Income Inequality: Lorenz Curve and Gini Coefficient
Income inequality is a pervasive and critical issue in economics that reflects how income is distributed unevenly among the population of a country or region. It impacts social cohesion, economic growth, and the overall well-being of societies. To analyze and quantify income inequality, economists use graphical and numerical tools — primarily the Lorenz Curve and the Gini Coefficient. These tools help policymakers, researchers, and students understand the extent of inequality and design targeted interventions.
In this blog, we provide an in-depth understanding of income inequality, how the Lorenz Curve visually represents income distribution, and how the Gini Coefficient numerically measures inequality. We also discuss their significance, limitations, and practical applications.
1. Understanding Income Inequality
Income inequality refers to the unequal distribution of income among individuals or households within an economy. While some degree of inequality is inevitable in a market economy — incentivizing innovation and effort — excessive inequality can lead to economic inefficiencies, reduced social mobility, political instability, and poverty traps.
Why measure income inequality?
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To assess economic fairness and social justice.
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To evaluate the effectiveness of redistributive policies such as taxation and welfare.
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To understand the relationship between inequality and economic growth.
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To identify vulnerable groups and target poverty alleviation programs.
2. The Lorenz Curve: A Visual Representation of Income Distribution
Definition and Construction
The Lorenz Curve, developed by Max O. Lorenz in 1905, is a graphical tool that depicts the cumulative share of income received by the cumulative percentage of the population. It provides a clear visual picture of income inequality.
To construct a Lorenz Curve:
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The x-axis represents the cumulative percentage of the population, arranged from the poorest to the richest (0% to 100%).
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The y-axis represents the cumulative percentage of total income earned (0% to 100%).
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The curve plots the cumulative income share corresponding to each cumulative population share.
Interpretation
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The line of equality is a 45-degree diagonal line where income is perfectly equally distributed (e.g., 20% of the population earns 20% of the income).
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The Lorenz Curve lies below the line of equality, with the degree of bowing indicating the level of inequality.
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The more the curve bows away from the line of equality, the greater the income inequality.
Example
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If 10% of the population earns only 2% of total income, and 50% earns 25%, the curve will be significantly bowed.
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If everyone earned the same income, the Lorenz Curve would coincide with the line of equality.
3. The Gini Coefficient: A Numerical Measure of Inequality
Definition
The Gini Coefficient (or Gini Index) is a single number derived from the Lorenz Curve that quantifies income inequality. It was developed by Corrado Gini in 1912.
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It measures the area between the Lorenz Curve and the line of equality, expressed as a proportion of the total area under the line of equality.
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Mathematically,
Gini Coefficient=AA+B\text{Gini Coefficient} = \frac{A}{A + B}Gini Coefficient=A+BAwhere A is the area between the line of equality and the Lorenz Curve, and B is the area under the Lorenz Curve.
Range and Interpretation
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The Gini Coefficient ranges from 0 to 1 (sometimes expressed as 0 to 100).
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A Gini of 0 implies perfect equality — everyone has the same income.
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A Gini of 1 implies perfect inequality — one person or household earns all the income.
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Values between 0 and 1 indicate the degree of inequality:
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0 to 0.3 is generally considered low inequality.
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0.3 to 0.5 indicates moderate inequality.
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Above 0.5 signals high inequality.
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Calculation Methods
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The Gini Coefficient can be calculated from income data using formulae based on ranked income distributions or derived directly from Lorenz Curve data.
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It is commonly used by organizations such as the World Bank, OECD, and UNDP in development reports.
4. Significance and Applications
Policy Formulation
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Governments use the Gini Coefficient to monitor the effectiveness of redistributive policies, including progressive taxation, social welfare, and minimum wage laws.
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A rising Gini may prompt stronger social safety nets and inclusive growth policies.
Economic and Social Research
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Researchers analyze how income inequality correlates with economic growth, poverty, education, health outcomes, and political stability.
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It helps identify structural issues like unequal access to education or labor market discrimination.
International Comparisons
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The Gini Coefficient facilitates comparison of inequality levels across countries or regions, highlighting disparities and best practices.
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For instance, Nordic countries like Sweden tend to have low Gini coefficients (~0.25), while some Latin American and African countries show higher values (~0.5 or more).
5. Limitations of the Lorenz Curve and Gini Coefficient
Despite their popularity, these tools have limitations:
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Sensitivity to Data Quality: Accurate income or consumption data is crucial, but informal economies and underreporting can skew results.
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No Information on Absolute Income: Two countries can have the same Gini coefficient but vastly different average income levels and poverty rates.
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No Indication of Poverty or Wealth: The measures do not distinguish whether inequality arises from the very rich or the very poor.
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Ignores Non-Income Dimensions: Inequality in wealth, health, education, and opportunity require complementary indicators.
Therefore, these measures are best used as part of a broader analytical framework.
6. Conclusion
Income inequality is a complex socio-economic phenomenon with profound implications for growth, equity, and social stability. The Lorenz Curve and Gini Coefficient are powerful tools that allow economists and policymakers to visualize and quantify inequality, track trends over time, and evaluate policy impacts.
A nuanced understanding of these tools helps IAS aspirants, MBA students, and policymakers alike to grasp the multi-dimensional nature of inequality and underscores the need for comprehensive strategies that promote equitable economic development.