DP Economics HL 3.4 Economics of Inequality and Poverty

DP Economics HL 3.4 Economics of Inequality and Poverty - Full notes

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DP Economics HL | 3.4 Economics of Inequality and Poverty

DP ECONOMICS · UNIT 3: MACROECONOMICS

3.4

Economics of Inequality and Poverty

Full notes for HL · IB-style

Contents

1	Equality, equity and inequality
2	Measuring income and wealth inequality
3	Poverty: absolute, relative and multidimensional
4	Causes of inequality and poverty
5	Consequences of inequality and poverty
6	Policies to reduce inequality and poverty
7	Evaluating redistribution
8	Measuring inequality: Lorenz and Gini in practice
9	Income quintiles and ratios
10	Measuring poverty
11	Causes of inequality and poverty
12	Consequences of inequality
13	The Great Gatsby curve
14	Policies: taxation
15	Policies: transfers and public services
16	Policies: labour market measures
17	Universal basic income
18	Evaluating policies
19	Mixed review: worked problems
20	Additional exam-style practice
21	Inequality between countries
22	Gender and inequality
23	Common misconceptions and links
24	Exam-style question with markscheme
25	Check your understanding
26	Summary and topic map

These are full teaching notes. Read each section in order, try the Think about it question before you read on, and do every Quick check before moving to the next section.

Before you start

Rate yourself on each statement now, and again after you've worked through the notes. Shade R (not yet), A (getting there) or G (confident).

I can…	R	A	G
distinguish equality and equity, and income and wealth inequality
interpret Lorenz curves, the Gini coefficient and income shares
distinguish absolute, relative and multidimensional poverty
explain the causes of inequality and poverty
explain the economic and social consequences of inequality
explain and evaluate taxation, transfers, merit goods, minimum wages and other policies

Inequality and poverty are studied at the same depth at SL and HL.

Guiding questions

How unequal is income in your country, and how would you measure it? Why are some people poor even in rich countries? Does reducing inequality help or hurt economic growth?

How this topic is examined

3.4 is often examined through data: Paper 2 texts with Lorenz curves, Gini coefficients or poverty statistics, followed by questions on causes and policies. Paper 1 essays ask you to evaluate policies such as progressive taxation, transfers or universal basic income.

Because 'fairness' is normative, good answers separate evidence about what policies do from value judgements about what is fair, and always consider costs and incentives.

Command term	What the examiner wants
Define	the precise meaning, ideally in the IB wording, in one or two sentences
Draw / Sketch	a fully labelled diagram with every axis, curve, equilibrium and change labelled
Explain	a causal chain linked to economic theory, usually supported by a diagram
Analyse	break a situation into its parts and trace the effects of each
Evaluate / Discuss	weigh up arguments, question assumptions and reach a justified conclusion using real-world examples
Calculate	show percentages, ratios and tax calculations step by step

How to use these notes

Each section teaches one part of the syllabus in full. You'll see these boxes throughout; each has one job:

Box	What it's for
Think about it	a question to get you thinking before a section; the answer comes in the section
Key point	the one idea you must not forget
Common mistake	an error examiners see every year, and how to avoid it
In the real world	where the economics shows up outside the classroom
Try this	something quick you can do yourself to test the idea
Worked example	full solutions with IB-style marks (M1 method, A1 answer, R1 reasoning)
Quick check	short questions to test yourself at the end of each section

1 Equality, equity and inequality

Inequality is about differences; equity is about whether they are fair.

Think about it

In many countries the richest 10% receive over a third of all income. Is that a problem in itself, or only if the poorest are very poor?

Equality means everyone has the same; equity means fairness. Most people do not want perfect equality of income, but most think some degree of inequality is unfair, especially when it reflects unequal opportunities rather than effort.

Economists distinguish inequality of outcome (differences in income and wealth) from inequality of opportunity (differences in the chances people have, based on circumstances they did not choose: family background, gender, ethnicity, where they were born).

Income is a flow: what is received over a period (wages, rent, interest, profits, transfers). Wealth is a stock: the value of assets owned at a point in time (property, shares, savings, minus debts). Wealth inequality is usually much greater than income inequality, because wealth accumulates and is inherited.

Concept	Meaning	Example
Income	a flow received over time	monthly salary, rental income
Wealth	a stock of assets at a point in time	house, shares, savings
Inequality of outcome	differences in income or wealth	top 10% earn 35% of income
Inequality of opportunity	differences in life chances	children from poor families less likely to attend university

Quick check

1. Distinguish income and wealth.

2. Why is wealth more unequal than income?

3. What is inequality of opportunity?

Answers: 1. income is a flow; wealth is a stock 2. wealth accumulates and is inherited 3. differences in life chances due to circumstances not chosen

2 Measuring income and wealth inequality

Lorenz curves, the Gini coefficient and income shares.

The Lorenz curve plots the cumulative share of income (vertical axis) received by the cumulative share of the population, ranked from poorest to richest (horizontal axis). The 45° line of equality shows perfect equality. The further the Lorenz curve bows away from it, the greater the inequality.

The Gini coefficient equals the area between the line of equality and the Lorenz curve (A), divided by the total area under the line of equality (A + B). It ranges from 0 (perfect equality) to 1 (perfect inequality). Nordic countries have Gini coefficients around 0.25 to 0.28; the United States about 0.39; South Africa above 0.6.

Income shares by quintile or decile give a simpler picture: for example, the share of income received by the top 20% compared with the bottom 20%.

Figure 1. Lorenz curves for a country: inequality rose between 2000 and 2020.

Figure 2. Income shares by quintile.

WORKED EXAMPLE 1 Income shares

Using the quintile data above, calculate the ratio of the top 20% share to the bottom 20% share, and the share of the bottom 40%.

Solution

Ratio = 44 ÷ 6 = 7.3: the top fifth receives over seven times the income of the bottom fifthA1

Bottom 40% = 6 + 11 = 17% of incomeA1

Taxes and transfers reduce measured inequality. Many countries report Gini coefficients both before and after taxes and transfers: in OECD countries, redistribution typically reduces the Gini by about a quarter to a third.

Quick check

1. What does a Lorenz curve further from the line of equality show?

2. What is the range of the Gini coefficient?

3. Why is the Gini lower after taxes and transfers?

Answers: 1. more inequality 2. 0 to 1 3. redistribution raises low incomes and reduces high ones

3 Poverty: absolute, relative and multidimensional

Poverty can be defined by a fixed line, by comparison with others, or by deprivations.

Absolute poverty means having income below the level needed to meet basic needs: food, water, shelter, clothing. The World Bank's international poverty line is $2.15 a day (2017 PPP). Absolute poverty has fallen dramatically worldwide since 1990, mainly because of growth in China and India, but around 700 million people remain below the line.

Relative poverty means having income well below the typical level in a society, commonly defined as below 50% or 60% of median income. It measures social exclusion: people who cannot afford what most others take for granted. Relative poverty can persist or even rise as a country gets richer, if lower incomes grow more slowly than the median.

The Multidimensional Poverty Index (MPI), developed by the UNDP and Oxford University, measures poverty directly through deprivations in three dimensions: health (nutrition, child mortality), education (years of schooling, attendance) and living standards (electricity, water, sanitation, housing, cooking fuel, assets). A household is multidimensionally poor if it is deprived in at least a third of the weighted indicators.

Measure	Definition	Strength	Weakness
Absolute poverty	income below a fixed basic-needs line	comparable across countries and time	ignores social context
Relative poverty	income below a share of median income	captures social exclusion	can rise even when everyone is better off
MPI	deprivations in health, education, living standards	measures actual deprivation	data-intensive; weights are a judgement

Common mistake

Saying relative poverty disappears as a country grows. It depends on the gap between low incomes and the median, not on the level of income.

Quick check

1. Define absolute poverty.

2. How is relative poverty usually measured?

3. Name the three dimensions of the MPI.

Answers: 1. income below that needed for basic needs 2. below 50% or 60% of median income 3. health, education, living standards

4 Causes of inequality and poverty

Unequal resources, unequal opportunities and unequal power.

Inequality of opportunity. Children from poor families often have less access to good schools, health care and networks, so they earn less as adults. Poverty is passed between generations.

Differences in human capital. Education and skills strongly determine earnings. Technological change has raised the returns to high skills, widening wage gaps.

Ownership of capital and inheritance. Returns to capital (profits, rent, interest) go to those who already own assets. When the return on capital exceeds the growth rate of the economy, as Thomas Piketty argued, wealth concentrates further.

Discrimination by gender, ethnicity, caste, religion or disability lowers the wages and job prospects of some groups.

Market power and weakened labour bargaining power. Declining union membership and dominant employers can hold down wages.

Globalization. Competition from low-wage countries has reduced demand for low-skilled workers in high-income countries, while raising returns to capital and high skills.

Tax and benefit systems. Cuts in top tax rates and less generous benefits increase post-tax inequality.

Unemployment, ill health and old age. People without work or unable to work are at high risk of poverty, especially where social protection is weak.

Quick check

1. Give four causes of inequality.

2. How does technology affect inequality?

Answers: 1. opportunity, human capital, capital ownership, discrimination, globalization, tax systems 2. raises returns to high skills, widening wage gaps

5 Consequences of inequality and poverty

High inequality has economic, social and political costs.

Lower human capital and productivity. Poor households cannot invest in education and health, so talent is wasted and the economy's productive potential is lower.

Lower and less stable growth. IMF research has found that high inequality is associated with shorter spells of growth. Lower-income households spend a higher share of income, so concentrating income among the rich can weaken aggregate demand.

Social problems. Higher inequality is associated with more crime, poorer health, lower trust and lower social mobility.

Political consequences. Concentrated wealth can bring concentrated political influence, and inequality can fuel social unrest and populism.

Some inequality is also seen as a necessary incentive: higher rewards for skill, effort and risk-taking encourage education, work and entrepreneurship. The debate is about how much inequality is useful and how much is harmful.

6 Policies to reduce inequality and poverty

Taxes, transfers, services, the labour market and opportunity.

6.1 Taxation

A progressive tax takes a rising share of income as income rises (2.12). Progressive income taxes, along with wealth, property and inheritance taxes, reduce inequality directly. Regressive taxes, such as VAT and excise duties, take a larger share of low incomes and increase inequality, although they can be designed with exemptions for essentials such as food.

WORKED EXAMPLE 2 Effective marginal tax rate and the poverty trap

A low-income worker loses $0.70 of benefits and pays $0.20 of tax for each extra $1 earned. Calculate the effective marginal tax rate and explain the problem.

Solution

Effective marginal tax rate = 0.70 + 0.20 = 0.90, or 90%A1

The worker keeps only 10 cents of each extra dollar earnedR1

This is a poverty trap: little incentive to work more or seek promotionR1

6.2 Transfer payments

Transfer payments (pensions, unemployment and child benefits, disability payments) raise the incomes of those with little or no market income. Means-tested benefits go only to those below an income threshold: they are well targeted and cheaper, but can create poverty traps and stigma, and take-up is often low. Universal benefits go to everyone in a category: simple and without stigma, but costly.

Universal basic income (UBI) would give every adult a regular unconditional payment. Supporters argue it would end poverty traps and give security in a changing labour market; critics point to its very high cost and possible effects on work incentives. Trials in Finland and Kenya have produced mixed evidence.

Conditional cash transfers pay poor families if they meet conditions such as school attendance and health check-ups. Brazil's Bolsa Família and Mexico's Prospera are well-known examples that reduced poverty while improving children's education.

6.3 Merit goods, labour market and opportunity policies

Free or subsidized education and health care give equal access and build human capital, reducing future inequality. Minimum wages raise low pay (2.7). Anti-discrimination and equal-pay laws address unequal treatment. Early-childhood education, affordable housing and access to credit (for example microfinance) improve opportunity.

Policy	How it helps	Possible drawback
Progressive taxation	reduces high incomes' share	disincentives, avoidance, capital flight
Means-tested transfers	targets the poor	poverty trap, stigma, low take-up
Universal basic income	security, no poverty trap	very costly
Conditional cash transfers	income plus human capital	administration, conditions may exclude the poorest
Free education and health care	equal access, long-term gains	cost, quality, slow effects
Minimum wage	raises low pay	possible job losses

Quick check

1. What is a poverty trap?

2. Give one advantage of means-tested benefits.

3. How do conditional cash transfers work?

Answers: 1. high effective marginal tax rates discourage extra work 2. well targeted and cheaper 3. payments conditional on schooling or health checks

7 Evaluating redistribution

Weigh fairness against incentives, cost and evidence.

When evaluating policies to reduce inequality and poverty, consider: effectiveness (does it reach those in need?); cost and opportunity cost (what else could the money do?); incentives (does it discourage work, saving or investment?); time scale (education takes years to affect incomes); unintended consequences (poverty traps, avoidance, capital flight); and evidence from countries that have tried the policy.

Nordic countries combine high taxes and generous services with high employment and productivity, suggesting that well-designed redistribution need not damage efficiency. But policies that work in one country may not transfer easily to another with different institutions and tax capacity.

Key point

Strong evaluation names a specific policy, a specific group, a specific trade-off, and a specific country example.

8 Measuring inequality: Lorenz and Gini in practice

Comparing countries.

Lorenz curves and Gini coefficients compare inequality between countries and over time. Pre-tax Gini measures market income inequality; post-tax-and-transfer Gini shows the effect of redistribution.

Figure 3. Redistribution moves the Lorenz curve towards the line of equality.

WORKED EXAMPLE 3 Redistribution (standard)

A country's Gini is 0.48 before taxes and transfers and 0.31 after. Interpret.

Solution

Market incomes are quite unequalR1

Taxes and transfers substantially reduce inequalityR1

9 Income quintiles and ratios

Simple inequality measures.

Inequality can be measured by the share of income of each quintile (20% group) or by ratios such as the income of the top 10% divided by the bottom 10% (S90/S10) or the Palma ratio (top 10% share / bottom 40% share).

Quintile	Share of income
poorest 20%	6%
second	11%
third	16%
fourth	23%
richest 20%	44%

WORKED EXAMPLE 4 Ratio (standard)

Calculate the ratio of the richest to the poorest quintile's share.

Solution

44/6M1

= 7.3A1

10 Measuring poverty

Absolute, relative and multidimensional.

Absolute poverty uses a fixed line (World Bank $2.15 per day at 2017 PPP). Relative poverty uses a share of median income (often 60%). The Multidimensional Poverty Index (MPI) considers deprivations in health, education and living standards.

WORKED EXAMPLE 5 Relative poverty (standard)

Median income is $30 000. Using 60% of median, calculate the relative poverty line.

Solution

0.6 × 30 000M1

= $18 000A1

11 Causes of inequality and poverty

A range of factors.

Causes include: inequality of opportunity (education, health), differences in human capital, wealth and inheritance, discrimination, globalization and technological change (skill-biased), weak tax systems, and limited social safety nets.

WORKED EXAMPLE 6 Technology (exam level)

Explain how technological change can increase inequality.

Solution

Raises demand and wages for high-skilled workersR1

Automation reduces demand for low-skilled routine jobsR1

12 Consequences of inequality

Economic and social effects.

High inequality is associated with lower social mobility, poorer health outcomes, higher crime, reduced social cohesion and political instability; it may lower long-term growth by limiting human capital investment.

Quick check

1. Give two consequences of high income inequality.

Answers: 1. lower social mobility; poorer health and social outcomes

13 The Great Gatsby curve

Inequality and mobility.

Countries with higher income inequality tend to have lower intergenerational mobility: children's incomes are more closely linked to their parents'. This is shown by the 'Great Gatsby curve'.

In the real world

Denmark and Norway have low inequality and high mobility; the United States and United Kingdom have higher inequality and lower mobility.

Quick check

1. What does the Great Gatsby curve show?

Answers: 1. higher inequality is associated with lower social mobility

14 Policies: taxation

Progressive taxes.

Progressive income taxes, wealth taxes, inheritance taxes and capital gains taxes reduce inequality. Design issues include avoidance, evasion, capital flight and incentive effects.

WORKED EXAMPLE 7 Wealth tax (exam level)

Evaluate a wealth tax as a policy to reduce inequality.

Solution

Targets the most unequal distribution (wealth)R1

Hard to value assets; avoidance; capital flightR1

15 Policies: transfers and public services

Spending to reduce inequality.

Transfer payments (unemployment benefits, child benefits, pensions, conditional cash transfers) and universal public services (education, healthcare) reduce inequality and poverty.

WORKED EXAMPLE 8 Conditional cash transfers (standard)

Explain how conditional cash transfers can reduce long-term poverty.

Solution

Cash provided if children attend school or health check-upsR1

Improves human capital of the next generationR1

In the real world

Brazil's Bolsa Família programme gives monthly payments to low-income families conditional on school attendance and vaccinations; it reached about a quarter of the population.

16 Policies: labour market measures

Minimum wages and training.

Minimum wages raise the incomes of the lowest paid; training and apprenticeships increase skills; anti-discrimination laws improve opportunities. Effects depend on how policies are designed and enforced.

Quick check

1. Why might training be more effective than minimum wages in the long run?

Answers: 1. raises productivity and earning potential permanently

17 Universal basic income

A radical proposal.

A universal basic income (UBI) pays every adult a regular unconditional sum. Supporters argue it reduces poverty and bureaucracy and supports workers as automation grows; critics point to high cost and possible reduced work incentives.

Quick check

1. Give one argument for and one against UBI.

Answers: 1. simple, reduces poverty; very expensive, may reduce incentives

18 Evaluating policies

Trade-offs and evidence.

Evaluate policies by effectiveness, cost, incentive effects, administrative feasibility, political acceptability and time frame. Evidence from different countries helps judge what works.

WORKED EXAMPLE 9 Framework (standard)

List four criteria for evaluating an anti-poverty policy.

Solution

Effectiveness; cost to governmentA1

Incentive effects; time lag/feasibilityA1

19 Mixed review: worked problems

Bringing the ideas together.

WORKED EXAMPLE 10 Mixed problem (exam level)

Explain why a country's Gini coefficient might rise even when absolute poverty falls.

Solution

Incomes of the poor rise above the absolute lineR1

But incomes of the rich rise faster, increasing inequalityR1

20 Additional exam-style practice

Paper 1 and Paper 2.

WORKED EXAMPLE 11 Paper 1 part (b) (exam level)

Using real-world examples, evaluate policies to reduce poverty. [15]

Solution

Transfers, public services, minimum wage, educationR1 R1

Examples (Bolsa Família, Nordic countries)R1

Costs, incentives, sustainability; judgementR1 R1

21 Inequality between countries

Global inequality.

Global inequality has fallen since 1990 as countries such as China and India grew rapidly, but inequality within many countries has risen. Billions of people still live on low incomes.

Quick check

1. Why has global inequality between countries fallen since 1990?

Answers: 1. rapid growth in large emerging economies such as China and India

22 Gender and inequality

Pay gaps.

Gender pay gaps reflect occupational segregation, discrimination, unpaid care work and career breaks. Policies include equal pay laws, affordable childcare and shared parental leave.

Quick check

1. Give one cause of the gender pay gap.

Answers: 1. occupational segregation or unpaid care responsibilities

23 Common misconceptions and links

Students often think…	Actually…
inequality and poverty are the same thing	a country can have little poverty but high inequality, or vice versa
relative poverty falls as a country grows	it depends on the gap with median income
a high Gini means a poor country	the Gini measures distribution, not income level
all redistribution reduces growth	some policies, such as education, may raise growth

How 3.4 connects to the rest of the course

Topic	Connection
2.12 Equity (HL)	the market's inability to achieve equity
3.3 Objectives	equitable distribution as a macro objective
3.5 Fiscal policy	taxes and transfers
4.8 Measuring development	MPI and inequality-adjusted HDI

24 Exam-style question with markscheme

Try this under exam conditions (about 18 minutes) before reading the markscheme.

Figure 4. Poverty rates by location and household head.

Text A. Poverty is concentrated in rural areas, especially among women-headed households. The government is considering a conditional cash transfer for families who keep children in school.

(a) Identify the group with the highest poverty rate. [1]

(b) Explain why poverty is higher in rural areas. [3]

(d) Explain how a conditional cash transfer could reduce poverty now and in the future. [4]

Markscheme

Part	Answer	Marks
(a)	rural women-headed households (38%)	A1
(b)	fewer jobs / dependence on agriculture	R1
	poorer access to education and health	R1
	weaker infrastructure	R1
(c)	lower wages / discrimination	R1
	unpaid care work limits employment	R1
	less access to land or credit	R1
(d)	cash raises current income	R1
	condition increases school attendance	R1
	builds children's human capital	R1
	higher future earnings; breaks intergenerational poverty	R1

Examiner's comments. In (d), the best answers separated the immediate income effect from the long-term human capital effect.

25 Check your understanding

Section A: multiple choice

1. Absolute poverty is

A. income below that needed for basic needs B. income below the median C. unemployment D. low wealth

2. Relative poverty is measured

A. by a fixed international line B. by GDP C. in relation to average incomes D. by inflation

3. A Gini coefficient of 0.31 compared with 0.48 indicates

A. more inequality B. less inequality C. higher GDP D. more poverty

4. Which policy most directly reduces relative poverty?

A. cutting top tax rates B. regressive taxes C. removing minimum wages D. means-tested transfer payments

5. Wealth inequality persists because

A. wealth is always taxed heavily B. returns on wealth accumulate and are inherited C. wages rise equally D. assets lose value

6. A poverty trap occurs when

A. people lose benefits as they earn more B. everyone is poor C. taxes are low D. inflation is high

7. Conditional cash transfers pay families

A. whatever they do B. only if unemployed C. only if retired D. if they meet conditions such as school attendance

8. The MPI measures

A. income only B. GDP growth C. deprivations in health, education and living standards D. trade

Section B: structured

9. Explain the difference between absolute and relative poverty. [4]

10. Explain two causes of income inequality. [4]

11. Evaluate universal basic income as a policy to reduce poverty. [8]

Answers

1. A 2. C 3. B 4. D 5. B 6. A 7. D 8. C

9. Absolute: below basic-needs line ($2.15/day); relative: below a share of median income; relative poverty can rise as incomes grow.

10. e.g. differences in human capital; ownership of capital and inheritance.

11. Ends poverty traps, no stigma, security; very costly, may reduce work, trial evidence mixed; alternatives; judgement.

26 Summary and topic map

Idea	Remember
Income / wealth	flow / stock
Lorenz curve and Gini	distribution; 0 to 1
Absolute poverty	below basic-needs line
Relative poverty	below 50% or 60% of median
MPI	health, education, living standards
Causes	opportunity, human capital, capital, discrimination, globalization
Policies	progressive taxes, transfers, UBI, CCTs, merit goods, minimum wage

Before the exam, make sure you…

•define poverty precisely and say which measure
•link each cause to a mechanism
•evaluate policies with cost, incentives and evidence
•use a named country example

Inequality and Poverty on one page

Cover this page with a sheet of paper and try to rebuild it from memory. Whatever you can't recall is what to revise next.

Figure 5. Topic map for Inequality and Poverty.

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