Chapter 6

Economic Inequality

Presented by: Naima Mubeen

Presented to:DR A R Chaudhary

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 About Author
Debraj Ray is an Indian-American economist whose focus
is development economics and game theory. Ray is
currently Julius Silver Professor in the Faculty of Arts and
Science, and Professor of Economics at New York
University.

Born:3 September 1957 (age 59 years), India

Books:DevelopmentEconomics,
A Game-Theoretic Perspective on Coalition Formation,
Economia del Desarrollo

Education:CornellUniversity (1983), University of

Calcutta

Awards:Guggenheim Fellowship for Social Sciences,

US & Canada 2
What is economic inequality?

Economic inequality is the fundamental disparity that permits one individual

certain material choices, while denying another individual those very same
choices.

There are two reasons to be interested in the inequality of income and wealth
distribution.
1)First, there are philosophical and ethical grounds for
aversion to inequality per se.
1)Second, even if we are uninterested in the problem of inequality at an intrinsic
level, there is still good reason to worry about it. Inequality is important not for
its own sake, but because it has an impact on other economic features that you do
care about.

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Economic Inequality not only linked with
Life time
Personal capabilities
Political freedom

But also considered in

Narrow Sense Broader Sense

Income and wealth Freedom and Capabilities

So economic inequality is studied in terms of income and wealth

because inequality in income and wealth not only represents all
inequalities but also represents all components of the economies. So
economic inequality is disparity in wealth and income.
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Aspects of the distribution of income and wealth:

Depending on the particular context, distribution of current expenditure or income

flows, the distribution of wealth (or asset stocks), or even the distribution of lifetime
income is considered.

Current or lifetime inequality hide considerations of social mobility

The distribution of income can also be observed with respect to the class of
recipient (i.e. population grouped by gender, ethnicity, age, marital status and
geographical area)

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Cont
The analysis of the distribution of income, or wealth, among different groups in
society because of

philosophical and ethical for aversion to inequality per se;

inequality in income and wealth affects the possibility of growth;
DCs are disposed to to huge disparities in living standards

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 Perspectivesoneconomicinequality2
The distribution of income can be observed among the population,
called size (or personal) distribution of income, and can be
expressed between some demographic unit: households, individual
earners, or all individuals with respect to the command over some
definition of income (gross or net) or expenditure.

Functional distribution of income relates to disparities in factors of

production rewards: income inequality depends on how labour,
(physical and financial) capital and land are rewarded with wage,
profit, interest and rent (the last two are property income),
respectively.

The distribution of wealth measures the value of a persons assets

at some point in time. It is related to inheritance, different
propensities to save, investment talent/luck, and income inequality.
Empirically, it is very hard to measure it because a stock of assets
is measurable only when sold.
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Perspectives on economic inequality 3
Functional Distribution Personal Distribution

Ownership of Factors Household 1

Wages of Different
Skil s

Household 2

Production

Rents
Household 3

Profits Household 4

Functional and personal distribution of income

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MeasuringEconomicInequality

On the basis of how much inequality is measured and which

measure is more appropriate there are following

Four Criteria for Inequality Measurement 9

Measuring inequality: notation
Goal: we have to develop indices that permit the
ranking of (lifetime) income or wealth distributions
in two different situations
Suppose society is composed of i=1,2,, n
individuals; income distribution is a description of
how much yi is received by each i: (y1, y2, yn); we
want to compare two distributions
Inequality measure, I, is a rule that assigns a degree
of inequality to each possible distribution of the
national cake
I=I(y1, y2, yn), defined over all conceivable
distributions (y1, y2, yn)

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1) AnonymityPrinciple

In anonymity principle it does not mattern who is earning the income. Suppose
because of larger in income of one person it will be very difficult for him to
influence other people that the overall degree of inequality in his society has
deteriorated because of this. Thus variations of incomes among people should
not matter for inequality judgments: this is the principle of anonymity.
Formally, this means that we can always arrange our income distribution. so
that
Y 1<y2<<yn
which is the equivalent of arranging individuals so that they are ranked from
poorest to richer

2)PopulationPrinciple

Cloning the entire population (and their incomes) should not alter inequality.The
population principle is a way of saying that population size does not matter:
all that matters are the proportions of the population that earn different levels
of income.

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(3)RelativeIncomePrinciple

In order to measure inequality on the basis of relative income principle we use

quintiles . For each quintile, we record the income share earned by that quintile of
the population. The relative income principle tells us that income shares are all we
need in the measurement of inequality.

(4)TheTransfersorDaltonPrinciple.
A transfer of income from the "not richer" individual to the "not poorer" individual
will be called a regressive transfer. The Dalton principle states that if one income
distribution can be achieved from another by constructing a sequence of regressive
transfers, then the former distribution must be deemed more unequal than the latter.

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 Completemeasuresofinequality
(1)Therange.

This value is given by the difference in the incomes of

the richest and the poorest individuals, divided by the mean to express it
independently of the units in which income is measured. Thus the range R
is given by

range is often used as a

crude, though useful, measure when detailed information on income distribution
is missing.

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2)The Kuznets ratios.

Simon Kuznets introduced these ratios in his pioneering study of income

distributions in developed and developing countries. These ratios refer to the
share of income owned by the poorest 20 or 40% of the population, or by the
richest 10%, or more commonly to the ratio of the shares of income of the richest
x% to the poorest y%, where x and y stand for numbers such as 10, 20, or 40. The
ratios are essentially "pieces" of the Lorenz curve and, like the range, serve as a
useful shorthand in situations where detailed income distribution data are
missing.

3)The mean absolute deviation.

This is our first measure that takes advantage of the entire income distribution.
The idea is simple: inequality is proportional to distance from the mean income.
Therefore, simply take all income distances from the average income, add them
up, and divide by total income to express the average deviation as a fraction of
total income

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(4)The coefficient o f variation

The coefficient of variation (C) is just the standard

deviation divided by the mean, so that only relative incomes matter.

5)TheGinicoefficient

Instead of taking deviations from the mean income, it takes the difference between all
pairs of incomes and simply totals the (absolute) differences. The Gini coefficient is
normalized by dividing by population squared (because all pairs are added and there
are n2 such
pairs) as well as mean income.

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Inequality measures: Lorenz curve 1
A diagrammatic way to depict distribution

X-axis: cumulative percentages of the population

arranged in increasing of income
Y-axis: % of national income accruing to any fraction
of the population thus arranged
The graph connecting these points is the Lorenz
curve

If everybody earned the same income, this curve

would coincide with the 45o line
The overall distance between the 45o line and the
Lorenz curve is indicative of the amount of inequality
present in the society

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 Inequality measures: Lorenz curve 2

100%
Cumulative Income

70%
B

Lorenz Curve

45 0

10%
A

20% Cumulative Population 80% 100%

The Lorenz curve of a distribution of income

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 Inequality measures: Lorenz curve 3
Using Lorenz curve to make judgements
100%

L(1) lies above L(2)

Interpretation: if we choose
a poorest x% of the
population, then L(1) always
Cumulative Income

has this poorest x% earning

L(1) at least as much as they do
under L(2)
L(2)
It stands to reason that L(1)
45
0
should be judged more
equal than L(2)
0 100%
Cumulative Population

This criterion for inequality comparison is known as Lorenz

criterion

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Lorenz curves for selected countries 1

C u m u l a ti v e S h a r e s o f I n c o m e
C u m u l a ti v e S h a r e s o f I n c o m e
Brazil Mexico

100 100

80 80

60 60

(% )
(% )

40 40 41
35

20 20 22
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7 10
0 2 0 3
0 20 40 60 80 100 0 20 40 60 80 100

C u m u l a ti v e S h a r e s o f I n c o m e (% )
Cumulative Shares of Popula tion (%) Cumulative Sha res of Population (%)
C u m u l a ti v e S h a r e s o f I n c o m e

Egypt India

100 100

80 80

60 59 60 59
(% )

40 37 40 38

20 21 20 21
9 9
0 0
0 20 40 60 80 100 0 20 40 60 80 100
Cumulative Share s of Population (%) Cumulative Sha res of Population (%)

C u m u l a ti v e S h a r e s o f I n c o m e
C u m u l a ti v e S h a r e s o f I n c o m e

Kenya Uganda

100 100

80 80

60 60
(% )
(% )

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40 38 40
31
20 21 20 17
10 7
0 3 0
0 20 40 60 80 100 0 20 40 60 80 100
Cumula tive Shares of Population (%) Cumulative Shares of Population (%)

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Lorenz curves for different countries (Deininger and Squire, 1996)
Lorenz curves for selected countries 2
Korea Taiwan
C u m u la tive S h a re s o f In co m e (%)

Cu m u la tive S h a re s o f In co m e
100 100

80 80

60 60 61
58

(%)
40 40 38
36

20 20 20 20

7 7
0 0
0 20 40 60 80 100 0 20 40 60 80 100

Cumulative Shares of Population (%) Cumulative Shares of Population (%)

United Kingdom
C u m u la tive S h a re s o f In co m e (%)

United States

Cu m u la tive S h a re s o f In co m e
100 100

80 80

60 59 60
(%) 56

40 40
36
32
20 20 20
15
8 5
0 0
0 20 40 60 80 100 0 20 40 60 80 100
Cumulative Shares of Population (%) Cumulative Shares of Population (%)

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References

Ray D., (1998), Development Economics, Princeton University Press,

Chapter: 6

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