Markets produce income, but not equally. How income and wealth are distributed, why, and what if anything should be done about it, are among the most debated questions in economics and politics. This level looks at how inequality is measured, what might cause it, and the main arguments in policy debates.

Income and wealth

Income is a flow: what you receive over a period, such as wages, interest or benefits. Wealth is a stock: what you own minus what you owe at a point in time, such as savings, a home or shares. In most countries, wealth is distributed much more unequally than income.

Measuring inequality

The most common single measure is the Gini coefficient. It ranges from 0, meaning perfect equality (everyone has the same income), to 1, meaning one person has everything. It is often shown with a Lorenz curve, a graph of what share of total income goes to the poorest 10 percent, 20 percent and so on. The further the curve bows away from a straight line, the more unequal the distribution.

For income after taxes and transfers, Gini coefficients in the Nordic countries are roughly 0.25 to 0.30, while South Africa, among the most unequal countries measured, is above 0.6. Other measures include the share of income going to the top 1 percent, the ratio between incomes at the 90th and 10th percentiles, and the poverty rate. Each captures something different, and a country can look more or less unequal depending on the measure and on whether taxes and benefits are counted.

Causes debated

Economists offer several explanations, often combined:

• Technology may raise demand for highly skilled workers faster than their supply grows, widening wage gaps.
• Globalization: trade and offshoring can reduce demand for some workers in rich countries while raising incomes in poorer ones.
• Institutions: the strength of unions, minimum wage laws and tax systems affect who gets what.
• Returns to capital: Thomas Piketty, in Capital in the Twenty-First Century (2013), argued that when returns on wealth exceed overall growth, wealth tends to concentrate. Critics dispute his data and predictions.
• Winner-take-all markets, family background and luck also play roles.

Policy debates

Views on what to do differ partly on facts and partly on values.

• Those who favor more redistribution argue that high inequality can limit opportunity, concentrate political influence and weaken social trust, and that an extra dollar means more to a poor person than to a rich one. They support progressive taxes, transfers, public services and stronger bargaining power for workers.
• Those cautious about redistribution argue that high taxes can weaken incentives to work, save and invest, that some inequality reflects differences in effort, skill and risk-taking, and that the main concern should be reducing poverty and expanding opportunity rather than equalizing outcomes.

The economist Arthur Okun (1975) described a possible trade-off between equality and efficiency with the image of a leaky bucket: moving money from rich to poor loses some along the way through administrative costs and weaker incentives. People disagree about how big the leak is and how much is acceptable. Philosophers add different principles: John Rawls argued that inequalities are just only if they benefit the least advantaged, while Robert Nozick argued that a distribution is just if it arose through fair acquisition and voluntary exchange.

Evidence can narrow these disagreements, for example by measuring how taxes actually affect work. But how much equality to seek is finally a question of values.

Worked example: two towns, same average

Two towns each have five households and an average income of $60,000 a year.

• Elmton: $40,000, $50,000, $60,000, $70,000, $80,000.
• Oakville: $15,000, $25,000, $35,000, $45,000, $180,000.

The averages are identical, which shows how averages alone can mislead. The median (the middle household) tells more: $60,000 in Elmton, $35,000 in Oakville. In Oakville the top household receives 60 percent of all income; in Elmton, about 27 percent. Oakville's Lorenz curve bows much further from the line of equality, and its Gini coefficient is much higher.

Now add taxes and transfers. Suppose Oakville taxes the top household $40,000 and gives $20,000 each to the two poorest households. Incomes become $35,000, $45,000, $35,000, $45,000 and $140,000. Inequality falls sharply, and the poorest household's income more than doubles.

Questions an economist would ask next:

• Incentives. Would the top earner work less, move away or avoid the tax? Would the transfers change the poorer households' decisions about work? Evidence can help answer these factual questions.
• Mobility. Is the same household always at the bottom, or do people move up over their lives? A young worker earning $15,000 who will earn much more later is in a different position from someone stuck there.
• Causes. Does the top income come from a rare skill, a new business, inherited wealth or a protected position? Judgments of fairness often depend on the answer.

Finally, the value question: is Oakville after redistribution better, worse or simply different? The numbers clarify the choice; they do not make it.