Economics Terms A-Z - The most important terms in economics.

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Economics Terms A-Z

Inequality

Inequality in economics refers to the study of the (unequal) distribution of resources within a society. Usually when economists talk about inequality they mean income inequality, i.e., the unequal distribution of the total income in an economy among its citizens. Sometimes the term inequality is used in other contexts as e.g. wealth inequality or also inequality of opportunities or consumption.

The total income in an economy is distributed among its citizens and every one receives a certain share of this income. In most societies the majority of the people earn a comparatively low income relative to the average income. That is, in most countries the median income is lower than the mean (or average) income, implying that for the majority of people their share of the total income is small. At the same time, a few very rich people with extremely high salaries own a large share of the income in an economy. This means that income is distributed unequally, because a few people have a lot, while the majority of the population has very little. In a perfectly egalitarian world in which everyone earned the same, income would be distributed equally. Just imagine the economy as a whole as a small firm. The money that the firm earns is distributed among its employees. Usually the boss or CEO obtains the highest share followed by managers or employees in leading positions. The other employees receive lower shares depending on their position and the cleaning and maintenance stuff will earn the least. 

If you are studying economics (or had some economics courses during your degree) you will know that we economists usually care about whether the distribution of resources is efficient and whether redistribution can increase efficiency. An efficient distribution however does not have to be fair or just (see Pareto efficiency). While there is widespread consensus among economists that efficiency is a desirable property, economists do not agree on whether inequality is problematic or not. Or to be more precise, no one knows what would be a good level of inequality. Most economists agree that a certain level of inequality is necessary to make sure that individuals or firms have an incentive to innovate and exert effort, which is crucial for economic growth. The possibility to earn (and consequently consume) more than others provides an incentive for firms to invent new products or produce more efficiently. At the same time high levels of inequality may impede growth and many high-income countries have comparatively low levels of inequality. Besides this, countries with a high degree of income inequality might be more prone to social unrest, meaning more resources have to be dedicated to enforce property rights, and guarantee safety and stability. This is why many policymakers are concerned about the distribution of income and wealth and often use taxes to redistribute income and guarantee a certain standard of living to their citizens. Given the question of how much equality or inequality is desirable is a controversial one, many economists that study inequality focus on describing and analyzing the evolution of inequality over time or comparing how income is distributed in different countries or regions.

How to measure inequality

There are different ways of measuring and quantifying (income) inequality. In general, we say that the more concentrated the income (or wealth) is in the hands of a few, the higher the inequality in the society. When we are interested in studying the income distribution in an economy we often start by comparing the income being earned by different quantiles or percentiles of the society. These measures are also called share ratios. For instance, the 80-20 ratio compares the share of the total income that is earned by the top 20% of the income distribution to the bottom 20%. Another important measure of inequality is the Lorenz curve together with the Gini-coefficient which takes a value between 0 and 1. Higher values of the Gini-coefficient are associated with a less equal distribution of income. Besides share ratios and the Gini-coefficient, other important measures are the Theil-coefficient or the Palma ratio. As each of these measures has its own strengths and weaknesses it is usually recommended to use several of them together to get a more accurate picture of the distribution of income in a society.

So far, we have only been talking about inequality from a purely theoretical point of view and many of you may be interested in looking at the data. Comparing income inequality across different countries, we can see that many countries with comparatively low levels of inequality (often with Gini-coefficients around or below 0.3) are in Europe as e.g. Austria, the Czech Republic, Denmark, Germany, Finland, Norway or Sweden. High levels of inequality can be found in the South of the African continent (the Gini-coefficient for South Africa for instance is estimated to be above 0.6) or in Central America as in Brazil, Columbia, Mexico or Venezuela (see e.g. The World Bank – Gini index). In many Central American countries, however, inequality has (at least slightly) decreased over the last decades. While inequality in most high-income countries has decreased over the last century, some countries as e.g. the United States have experienced again rising levels of inequality during the last decades. 

Further reading

One concern some economists share about high levels of inequality in a society is a possible positive relationship between inequality in crime. Choe (Economic Letters, 2008) investigates the relationship between income inequality and crime in the United States and finds that there is a strong effect of relative income inequality on burglary as well as on robbery. Enamorado et al (Journal of Development Economics, 2016) use MexicoΒ΄s drug war to study the relationship between income inequality and violent crime. They also find evidence of a positive relationship between higher levels of inequality and violent crime and show that a one-point increment in the Gini coefficient implies a 36 increase in the homicide rate.

Good to know

One main problem for economists interested in income or wealth inequality is the lack of availability of reliable data. Especially the comparison across countries can be difficult simply because different countries use different databases and some (developing) countries do not have reliable or consistent data at all. If you are interested in studying income and wealth distribution there are a few data sources you might be interested in having a look at. For example, the Luxembourg wealth studies attempt to construct a detailed database containing wealth data of most European countries. On the same page you can also find the Luxembourg income studies that provide the same information on the income level. Another database is the β€œSurvey of consumer finances” that collects detailed information about the income and wealth situation in US households.