Inequity and Income Inequality

Idea

Even when resources are efficiently allocated, the market may produce an inequitable outcome. The market responds to willingness and ability to pay, so low-income households — willing but unable to pay — fail to register their demand for essential goods and services.

Mechanism

Producers supply according to effective demand. Low-income consumers lack the purchasing power to back their wants with payment, so their demand goes unrecorded — they lack the “economic votes” to influence what is produced. Essential goods such as food, clean water, healthcare and education are therefore under-supplied to those who most need them.

The degree of income inequality is measured by the Gini coefficient, which ranges from 0 (perfect equality) to 1 (perfect inequality); a higher value means greater inequality. Two broad approaches narrow the gap:

Levelling up — raising the poor towards the rich by equipping low-income workers with skills and resources (retraining and reskilling).
Levelling down — redistributing from rich to poor through a more progressive tax system and larger transfer payments.

Specific instruments include progressive taxes (higher earners taxed a larger share of income), transfer payments and subsidies (MediFund medical subsidies), retraining, a minimum wage (a wage floor above the equilibrium wage), and Singapore’s Workfare Income Supplement (cash and CPF top-ups for low-income workers).

Diagram

Minimum wage in the labour market. A wage floor Wm above the equilibrium wage W0 raises pay for those still employed, but quantity of labour demanded falls to Qd while quantity supplied rises to Qs, creating a surplus of labour (unemployment) of Qs−Qd.

Considerations

A neutral catalogue of the trade-offs:

Disincentive effects. A tax system that is too progressive, or transfers that are too generous, can discourage work, since additional income is heavily taxed or substitutes for earnings.
Budget strain. Transfer payments and retraining are costly and pressure the budget.
Unemployment from a minimum wage. A wage floor raises pay for those who keep their jobs but, by raising the quantity of labour supplied above the quantity demanded, throws $Q_s - Q_d$ workers out of work — some gain at the expense of others.
Timing of benefit. Retraining yields gains only in the long run, whereas Workfare and transfers deliver immediate support; Workfare, by targeting the employed, preserves the incentive to work that unconditional benefits may erode.

The Gini coefficient is presented here in prose. Its formal construction from the Lorenz curve is a macroeconomic-indicators topic (Theme 3) rather than part of this microeconomic sub-theme.