💰 Why Markets Produce Inequality
Free markets allocate resources efficiently, but they have no built-in mechanism to ensure fair distribution. Income and wealth inequality arise naturally:
Causes of income inequality
- Different skills and education — workers with more human capital earn higher wages.
- Different productivity — more productive workers are paid more in competitive labour markets.
- Inherited wealth — some people start life with capital (property, investments) that generates income.
- Market power — monopolies and oligopolies can extract supernormal profits, enriching owners.
- Discrimination — gender, racial, and other forms of discrimination lead to unequal pay for equal work.
- Globalisation and technology — high-skilled workers benefit; low-skilled workers face wage stagnation or job losses.
Income vs wealth
- Income.
- Wealth.
- Wealth inequality is typically even greater than income inequality, and wealth generates income (interest, rent), creating a self-reinforcing cycle.
🛠️ Tools of Redistribution
Governments can use several tools to reduce inequality and improve equity:
1. Progressive taxation
Progressive tax. E.g. income tax brackets. Directly reduces post-tax income inequality.
2. Transfer payments
Transfer payments. Directly increase the income of the poorest households.
3. Minimum wages
A legal wage floor raises pay for the lowest-paid workers. But if set too high, it can cause unemployment (link to topic 2.7 — price floors).
4. Public provision of services
Free or subsidised education, healthcare, and housing improve the living standards of lower-income groups without directly changing wages.
Real-world examples: Scandinavian countries combine high progressive taxes with generous welfare states, achieving Gini coefficients around 0.25. The US has lower tax rates and less redistribution, with a Gini around 0.40.
Memorize terms 3x faster
Smart flashcards show you cards right before you forget them. Perfect for definitions and key concepts.
⚖️ Evaluation of Redistribution
- ✅ Progressive taxes and transfers directly reduce income inequality (Lorenz curve shifts toward 45° line).
- ✅ Public services improve access for the poor, promoting equality of opportunity.
- ✅ Minimum wages raise pay for the lowest-paid without costing the government directly.
- ✅ Reduced inequality can improve social cohesion, health outcomes, and economic stability.
- ❌ High tax rates may reduce work incentives and encourage tax avoidance (equity–efficiency trade-off).
- ❌ Transfer payments may create dependency and reduce labour market participation.
- ❌ Minimum wages above equilibrium can cause unemployment, hurting the very workers they aim to help.
- ❌ Government failure — redistribution programmes are costly to administer and can be poorly targeted.
The IB wants balanced evaluation. Acknowledge that reducing inequality is desirable, but every policy has trade-offs. The optimal level of redistribution depends on a society's values — it's a normative question.