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The Distribution of Income and Wealth: Poverty and Inequality | 4.1.7 | Microeconomics | AQA A-Level Economics Notes

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4.1.7.1 The Distribution of Income and Wealth

  • Income is a flow of money.
  • Wealth is a stock of assets.
  • The distribution of income is influenced by: MRP/ education and skills, wage differentials, earned and unearned income (owning factors of production, financial assets etc.)
  • The distribution of wealth is influenced by: age (wealth is an accumulation of income over time), inheritance/ the ability to benefit from capital gains (e.g. house price rises), and income is taxed much more heavily than wealth.
  • Equity refers to fairness or just.
  • The Lorenz curve shows the cumulative percentage of income against the cumulative percentage of the population, against a straight, diagonal line of equality through the origin.
  • The Gini Coefficient is a measure of the area between the two curves, divided by the total area.
  • The benefits of equality: those on low incomes have a high MPC, leads to economic growth faster (multiplier effect), talents of children in low income families are not wasted.
  • On the other hand, progressive taxation and equal outcomes reduces incentives.
  • The degree of equality can be measured but whether or not a given distribution of income is equitable (fair and just) involves a value judgement.
  • Excessive inequality is both a cause and consequence of market failure.
  • Judgements will influence people’s views of what constitutes an equitable distribution of income and wealth and these views will influence policy prescriptions.

4.1.7.2 The Problem of Poverty

  • Absolute poverty refers to severe deprivation of basic human needs, including food, sanitation, safe drinking water, shelter and education.
  • Relative poverty occurs when an income is below a specified proportion of average income (e.g. below 60% of median income in UK).
  • Poverty is caused by unemployment, a lack of education and skills, poor healthcare, wage differentials, tax cuts for those on higher incomes, inherited wealth (or lack of it), old age (reliance on pension).
  • The key factors that affect growth and development are investment, education and training.
  • Investment on infrastructure can allow access to schools and hospitals, and lead to increases in FDI.
  • Education and training leads to higher levels of productivity, jobs, higher incomes and also gender equality.
  • Healthcare can lead to a greater, more productive working population, better living standards and happiness.
  • The poverty trap means that low incomes lead to low savings and a lack of investment, and this continues in a cycle. Also there is a disincentive to work as workers are unable to earn more than their benefits.
  • The development trap means that low incomes mean low levels of education and health, poor human capital and productivity, and this continues in a cycle.

4.1.7.3 Government Policies to Alleviate Poverty and to Influence the Distribution of Income and Wealth

  • Policies to alleviate poverty include: progressive taxes, benefits and transfer payments, minimum and maximum wages, legislation to prevent discrimination, and government spending on education and healthcare.
  • Problems: progressive tax reduces incentives, biggest spenders lose out, poverty trap, incentives to earn benefits created (voluntary unemployment), and minimum wages often cause more unemployment, costs to businesses, government spending and time.
  • The Laffer curve is an upside down u-shaped curve showing the relationship between government tax revenue and the tax rate they are charging. Increasing tax rate will only cause an increase in tax revenue up until a certain point, before creating incentives to not work, emigrate or avoid/ evade tax.
  • The trickledown effect argues that cutting taxes on the highest income earners is not such a bad idea. Lower income taxes will be an incentive for people to continue to work and increase productivity. Also, if higher earners earn greater disposable income, they will increase spending and this will create greater AD and jobs in the economy. Also greater profits for firms will lead to greater investment as well as jobs.
  • There are a variety of moral and political perspectives of such policies.