

this way:

"The cumulative percentage of income can be plotted against the cumulative percentage of the

population, producing a so-called Lorenz curve (see the figure). The more even the income

distribution is, the closer to a 45-degree line the Lorenz curve is. At one extreme, if each income

group had the same income, then the cumulative income share would equal the cumulative

population share, and the Lorenz curve would follow the 45-degree line, known as the line of

equality. At the other extreme, if the highest income group earned all the income, the Lorenz

curve would be flat across the vast majority of the income range, following the bottom edge of

the figure, and then jump to the top of the figure at the very right-hand edge.

Lorenz curves for actual income distributions fall between those two hypothetical extremes.

Typically, they intersect the diagonal line only at the very first and last points. Between those

points, the curves are bow-shaped below the 45-degree line. The Lorenz curve of market income

falls to the right and below the curve for after-tax income, reflecting its greater inequality. Both

curves fall to the right and below the line of equality, reflecting the inequality in both market

income and after-tax income."

The Gini coefficient

The Gini coefficient was developed by an Italian statistician (and noted fascist thinker) Corrado

Gini in a 1912 paper written in Italian (and to my knowledge not freely available on the web).

The intuition is straightforward (although the mathematical formula will look a little messier).

On a Lorenz curve, greater equality means that the line based on actual data is closer to the

45-degree line that shows a perfectly equal distribution. Greater inequality means that the line

based on actual data will be more "bowed" away from the 45-degree line. The Gini coefficient is

based on the area between the 45-degree line and the actual data line. As the CBO writes:

"The Gini index is equal to twice the area between the 45-degree line and the Lorenz curve.

Once again, the

extreme cases of complete equality and complete inequality bound the measure. At one

extreme, if

income was evenly distributed and the Lorenz curve followed the 45-degree line, there would be

no area

between the curve and the line, so the Gini index would be zero. At the other extreme, if all

income was

in the highest income group, the area between the line and the curve would be equal to the

entire area

under the line, and the Gini index would equal one. The Gini index for [U.S.] after-tax income in

2007 was

0.489about halfway between those two extremes."

In general, a diagram illustrating the degree of inequality and concentration for a group. This is

accomplished by plotting the cumulative percentage of a total amount obtained by cumulative

percentages of the group. A common use of the Lorenz curve is the distribution of income, in

which the cumulative percentage of income is measured on the vertical axis and the cumulative

percentage of the population is measured on the horizontal axis. Perfect equality is indicated by

a 45-degree line (that is, 10% of the population has 10% of the income, 20% of the population

has 20% of the income, etc.). The actual Lorenz curve inevitably lies below the 45-degree line.

The extent that the Lorenz curve differs from the 45-degree line indicates the extent of

inequality.

Report in Econ-110

Mary Ann V. Perez Econ 1-A

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