Causes of Poverty and Inequality in Income and Wealth
Absolute poverty means an income too low to afford a fixed real standard of basic needs (food, shelter, clothing), while relative poverty is usually measured as household income below 60 percent of the median household income in a given year, so it changes as the whole income distribution changes.
Before you start
Make sure you're comfortable with these topics first:
Method
- Define absolute poverty and relative poverty precisely, and state that the two can move in opposite directions (relative poverty can fall even while absolute poverty rises, if median income falls sharply).
- Distinguish income inequality from wealth inequality, and note that wealth inequality is usually greater because assets accumulate and compound over a lifetime.
- Group the causes of poverty and inequality under four headings: labour market causes (unemployment, low pay, skills mismatch), capital and wealth causes (unequal asset ownership, inheritance, capital gains), demographic causes (household type, disability, age) and government policy causes (the design of the tax and benefit system).
- Use Gini coefficient or income quintile share data as evidence when discussing a change in inequality over time, and explain what a rising or falling Gini coefficient means.
- Explain that causes interact over time, e.g. unemployment causes low current income (poverty) and, through lost saving, can also widen wealth inequality later in life.
- For an evaluation question, judge which cause matters most for the specific period or country in the question, since the relative importance of labour market, capital and policy causes differs across time and place.
Worked example
In Year 1 a country's Gini coefficient for income is 0.30 and the income share of the top 1 percent of earners is 8 percent. By Year 20 the Gini coefficient has risen to 0.36 and the top 1 percent's income share has risen to 14 percent. Interpret this change and suggest one likely cause.
- Recall that the Gini coefficient ranges from 0 (perfect equality) to 1 (perfect inequality), so a rise from 0.30 to 0.36 means income has become more unequally distributed.
- Note that the top 1 percent's income share has nearly doubled, from 8 percent to 14 percent, which is a large increase concentrated at the very top of the distribution.
- Since both measures point the same way (rising inequality, concentrated among top earners), consider causes that particularly raise incomes at the top, such as skill-biased technological change raising demand for the highest-skilled workers, or a rising share of national income going to capital (profits, dividends, bonuses) relative to ordinary wages.
- State the conclusion: the data is consistent with rising income inequality driven by gains concentrated among the highest earners, most plausibly linked to structural changes such as skill-biased technology or a rising capital share of income, rather than a broad-based rise in incomes across all households.
Practice questions
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Q1Distinguish absolute poverty from relative poverty.Show answer
Answer: Absolute poverty means an income too low to meet a fixed real standard of basic needs; relative poverty means household income below a set proportion (commonly 60 percent) of that year's median household income.
Q2Distinguish income inequality from wealth inequality.Show answer
Answer: Income inequality is the unequal distribution of earnings and benefits received in a period; wealth inequality is the unequal distribution of accumulated assets such as property, pensions and savings, and is usually more unequal than income.
Q3State one labour market cause of poverty.Show answer
Answer: Unemployment, or low pay in low-skilled occupations.
Q4State one demographic factor associated with a higher risk of relative poverty.Show answer
Answer: Being a lone-parent household, living with a disability, or being an older person reliant on an inadequate pension.
Q5What does a Gini coefficient of 0 represent?Show answer
Answer: Perfect income equality, where every household has an identical income.
Q6Give one reason why skill-biased technological change can widen income inequality.Show answer
Answer: It raises the demand (and wage) for highly skilled workers who can use new technology effectively, while reducing demand for workers doing routine or low-skilled tasks that can be automated.
Q7Give one government policy cause that can widen income inequality.Show answer
Answer: Cutting the top rate of income tax, or reducing the real value of means-tested benefits over time (weak benefit uprating), leaves post-tax-and-benefit income more unequally distributed.
Exam-style questions
Written in the style of a A Level Economics exam paper, with a full mark scheme.
Explain two reasons why lone-parent households are more likely to experience relative poverty than two-parent households.
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Discuss the extent to which globalisation, rather than domestic tax and benefit policy, is the main cause of rising income inequality in the UK since the 1980s.
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