6.5 Inequality

TLDR

Inequality is a way markets can fail: market outcomes often leave income and wealth spread unevenly across people and groups. For AP Microeconomics, you should be able to define income versus wealth inequality, name the tools used to measure it (the Lorenz curve and Gini coefficient), and explain why inequality happens, including factor payments, human and social capital, inheritance, discrimination, and tax structures.

more resources to help you study

practice multiple choiceFRQ practice & scoringcheatsheetsscore calculatorAMSCO guided noteskey terms

Why This Matters for the AP Microeconomics Exam

Inequality closes out Unit 6, the unit on market failure and the role of government. It connects to a big idea you have built all course: markets allocate resources, but they do not guarantee a fair distribution of income or wealth. On the exam, this topic shows up as conceptual questions rather than heavy graphing.

You may be asked to:

• Identify the difference between income inequality and wealth inequality.
• Recognize the Lorenz curve and Gini coefficient as measures of inequality and read what they represent.
• Explain sources of income and wealth inequality, including how factor markets pay each input the value of its marginal product.
• Compare progressive and regressive tax structures and connect them to inequality.

One important note: drawing the Lorenz curve and calculating the Gini coefficient are outside the scope of the course and the exam. You need to know what these tools measure and how to interpret them, not how to construct them.

Key Takeaways

• Income inequality looks at how annual earnings are distributed; wealth inequality looks at how assets are distributed. They are related but not the same.
• Income levels and poverty rates vary widely both across and within groups (such as age, gender, and race) and across countries.
• The Lorenz curve and Gini coefficient are tools to represent inequality and to compare distributions across countries, policies, or time periods. You interpret them, not draw or calculate them.
• Each factor of production earns the value of its marginal product, which can lead to unequal incomes.
• Sources of inequality include tax structures, human capital, social capital, inheritance, discrimination, access to financial markets, mobility, and bargaining power within firms, unions, and families.
• Progressive taxes take a larger share of income from higher earners; regressive taxes take a larger share from lower earners. A flat dollar tax or a simple sales tax tends to be regressive in effect.

Types of Inequality

There are two types of economic inequality: income inequality and wealth inequality. Income inequality looks at how annual earnings are distributed across people. Wealth inequality looks at how assets, like savings, property, and investments, are distributed. Someone can have a high income but little accumulated wealth, or large wealth with modest current income, so the two measures can tell different stories.

Income levels and poverty rates vary a lot, both across countries and within groups inside a country. Differences tied to age, gender, and race are common examples of this variation.

Sources of these two types of inequality include:

• Human capital (education, training, and skills)
• Social capital (networks and connections)
• Inheritance and intergenerational transfers of wealth
• Effects of discrimination
• Access to financial markets
• Mobility (the ability to move between income levels over time)
• Bargaining power within firms, labor unions, and families

A useful link back to factor markets: each factor of production tends to receive the value of its marginal product. Workers and resources with higher marginal products earn more, which is one economic reason incomes differ.

Measuring Inequality: The Lorenz Curve and Gini Coefficient

Economists use the Lorenz curve to represent income distribution in a society. It compares the actual distribution of income to a line of perfect equality. The bigger the gap between the line of perfect equality and the Lorenz curve, the more income inequality there is.

The Gini coefficient is a single number that summarizes inequality. It ranges from 0 to 1, where 0 means perfect equality (everyone has the same income) and 1 means perfect inequality (one person has all the income). A higher Gini coefficient means more inequality.

For the AP Microeconomics exam, you should be able to explain what these tools measure and use them to compare distributions across different countries, policies, or time periods. You are not expected to draw the Lorenz curve or calculate a Gini coefficient; both are outside the scope of the course and the exam.

Governments sometimes try to reduce income inequality, for example by changing how much they tax higher earners or by increasing transfer payments. Transfer payments are government payments to individuals designed to meet a specific objective rather than to pay for goods or resources, such as welfare programs.

Types of Taxes

Tax structures are one source of income and wealth inequality, and they can either widen or narrow gaps depending on how they are designed.

• Progressive taxes take a larger percentage of income from high-income groups than from low-income groups. A common example is a tiered income tax system that places people into brackets and taxes higher income at higher rates. As income rises, the share paid in tax rises too.
• Regressive taxes take a larger percentage of income from low-income groups than from high-income groups. A sales tax often works this way in effect: if two people spend the same dollar amount on taxed goods, the person with the lower income pays a larger share of their income in tax. A flat dollar amount charged to everyone is also regressive in effect, because that fixed amount is a bigger percentage of a small income than of a large income.
• Proportional taxes take the same percentage of income from all income groups. If every income level pays 20 percent, then someone earning $100 pays $20 and someone earning $1,000 pays $200. The percentage stays constant across incomes.

Progressive structures tend to reduce after-tax income inequality, while regressive structures tend to increase it. This is why tax design is treated as a source of inequality, not just a way to raise revenue.

How to Use This on the AP Microeconomics Exam

Multiple Choice

• Match the term to the definition. Be ready to separate income inequality (flow of earnings) from wealth inequality (stock of assets).
• Identify the Lorenz curve and Gini coefficient as measures of inequality. Remember 0 is perfect equality and 1 is perfect inequality.
• Classify a tax as progressive, regressive, or proportional based on how the percentage paid changes as income changes, not just the dollar amount.

Free Response

• If a prompt asks for sources of inequality, name specific ones from the list (human capital, inheritance, discrimination, bargaining power, tax structure, and so on) and briefly explain how each affects income or wealth.
• Connect factor markets to inequality: explain that each factor earns the value of its marginal product, so differences in productivity and skills show up as differences in income.
• If asked about a policy, explain the direction of the effect. For example, a more progressive tax or larger transfer payments tend to reduce after-tax income inequality.

Common Trap

• Do not try to draw a Lorenz curve or compute a Gini coefficient on the exam. You only need to interpret them.
• Watch the word "flat." A flat dollar amount per person is regressive in effect, and a flat percentage is proportional. Read carefully.

Common Misconceptions

• Income and wealth are not the same thing. Income is what you earn over a period, like a year. Wealth is the total value of assets you have accumulated. A person can rank very differently on each measure.
• A higher Gini coefficient means more inequality, not more income. The Gini coefficient measures how unevenly income is distributed, not how rich a country is overall.
• A flat tax is not automatically fair or neutral. A flat percentage tax is proportional, but a flat dollar charge is regressive in effect because it takes a larger share of a low income.
• The Lorenz curve and Gini coefficient are interpretation tools here, not calculation tasks. Drawing the curve and computing the coefficient are outside the scope of the course and the exam.
• Inequality is a distribution issue, not the same as inefficiency. A market can be efficient and still produce a very unequal distribution of income, which is exactly why inequality is studied as part of the role of government.
• Transfer payments are not payments for goods or services. They are payments meant to meet a specific objective, such as supporting low-income households, rather than buying resources.

Related AP Microeconomics Guides

• 6.1 Socially Efficient and Inefficient Market Outcomes
• 6.2 Externalities
• 6.4 The Effects of Government Intervention in Different Market Structures
• 6.3 Public and Private Goods
• Unit 6 Overview: Market Failure and the Role of Government