Income, wealth and the distribution of income
The distribution of income is how income is shared out among the people in an economy — whether most of it goes to a small number of people, or is spread more evenly.
The types of income named in the specification correspond to the factors of production from 1.1, which makes them easy to remember: wages for labour, rent for land, interest for capital and profit for enterprise. To those add transfer payments — benefits and the state pension — which are income received from the government rather than earned from supplying a factor.
Calculating them is a matter of adding the sources for income, and subtracting debts from assets for wealth.
Worked example
Sam earns a salary of £28,000, receives £600 in interest on savings and £4,200 in rent from a flat. He owns a house worth £250,000 with a £160,000 mortgage, savings of £15,000 and a car worth £8,000. Calculate his annual income and his wealth.
- Income is a flow, so add everything received over the year.
- £28,000 salary + £600 interest + £4,200 rent = £32,800.
- Wealth is a stock, so add the value of everything owned.
- £250,000 house + £15,000 savings + £8,000 car = £273,000 in assets.
- Then subtract what is owed, since wealth is net.
- £273,000 − £160,000 mortgage = £113,000.
Answer: Sam's annual income is £32,800 and his wealth is £113,000. Note that the flat generating £4,200 of rent is an example of wealth producing income — the two are linked, but they are counted separately and measured differently.
- Distribution of income
- how income is shared out among the people in an economy — whether most of it goes to a small number of people, or is spread more evenly
- Wealth
- the total value of the assets a person owns, as opposed to income, which is what they receive over a period
Causes of unequal distribution
Consequences for the economy
The specification asks you to evaluate the consequences, which means giving both sides rather than assuming inequality is simply bad.
The case that some inequality is useful. Higher pay for difficult, skilled or risky work gives people a reason to train, to work hard and to start businesses. If every job paid the same, few would take on years of training or the risk of setting up a firm. Inequality is, on this argument, the incentive that makes an economy productive.
The case against large inequality. Those on low incomes may not afford decent housing, food or healthcare, so poverty limits health, education and opportunity — and children born into it are less likely to escape it, which wastes talent the economy needs. High inequality can also reduce total spending, because people on low incomes spend nearly all of what they receive while the very wealthy save a larger share, so shifting income towards the top can reduce demand. It also raises government costs, through benefits and the health and social consequences of poverty, and can cause resentment and social tension.
The judgement most answers reach is that some inequality is necessary as an incentive, but that extreme inequality carries economic costs of its own. What the government does about it — progressive taxes, benefits, and spending on education and healthcare — is the subject of 3.5.
Common mistake
Income and wealth are not interchangeable. Income is a flow received over a period; wealth is a stock of assets held at a point in time. A question about one will not accept an answer about the other.
Before you practise
- The distribution of income is how income is shared among people in an economy.
- Income is a flow over time; wealth is a stock of assets at a point in time.
- Types of income: wages, rent, interest, profit, and transfer payments such as benefits.
- Calculate income by adding what is received; calculate wealth by adding assets and subtracting debts.
- Causes of inequality: skills, type of employment, unemployment, inheritance, asset ownership, region, age and discrimination.
- Wealth is usually distributed more unequally than income, because it accumulates and is inherited.
- Some inequality provides an incentive to train, work and take risks.
- Large inequality limits opportunity, can reduce total spending, and raises government costs.