Lorenz Curve

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Limitations of the Lorenz Curve

The Lorenz Curve illustrates the degree of equality (or inequality) of distribution of income in an economy. It plots the cumulative percentage of income received by cumulative shares of the population and includes a straight line to illustrate perfect income equality. Thus, the closer the Lorenz curve is to the straight line, the greater the equality in income distribution, while, the further away it is from the straight line, the more unequal the distribution of income.

In the diagram above, the ratio of the area between the diagonal and the Lorenz curve, to the total area under the diagonal is known as the Gini Coefficient. However, despite its simplicity there are numerous limitations to this curve. Firstly, the Lorenz curve is based on the data relating to money income rather than disposable income. It does not take into consideration personal income taxes, social security deductions, subsidies received by the poor families etc. Moreover, the data are converted to a per capita basis to adjust for differences in average family size within each quantile (5th) or decile (10th) group of the population. As a consequence, smaller families may sometimes be shown better off than large ones with greater incomes.

Furthermore, the measurement of income inequality with a Lorenz curve shows income distribution only at a given time and therefore does not take into consideration lifetime income. For instance, the income of a sports man and of a lecturer may be about the same over their lifetimes. But the income of the lecturer may be spread over a number of years say for 40 years whereas that of sports man may be realized in 10 years. Hence, the two incomes are likely to be highly unequal in a given year. Moreover, the construction of a Lorenz curve does not consider the ages of the persons, who receives income. The income of a young individual who enters jobs recently those in mid-career and of old people who have retired are...
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