Explain how the Lorenz curve and the Gini coefficient are used to measure differences in income inequality between countries.

Discuss the view that taxation is the most effective means of achieving equity in the distribution of income.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part A.

Answers may include:

• definitions of income inequality, Lorenz curve, Gini coefficient
• Lorenz curve diagram(s) with one Lorenz curve that is closer to the line of perfect income equality and another Lorenz curve that is further away from the line of perfect income equality
• explanation of why a Lorenz curve closer to the line of perfect income equality (Gini coefficient closer to zero) indicates higher income equality and/or explanation of why a Lorenz curve further away from the line of perfect income equality (Gini coefficient closer to 1) indicates lower income equality 
• examples of countries with a relatively equal (e.g. Sweden, Denmark) and relatively unequal (e.g. Brazil) distribution of income.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part B.

Answers may include:

• definitions of taxation, equity, distribution of income 
• diagram(s) showing the Lorenz curve shifting closer to the line of perfect income equality and/or the effect of imposing taxes on a market 
• explanation of why progressive taxation may increase the income equality in a country; explanation of why other government policies may also increase the income equality in a country 
• examples of progressive taxes in practice, examples of alternative policies that will make the distribution of income in a country more equal (e.g. subsidized health care services, subsidized education, subsidized utilities, old age pensions, unemployment benefits, child allowances)
• synthesis or evaluation (discuss).

Discussion may include: consideration of the meaning of the word “equity”; the difference between equity in the distribution of income and equality in the distribution of income; a consideration of whether it is the most effective means of achieving equity; the effect on equity/equality depends on the type of taxation – progressive (direct) taxation tends to decrease equality/equity while regressive (indirect) taxation may decrease equality/equity; taxation is a major source of government revenue; taxation may be used to discourage the consumption and production of goods with negative externalities; too much taxation may discourage hard work and entrepreneurship; government expenditures on human and physical capital formation may have positive effects on economic growth in the long run; transfer payments may improve the quantity and quality of human capital but may also decrease the incentives to look for employment and to work hard or study; government expenditures and transfer payments may lead to budget deficits and high levels of indebtedness.

NB It should be noted that definitions, diagrams, theory and examples that have already been given in part (a), and then referred to in part (b) should be rewarded.

Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.

A large number of candidates were unable to correctly label the axes of the diagram showing the Lorenz curve. Often they were labelled back to front, meaning that the Lorenz curve was then incorrectly drawn. Many candidates struggled to clearly explain how the Gini coefficient is derived from the information illustrated in the diagram. However, there were also candidates who were very clear in their explanations and who were also able to draw on actual Gini coefficient values for countries. Such responses were often, very well explained.  

It was important for candidates to clearly identify what was being asked for in this question. The question required candidates to consider what equity might mean. A lot of responses seemed to feel that this meant equality and framed their responses accordingly. The question was also asking candidates whether they thought taxation was "the most effective means" to achieve equity. To do that, candidates should have explored alternatives to taxation. Many candidates confined their responses to the relative merits of direct and indirect taxes and therefore struggled to generate a convincing level of synthesis. Once again, the highest-achieving responses were able to structure a well-reasoned argument supported by alternative policies and relevant use of real-word examples.