Income is a flow, wealth is a stock

• Income is a flow of money over a period of time: wages, rent, interest, profit, benefits and pensions. Measured in £ per week/year.
• Wealth is a stock of assets held at a point in time: property, pension pots, shares, savings, physical assets. Measured in £.

They are linked: wealth generates income (rent, dividends, interest), and income that is saved becomes wealth. That link is what makes inequality self-reinforcing — a point Thomas Piketty pressed by arguing that when the return on capital exceeds the growth rate (r > g), inherited wealth grows faster than earned income.

Key empirical fact for the exam: in the UK, wealth is distributed far more unequally than income. Income is compressed by wages, taxes and benefits; wealth compounds across generations and is barely taxed.

Why inequality arises: differences in MRP and skills (4.1.6), unemployment and ill-health, inheritance, home ownership, pension entitlements, regional differences, and the tax and benefit system itself.

The Lorenz curve and the Gini coefficient

The Lorenz curve plots the cumulative % of income (vertical) against the cumulative % of the population, ranked from poorest to richest (horizontal).

• The 45° line is perfect equality — the poorest 20% of people would earn 20% of the income.
• The further the curve bows away from the 45° line, the more unequal the distribution.

• Gini = 0 → perfect equality (the Lorenz curve is the 45° line, so area A = 0).
• Gini = 1 → perfect inequality (one person has all the income).
• The UK's Gini for disposable income is roughly 0.35; the Nordic countries are nearer 0.25; South Africa is above 0.6.

Evaluate the measure: a single Gini number hides where in the distribution the inequality sits — a rise at the very top and a rise at the bottom can produce the same Gini. It also ignores wealth, non-cash benefits (the NHS, state schooling) and the fact that people move between deciles over a lifetime. Always pair it with the poverty rate.

Other ways to measure inequality

The Gini is not the only tool, and a good answer triangulates.

• Quintile and decile shares — split the population into fifths or tenths and report the share of income each receives. Transparent, and it shows exactly where in the distribution the change happened.
• The quintile ratio — the richest fifth's share divided by the poorest fifth's share. A ratio of 6 means the top 20% receive six times the income of the bottom 20%.
• The Palma ratio — the income share of the top 10% divided by that of the bottom 40%. It deliberately ignores the stable middle, where most of the action is not.
• The poverty rate — the share of the population below the relative poverty line.

Before and after: always distinguish original income (market income before any state action) from disposable income (after taxes and cash benefits) and final income (after benefits in kind such as the NHS and state schooling). The UK's Gini for original income is far higher than for final income — the tax and benefit system does a great deal of work, and quoting only the raw figure hides it.

Your turn — the Gini coefficient

Reading the Lorenz curve

Absolute and relative poverty

• Absolute poverty — income below the level needed to afford the basic necessities of life (food, shelter, clean water, clothing). The World Bank's international line is around $2.15 a day at PPP. Absolute poverty can, in principle, be eliminated by economic growth alone.
• Relative poverty — income below a given proportion of the median in that society. The UK/EU standard is below 60% of median household income (after housing costs are often shown too). It measures exclusion from the normal life of your society.

The crucial distinction: relative poverty is a measure of inequality, not destitution. It can only be eliminated by redistribution, never by growth alone — if all incomes double, the median doubles too and the relative poverty rate is unchanged. Conversely, in a recession where the median falls faster than the bottom decile, measured relative poverty can fall while everyone is worse off. Point that out and you are doing genuine A-level evaluation.

Causes of poverty: unemployment and low pay, low skills, ill-health and disability, old age, single parenthood, discrimination, and inadequate benefits. Note the vicious circle: poverty → poor education and health → low MRP → low pay → poverty.

Your turn — the relative poverty line

The poverty trap and the unemployment trap

The benefit system creates two perverse incentives, and both are exam favourites.

• The poverty trap (the earnings trap): a low earner who works extra hours loses means-tested benefits and pays income tax and National Insurance. Their effective marginal tax rate can exceed 70% — higher than the rate faced by a millionaire. Extra work barely pays, so the incentive to progress is destroyed.
• The unemployment trap: the gap between out-of-work benefits and low-paid work is so small that taking a job leaves someone scarcely better off — so they rationally stay unemployed.

Policy responses: Universal Credit was designed with a single, smoother taper rate (currently 55p of benefit withdrawn per £1 earned, plus work allowances) to make work always pay; raising the income tax personal allowance; the National Living Wage; and in-work benefits/tax credits.

The core trade-off: a benefit system generous enough to abolish poverty is expensive and blunts work incentives; one mean enough to sharpen incentives leaves people in poverty. There is no costless answer, and saying so is exactly what the top band asks for.

Why wealth inequality is so much larger

UK wealth inequality dwarfs income inequality, and the reasons are structural:

• Compounding and inheritance — wealth begets wealth. Assets earn returns which are reinvested, and are then passed on largely untaxed. Piketty's r > g: when the return on capital exceeds the growth rate, inherited wealth grows faster than earned income, and the share of national income going to capital rises.
• Housing — the single biggest asset for most households. Decades of house price inflation, driven by inelastic supply, have transferred enormous wealth to existing owners and locked out non-owners.
• Pensions — the second biggest, and heavily skewed by lifetime earnings.
• Asset price effects of policy — QE (4.2.4) raised bond, share and house prices. Those assets are held overwhelmingly by the already-wealthy, so a policy designed to save the economy also widened the wealth gap. A superb evaluation link between two spec sections.

Why wealth taxes are rare: wealth is mobile (it leaves), hard to value (art, private companies), and often illiquid (a pensioner in a valuable house has no cash to pay). Hence the perennial gap between the case for taxing wealth and the difficulty of doing it.

Your turn — the quintile ratio

Government policies to reduce inequality and poverty

• Progressive taxation — the average rate of tax rises with income (UK income tax: 20% / 40% / 45% bands). Contrast with regressive taxes, where the average rate falls as income rises (VAT, duties on tobacco and fuel — the poor spend a larger fraction of income on them).
• Transfer payments and benefits — Universal Credit, the state pension, disability benefits. The most direct lever on poverty.
• State provision in kind — the NHS and state education. These are worth far more, proportionally, to the poor, so they cut inequality even though they never show up in a cash income figure.
• The National Living Wage and in-work support.
• Supply-side interventionist policies — education, training and childcare that raise the MRP of the low-paid. This is the only route that raises pre-tax incomes rather than redistributing after the fact, but it is slow.
• Wealth taxes — inheritance tax, capital gains tax, council tax. Politically difficult and easy to avoid.

Equity vs efficiency — the trade-off at the heart of this topic: redistribution can blunt incentives to work, save, invest and take risks (the Laffer argument, 4.2.5), and it costs money to administer. But the counter-arguments are strong: falling marginal utility of income means £1 is worth more to a poor person than a rich one; the low-paid have a higher MPC, so redistribution supports AD; and inequality itself imposes costs (crime, poor health, wasted human capital, lower social mobility). The honest conclusion is that the trade-off exists but its steepness is an empirical question.

Which way does it push inequality?

Tap a policy or event, then tap its likely effect on income inequality.

Progressive or regressive?

Growth versus relative poverty

Match the term to its meaning

Tap a description on the left, then the term it defines.

Which trap?

Is inequality always bad?

The examiner's favourite trap is to assume the answer is obviously yes. It is not.

• The case that some inequality is necessary: differential rewards create incentives to work, train, take risks and innovate. Perfect equality of outcome destroys the price signal in the labour market. Inequality can raise the savings rate (the rich have a lower MPC), funding investment.
• The case against high inequality: the marginal utility of income diminishes, so a pound transferred from rich to poor raises total welfare. High inequality is associated with lower social mobility (the Great Gatsby curve), worse health and crime outcomes, and wasted human capital when talented poor children cannot access education. And since the poor have a higher MPC, high inequality can actually depress AD.

The mature line: the question is not equality or inequality but how much, of what kind, and arising how. Inequality that rewards genuine effort and innovation is defensible; inequality that reflects inheritance, rent-seeking or blocked opportunity is not — and it is the second kind that damages growth as well as fairness.

The big ideas to know

You have covered the whole of AQA 4.1.7. Press Finish to see your score.