IB DP Economics: Inequality and poverty

This guide follows the IB Diploma Programme Economics guide (first assessment 2022, published February 2020), the course examined from the 2022 session onwards. It covers sub-topic 3.4, the economics of inequality and poverty, in Unit 3 Macroeconomics. Most of 3.4 is SL and HL; the construction of a Lorenz curve from quintile data and two tax calculations are HL only, and are marked that way below. Every country, figure and currency here is invented.

See the IB DP Economics hub and printable checklist. Condensed recall is in the revision notes, exam-style work in the practice set, and the wider unit in measuring and managing the economy. To find weak spots first, try the free diagnostics.

What 3.4 asks you to do

Content	What you should be able to do	Level
Equality, equity, income and wealth inequality	Explain the differences	SL and HL
Measuring inequality	Draw and interpret a Lorenz curve; explain the Gini coefficient (index)	SL and HL
Constructing a Lorenz curve from income quintile data	Calculate cumulative shares and plot	HL only
Poverty	Distinguish absolute from relative poverty	SL and HL
Measuring poverty	Use single indicators (international poverty lines, minimum income standards) and the Multidimensional Poverty Index (MPI)	SL and HL
Difficulties in measuring poverty	Explain why figures are imperfect	SL and HL
Causes	Explain the eight causes the guide lists	SL and HL
Impact of inequality	Assess effects on growth, standards of living and social stability	SL and HL
Taxation	Progressive, regressive and proportional taxes; average and marginal rates; direct and indirect taxes	SL and HL
Tax calculations	Indirect tax paid; total tax and average tax rate	HL only
Further policies	Human capital, transfers, targeted spending, universal basic income, anti-discrimination, minimum wages	SL and HL

The guide gives 40 hours for Unit 3 at SL and 75 at HL, with no separate figure for 3.4. Its command terms set the depth: “explain” wants reasons, “distinguish” wants clear differences, “evaluate” wants strengths and limitations weighed up.

Equality, equity and the two kinds of inequality

Equality describes similar outcomes for different people or groups. Equity is about fairness. Fairness is a normative idea, so people disagree about it: some accept differences that come from effort, others object that starting points differed.

Income is a flow: what people receive over a period from wages, profit, interest, rent and transfers. Wealth is a stock: the value of assets owned at a point in time, such as property, shares and savings, less debts. Someone can have a high income and little wealth, or the reverse.

Measuring inequality: the Lorenz curve and Gini coefficient

A Lorenz curve shows how income is distributed.

• The horizontal axis is the cumulative percentage of households, ordered from poorest to richest (0 to 100).
• The vertical axis is the cumulative percentage of total income they receive (0 to 100).
• The line of equality is the 45-degree line from the origin to the top right corner. On it, the poorest 20% get 20% of income, the poorest 60% get 60%, and so on.
• The Lorenz curve sags below the line. The further it sags, the more unequal the distribution.

If the curve moves closer to the line of equality, inequality has fallen; further away, it has risen. If two curves cross, you cannot rank them by eye.

The Gini coefficient summarises the curve as one number: the gap area between the 45-degree line and the Lorenz curve, divided by the whole area under that line. It lies between 0 (perfect equality) and 1 (one household has everything), or 0 to 100 as an index.

Worked example (illustrative): Veltoria

Veltoria is a made-up economy. Its quintile shares of income, poorest fifth first:

Quintile	1st	2nd	3rd	4th	5th
Before tax and transfers (%)	6	10	15	22	47
After tax and transfers (%)	8	12	17	22	41

Cumulative shares (this is the HL-only construction): add the shares as you move up.

Poorest households (cumulative %)	20	40	60	80	100
Cumulative income before (%)	6	16	31	53	100
Cumulative income after (%)	8	20	37	59	100

Plot each pair as a point, add (0, 0), and join the points. At every point the “after” curve lies above the “before” curve, so it is closer to the line of equality. Tax and transfers have narrowed the income gap. The poorest 60% hold 31% before and 37% after.

The guide does not ask you to calculate a Gini value. As a rough check, join the points with straight lines and add the strip areas (width 0.2): under “before” they sum to 0.312, so Gini ≈ 1 − 2 × 0.312 = 0.376. For “after” the area is 0.348, so Gini ≈ 0.304. Straight lines slightly understate the true gap, so treat both as estimates.

Limits: one Gini value can hide different curve shapes, and neither tool says why people have what they have or whether it is fair.

Poverty: absolute and relative

Absolute poverty means income or consumption below a fixed standard needed for basic needs such as food, shelter and clothing. The standard does not move with the average. Relative poverty means having far less than others in the same society, usually judged against a share of the typical (median) income. It rises or falls with the rest of the distribution.

The difference matters when an economy grows. Veltoria sets an absolute line at 10,000 vrels a year and a relative line at 50% of median income. The median is 24,000, so the relative line is 12,000. Now all other incomes rise 10%. The median becomes 26,400 and the relative line 13,200. The household stuck at 12,500 was above the relative line and is now below it, although it is no worse off in real terms. It was above the absolute line throughout. Absolute poverty can fall while relative poverty rises.

Measuring poverty and why it is hard

Single indicators use one measure:

• International poverty lines set a common threshold so countries can be compared. They are simple, but one line cannot match every country’s prices and needs.
• Minimum income standards price a basket of goods and services judged necessary. In Veltoria a basket of food 4,800, housing 6,000, transport 1,500 and other needs 1,700 costs 14,000 vrels a year. A household earning 13,000 falls below it.

Composite indicators combine several measures. The Multidimensional Poverty Index (MPI) looks beyond income to deprivation in health, education and living standards. It catches people whose income looks adequate but who lack, say, schooling or clean water. It needs more data and judgement about what to include.

Difficulties in measuring poverty include:

• thresholds are arbitrary, and a small move in the line changes the headcount;
• prices and needs differ between regions, and between families of different sizes;
• informal work and home-grown food are hard to value, and sharing inside a household is unseen;
• surveys are costly, infrequent and may miss remote groups;
• comparing countries needs price adjustments that add error.

Causes of inequality and poverty

The guide lists eight causes. For each, give the mechanism, not just the label.

1. Inequality of opportunity: birthplace affects schooling, health and contacts, so ability alone does not decide outcomes.
2. Different levels of resource ownership: owners of land, capital and property earn rent, profit and interest on top of any wage.
3. Different levels of human capital: skills and education raise productivity and pay.
4. Discrimination (gender, race and others): unequal pay or hiring for equal work lowers some groups’ incomes.
5. Unequal status and power: bargaining power and political influence let some groups shape rules in their favour.
6. Government tax and benefits policies: a regressive tax system or weak transfers widens gaps.
7. Globalisation and technological change: these can raise demand for high-skilled workers and cut demand for low-skilled ones.
8. Market-based supply-side policies: deregulation, weaker unions and lower top tax rates can raise efficiency and also widen pay gaps.

Impact of inequality

Be ready to argue both ways on economic growth, standards of living and social stability.

• Growth: high inequality can limit growth if poorer households cannot afford education or health care, which wastes talent, or if low incomes hold back spending. Against that, wide pay differences can reward effort and risk, and richer households save and invest more.
• Standards of living: average income can rise while the poorest gain little, and deprivation harms health.
• Social stability: large gaps can feed resentment, crime and political tension, though mobility eases this.

Weigh these: the effect depends on how high inequality is and why it exists.

Taxation to reduce poverty and inequality

A direct tax is levied on income or wealth and paid by the person it falls on: personal income tax, corporate income tax and wealth tax. An indirect tax is levied on spending, such as a sales tax, and is collected by sellers.

• Progressive: the average tax rate rises as income rises.
• Regressive: the average tax rate falls as income rises.
• Proportional: the average tax rate is the same at all incomes.

Average tax rate = total tax ÷ income × 100. Marginal tax rate = extra tax ÷ extra income, the rate on the next unit earned. Under a progressive income tax the marginal rate is above the average rate.

Worked example (HL only): total tax and average rate

Veltoria taxes income: nothing on the first 10,000; 20% on income from 10,000 to 30,000; 40% above 30,000.

For an income of 45,000:

Working:

• Band 10,000-30,000: 20,000 x 0.20 = 4,000
• Band above 30,000: 15,000 x 0.40 = 6,000
• Total tax = 10,000
• Average rate = 10,000 / 45,000 x 100 = 22.2%

For 20,000 the tax is 10,000 x 0.20 = 2,000 and the average rate 10.0%; for 80,000 it is 4,000 + 20,000 = 24,000, an average rate of 30.0%. The average rate climbs with income (10.0%, 22.2%, 30.0%), so the tax is progressive. The marginal rate at 45,000 is 40%.

Worked example (HL only): indirect tax paid

Veltoria charges a 12% sales tax. A household spending 8,500 on taxed goods pays 8,500 x 0.12 = 1,020.

An equal rate can still be regressive in effect. A household with income 20,000 spending 18,000 pays 2,160, or 10.8% of income. One with income 100,000 spending 60,000 pays 7,200, or 7.2%. The poorer household bears more because it spends a larger share of income.

Further policies

• Human capital and equal opportunities: spending on schools, training and health. It tackles causes, but pays off slowly and costs money now.
• Transfer payments: cash benefits such as pensions and unemployment benefit. They raise incomes quickly but cost taxpayers, and means-tested versions may weaken work incentives.
• Targeted spending on goods and services: subsidised food, housing or health care for low-income groups. It helps where needed, but targeting is hard to administer and some eligible people are missed.
• Universal basic income: a regular payment to everyone with no conditions. It is simple and avoids means tests, but is expensive: 3,000 vrels to 4 million adults costs 12 billion vrels a year, funded by taxes or lower spending elsewhere.
• Policies to reduce discrimination: equal-pay laws and enforcement. They narrow pay gaps but take time and depend on enforcement.
• Minimum wages: a legal pay floor. If set above the market wage it may reduce jobs for some workers, so the net effect on low-income households depends on how many are priced out.

When you evaluate, weigh cost, speed, side effects, who is helped, and any conflict with efficiency and growth.

Common errors

• Leaving the Lorenz axes unlabelled; both are cumulative percentages.
• Calling a tax progressive because richer people pay more in total; it must take a larger share of income.
• Confusing the marginal tax rate with the average rate.
• Listing policies without evaluating them.

Official syllabus

IB Diploma Programme Economics guide, first assessment 2022, published by the International Baccalaureate Organization (February 2020). This page covers sub-topic 3.4.