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Lorenz Curve

The Lorenz curve is a graphical representation used to represent inequality of wealth or income distribution. It plots the cumulative percentages of total income received against the cumulative percentage of recipients, displaying how income or wealth is distributed among the population. The closer the Lorenz curve follows the 45-degree line of perfect equality, the more equal the income distribution; the farther the curve from the 45-degree line, the more unequal the distribution. The Gini coefficient is a measure of statistical dispersion used to represent inequality of income distribution or inequality of wealth distribution of a nation's residents, derived from the Lorenz curve. It ranges from 0, indicating perfect equality, to 1, perfect inequality.

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276 views4 pages

Lorenz Curve

The Lorenz curve is a graphical representation used to represent inequality of wealth or income distribution. It plots the cumulative percentages of total income received against the cumulative percentage of recipients, displaying how income or wealth is distributed among the population. The closer the Lorenz curve follows the 45-degree line of perfect equality, the more equal the income distribution; the farther the curve from the 45-degree line, the more unequal the distribution. The Gini coefficient is a measure of statistical dispersion used to represent inequality of income distribution or inequality of wealth distribution of a nation's residents, derived from the Lorenz curve. It ranges from 0, indicating perfect equality, to 1, perfect inequality.

Uploaded by

Aayush Sharma
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Lorenz curve:

It was developed by Max O. Lorenz in 1905 for representing inequality of the wealth distribution.The Lorenz Curve is a graphical representation of the proportionality of a distribution. It represents a probability distribution of statistical values, and is often associated with income distribution calculations and commonly used in the analysis of inequality.

The population in the Lorenz curve is represented as households and plotted on the x axis from 0% to 100%. The income is plotted on the y axis and is also from 0% to 100%.It shows for the bottom x% of households, what percentage y% of the total income they have.

Plotting of Lorenz curve :


1. The Lorenz curve is a simple way to describe income distribution using a twodimensional graph. To do this, imagine lining people (or households, depending on context) in an economy up in order of income from smallest to largest. The horizontal axis of the Lorenz curve is then the cumulative percentage of these lined up people that are being considered. For example, the number 20 on the horizontal axis represents the bottom 20 percent of income earners, the number 50 represents the bottom half of income earners, and so on.

The vertical axis of the Lorenz curve is the percent of total income in the economy.

2. We can start plotting the curve itself by noting that the points (0,0) and (100,100) have to be the ends of the curve. This is simply because the bottom 0 percent of the population (which has no people) has, by definition, zero percent of the economy's income, and 100 percent of the population has 100 percent of the income.

3. The rest of the curve is then constructed by looking at all of the percentages of the population between 0 and 100 percent and plotting the corresponding percentages of income.

4. In the example, the point (25,5) represents the (hypothetical) fact that the bottom 25 percent of people have 5 percent of the income, the point (50,20) shows that the bottom 50 percent of people have 20 percent of the income, and the point (75,40) shows that the bottom 75 percent of people have 40 percent of the income.

Perfect Equality Line If income distribution were perfectly equal, 20% of households would generate 20% of income, 50% of households would generate 50% of income, 72% of households would generate 72% of income, and so on. This situation where each element has an equal value in its shares of X and Y, that is a linear relationship, is called the perfect equality line, and would be equal to the Lorenz curve. By contrast, a perfectly unequal distribution would be one in which one person has all the income and everyone else has none. In that case, the curve would be at "y" = 0 for all "x" < 100%, and "y" = 100% when "x" = 100%. This curve is called the "line of perfect inequality." Gini Coefficient The Gini coefficient is usually defined mathematically based on the Lorenz curve, which plots the proportion of the total income of the population (y axis) that is cumulatively earned by the bottom x% of the population . The line at 45 degrees thus represents perfect equality of incomes. The Gini coefficient can then be thought of as the ratio of the area that lies between the line of equality and the

Lorenz curve (marked 'A' in the diagram) over the total area under the line of equality (marked 'A' and 'B' in the diagram); i.e., G=A/(A+B). A low Gini coefficient indicates a more equal distribution, with 0 corresponding to complete equality, while higher Gini coefficients indicate more unequal distribution, with 1 corresponding to complete inequality. By way of reference, the United States has a Gini coefficient of 0.40-0.46; Sweden has a Gini coefficient of 0.25-0.30,India has a coefficient of 0.35-0.40.

Advantages of Gini coefficient as a measure of inequality


The Gini coefficient's main advantage is that it is a measure of inequality by means of a ratio analysis. The simplicity of Gini makes it easy to use for comparison across diverse countries and also allows comparison of income distributions across different groups as well as countries; for example the Gini coefficient for urban areas differs from that of rural areas in many countries
Disadvantages of Gini coefficient as a measure of inequality The weaknesses of Gini largely lie in its relative nature: It loses information about absolute national and personal incomes. Countries may have identical Gini coefficients, but differ greatly in wealth. Basic necessities may be equal (available to all) in a rich country, while in the poor country, even basic necessities are unequally available

Limitations of the Lorenz Curve 1. Not Based on Disposable Income The Lorenz curve is based on the data relating to money income rather than disposable income. It does not take into consideration personal income taxes, social security deductions, subsidies received by the poor families etc. Moreover, the data are converted to a per capita basis to adjust for differences in average family size within each quantile (5th) or decile (10th) group of the population. As a consequence, smaller families may sometimes be shown better off than large ones with greater incomes. 2. Does not take Life Time Income The measurement of income inequality with a Lorenz curve shows income distribution only at a given time. It does not take into consideration lifetime income. For instance, the income of a sports man and of a lecturer may be about the same over their lifetimes. But the income of the lecturer may be spread over a number of

years say for 40 years whereas that of sports man may be realised in 10 years. Hence, the two incomes are likely to be highly unequal in a given year. 3. Does not consider age Differences The construction of a Lorenz curve does not consider the ages of the persons, who receives income. The income of a young individual who enters jobs recently those in mid-career and of old people who have retired are not the same. But the Lorenz curve does not distinguish incomes by ages and reflects inequalities across all ages. It is therefore not correct to group the incomes of the people belonging to different age groups for measuring income inequality.

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