Income & Wealth
It is crucial to have an understanding of the difference between both concepts of income, and wealth.
Income: Receipt of spending power by persons. Such income may be productive or Non-productive.
- Productive Income: A reward to the factors of production.
- Non-productive Income: Received from the government by persons as cash social service benefits such as pensions.
There are different types of income!
Types of Income
- Private Income: Income earnt as an employee/self-employed person
- Gross Income: Private income plus government transfer payments
- Disposable Income: Gross income minus tax
- Final Income: Disposable income and any indirect government benefit.
Wealth
- Is a stock variable
- Refers to the stock of assets held, such as land, houses, shares, government securities, consumer durables such as cars, and money MINUS the liabilities including mortgage, bank loans and amounts owing on credit cards.
- It may be acquired by inheritance, income or luck.
We can combine these concepts to these descriptors, which describe the measurement of quantities.
Stock: Quantity measured at a fixed period of time, e.g. wealth, GDP, inventories
Flow: A quantity which is measured with reference to a period of time e.g. income, depreciation, expenditure
So to summarize, income is the flow of funds while wealth is the stock of assets.
Absolute Poverty: A situation where people live below a subsistence level of income
Relative Poverty: A situation where people do not achieve what our society defines as a minimum standard of living.
Measurement of Income Distribution
Income Inequality is a measure of the unevenness income distribution within a population.
- This can be illustrated using the Lorenz Curve and represented by the Gini coefficient.
The Lorenz Curve
The population is ranked according to their income, from the lowest to the highest income.
- A model showing cumulative proportion of the population, ranked by income. against their cumulative share of income.
The blue line indicate perfect equality, where 25% of the population earns 25% of the income, while 50% of the population earns 50% of the income, and so on. As the curve tends outwards, away from the line of equity, the distribution of income gets more and more unequal. The green line has more unequal income distributions than the blue line, and the the same for the yellow line to the green.
We can observe the “portion” of income each section receives by looking at the black points on the Lorenz Curves. As the Lorenz Curve moves outwards away from the blue line, we can see each point at every quartile decreasing, creating a larger gap between the “portion” of income that the bottom 75% receives and the top 25% receives.
The red line represents absolute inequality, where only one singular person receives 100% of the income. Both perfect equality and absolute inequality will not happen in a real economy, so Lorenz Curves tend to lie between these two extremities.
Gini Coefficient
Measures the degree of income inequality in a country
- Value between 0 and 1
- 0 = Income Equality, 1 = Absolute Inequality
- Calculation: Area between diagonal and Lorenz Curve / entire area under the diagonal
Looking at the Lorenz Curve above, we can say that that the blue line has a Gini coefficient of 0 while the red line has a Gini Coefficient of 1. The closer the Gini coefficient is to 1, the more unequal the income distribution is.
Real World Examples:
- South Africa has the highest Gini Coefficient -> 0.63
- Slovakia has the lowest Gini Coefficient -> 0.232
- The Gini Coefficient global average is -> 0.38
Explanation of Inequality
- Personal Traits
- Personalities and talents
- Occupational conditions
- Training, Education and responsibilities
- Opportunities
- Other factors
- Sickness, Disabilities, Age and Luck
Strategies for Income Distribution
Direct Taxation: Personal tax is progressive, higher tax earners pay greater proportion of income than lower tax earners.
Transfer Payments: Cash support for different groups
Indirect Government Payments: Social transfers increase access to basic services which may be under consumed if provided by the market.