Income inequality as a market failure

Overview

Why inequality counts as a market failure, its causes in the UK, measuring it with the Gini coefficient, Lorenz curves, means, medians and quantiles, its consequences for households, firms and government, and policies to reduce it.

What you need to know

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Questions from this subtopic

Each one with the model answer underneath.

1. 1

   Why is a highly unequal distribution of income regarded as a market failure?

   Model answer

   Markets reward people according to the value of what they own and sell, not need, so they can produce a distribution most people regard as unfair. Very poor households may also be unable to afford merit goods such as education and healthcare, leading to underconsumption.

2. 2

   Give three causes of income inequality in the UK.

   Model answer

   Differences in skills and qualifications, which affect wages; unequal ownership of wealth, which brings income from rent, interest and dividends; and differences in employment, as households without work rely on benefits.

3. 3

   What is the Gini coefficient, and roughly what is it for the UK?

   Model answer

   A measure of inequality from 0 (perfect equality) to 1 (one person has all the income). The UK's Gini coefficient for disposable income is around 0.33 to 0.35, higher than most Western European countries.

4. 4

   What does a Lorenz curve show, and how is it linked to the Gini coefficient?

   Model answer

   It plots the cumulative share of income against the cumulative share of households. The further the curve sags below the line of perfect equality, the greater the inequality; the Gini coefficient is the area between them divided by the whole area under the line.

5. 5

   What is the difference between the mean and the median, and why does it matter for earnings data?

   Model answer

   The mean is the total divided by the number of values; the median is the middle value when they are ranked. A few very high earners pull the mean up, so mean earnings are above median earnings, and the median better shows a typical worker's pay.

6. 6

   What are quantiles, and how are they used in inequality data?

   Model answer

   Quantiles divide ranked data into equal-sized groups: quintiles into fifths and deciles into tenths. Inequality is often shown by comparing the share of income received by the top and bottom deciles or quintiles.

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