Chapter 12 · Economics of inequality and poverty
Lorenz curve and Gini coefficient
Read a Lorenz curve to compare income inequality with perfect equality. Explain what the Gini coefficient measures and what it cannot tell us.
The economic idea
Income inequality is the extent to which income is distributed unevenly among individuals or households. It differs from wealth inequality because income is a flow received over time, whereas wealth is a stock of assets minus liabilities at a point in time.
A Lorenz curve orders the population from poorest to richest on the horizontal axis and plots the cumulative share of income received on the vertical axis. The line of perfect equality represents a distribution in which every cumulative share of the population receives the same cumulative share of income.
The Gini coefficient converts the whole gap between the Lorenz curve and the equality line into a summary index. A curve closer to equality has a lower Gini coefficient; a curve farther away has a higher one. If Lorenz curves cross, the visual ranking can be ambiguous even when a summary index gives a ranking.
Equality describes sameness in distribution, while equity concerns fairness and therefore involves value judgements. A more equal income distribution may be judged more equitable, but the concepts are not identical and the diagram cannot decide society’s preferred distribution.
Poverty is also distinct. Absolute poverty compares resources with a fixed basic-needs threshold, while relative poverty compares them with prevailing living standards. Two economies can have the same Lorenz curve but very different average incomes and poverty rates.
Reading Lorenz curve against Perfect income equality
“Cumulative percentage of population” runs horizontally, with households ordered from the lowest to the highest income. “Cumulative percentage of income” runs vertically.
Every point on “Lorenz curve” pairs a cumulative population share with the cumulative income share that group receives.
“Perfect income equality” is the benchmark, not an observed demand or supply curve. “Income inequality” is the complete gap used to derive the Gini coefficient when shading is displayed.
Start with the cumulative reading
Choose any point on “Lorenz curve”. Read down to “Cumulative percentage of population” to identify the poorest cumulative share of the population, then read across to “Cumulative percentage of income” to identify its cumulative share of total income.
Compare the distribution with Perfect income equality
“Lorenz curve” bows substantially below “Perfect income equality”, showing a larger degree of relative income inequality within the model. The wider the complete area between the two curves, the higher the Gini coefficient.
Interpret the Gini coefficient carefully
The Gini coefficient uses the entire “Income inequality”, rather than one selected point on “Lorenz curve”. It summarises relative inequality but does not reveal where in the distribution the gap is concentrated.
Read income shares, not individual incomes
Each point is cumulative: it compares the poorest share of the population with the share of total income they receive together. It does not show the income of one household or the percentage of people who live below a poverty line.
The area between the Lorenz curve and the line of equality helps measure relative inequality through the Gini coefficient. It is not consumer surplus, producer surplus or deadweight loss. Comparing absolute living standards requires information about real incomes as well.
From household incomes to the curve currently shown
Rank households from the lowest to the highest income using one consistent income concept and population definition.
Calculate each cumulative population group’s cumulative share of total income.
Plot those cumulative shares to form “Lorenz curve” and compare the complete curve with “Perfect income equality”.
Common mistakes to avoid
- The horizontal axis does not show the amount of income; it shows the cumulative population ordered from poorest to richest.
- A single point on “Lorenz curve” is not the Gini coefficient. The coefficient is derived from the complete distribution.
- A lower Gini coefficient does not prove that every household is richer or that absolute poverty has fallen.
- The Lorenz curve measures income distribution, not wealth distribution, social mobility or equality of opportunity.
- A more equal distribution is not automatically an equitable one; equity requires an explicit normative judgement.
How to draw this diagram
- Title the diagram “Lorenz curve and Gini coefficient”. Label the horizontal axis “Cumulative percentage of population” and the vertical axis “Cumulative percentage of income”.
- Draw Perfect income equality first and label it clearly.
- Draw Lorenz curve next and label it clearly.
- Mark each relevant intersection and distinguish the initial, market and socially optimum or policy outcomes where applicable.
- Add the relevant guide lines and shade the economic area only after its boundaries are established.
- Check that every symbol used in the explanation appears on the diagram and add arrows showing the direction of change.
Assumptions and limitations
- The smooth curve is an illustrative summary; real survey and administrative data contain sampling, reporting and top-income measurement problems.
- Meaningful comparisons require the same income definition, equivalence scale, population coverage and time period.
- Different distributions can share a similar Gini coefficient, and crossing Lorenz curves complicate ranking.
- Household size, taxes, transfers, public services and cost-of-living differences can change the interpretation of income data.
- The model is descriptive and does not identify the causes of inequality or the policy that would best change it.