Pearson Edexcel International Advanced Level Economics: Poverty and inequality (YEC11)

This guide teaches topic 4.3.4, Poverty and inequality, from Unit 4: Developments in the global economy, in the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (Issue 2, June 2018). The specification names Units 1 and 2 as the International AS units and Units 3 and 4 as the extra International A2 units, so this topic is full International A Level content only. Unit 4 includes a data-response section and 20-mark essays, so you need both calculations and extended evaluation. Every figure below is invented for illustration. None is a real statistic.

Use the revision notes to recap and the practice questions to test yourself. Also see the Edexcel A Level Economics hub, the printable checklist, the free diagnostics and the exam preparation guide.

What this topic covers

Outcome	You must be able to
4.3.4 1a-b	Distinguish absolute and relative poverty; use measures of each
4.3.4 1c	Explain why poverty changes: growth, education and training, benefits, tax structure, structural change, aid, conflict
4.3.4 2a-b	Distinguish wealth and income inequality; use the Lorenz curve and Gini coefficient
4.3.4 2c	Explain causes of inequality within and between countries
4.3.4 2d	Analyse effects on enterprise, incentives, savings, education, migration, life expectancy
4.3.4 2e-f	Assess how economic change, development and free market capitalism affect inequality

1 Poverty (outcomes 1a and 1b)

Absolute poverty means income or consumption below a fixed level needed for basic needs such as food, water, shelter and basic health care. The line is set in real terms and does not move with average incomes. Relative poverty means income well below the typical income in the same society. The line moves as the average moves.

Measures of absolute poverty

• The headcount ratio: people below the line as a percentage of the population.
• The poverty gap: how far below the line the poor are, on average.
• An international poverty line expressed in dollars per day, and multidimensional indices that combine health, education and living standards.

Measures of relative poverty

• The share of people with income below a set fraction of the median, often 60%.
• Ratios between income groups, such as the top 10% to the bottom 10%.

Worked example 1 (illustrative). Country Alpha has 20 sampled households and a poverty line of 1,200 units a month. Five households fall below it, at 600, 800, 900, 1,000 and 1,100.

• Headcount ratio: 5 / 20 = 25%.
• Shortfalls: 600, 400, 300, 200, 100. Total 1,600.
• Average gap among the poor: 1,600 / 5 = 320, which is 26.7% of the line.
• Average gap across all households: 1,600 / 20 = 80, or 6.7% of the line.

The headcount ignores depth. A household 100 below the line counts the same as one 600 below. The gap measures catch depth, which is why you should quote both.

Worked example 2 (relative against absolute). In Alpha the median income is 2,000, so the 60% line is 1,200. A household earns 1,300 and is above the line. Median income then rises 25% to 2,500, so the line rises to 1,500. The household’s income rises 5% to 1,365.

• It is better off in real terms, assuming stable prices.
• It is now 135 below the line, so it is in relative poverty.

Absolute poverty can fall while relative poverty rises. This is the key contrast the examiner wants.

2 Causes of changes in poverty (outcome 1c)

Economic growth. Growth raises incomes and employment, and can raise tax revenue for services. The effect depends on who gains. Suppose mean income rises 4% and the headcount ratio falls from 40% to 36.8%. The change is (36.8 - 40) / 40 = -8%, so the responsiveness of poverty to growth is -8 / 4 = -2.0. Now compare a growth episode where total income rises from 1,000 to 1,200 but the poorest fifth’s share falls from 5% to 4%. Their income goes from 50 to 48, a fall of 4%. Total income grew, yet the poorest fifth lost out and inequality widened. Evaluate by asking whether growth is broad-based, labour-intensive and shared.

Education and training. Higher skills raise productivity and earnings and widen job options. The chain: more years of schooling, higher marginal product of labour, higher wages, escape from the poverty line. Lags are long, and the poorest may not afford to stay in school.

Welfare benefits. Cash transfers raise the incomes of the poor directly and reduce the poverty gap. Means-tested benefits can create a poverty trap. If a worker earns an extra 100, loses 60 in withdrawn benefits and pays 20 in tax, they keep 20. The effective marginal tax rate is (60 + 20) / 100 = 80%. Work incentives are weak, so poverty may persist.

Changes in tax structure. Progressive income taxes take a rising share as income rises. Indirect taxes can be regressive. A 10% sales tax on spending takes 900 from a household with income of 10,000 spending 90% (9% of income), but 5,000 from a household with income of 100,000 spending 50% (5% of income). A shift from direct to indirect taxes can therefore raise relative poverty. Raising the tax-free allowance does the opposite.

Structural change. Moving from farming to manufacturing and services can raise productivity and wages. It can also create structural unemployment where workers lack the new skills, or where regions lose their main industry. Net effect depends on retraining and mobility.

Aid. Aid can fund schools, clinics and infrastructure, and so cut poverty. It can fail if it is tied to the donor’s exports, is lost to corruption, creates dependency or crowds out domestic tax collection.

Civil wars and conflict. Conflict destroys capital and infrastructure, displaces people, disrupts farming and trade, diverts spending to the military and deters investment. Poverty rises sharply and may persist after peace returns.

3 Inequality: wealth, income and measurement (outcomes 2a and 2b)

Income is a flow, earned over a period from work, capital and transfers. Wealth is a stock of assets less debts, such as property, shares and savings. Wealth is usually distributed more unequally than income because it accumulates over time and is inherited, and its returns add to the owner’s income.

The Lorenz curve shows how much of total income the poorest 20%, 40% and so on receive: households are lined up from poorest to richest along the horizontal axis, and the vertical axis shows the running total of their income share. The straight diagonal is the line of equality: every group has an income share equal to its population share. A curve sagging further beneath that diagonal means a more unequal distribution.

The Gini coefficient divides area A by the total area (A + B). Area A is the gap enclosed between the diagonal and the curve. Area B is the region beneath the curve. It runs from 0 (perfect equality) to 1 (one household has everything).

Worked example 3 (illustrative). Country X has income shares by fifth, poorest to richest: 5%, 9%, 14%, 22%, 50%.

• Cumulative shares: 5, 14, 28, 50, 100.
• Area under the Lorenz curve, using straight lines between points, as trapezia of width 0.2: 0.2 x [(0 + 0.05)/2 + (0.05 + 0.14)/2 + (0.14 + 0.28)/2 + (0.28 + 0.50)/2 + (0.50 + 1.00)/2] = 0.2 x 1.47 = 0.294.
• B = 0.294, so A = 0.5 - 0.294 = 0.206.
• Gini = A / 0.5 = 1 - 2B = 1 - 0.588 = 0.412.

After taxes and benefits the shares become 8, 12, 16, 22, 42. Cumulative: 8, 20, 36, 58, 100. B = 0.344, so the Gini is 1 - 0.688 = 0.312. Redistribution shifted the Lorenz curve towards the line of equality. Country Y with shares 8, 12, 17, 23, 40 has B = 0.350 and a Gini of 0.300, so it is the most equal of the three.

Limits: grouped data hide the very top. Different curves can give the same Gini, and a Lorenz curve says nothing about the level of living standards.

4 Causes of inequality (outcome 2c)

Within countries

• Differences in skills, education and experience, which produce wage differentials.
• Discrimination and unequal access to schooling or credit.
• Ownership of assets: returns to capital and inheritance widen wealth gaps.
• Market power and rents at the top, such as high pay for scarce talent.
• Unemployment, part-time work and low-wage sectors at the bottom.
• Tax and benefit design, and regional differences.
• Technology that raises the premium on skills.

Between countries

• Differences in capital stock, human capital, technology and institutions.
• Dependence on a few primary exports with volatile prices.
• Conflict, weak governance and corruption.
• Unequal access to markets and finance, and debt.
• Population growth and health.

Worked example 4 (illustrative). Country P has income per head of 40,000 and Country Q has 2,000, a ratio of 20. P grows 2% and Q grows 4%.

• P: 40,800, a rise of 800. Q: 2,080, a rise of 80.
• Absolute gap: 38,000 rises to 38,720.
• Ratio: 40,800 / 2,080 = 19.6.

The proportionate gap narrows, yet the absolute gap widens. Say which measure you use.

5 Effects of inequality (outcome 2d)

Always give both a mechanism and a counter-point.

• Enterprise. Large rewards can encourage risk-taking. But very unequal societies may lack credit and demand for the poor, and the poor face barriers to starting firms.
• Incentives. Higher pay rewards effort and skills. Yet extreme gaps can demotivate, and high marginal rates or benefit withdrawal cut incentives at the bottom.
• Savings. The rich have a higher marginal propensity to save. If it is 30% for a high earner and 5% for a low earner, an extra 2,000 yields 600 against 100 saved, so inequality can raise national saving and investment. But low demand from the poor can reduce consumption.
• Education. Poor families may be unable to afford fees, books or time out of work. Human capital is underused and the cycle repeats across generations.
• Migration. Wage gaps push skilled workers abroad (brain drain) and pull workers to cities. Remittances may then raise recipient incomes.
• Life expectancy. Lower incomes bring poorer nutrition, housing and health care, so life expectancy is shorter.

6 Economic change, development and capitalism (outcomes 2e and 2f)

Economic change and development. The Kuznets hypothesis suggests inequality first rises as workers move into higher-paid modern sectors, then falls as schooling spreads and the state taxes and spends more. It is not a law. Globalisation and technology can widen gaps by rewarding skills and capital, though trade can also lift low-income workers into jobs. Evaluate by time period and policy.

Free market capitalism. Market prices reward productivity, risk and scarcity, so unequal rewards follow. Pro: efficiency, incentives, growth that can lift all incomes. Anti: no automatic redistribution, inherited wealth, market power, underprovision of merit goods, and poor access to credit. Most economies use taxes, transfers and public services, so the key issue is how far to intervene against the cost to efficiency.

Common errors

• Calling any fall in the poverty headcount a fall in relative poverty.
• Reading a higher Gini as more equality.
• Mixing up the Lorenz axes, or forgetting the starting point at 0%.
• Treating wealth and income as the same.
• Giving only the benefits of growth for the poor with no check on distribution.
• Stating effects of inequality with no counter-argument or time frame.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification, Issue 2, June 2018, Pearson Education Limited: Unit 4, topic 4.3.4 Poverty and inequality, points 1 and 2.