As you know, the terms middle and upper class are used often in the UK, but what do they actually mean and how are they related to income? How is income distributed in society, and what factors influence it? Read on to learn more about the distribution of income.
The meaning of income distribution
The easiest way to understand income distribution is with a simplified example. Imagine there are ten individuals who receive the same amount of income. In that case, the distribution of income occurs in an equal way. On the other hand, if only two individuals make an income and the other 8 receive nothing, we have uneven income distribution.
The distribution of income is a measure of how income is distributed amongst individuals and households in a society.
Additionally, income distribution as a field of study in Economics aims to analyse how income is distributed across geographies, genders, and generations. For example, it studies the difference in income between someone living in Cambridge and someone living in central London, between men and women, or between millennials and generation X.
Income distribution is also essential in measuring the difference between people living in countries with lower GDP levels and those with higher GDP. Income distribution is critical for determining the poverty rate at any GDP level for any country. A more equal distribution of income is associated with lower poverty rates in an economy.
Market failures are one of the main causes of unequal distribution of income, which is why governments should pay close attention to this topic.
Factors influencing the distribution of income
There are many factors influencing the distribution of income. Let’s study the main ones.
Factors of production
The way the income is distributed amongst the factors of production, namely, land, labour, capital, and entrepreneurs, plays a vital role in how much income an individual makes.
Think about the owners of large estates in central London near Downing Street. The amount of revenue they receive from rent does not compare to the rent one would receive from renting out an apartment in Barking and Dagenham.
Additionally, entrepreneurs owning shares in a large company make significant income from their dividend payments.
On the other hand, labour has the smallest share of the income distribution. Someone working in the factories of Tesla receives less income than the people who own Tesla shares.
Difference between earned and unearned income
Earned income is the income you get when you work an 8-hour shift and receive a salary at the end of the month. On the other hand, unearned income is the income you get when you have invested in a company and received dividend payments for that.
Unearned income usually comes from sources other than employment. The difference between earned and unearned income plays an important role in income distribution. When the difference between these two is wide, you generally would have unequal income distribution in the economy. The reason for that is that most people in a society have earned income as their primary source of income.
Wage and salary difference
The difference between salaries in the labour market plays an essential role in income distribution. When you have a wide difference between those at the top and the bottom of a company, you have a more uneven distribution of income.
The two main reasons that cause the wage and salary difference are labour productivity and labour supply.
Labour productivity plays an important role when it comes to wage differences. Think about a company’s CEO and someone who just joined the company in a junior position. The company's CEO has much higher productivity due to their experience, training, and education. In contrast, a junior position has lower productivity as they are still learning to do the job. This translates into higher demand for someone with higher labour productivity, which increases their wages.
Labour supply is another factor that influences wage differences and, therefore, income distribution. In industries with a high supply of labour, such as cleaners, the salary paid will be lower. In contrast, sectors with relatively low labour supply, such as in the autopilot labour market have higher earnings.
Globalisation and migration
Globalisation and the inflow of workers from relatively low-income countries have also played an important role in influencing income distribution. This is especially true for developed countries, particularly the UK.
The influx of workers has decreased salaries in some sectors. That’s because the labour supply is high, which then translates into lower wages.
Additionally, globalisation has also played a role in influencing income distribution. Many of the jobs that would have otherwise been in the UK have been outsourced overseas.
That’s because in less developed countries labour is cheaper. This means lower demand for UK workers, which in turn has decreased salaries and influenced the distribution of income.
Income distribution measurement
The main difference between income and wealth is that income refers to the flow of money, whereas wealth is an individual's stock.
Income distribution is the spread of income across individuals or households in society. As such, income distribution makes a great measurement to capture inequality: you can easily see the wide income distribution gap between high and low earners.
There are two main types of income distribution measurement: the Lorenz Curve and the Gini Coefficient.
The Lorenz curve
Fig. 1 - Lorenz Curve
Figure 1 shows the Lorenz Curve. Notice that the income in terms of percentage is on the vertical axis, and on the horizontal axis you have the population.
The 45-degree line of equality represents the Lorenz curve if the income distribution was equal. Notice that the population change is proportional to the change in income. In general, whenever you have a Lorenz curve close to the 45-degree line of equality, you have a more equal distribution of income in that society.
The Lorenz curve which is coloured in green shows the unequal distribution of income in society. Note that only 5% of the cumulative income in society is owned by 50% of the population.
The Gini coefficient
The Gini Coefficient is another type of measurement of income inequality.
Fig. 2 - The Gini Coefficient and the Lorenz Curve
Figure 2 shows the areas used in the calculation of the Gini coefficient around the Lorenz curve. The closer the Lorenz curve is to the 45 degree line of equality, the more equally distributed the income is.
To measure the Gini coefficient, use the following formula:
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From our graph, you can see that the Gini coefficient is:
Gini coefficient = 7/20= 0.35
The smaller the Gini coefficient, the more equal the income distribution in a country is.
Types of income distribution
The two types of income distribution are equal and unequal income distribution.
Equal distribution occurs when everyone in a society or group receives the same income.
If there were five people and the income flow was £10,000 and each of them received £2,000, they would have an equal distribution of income.
This can hardly be found in the real world on an aggregate level. Many factors at play prevent an equal distribution of income from happening.
On the other hand, unequal distribution of income happens when there are individuals who receive more than others.
If there were £10,000 flowing in a group of 5, and one received £8,000 while the remaining money was distributed equally between the other 4, they would have an unequal income distribution.
Unequal income distribution is widespread in the real world.
Income Inequality in the UK
The chart below shows income inequality in the UK during the last 10 years by plotting the values of the Gini coefficients.1
Fig. 3 - Gini Coefficient in the UK
Figure 3 above highlights the increase in household income inequality over the last 10 years. The Gini coefficient for gross income has increased by 1.8 percentage points. This represents the diminishing effectiveness of cash benefits at reducing income inequality as it reflects the moderation in the value of cash benefits received relative to the households' original incomes.
Throughout 2020, households' finances were affected because of restrictions and financial support measures put in place because of the Covid-19 pandemic.
Income inequality for retired households increased by 3.5 percentage points to 30.7% over the last 10 years, although it remains broadly unchanged compared to over the last five years according to the ONS.
In contrast, income inequality for non-retired households steadily increased by 0.2 percentage points per year to 36.5% between 2011–20 according to the ONS.
The income of the richest 1% has increased by 1.3 percentage points to 8.3% between 2011–20, thus increasing the gap between the rich and poor.
Distribution of Income - Key takeaways
- The distribution of income is a measure of how income is distributed amongst individuals and households in a society.
- An equal distribution of income is associated with lower poverty rates in an economy.
- Income distribution is critical in determining the poverty rate at any GDP level for any country.
- Factors affecting the distribution of income include: factors of production, difference between earned and unearned income, wage and salary difference, globalisation, and migration.
- There are two main types of income distribution measurement: the Lorenz curve and the Gini coefficient.
- In general, whenever you have a Lorenz curve closer to the 45-degree line of equality, you have a more equal distribution of income in society.
- The smaller the Gini coefficient, the more equal the income distribution in a country is.
- The two types of income distribution are equal and unequal income distribution.
Sources
1. Office for National statistics, ‘Household income inequality, UK: financial year ending 2020’, 2021.
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