An Overview of Income Distribution

  • Bhumika Dutta
  • Sep 14, 2021
  • Financial Analytics
An Overview of Income Distribution title banner

Economic Analysis is one such field of study that is practiced every day in the real world. If we look around, there are many people who are more fortunate than others in terms of wealth. The most common question in this topic is whether income and wealth are the same things.

 

 

What is the difference between Wealth and Income?

 

Wealth is an amassed collection of belongings and financial claims. It may be assigned a monetary worth if values for each of the items can be calculated; this procedure might be difficult when the possessions are such that they are unlikely to be offered for sale. 

 

Income, on the other hand, is the net sum of all payments received within a certain time period. Some nations compile wealth data based on legally mandated appraisals of deceased people's estates, which may or may not be representative of what the living own.

 

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There are also many questions that come along with it like, “What makes some people rich, some in the middle, and others poor?” and “ Is large income due to luck, effort, or a combination? These questions are understood and answered by economists. 

 

If we have to understand the problem of economic distribution, we have to understand this example discussed by the econlib, ‘If there were two people living in a world and one of them got good soil for irrigation and the other was left with rocky and infertile soil, then 50% of the population in the world would be considered as rich, and the rest would be poor”.

 

In real life, there are lots of people and the economy is more complex. This is where the distribution of income plays a major role. The word "income distribution" typically refers to obtaining basic statistical information. Even yet, it's nearly hard to ponder or talk about these issues without becoming agitated. Once the facts are established, the term "income distribution" may raise questions about justice. Let us learn more about it in detail.

 

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Income Distribution

 

The smoothness or equality with which income is distributed among members of a community is referred to as income distribution. The income distribution is fully equal if everyone earns the same amount of money. If no one makes any money except for one individual who earns everything, the income distribution is completely uneven. However, in most societies, income distribution lies somewhere in the center between equal and unequal. 

 

To measure the degree of equality or inequality, economists measure how much income is earned by several sectors of the population. As explained by this example given by SparkNotes, ‘We can create a chart detailing how much income each segment earns out of the total amount of income for all workers if we divide all workers into five segments based on how much money they make: the top 20%, the second 20%, the third 20%, the fourth 20%, and the bottom 20%, and we obtain data on how much money they make. The wider the disparity between income groups, the higher the income inequality.’ 

 

The limitation of Income distribution comes along with the difference in its definition. Sometimes there are payments that are transfers rather than the outcome of productive effort that are considered income, as are capital gains or losses that affect the worth of an individual's wealth.

 

A classification foundation must be developed in order to categorize patterns of national wealth and income. One categorization scheme divides wealth and income based on the possession of elements of production such as labour, land, capital, and, on occasion, entrepreneurship, with the corresponding kinds of revenue designated wages, rent, interest, and profit. Personal distribution data, which are often derived from tax returns, classify wealth and returns on a per capita basis. We have to learn what GNI is.

 

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What is Gross National Income (GNI)?

 

As stated in Britannica, Gross national income (GNI) per capita is an approximate estimate of yearly national income per person in various nations. Countries with a significant modern industrial sector have a substantially greater GNP per capita than less industrialized economies. 

 

In the early twenty-first century, for example, the World Bank calculated that per-capita GNP in the most-developed nations was around $10,000 or higher, but less than $825 in the least-developed ones. 

 

Within nations, income also varies considerably. In a high-income country like the United States, there is a lot of variance across industries, regions, rural and urban areas, males and females, and ethnic groupings.

 

Due to many reasons and disparities in different segments of any society, income inequality arises. Let us look into what income inequality is and how we can study it.

 

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Income Inequality

 

Income inequality and income gap division may be studied using several segmentations. Income disparity analysis segmentations are used to examine various sorts of income distributions. The study of income inequality and income disparity is based on income distributions by demographic segmentation. There are many factors that come into play while analyzing income inequality, like gender, ethnicity, occupation, income history, location, etc.

 

According to Investopedia, There are numerous notable research papers and analytical reports that provide insight into income inequality, economic disparity, and income distributions in the United States and throughout the world. Some of them are listed below:

 

 

  1. The Urban Institute:

 

One source of information on income disparity is the Urban Institute. The Urban Institute found that the poorest became poorer while the wealthy gained substantially richer in a study of 50 years of economic data.

 

 

  1. The Federal Reserve:

 

The Federal Reserve publishes a quarterly report on Distributional Financial Accounts. This study depicts the wealth distributions of US families. The Federal Reserve (source)  reported the following wealth distributions across the United States in the fourth quarter of 2019.

 

 

($T)

%

Top 1%

36.80

33%

90%-99%

41.69

37%

50%-90%

31.63

28%

Bottom 50%

1.66

1%

Total %

111.78

100%


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  1. Economic Policy institute:

 

The Economic Policy Institute published a research in 2018 that showed an overall pattern toward higher incomes for the highest earners following the 2008 recession. 

 

Many reasons may be contributing to this trend, including pay stagnation for wage earners, tax cuts for the wealthiest Americans, the loss of manufacturing employment, and a booming stock market that has inflated the value of corporate leaders and hedge fund managers. 

 

Companies are also investing extensively post-recession to attract and retain people with specialised skills in sectors such as engineering and healthcare. This has resulted in job cuts or new robotic takeovers in other functions, lowering salaries for people in less competitive jobs.

 

 Income inequality can occur due to many reasons, but one of them is Income mobility.

 

 

What is Income mobility?

 

When we are studying income inequality, we have to consider the amount of income mobility in the society. The flexibility with which individuals may move up and down the earning power hierarchy is referred to as income mobility. If the affluent continue to be rich and the poor continue to be poor, then unequal income distribution is a persistent and significant problem. 

 

However, if employees may readily move from the middle class to the top class or from the lower class to the middle class, the degree of inequality becomes less significant since the disparity is fluid and transitory (on an individual basis).

 

 

Calculation of Income Distribution

 

While percentage and cumulative percentage statistics can give us a general notion of how equal or unequal income distribution is, it is sometimes helpful to see how they line up on a graph to gain a visual sense of income equality. 

 

To do so, we must first calculate how much each population segment makes (cumulatively) and then compare the resultant curve to a completely equal income distribution, which would be a straight-line graph:


Lorenz curve (source)


A Lorenz curve is a type of graph that depicts income distribution among population segments. The Lorenz curve may also be used to calculate the Gini coefficient, which is a numerical representation of income equality. 

 

The Gini coefficient, which runs from 0 to 1, is equal to the difference in area between the actual and equal distribution curves divided by the total area under the equal distribution curve. The Gini coefficient is equal to the area of A divided by the area of (A + B) in the image above. 

 

The greater the Gini coefficient, the more income inequality there is. A perfectly equal income distribution will have a Gini coefficient of 0, whereas a fully uneven distribution will have a Gini value of 1.

 

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Conclusion

 

In any economy, balance is very important. Income disparity distributions are a continuing topic of study for both local and global governance entities. 

 

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As part of a global financial inclusion drive, new developments in financial technology and production are also helping to enhance the banking services of the world's lowest-income earners. In this article, we have learned about income distribution and income inequality.

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