6.5 Inequality

The Lorenz curve plots the cumulative percentage of income (y-axis) earned by the cumulative percentage of households (x-axis), ranked poorest to richest. The 45-degree line is perfect equality; the more the curve bows below it, the greater the inequality. The Gini coefficient is the area between the equality line and the Lorenz curve divided by the entire area under the equality line, so it runs from 0 (equal) to 1 (one household earns everything).

Inequality has many sources: differences in human capital and education, discrimination, bargaining power, inheritance, and access to financial markets. Keep income and wealth distinct — income is a flow earned per period, wealth is the accumulated stock — and wealth is typically distributed far more unequally than income.

Policy levers work through taxes and transfers. A progressive tax takes a rising average rate as income rises and reduces inequality; a regressive tax (like a sales tax) takes a falling average rate and worsens it; a proportional (flat) tax holds the average rate constant. Transfer payments shift income directly toward lower-income households.