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1 Introductory concepts 2  Market mechanism  3 Elasticities  4 Market structures 5  Market failures  6  Macro economic activity/eco growth  7 Inflation 8  Employment & unemployment  9  External Stability  10  Income distribution 11.Factors affecting economy  12  Fiscal/Budgetary policy  13  Monetary Policy   14 Aggregate Supply Policies  15 The Policy Mix

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The lorenz curve


The Lorenz curve plots the percentage share of total income earned on the vertical axis against each quintile on the x-axis. It highlights the share of total income earned by each 20% of the household population (i.e. by each quintile).  Hypothetically, it is possible for each quintile to earn exactly the same share of total income, as shown in the table below:













This would mean that the distribution of income in the economy is absolutely equal with each quintile earning 20% of total income as shown in the first diagram below (Construction of Lorenz curve A).  In reality, there is no country in the world that has a Lorenz curve that coincides with the line of absolute equality.  Despite this, the 45 degree line is used as a useful ‘reference point’ from which we can visually determine the degree of inequality that actually exists in an economy.  The Lorenz curve for every economy will lie below the 45 degree line, highlighting that lower income groups will receive a smaller share of total income than higher income groups.


Constructing a Lorenz curve for the Australian economy based on the income statistics for 2009-10 requires us to plot each of the points A-E from the table below.








 



When plotting actual statistics it is necessary to add each of the income shares as done in the table, just as we did in the previous hypothetical example.  Figure B below demonstrates the construction of the Lorenz curve for the Australian economy in 2009-10.  It should be noted that as the Lorenz curve moves away from the 45 degree line, inequality worsens and inequality is reduced as the Lorenz curve approaches the 45 degree line.  Figure 3 highlights what would happen to the Lorenz curve if there was a significant decrease in equality.



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