Measuring Income Inequality
2. How Do You Separate Poverty and Income Inequality?
Poverty levels can be subjective based on the overall income levels of a country; typically poverty is measured based on a percentage of the median income. Income inequality, however, has to do with the distribution of that income, in terms of which group receives the most or the least income. Income inequality involves comparing those with high incomes, middle incomes, and low incomes - not just looking at those below or near the poverty line. In turn, measuring income inequality means dividing up the population into various groups and then comparing the groups, a task that can be carried out in several ways.
Figure 1. Growth of Family Income.
Poverty can change even when inequality does not move at all. Imagine a situation in which income for everyone in the population declines by 10%. Poverty would rise, since a greater share of the population would now fall below the poverty line. However, inequality would be the same, because everyone suffered the same proportional loss. Conversely, a general rise in income levels over time would keep inequality the same, but reduce poverty.
It is also possible for income inequality to change without affecting the poverty rate. Imagine a situation in which a large number of people who already have high incomes increase their incomes by even more. Inequality would rise as a result - but the number of people below the poverty line would remain unchanged.
Why did inequality of household income increase in the United States in recent decades? Indeed, a trend toward greater income inequality has occurred in many countries around the world, although the effect has been more powerful in the U.S. economy. Economists have focused their explanations for the increasing inequality on two factors that changed more or less continually from the 1970s into the 2000s. One set of explanations focuses on the changing shape of American households; the other focuses on greater inequality of wages, what some economists call "winner take all" labor markets. We will begin with how we measure inequality, and then consider the explanations for growing inequality in the United States.