Types of Equity

Horizontal equity: Fair treatment of people whose circumstances are the same.

Vertical equity: Fair treatment of people whose circumstances differ.

Measurement of Inequality

There are two main methods of measuring inequality.

1) Lorenz Curve

Lorenz curve shows % of income earned by given % of population. Perfect income distribution would be one where each % receive same % of income. The further away the Lorenz is from the perfect line the less equal the distribution of income. Shift in position of Lorenz = change in distribution of income.

2) Gini coefficient

The gini coefficient measures the area between the Lorenz curve and the line of perfect equality as a ratio of the total area under the line of perfect inequality.

Gini coefficient = Area A / (Area A + Area B)

This measurement condenses the entire income distribution into a number between 0 and 1

0 = absence of inequality

1 = extreme inequlity (a single individual having all the income)

Equity-Efficiency Trade Off

Reduced inequality may enhance equity (fairness) but blunt economic incentive.

Inequality can be useful in creating incentives and thus efficiency.

E.g. High incomes of those with high skill level creates an incentive for people to acquire similar skills

E.g. 2 High level of profit is necessary to encourage entrepreneurs to take risk