# Income and Wealth Inequality

> IB Economics Higher Level · IB HL Economics
> Source: https://www.owlsprep.com/study/ib-economics-hl-u3-income-and-wealth-inequality/

This sub-topic distinguishes between income and wealth inequality, covers core measurement tools including the Lorenz curve and Gini coefficient, explores key causes and consequences, and evaluates common government policies to reduce inequality.

**Prerequisites:** [Fiscal policy fundamentals](https://www.owlsprep.com/study/ib-economics-hl-u3-fiscal-policy/); [Macroeconomic objectives](https://www.owlsprep.com/study/ib-economics-hl-u3-macroeconomic-objectives/)

## Learning objectives

- Distinguish between income inequality and wealth inequality
- Explain core measures of inequality including the Lorenz curve and Gini coefficient
- Analyze key causes and consequences of inequality
- Evaluate common government policies to reduce inequality

## Key Distinction: Income vs Wealth Inequality

**Income inequality** — Unequal distribution of total disposable income (a flow variable measured per period of time, e.g. annually) across all households in a population.

*Example:* In the US, the top 10% of earners earn approximately 11 times more than the bottom 10% of earners.

**Wealth inequality** — Unequal distribution of accumulated assets (a stock variable measured at a point in time) across all households in a population. Assets include property, stocks, land and savings.

*Example:* In most advanced economies, the top 1% of households hold roughly 30% of total national wealth.

The most common foundational exam question asks you to distinguish between these two concepts. The core difference is that income is a flow of new earnings per year, while wealth is the total stock of assets accumulated over time. Wealth almost always is far more unequally distributed than income across all countries.

**Check your understanding**

Test your understanding of the core distinction

1. Which of the following is an example of wealth rather than income?

   - Annual teacher salary
   - Monthly stock dividends
   - Equity in a privately owned home
   - Rental income from a second apartment

   *Why:* Correct! Home equity is an accumulated asset (a stock = wealth). All other options are flows of money received per period = income.

## Measuring Inequality

**Lorenz Curve** — A graphical representation of inequality that plots the cumulative share of total income/wealth held by the cumulative percentage of the population (ordered poorest to richest). A 45-degree line of perfect equality is used as a reference.

*Example:* The further the Lorenz curve curves below the 45-degree line, the higher the level of inequality.

**Gini Coefficient** — A numerical summary of inequality calculated from the Lorenz curve. It is the ratio of the area between the line of perfect equality and the observed Lorenz curve (A) to the total area under the line of perfect equality (A+B).

*Notation:* G

$$G = \frac{A}{A+B}$$

The Gini coefficient ranges from 0 (perfect equality, all people have the same income/wealth) to 1 (perfect inequality, one person holds all income/wealth). Higher values always mean higher inequality.

**Worked example:** A country has an income Gini of 0.34 and a wealth Gini of 0.68. Interpret what this means.

1. First, recall that Gini coefficients range from 0 (full equality) to 1 (full inequality), with higher values meaning more inequality.
2. Next, compare the two values: 0.34 is a relatively low Gini for income, while 0.68 is a much higher Gini for wealth.
3. Conclusion: Wealth is distributed far more unequally than income in this country, which matches the typical pattern observed across almost all modern economies.

## Causes and Consequences of Inequality

Over the past 40 years, income and wealth inequality has risen in most advanced and emerging economies. The most commonly cited causes are:

- Skill-biased technological change: Rising demand for high-skilled labor has outpaced supply, increasing the wage gap between skilled and unskilled workers
- De-unionization: Declining union membership has reduced bargaining power for low and middle-wage workers
- Intergenerational inheritance of wealth: Wealth accumulates across generations, creating persistent gaps between families
- Globalization: Low-wage foreign competition has reduced manufacturing wages in advanced economies

Inequality has a range of economic and social consequences, which are frequently tested in 15-mark essay questions:

- Macroeconomic: High inequality reduces aggregate demand, as wealthy households have a lower marginal propensity to consume than poorer households
- Social: Higher inequality is linked to lower social mobility, worse health outcomes, and higher crime rates
- Efficiency: High inequality blocks low-income households from investing in education and business, reducing long-run potential output

**Worked example:** Explain how inheritance of wealth creates persistent wealth inequality.

1. A household that inherits assets gains two key advantages over households that inherit nothing.
2. First, the inherited assets generate ongoing flows of income (rent, dividends, interest) that increase annual disposable income, allowing the recipient to save and accumulate more wealth over time.
3. Second, assets can be used as collateral for loans to invest in education, property, or business, generating further returns. This creates a self-reinforcing cycle of wealth accumulation for already wealthy families.

## Policies to Reduce Inequality

**Progressive Taxation** — A tax system where the marginal tax rate increases as income or wealth increases, so higher earners/wealthier households pay a larger share of their income in tax than lower-income groups.

- Transfer payments: Means-tested welfare benefits directly increase disposable income for low-income households
- Wealth taxes: Annual taxes on net wealth above a threshold reduce concentration of wealth at the top
- Minimum wages: Legally mandated minimum wages raise incomes for low-wage workers
- Free public education/healthcare: Reduces living costs for low-income households, indirectly reducing inequality

**Worked example:** Evaluate the use of progressive income tax to reduce income inequality.

1. First, outline the advantages of the policy:
2. Progressive income tax directly reduces the disposable income of high earners. Revenue raised can fund transfer payments to low-income households, directly narrowing the income gap. It is also administratively simple to collect in most economies.
3. Next, outline potential disadvantages of the policy:
4. Very high top marginal tax rates can create disincentives for work and investment, potentially reducing long-run economic growth. Wealthy households may also use tax loopholes to avoid paying the full tax rate, reducing effectiveness.
5. Conclusion: Overall, progressive income tax is an effective tool for reducing inequality when combined with measures to close tax loopholes. It has only small negative growth impacts when top rates are set at moderate levels.

> **Exam tip:** Always include balanced advantages and disadvantages when evaluating policies in IB essays to reach the highest mark bands.

## Common pitfalls

- **Wrong:** Confusing income (flow) and wealth (stock) in exam answers
  - Why it fails: Examiners explicitly test this distinction, mixing them up leads to unnecessary lost marks
  - Correct: Always explicitly state that income is a flow per period and wealth is a stock of accumulated assets when answering questions about the two
- **Wrong:** Interpreting a Gini coefficient of 0.6 as low inequality
  - Why it fails: Gini ranges from 0 to 1, so higher values mean more inequality, a common reverse interpretation mistake
  - Correct: Memorize: Gini = 0 = perfect equality, Gini = 1 = perfect inequality, so higher values always mean higher inequality
- **Wrong:** Claiming all inequality is bad for economic growth with no counterpoints
  - Why it fails: IB markers expect balanced evaluation; moderate inequality can have positive incentives for growth
  - Correct: Acknowledge that moderate inequality can incentivize work and investment, while high inequality has mostly negative effects on growth and social outcomes
- **Wrong:** Discussing only income inequality when the question asks about wealth inequality
  - Why it fails: The two concepts are distinct, and failing to address the requested concept leads to major mark deductions
  - Correct: Read the question carefully to confirm if it asks for income, wealth, or both, and tailor your answer accordingly

## Cheatsheet

| Concept | Key Fact | Exam Note |
| --- | --- | --- |
| Income inequality | Flow variable (per period) distribution | Common 2-mark distinction question |
| Wealth inequality | Stock variable (accumulated assets) distribution | Almost always more unequal than income |
| Lorenz curve | Further from 45° line = higher inequality | May be asked to draw this in Paper 1 |
| Gini coefficient | 0 = full equality, 1 = full inequality | Higher value = higher inequality |
| Progressive tax | Higher rate on higher incomes/wealth | Most common policy for evaluation essays |

## What's next

Understanding income and wealth inequality is core to evaluating the key macroeconomic trade-off between economic growth and equity, a recurring theme in IB HL Economics. This topic connects directly to fiscal policy, where you can apply your understanding of progressive taxation and transfer payments to evaluate how governments balance equity and efficiency goals. It also links closely to development economics, where inequality is a key barrier to sustained growth and poverty reduction. Exam essay questions frequently combine this topic with policy evaluation, so practicing balanced arguments for policy options is critical for achieving high marks.

- [Fiscal Policy](https://www.owlsprep.com/study/ib-economics-hl-u3-fiscal-policy/)
- [Macroeconomic Objectives](https://www.owlsprep.com/study/ib-economics-hl-u3-macroeconomic-objectives/)
- [Phillips curve (HL only)](https://www.owlsprep.com/study/ib-economics-hl-u3-phillips-curve/)

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