Select your language

Suggested languages for you:
Log In Start studying!
StudySmarter - The all-in-one study app.
4.8 • +11k Ratings
More than 3 Million Downloads
Free
|
|

All-in-one learning app

  • Flashcards
  • NotesNotes
  • ExplanationsExplanations
  • Study Planner
  • Textbook solutions
Start studying

Poverty and Inequality

Save Save
Print Print
Edit Edit
Sign up to use all features for free. Sign up now
Economics

Poverty affects millions of people around the world. Poverty and inequality can lead to issues that prevent people from fully participating in society. In this explanation, we will look at what poverty and inequality mean in economic terms. You will see how they are measured and their relationship with economic growth.

Absolute and relative poverty in the world

Poverty can be measured in two different ways: absolute poverty and relative poverty.

Absolute poverty is when people are unable to afford the sufficient necessities to sustain themselves. The World Bank defines absolute poverty as the percentage of the population in a country that lives on less than $1.90 a day.

The United Nations (UN) define absolute poverty as

A condition characterised by severe deprivation of basic human needs, including food, safe drinking water, proper sanitation facilities, health facilities, shelter and education.

Relative poverty is the level of household income that is below a certain percentage of the median level of income of the particular country.

In the UK, relative poverty is less than 60% of median income (£30,800 in 2020). In other words, relative poverty encompasses those who cannot afford to buy the goods they need to not be considered poor according to social norms. For example, if they can't afford a refrigerator or car.

Inequality in economics

Inequality can be measured in two different ways: income inequality and wealth inequality.

Income is a flow of earnings received at a certain rate in a given period, such as a salary or rental earnings.

Wealth is the stock or monetary value of a person's marketable assets.

Income inequality is the degree to which income is distributed unequally throughout a population. Wealth inequality is how unequal the distribution of wealth is throughout a population.

A population can be divided up in many different ways to study and understand how income and wealth are distributed.

The population can be divided up by age to see how income is distributed between the old and the young.

Measurements of income inequality

Economists measure income inequality using a variety of criteria. The most generally used measures -the Lorenz curve, the Gini coefficient, decile ratios, the Palma ratio, and the Theil index- all have merits and limits.

The choice of what to measure is also crucial: pre-tax and after-tax income, consumption, and wealth are helpful indicators, as are various sources of income such as wages, capital gains, taxes, and perks.

Understanding the dimensions of economic inequality is a critical first step in determining the best solutions to combat it.

The Lorenz curve

The Lorenz curve is one measure of income inequality. It graphically depicts how income is distributed throughout a population.

Poverty and Inequality In economics we can measure poverty and inequality with the Lorenz curve StudySmarterFigure 1. Lorenz Curve - StudySmarter.

As Figure 1 above shows, the cumulative percentage of the population is plotted against the cumulative percentage of the income of a population. The straight line of equality shows a perfectly equal society. The Lorenz curve is below the line of equality. The further away it is, the greater the income inequality.

Our explanation on the Lorenz Curve discusses this graph further, how you can interpret it and some of its limitations.

The Gini coefficient

The Gini Coefficient is related to the Lorenz curve. It shows the ratio of the area between the 45-degree line of equality and the Lorenz curve.

As it is a ratio, it can be calculated mathematically. Its values range between 0 and 1. A value of 0 means that income is perfectly shared equally across society. A value of 1 would mean that one single person has access to all the income in a country.

Our explanation on the Gini Coefficient discusses this ratio further and how you can calculate it.

Causes of wealth and income inequality

There are many causes of both wealth and income inequality. Some causes are:

  • Wages. Unequal distribution of wages on grounds of higher educational achievements or longer working hours causes a disparity among the higher income earners and lower-income earners. A higher-income earner assures more savings, which build up more wealth compared to a lower-income earner whose basic needs take precedence.
  • Wealth levels. A higher level of wealth eventually leads to more wealth. With more wealth, people can undertake risky investments with a higher rate of return and therefore increased interest and income rates.
  • Chance. This is based on good decision making and luck of the people who either choose the right sort of job that increases their income or they invest in assets that increase their wealth.
  • Age. The age group of working adults at the peak of their career have a higher chance of increased incomes than the fresh starters, similar to the older ones who have had their chance to accumulate wealth and assets in their prime.
  • Socioeconomic status. This can explain the difference in how income and wealth are distributed between countries. Developing countries may be marginalised compared to developed countries that favor international trade and negotiations that help them in economic development.

The relationship between economic growth, poverty, and inequality

Economic growth is one macroeconomic objective for governments. Poverty and inequality, though, impact economic growth and development.

The Kuznets hypothesis helps us understand this relationship.

The Kuznets hypothesis suggest how economic growth and development initially lead to a worsening of poverty and inequality. But after a certain level of economic growth, poverty and inequality reduce.

The Kuznets hypothesis is also known as the Kuznets curve. It can also be applied to show the relationship between economic growth/development and environmental degradation.

Poverty and Inequality The Kuznets curve StudySmarterFigure 2. Kuznets Curve - StudySmarter.

Figure 2 above shows the Kuznets curve. Initially, an economy is heavily reliant on the primary sector. This overdependence generates little economic growth.

As the economy moves towards the manufacturing sector, economic growth starts to increase. Absolute poverty will decline, but there will be an increase in relative poverty as capital owners benefit more from the change to a manufacturing sector. They take advantage of cheap labour and this increases their wealth.

The top of this curve is known as a turning point. Inequality and relative poverty will peak here. There is little pressure on wages to rise and a surplus of unskilled workers.

After this point though, spare capacity in the economy has been used up and wages are rising. Higher incomes result in higher tax revenue which the government can use to improve in education, healthcare, etc. The government focuses now on creating a more equitable society because economic growth and development are sustainable now.

China is a good example of this. China has shifted its economy to the manufacturing sector. The economy has experienced high levels of economic growth and many have been lifted out of absolute poverty. But relative poverty is on the rise, as capital owners benefit more from cheaper labour.

Capitalism also explains the relationship between economic growth and inequality. Capitalism gives birth to income inequality because of wage differentials based on the demand and supply of different jobs. Individuals that own resources and wealth also differ based on their income levels.

Hence, we could say that a capitalist economy can never achieve equality. In capitalism, it is important to encourage hard work and incentives without which the economy will not grow as the people will lose the motivation to work.

This proves that a certain degree of inequality is necessary and desirable for economic growth but excessive inequality will result in social justice problems and inefficiency.

Poverty and Inequality - Key takeaways

  • Absolute poverty is the situation where people can’t afford their basic needs to sustain a living.
  • Relative poverty is the income level that is lower than the median income of a given economy.
  • Income inequality can be measured using the Lorenz curve and the Gini coefficient.
  • Some causes of income and wealth inequality are: wages, wealth levels, chance, age, and socioeconomic status.
  • The Kuznets curve or hypothesis explains the relationship between economic growth, inequality and poverty.
  • Economic growth positively affects absolute poverty by raising the levels of income. However, it inversely affects relative poverty as the benefits from economic growth in the country may not be shared equally.

Poverty and Inequality

Poverty is when people don't have much to afford the sufficient necessities to sustain themselves. Inequality refers to the unequal distribution of income or wealth which results in some people having more than others.

Economic growth positively affects absolute poverty by raising the levels of income. However, it inversely affects relative poverty as the benefits from economic growth in the country may not be shared equally. 

Inequality can be measured through the Lorenz curve or the Gini Coefficient.

Final Poverty and Inequality Quiz

Question

What is the Lorenz curve?

Show answer

Answer

The Lorenz curve is a graph that shows income or wealth inequality in an economy.

Show question

Question

Why is the Lorenz curve important?

Show answer

Answer

It is important because it helps economists measure and understand income or wealth inequality. 


Show question

Question

What shifts the Lorenz curve?

Show answer

Answer

Any factor that improves the income or wealth distribution, such as high levels of education and a small family composition, will cause the Lorenz curve to shift closer to the line of equality.

Show question

Question

What is the poverty line?

Show answer

Answer

The poverty line is the minimum income level that is deemed necessary to sustain the standard of living in a given country. 

Show question

Question

Define income.

Show answer

Answer

Income is a flow of earnings received at a certain rate in a given period, such as a salary or rental earnings. 

Show question

Question

Define wealth.

Show answer

Answer

Wealth is the stock or monetary value of a person's marketable assets. 

Show question

Question

What are the two measures of income inequality?

Show answer

Answer

1. Lorenz curve 

2. Gini coefficient

Show question

Question

What are the causes of unequal distribution of income?

Show answer

Answer

1. Wages

2. High wealth levels

3. Age groups

4. Socioeconomic status

Show question

Question

Economic growth positively affects absolute poverty.

Show answer

Answer

True

Show question

Question

What is the Gini coefficient?

Show answer

Answer

The measure of the distribution income.

Show question

Question

What does a coefficient of 0 mean?

Show answer

Answer

It indicates perfect equality. This means that every 1% of a population has access to 1% of national income.

Show question

Question

What does a coefficient of 1 mean?

Show answer

Answer

It indicates perfect inequality. This means that one individual has access to 100% of the country’s national income.


Show question

Question

What is the difference between the Gini coefficient and the Lorenz curve?

Show answer

Answer

The Gini coefficient is a mathematical measure of the distribution of income, while the Lorenz curve is a visual representation of income or wealth inequality.

Show question

Question

What does a coefficient > 0.4 mean?

Show answer

Answer

It indicates that there is a big income gap and there must be some level of social and political instability.

Show question

Question

What does the Gini Coefficient measure in the Lorenz curve?

Show answer

Answer

It measures how far away the Lorenz curve is from the line of equality.

Show question

Question

What does an inward shift of the Lorenz curve mean?

Show answer

Answer

It means that income or wealth inequality has fallen in an economy.

Show question

Question

What are some limitations of using the Lorenz curve?

Show answer

Answer

It doesn't include non-market activities such as education, and healthcare.

Show question

Question

What does a Gini coefficient of 0 mean?

Show answer

Answer

Perfect equality. It means that every 1% of a population has access to 1% of national income.

Show question

Question

What does a Gini Coefficient of 1 mean?

Show answer

Answer

Perfect inequality. It means that 1 individual has access to the entire country’s national income.

Show question

Question

A low Gini coefficient means income or wealth is distributed unequally.

Show answer

Answer

True

Show question

Question

What is the range of the Gini coefficient?

Show answer

Answer

It ranges from 0 to 1.

Show question

Question

Why is the Gini coefficient important?

Show answer

Answer

It is important because it helps economists measure income or wealth inequality which they can use to compare different countries.

Show question

Question

What is the main limitation of using the Gini coefficient? 

Show answer

Answer

A lot of information can be lost such as the population size of a country, and how large an economy is.


Show question

Question

How is the Gini coefficient linked to the Lorenz curve?

Show answer

Answer

You can calculate the Gini coefficient from the Lorenz curve. It also measures how far the Lorenz curve is from the line of equality.

Show question

Question

What does poverty cause?

Show answer

Answer

Lack of economic progress and diminishing social well-being. 

Show question

Question

Define fiscal drag.

Show answer

Answer

Fiscal drag occurs in an economy where the government does not adjust tax thresholds in line with inflation. It results in an increase in income in monetary value, but the real income stays the same. Therefore, more people end up in the tax net and pay a large share of their incomes in taxes which slows down the economy. 

Show question

Question

What could fiscal drag cause?

Show answer

Answer

Poverty and unequal household incomes.

Show question

Question

What causes the poverty trap?

Show answer

Answer

The poverty trap or earning trap could be caused by fiscal drag.

Show question

Question

Define Means-tested benefits.

Show answer

Answer

Means-tested benefits are income-dependent. It means people whose income rises and now falls in a certain income bracket, do not get these benefits anymore. 

Show question

Question

Define universal benefits.

Show answer

Answer

Universal benefits can always be claimed. These benefits are not income-dependent.

Show question

Question

What causes the unemployment trap?

Show answer

Answer

The poverty trap could cause it. 

Show question

Question

How can government train unemployed people? 

Show answer

Answer

By setting up training programs for them. 

Show question

Question

Does a national minimum wage policy affect poverty?


Show answer

Answer

Yes, it does, especially for people with low income. 

Show question

Question

What does the Kuznets curve show?

Show answer

Answer

It shows how economic growth initially lead to poverty and inequality worsening. But after a certain level of economic growth, poverty and inequality reduces. 

Show question

Question

Explain how capitalism impacts inequality and poverty.

Show answer

Answer

Capitalism gives birth to income inequality because of wage differentials based on the demand and supply of different jobs. Individuals that own resources and wealth also differ based on their income levels. Hence, it can be stated that a capitalist economy can never achieve equality as it is important to encourage hard work and incentives without which the economy will not grow as the people will lose the motivation to work.

Show question

Question

What happens at the beginning of the Kuznets curve?

Show answer

Answer

Initially, an economy is heavily reliant on the primary sector. This over dependence generates little economic growth.

Show question

Question

As an economy moves towards the manufacturing sector, what does the Kuznets curve show?

Show answer

Answer

As the economy moves towards the manufacturing sector, economic growth starts to increase. Absolute poverty will decline, but there will be an increase in relative poverty as capital owners benefit more from the change to a manufacturing sector. They take advantage of cheap labour and this increases their wealth.

Show question

Question

What does the Kuznets curve show after inequality peaks?

Show answer

Answer

After inequality peaks, spare capacity in the economy has been used up and wages rise. Higher incomes result in higher tax revenue which the government can use to improve in education, health care etc. The governments focus now is creating a more equitable society because economic growth and development is sustainable now. 

Show question

Question

What does the straight line of equality on the Lorenz curve show?

Show answer

Answer

It shows a perfectly equal society.

Show question

Question

What values do the Gini coefficient range from?

Show answer

Answer

It ranges between 0 and 1.

Show question

Question

What do the Gini coefficient values of 0 and 1 mean?

Show answer

Answer

A value of 0 means that income is perfectly shared equally across society. A value of 1 would mean that one single person has access to all the income in a country.

Show question

Question

What are the causes of poverty?

Show answer

Answer

1. Unemployment: a large number of the population are either underemployed or in light of the recent pandemic have been made redundant or furloughed which has led to hysteresis or prolonged unemployment due to obsolete skills of the affected workers.

2. Inequality in wages: lower skills and education limits their opportunities to a better wage and hence, are exploited because there is no such policy to protect the minimum wage rate.

3. Regressive taxes: indirect taxes on certain goods extract a higher percentage of the lower-income earners especially when they are affected by unequal wages. 

4. Economic inactivity: long term unemployment leads to economic inactivity and more people become dependent on state benefits. This shows an increase in the relative poverty index.

Show question

Question

How does wage inequality lead to poverty?

Show answer

Answer

People with lower skills and education find it hard to get a matched job, and even if they do, they are underpaid or exploited.  This lowers their purchasing power and leads to more poverty.

Show question

Question

How does unemployment lead to poverty?

Show answer

Answer

When an individual is unemployed, they have no source of income. The higher the unemployment rate, the higher the poverty rate.

Show question

Question

How do regressive taxes cause an increase in poverty?

Show answer

Answer

Indirect taxes have potentially put a higher burden on the poor, therefore causing an increase in income inequality. Although the overall tax burden has remained unchanged, the indirect tax and VAT charged on certain goods such as petrol, alcohol, etc extract a higher percentage of income. 

Show question

Question

Why are pensioners more prone to relative poverty?

Show answer

Answer

Pensioners are more at risk of relative poverty as they earn significantly less than the average. However, pension poverty has seen a sharp decline due to the rise in the real value of state pension. 

Show question

Question

What is absolute poverty?

Show answer

Answer

Absolute poverty is when individuals are not able to consume the basic necessities needed to maintain a basic lifestyle. 

Show question

Question

What is relative poverty?

Show answer

Answer

Relative poverty is when households receive 50% less than the average household income level that covers the cost for the basic necessities, however not enough to afford anything above the basics.

Show question

Question

Mention an example of poverty.

Show answer

Answer

An individual who isn't capable of paying their rent or doesn't have a roof over their house.

Show question

Question

How to solve the problem of poverty?


Show answer

Answer

Some policy solutions to poverty include sustaining economic growth, increasing employment opportunities, maintaining a minimum wage rate and the re-introduction of progressive taxes.

Show question

60%

of the users don't pass the Poverty and Inequality quiz! Will you pass the quiz?

Start Quiz

Discover the right content for your subjects

No need to cheat if you have everything you need to succeed! Packed into one app!

Study Plan

Be perfectly prepared on time with an individual plan.

Quizzes

Test your knowledge with gamified quizzes.

Flashcards

Create and find flashcards in record time.

Notes

Create beautiful notes faster than ever before.

Study Sets

Have all your study materials in one place.

Documents

Upload unlimited documents and save them online.

Study Analytics

Identify your study strength and weaknesses.

Weekly Goals

Set individual study goals and earn points reaching them.

Smart Reminders

Stop procrastinating with our study reminders.

Rewards

Earn points, unlock badges and level up while studying.

Magic Marker

Create flashcards in notes completely automatically.

Smart Formatting

Create the most beautiful study materials using our templates.

Sign up to highlight and take notes. It’s 100% free.