Economics

Lorenz Curve Of Income Inequality And Wealth Distribution

This simple turn-of-the-20th-Century graph depicts a small portion of people holding a majority of society's wealth and vice versa.

The Lorenz curve of income inequality and wealth distribution is a graphical representation of the distribution of income and wealth. It was named after its developer, Max Lorenz. The X-axis represents the percentage of the number of households while the Y-axis represents the percentage of the total revenue. The graph can also be used to show the distribution of wealth (assets) the households’ posses.

Using the Lorenz Curve

The Lorenz curve is explained by statements such as “bottom 30% of all households have 12% of the total income”. The statement implies that 30% of the total populations who earn the least income earn 12% of the total income. When the income distribution is perfectly equally distributed, then, a straight line is drawn from the origin which is 45° to the Y-axis. Therefore, in this case, Y=X. This will show that each and every person earns an equal amount of income. On the other hand, if the distribution is perfectly unequal, the Y=0% for all X<100% and Y=100% when X=100%. This means that only one person is earning 100% of the income while all other people earn nothing.

Steps in Plotting the Lorenz Curve

The first step involves accumulating all income values and their corresponding frequencies. Next, one must find the percentage of the accumulated figures and represent the percentage of the frequencies on X-axis and those of the values on the Y-axis. Draw a diagonal line representing a perfect equally income distribution from the origin (X=Y). Plot the percentages of accumulated values against the percentages of the accumulated frequencies of a given distribution and join the points using a free hand. The curve must be smooth and therefore do not use a ruler. Unlike other graphs, the Lorenz graph starts at 0% and ends in 100% mark.

Relevant Applications

The concept of the Lorenz curve is used in describing inequality among people in society. The government or any other interested body will then have a clear picture of social disparities in an economy. In business circles, it is used in business modeling. For example, in consumer finance, it can be used to measure the actual percentage of debt which is attributable the percentage of people with the worst credit scores. The business is, therefore, able to know how to advance credit and to whom.

Evolution Over Time

In any capitalist economy, inherent social disparities will be encountered. In some economies, the gap between the poor and the rich is very wide, with a few individuals holding a large percentage of the total wealth and assets. Globally, most governments have been making deliberate efforts to bridge this gap by growing the percentage of the middle class. The Lorenz curve has become a very vital tool in showing the true picture of the economy. It has also been used to measure the success of poverty eradication measures.

Praises and Criticisms

There are two major drawbacks to the use of the Lorenz curve. First, the use of percentages does not give the exact value of the distribution. For example, a statement like “bottom 20% o the total population has 10% of the total income” does not show the exact number of people nor income value. It is also difficult to compare different sets of data. However, proponents have praised its ability to illustrate the proportional distribution of incomes.