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The theoretical view in economic inequality has a long history. The deliberation of fair distribution can be old-fashioned to classical economist David Recardio and leftist theoretical matters as Karl Marx. These theorists have already documented the magnitude of distribution in the society, and among different classes of the people.

3.2.1 Kuznets Hypothesis:

A reasonably moderate theory which has prevailed in the mainstream academia for about half a century is attributed to Kuznets (1955), which argues that income inequality would change as economic growth changes or more precisely, income inequality would rise first and then decline with economic growth. This theory is related with factor movement between sectors where there is inequality, which permits income distribution does not need to be fully equalized. This theory implies that fairer distribution may lead to higher productivity.[1]

Kuznets curve is the graphical representation of Simon Kuznets's theory ('Kuznets hypothesis') that economic inequality increases over time while a country is developing, then after a critical average income is attained, begins to decrease.

Figure 3.1: Graphical representation of Kuznets curve

One theory as to why this happens, in early stages of development, when investment in physical capital is the main mechanism of economic growth, inequality encourages growth by allocating resources towards those who save and invest the most. Whereas in mature economies human capital accrual, or an estimate of cost that has been incurred but not yet paid, takes the place of physical capital accrual as the main source of growth, and inequality slows growth by lowering education standards because poor people lack finance for their education in imperfect credit markets. Kuznets curve diagrams show an inverted U curve, although variables along the axes are often mixed and matched, with inequality or the Gini coefficient on the Y axis and economic development, time or per capita incomes on the X axis.[2]

3.2.2 The Gini coefficient:

Gini’s Index introduced by Italian Statistician Corrado Gini (1912) arguably or unarguably is the most commonly used inequity metrics. It measures the extent to which the distribution of income (or consumption) among individuals or households within a country deviates from a perfectly equal distribution.[3]

The Gini coefficient is a measure of statistical dispersion most prominently used as a measure of inequality of income distribution or inequality of wealth distribution. It is defined as a ratio with values between 0 and 1: A low Gini coefficient indicates more equal income or wealth distribution, while a high Gini coefficient indicates more unequal distribution. 0 corresponds to perfect equality (everyone having exactly the same income) and 1 corresponds to perfect inequality (where one person has all the income, while everyone else has zero income). A value of 0 represents perfect equality, a value of 1 perfect inequality.

Gini’s Coefficient is mathematically expressed as[4]:

Where, G is the Gini’s coefficient n = number of individuals (households) in a group xi = income (expenditure) of ith individual (household)

3.2.3 The Lorenz curve:

The Lorenz curve is a graphical representation of the cumulative distribution function of a probability distribution; it is a graph showing the proportion of the distribution assumed by the bottom y% of the values (Arthur and et.al. 2003). It is often used to represent income distribution, where it shows for the bottom x% of households, what percentage y% of the total income they have. The percentage of households is plotted on the x-axis, the percentage of income on the y-axis. It can also be used to show distribution of assets. In such use, many economists consider it to be a measure of social inequality. It was developed by Max O. Lorenz in 1905 for representing income distribution.

Figure 3.2: Graphical representation of Gini’s index and Lorenz curve

[Source: http://en.wikipedia.org/wiki/Gini_coefficient]

However, a Lorenz curve plots the cumulative percentage of total income received against the cumulative number of recipients, starting with the poorest individual or household. The Gini index measures the area between the Lorenz curve and the hypothetical line of absolute equality, expressed as the percentage of maximum area under the line.

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[1] See Qi S, ….…..

[2] http://en.wikipedia.org/wiki/Kuznets_curve

[3] See Bhattacharya, S. and Bhattacharya, S. --------

[4] http://en.wikipedia.org/wiki/Gini_coefficient

Inequality

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Income per capita

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