Poverty and Inequality
Contents: 12 sections
Absolute and relative poverty
| Absolute poverty | Relative poverty | |
|---|---|---|
| Meaning | Income too low to afford basic necessities | Income well below the average in that society |
| Measured against | A fixed international line | Typically 60% of median income |
| Can it be eliminated? | Yes, in principle | No: some will always fall below the median |
| Found in | Mainly low-income countries | Every country |
The insight Edexcel rewards: economic growth can lift millions out of absolute poverty while relative poverty stays flat or worsens, because the benchmark rises with average income. The two measure genuinely different things, survival, and exclusion from normal life in your own society.
Measuring inequality
The Lorenz curve plots the cumulative percentage of total income against the cumulative percentage of the population, ranked poorest to richest.
The 45° line of perfect equality shows the distribution where each x% of the population receives exactly x% of income. The actual curve lies below it and bows further out as inequality rises.
The Gini coefficient turns that picture into a number:
Gini = A ÷ (A + B), where A is the area between the line of equality and the Lorenz curve, and A + B is the whole area beneath the line of equality.
It runs from 0 (perfect equality, curve sitting on the line) to 1 (perfect inequality).
Limitations: it is a single summary statistic, so two countries can share a Gini of 0.35 while one has a very poor bottom decile and the other a very rich top 1%, the same area can be produced by differently shaped curves. It also measures income, not wealth. Reading it alongside decile ratios gives a fuller picture.
Wealth and income
| Income | Wealth | |
|---|---|---|
| Nature | A flow over a period | A stock at a point in time |
| Examples | Wages, rent, interest, dividends, benefits | Property, shares, pensions, savings, land |
Income is what you earn; wealth is what you own.
Wealth inequality is far greater than income inequality in almost every country, because wealth accumulates over a lifetime and is inherited. An answer on inequality that discusses only income misses most of the problem, and saying so explicitly is a reliable mark-earner. The policy instruments differ too: income tax addresses income, while capital gains, inheritance and property taxes address wealth.
Causes of inequality
- Differences in wages, driven by differing MRP, skills and education (3.5).
- Unemployment and worklessness.
- Wealth inequality compounding itself: assets generate income, which buys more assets.
- Inheritance, transmitting advantage across generations.
- Differences in household composition: pensioners, single-parent households.
- The tax and benefit system, which can reduce inequality or, if it relies on regressive indirect taxes, increase it.
- Discrimination.
- Globalisation and technological change, raising returns to capital and skilled labour relative to unskilled labour.
- Regional differences in productivity and opportunity.
Impacts of inequality
Arguments that some inequality is necessary:
- Incentives: the prospect of higher reward encourages work, risk-taking, education and enterprise. Perfect equality removes the incentive to do any of them.
- Higher incomes generate savings, which fund investment.
- The trickle-down argument, that gains at the top eventually raise incomes throughout, though the empirical support for it is weak, which is worth saying.
Arguments that high inequality is harmful:
- Lower aggregate demand, since poorer households have a higher MPC; concentrating income at the top, where the MPC is lower, reduces consumption.
- Reduced social mobility and wasted talent, the poverty cycle means able children never reach their productive potential, so long-run growth suffers.
- Health and social costs: worse health outcomes, higher crime.
- Political instability and reduced social cohesion.
- Market failure: under-consumption of education and healthcare among the poor is a positive externality forgone.
Policies to reduce inequality
| Policy | Mechanism | Drawback |
|---|---|---|
| Progressive taxation | Higher earners pay a larger proportion | May weaken work incentives; avoidance and evasion; the Laffer argument |
| Benefits and transfers | Raise the incomes of the poorest directly | Cost; possible dependency and the poverty trap |
| National minimum / living wage | Raises the lowest wages | Possible unemployment if set above the competitive wage (3.5) |
| Free education and training | Raises human capital and future earnings: attacks the root | Very slow, a generation to work through |
| Free healthcare | Keeps people able to work; prevents medical costs causing poverty | Expensive; opportunity cost |
| Inheritance and wealth taxes | Address the stock, not just the flow | Avoidance; capital flight; politically difficult |
| Regional and infrastructure policy | Raises productivity in poorer regions | Long lags; risk of government failure |
The recurring trade-off is equity versus efficiency: redistribution works quickly but may blunt incentives; raising productivity is durable but slow. The strongest answers argue for a combination and note that education is the only measure that reduces inequality and raises growth.
Working the numbers
Reading a Lorenz curve. Income shares by quintile, poorest first:
| Quintile | Share of income | Cumulative |
|---|---|---|
| Poorest 20% | 5% | 5% |
| Second 20% | 10% | 15% |
| Third 20% | 15% | 30% |
| Fourth 20% | 23% | 53% |
| Richest 20% | 47% | 100% |
The cumulative column is what gets plotted. A point at (40, 15) means the poorest 40% receive 15% of income. Always cumulative, always poorest-first. Under perfect equality that point would be (40, 40), and the vertical gap between the two is the inequality the diagram shows.
The richest fifth receives 47%, more than the bottom three-fifths combined (30%). That single comparison is often worth more than quoting a Gini figure.
Progressive, proportional, regressive. The test is what happens to the average rate as income rises, not the amount paid.
A 20% VAT. Household A earns £20,000 and spends £19,000; Household B earns £80,000 and spends £48,000.
A pays 20% × £19,000 = £3,800, which is 19% of income
B pays 20% × £48,000 = £9,600, which is 12% of income
B pays two and a half times as much in cash, yet the tax takes a smaller share of its income. The average rate falls as income rises, so VAT is regressive, despite an identical rate for everyone. The mechanism is that poorer households must spend a larger proportion of what they earn, so a tax on spending reaches more of it.
The redistributive effect. If a Gini of 0.49 before taxes and transfers falls to 0.34 after, the system is clearly redistributive, but that measures whether it redistributes, not whether it redistributes enough, which is a normative question about equity rather than a measurement one.
Worked example
A government raises the top rate of income tax to reduce inequality.
- Higher earners' post-tax income falls
- the income distribution narrows
- the Lorenz curve moves towards the line of equality
- the Gini coefficient falls
- and if the revenue funds benefits or public services, the incomes of the poorest rise, narrowing it further.
Evaluation.
- Incentive effects. Higher marginal rates may reduce hours worked, discourage entrepreneurship, or prompt emigration of high earners. Note that this is theoretically ambiguous: the substitution effect discourages work, but the income effect may increase it, since a person needs more hours to reach a target income. Which dominates is an empirical question.
- The Laffer curve suggests that beyond some rate, revenue falls as avoidance, evasion and relocation rise. The theoretical point is uncontroversial; where the peak lies is contested and the evidence weak, so it should be used with caution rather than asserted.
- Avoidance and evasion mean the measured burden may fall well short of the intended one.
- It addresses income, not wealth, and since wealth inequality is much larger, the effect on overall inequality may be modest. Capital gains and inheritance taxes would reach further.
- How the revenue is spent matters as much as how it is raised. Revenue funding education reduces inequality durably; revenue funding transfers reduces it immediately but not permanently.
Judgement: a higher top rate reduces measured income inequality but reaches only part of the problem, and its revenue yield is uncertain. Pairing it with wealth taxation and with spending on education addresses both the stock and the root cause, though only the last of these raises growth as well as equity.
Common exam mistakes
- Confusing absolute with relative poverty.
- Saying growth eliminates relative poverty; it does not, because the benchmark moves.
- Confusing wealth (a stock) with income (a flow). The single most common error here.
- Describing the Lorenz curve without giving the Gini ratio, or vice versa.
- Getting the Gini scale backwards, 0 is perfect equality.
- Treating all inequality as harmful, ignoring the incentive argument.
- Listing policies without a drawback for any of them.
Exam technique
Draw the Lorenz curve with both axes labelled as cumulative percentages, the 45° line, and areas A and B marked, then state Gini = A ÷ (A + B). Most of the marks in measurement questions attach to that diagram.
Distinguish income from wealth explicitly whenever inequality is discussed; it is a reliable route into the higher bands.
For policy evaluation, use equity versus efficiency, the income and substitution effects on labour supply, and the distinction between measures that address the flow and those that address the stock.
Quick revision
- Absolute poverty: cannot afford necessities; a fixed line; can be eliminated. Relative: below 60% of median income; exists everywhere.
- Lorenz curve: cumulative income share against cumulative population share, against the 45° line.
- Gini = A ÷ (A + B), from 0 (equality) to 1 (inequality).
- Income is a flow; wealth is a stock. Wealth inequality is far greater.
- Causes: wage differences, unemployment, inherited wealth, tax and benefit design, discrimination, globalisation, regional divides.
- Some inequality supports incentives; high inequality lowers AD, mobility and long-run growth.
- Policies: progressive tax, benefits, minimum wage, education, healthcare, wealth and inheritance taxes, regional policy.
- The trade-off is equity versus efficiency; education is the one measure that serves both.
What the syllabus asks for on this topicSpecification points
Specification points
- Absolute and relative poverty.
- The causes of, and measures of, inequality (the Lorenz curve and Gini coefficient).
- The distinction between wealth and income inequality.
- The impact of, and policies to reduce, inequality.
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