Income Inequality, Poverty, and Discrimination

Market economies generate enormous wealth, but they distribute it unequally. Why incomes differ so widely, how we measure the gaps, and what, if anything, policy should do about them are among the most consequential and contested questions in economics. This chapter examines the measurement of inequality, the facts of poverty, the case for and against redistribution, and the economics of discrimination.

Measuring Income Inequality

To discuss inequality precisely, economists need to measure it. Two tools dominate.

The Lorenz curve plots the cumulative share of income received against the cumulative share of households, ranked from poorest to richest. If income were perfectly equally distributed, the curve would be a straight 45-degree line. The further the actual Lorenz curve bows away from that line of perfect equality, the greater the inequality.

The Gini ratio (Gini coefficient) summarizes the Lorenz curve in a single number between 0 and 1. A value of 0 means perfect equality (everyone has the same income); a value of 1 means perfect inequality (one household has all the income). The Gini ratio lets us compare inequality across countries and over time, though, like any single number, it hides detail about where in the distribution the inequality lies.

Causes of Income Inequality

Incomes differ for many overlapping reasons:

• Ability and human capital — Differences in talent, education, training, and experience produce differences in productivity and pay.
• Occupational and risk differences — Some jobs pay more to compensate for danger, unpleasantness, or required investment.
• Wealth ownership — Income from property and capital is far more unequally distributed than labor income, and wealth compounds across generations.
• Market power and luck — Connections, monopoly power, inheritance, and sheer chance all play a role.

Interpreting the data also requires care: measured inequality overstates lifetime inequality somewhat, because people move through low- and high-earning stages of life, and because pre-tax, pre-transfer figures omit the effects of taxes and government benefits.

Poverty

Distinct from inequality is poverty — the condition of having income below a level deemed necessary for a minimally adequate standard of living. The poverty rate is the percentage of the population below the official poverty line. Poverty is not evenly distributed; rates differ by age, family structure, education, region, and race. A persistent concern is the invisible poor and the question of how much poverty is temporary versus long-term, since the policies suited to each differ.

The Income-Maintenance System

Governments respond to poverty and inequality with an income-maintenance system of two broad types. Social insurance programs (such as Social Security and Medicare) partially replace earnings lost to retirement, disability, or unemployment and are funded by payroll taxes earned through work. Public assistance (welfare) programs (such as SNAP food assistance, Medicaid, and the Earned Income Tax Credit) are entitlement programs that provide benefits to those who fall below income thresholds, funded from general tax revenues.

The Equality-Efficiency Trade-Off

Redistribution raises a fundamental tension. Greater equality may be desirable on fairness grounds and because an additional dollar arguably means more to a poor household than a rich one. But redistribution can blunt incentives: high taxes may discourage work and investment, and generous benefits may reduce the incentive to seek employment. This is the equality-efficiency trade-off — pursuing a more equal distribution may shrink the total to be distributed. How to balance the two is partly a positive question about how large these incentive effects are, and partly a normative question about how much equality society values. Reasonable people weigh these differently.

The Economics of Discrimination

Discrimination occurs when workers of equal ability and productivity are treated differently — in hiring, pay, or promotion — because of characteristics such as race or sex. Economically, discrimination is both unjust and inefficient: it misallocates labor, wastes human capital, and lowers total output by failing to employ people in their most productive roles. Economists distinguish several sources, including taste-based discrimination (prejudice on the part of employers, customers, or co-workers) and statistical discrimination (judging individuals by group averages in the presence of imperfect information). A long-standing argument holds that competitive markets should erode taste-based discrimination over time, since nondiscriminating firms can hire productive workers others overlook at lower cost; in practice, discrimination has proven more persistent than that argument predicts, which is itself an active area of study.

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Next chapter: we close the course by opening the economy to the world, examining the theory and the politics of international trade.

Further Listening & Reading

• 🎧 Planet Money #487: The Trouble With the Poverty Line (NPR) — how poverty is measured and why the official line is contested.
• 🎧 Planet Money #829: Rigging the Economy (NPR) — a debate on the causes of rising inequality.