Chapter 17 Income Distribution
I. Income Distribution
There are two major ways of categorizing where income goes in a country.
A. Functional Distribution
The Functional Distribution of Income shows total income in dollars for all factors of
production over the course of the year. More importantly it shows the amount that was
earned as income by each of the four factors of production.
Alternatively, it can represent total income for all factors as 100%, and show the
percentage of total income that was earned by each of the four factors of production.
B. Size distribution
The size distribution of income divides the nations households into five categories, all of
equal population in that each “quintile” contains one-fifth of the population. The groups
are divided by income such that the lowest earning 20% are in the first group, the next
lowest earning 20% are in the second group, and so on until the highest earning 20% of
the population compose the fifth group.
C. Lorenz Curve
1. The size distribution of income can be visually represented on a Lorenz Curve.
This curve shows the percentage of household income earned on the vertical axis by the
poorest X% of households, where X is the percentage of households that earn that total
income amount, measured on the horizontal axis. Notice that the first poorest 20% can be
mapped to the Lorenz curve directly from the distribution of income chart, since it says
what % of total income they earn.
2. However, for all subsequent points, an adjustment must be made in charting
points to the Lorenz curve. The poorest 40% and the amount they earn are not listed
directly on the Income distribution chart. Only the income earned by the second-lowest
earning quintile is listed. Therefore, to get the vertical level of the point that is
horizontally 40% of households, the % of income earned by the lowest quintile must be
added to the second-lowest quintile’s % of total income.
3. The Lorenz curve is described as being bowed outwards. This is because it is
usually drawn as a curve next to a line that is positively sloped from the intercept at 45
degrees. The curve only intercepts the straight line at the origin (0% of people always
earn 0% of income) and at 100% (all households earn all the income). The straight line
represent perfect income equality since at every point on the line X% of households earn
X% of income. 20% of people earn 20% of income, and so on. The more outwardly
bowed a Lorenz curve is, the more income inequality exists in a country. Two or more
Lorenz curves can be drawn on the same graph for comparing different countries or one
country in different time periods.