Topic E: Equity - Study Notes for HKDSE Economics

Hey everyone! Welcome to our notes on Equity. You might hear people talking about the gap between the rich and the poor. That's exactly what this chapter is about! We'll explore what "fairness" means in economics, how we measure it, and the tough choices governments face when trying to create a more equal society. It's a super important topic that affects everyone, so let's dive in!


1. Efficiency vs. Equity: The Big Picture

First, let's understand two key goals every economy has: being efficient and being equitable. They sound similar, but they're very different.

Analogy: The Economic Pie

Imagine the entire economy's output is one giant pie.
- Efficiency is about making the pie as BIG as possible. It means we're using our scarce resources in the best way, producing the most goods and services we can (maximising total social surplus, where Marginal Benefit = Marginal Cost).
- Equity is about how we SLICE the pie. Is it fair that one person gets half the pie while ten others share a tiny sliver? Equity deals with the fairness of how income and wealth are distributed among people.

The Crucial Point: They Don't Always Go Together!

This is the most important idea to grasp. An economy can be perfectly efficient but have terrible equity.

  • A market can be running at peak efficiency, producing a huge amount of value (a giant pie).
  • However, the way the market works might mean that a few very skilled or lucky people end up with huge slices, while many others get very small ones.
  • So, even if resource allocation is efficient, there can still be a serious issue of income inequality.
Quick Review Box

Efficiency = Size of the pie (Maximising output).
Equity = How the pie is sliced (Fair distribution of income).
Key Idea: A perfectly efficient economy can still be very unequal!

Key Takeaway

Efficiency and equity are two separate goals. In economics, when we talk about equity, we are almost always focusing on income inequality – the gap between high-income and low-income earners.



2. How Do We Measure Income Inequality?

To have a proper discussion about inequality, we need tools to measure it. Think of these like a ruler for fairness. The two main tools you need to know are the Lorenz Curve and the Gini Coefficient.

The Lorenz Curve

Don't be scared by the name! It's just a graph that shows us a picture of income distribution.

How to Read a Lorenz Curve: Step-by-Step
  1. The Axes: The bottom axis (x-axis) shows the cumulative percentage of households, ranked from poorest to richest. The side axis (y-axis) shows the cumulative percentage of total income they earn.
  2. The Line of Perfect Equality: This is a straight, 45-degree diagonal line. It represents a perfectly equal society where the bottom 10% of households earn 10% of the income, the bottom 50% earn 50% of the income, and so on. This is our benchmark for perfect fairness.
  3. The Lorenz Curve: This is the curved line that sags below the line of perfect equality. It shows the REALITY of income distribution in a country.

The Main Rule: The further the Lorenz curve bows away from the line of perfect equality, the MORE UNEQUAL the income distribution is.

Example: If the Lorenz curve shows that the bottom 50% of households only earn 20% of the total income, that tells you there's significant inequality.

The Gini Coefficient

The Gini Coefficient takes the information from the Lorenz curve and turns it into a single, easy-to-understand number.

  • It's a value between 0 and 1.
  • Gini = 0 means Perfect Equality. (The Lorenz Curve is the same as the Line of Perfect Equality).
  • Gini = 1 means Perfect Inequality. (One person has all the income, and everyone else has zero).
Memory Aid: "Gini is Greedy"

Think of it this way: the higher the Gini coefficient, the more "greedily" the income is held by the top earners. A higher Gini means more inequality.

Relationship between the two: A more bowed Lorenz Curve (more inequality) leads to a higher Gini Coefficient.

Did you know?

Hong Kong has one of the highest Gini coefficients among developed economies. This means that income inequality is a major social and economic issue in our city. When you see news reports about this, they are using the very concepts you're learning now!

Key Takeaway

The Lorenz Curve is a visual tool showing income distribution, while the Gini Coefficient is a numerical score from 0 (perfectly equal) to 1 (perfectly unequal). A more bowed Lorenz curve means a higher Gini coefficient and greater income inequality.



3. Where Does Income Inequality Come From?

Why do some people earn so much more than others? The syllabus points to three main reasons.

1. Human Capital (e.g., Skill Differentials)

  • What it is: Human capital is the economic value of a person's skills, knowledge, education, and work experience. Think of it as an investment in yourself!
  • How it causes inequality: People who invest more in their human capital (e.g., by going to university or getting special training) can often do more complex jobs. A doctor or a software engineer has higher human capital than an unskilled worker. Because their skills are more valuable and scarcer, they command a higher salary in the job market. This difference in pay based on skills is a major source of inequality.

2. Discrimination

  • What it is: This happens when people with the exact same skills and productivity are paid differently based on non-economic factors.
  • How it causes inequality: Unfortunately, discrimination based on gender, race, age, or other factors can still happen. If two accountants with the same experience and ability are paid differently simply because of their gender, that creates an unfair source of income inequality.

3. Unequal Ownership of Capital

  • What it is: Remember, people earn income from two main sources: labour (wages from a job) and capital (earnings from assets they own). Capital includes things like property (which earns rent), stocks (which pay dividends), or a business (which makes a profit).
  • How it causes inequality: Some people own a lot of capital—perhaps they inherited it or built a successful business. Their income from these assets can be massive, far exceeding what most people earn from their jobs. This difference in wealth creates a large and often growing gap in income.

Key Takeaway

Income inequality arises from differences in skills (human capital), unfair treatment (discrimination), and differences in wealth (unequal ownership of capital).



4. Policy Concerns: What Can Be Done?

Since high inequality can be a problem, governments often intervene. But this leads to a big debate about the best way to help and the potential side effects of those policies.

Equalizing Income vs. Equalizing Opportunities

These are two different philosophies for creating a "fairer" society.

1. Equalizing Income (or Equality of Outcome)

  • Goal: To reduce the final income gap between the rich and poor.
  • How: Through policies like progressive taxes (where the rich pay a higher percentage of their income in tax) and transfer payments (like social welfare or CSSA, which give money to the poor).
  • Analogy: Everyone gets a similar-sized slice of the economic pie, no matter what.

2. Equalizing Opportunities (or Equality of Opportunity)

  • Goal: To give everyone a fair chance to succeed based on their effort and talent, regardless of their family background.
  • How: Through policies like providing free public education, public healthcare, and subsidies for job training.
  • Analogy: Everyone gets a fair start and the same basic tools to bake their own pie. Some may still end up with a bigger pie, but everyone had a fair shot.

The choice between these two approaches is a normative one – it's based on values about what society considers "fair." Most societies use a mix of both.

The Trade-off between Equity and Efficiency

This is a classic dilemma in economics. Policies designed to make society more equal (improving equity) can sometimes hurt economic efficiency (shrink the pie).

Disincentive Effects of Taxes and Transfers

This is the main reason for the trade-off. "Disincentive" just means something that makes people not want to do something.

  • Disincentive to Work Hard (from high taxes): If the government imposes very high taxes on high earners to fund welfare programs, these individuals might lose motivation. Why work overtime or start a risky new business if a large chunk of the extra earnings will be taxed away? This could lead to less innovation and slower economic growth.
  • Disincentive to Find Work (from transfers): If welfare benefits are very generous and easy to get, some people might have less incentive to look for a job, especially a low-paying one. This can lead to higher unemployment and lower national output.
How to Analyse a Policy

When you are given a policy, you should be able to discuss its likely effects on both equity and efficiency.

Example Policy: The government provides a large cash handout to all low-income citizens.

  • Effect on Equity: It will likely reduce income inequality in the short term. The incomes of the poor rise, narrowing the gap with the rich. The Gini coefficient would likely decrease.
  • Effect on Efficiency: There might be a negative impact on efficiency. It could create a disincentive for some unemployed individuals to actively seek work, potentially lowering the labour supply and the economy's total output.
Common Mistake to Avoid

Don't just say "taxes are bad for efficiency." Be specific! Explain that it is the potential disincentive effect of high taxes on working, saving, or investing that may lead to a loss in efficiency (e.g., a deadweight loss).

Key Takeaway

There is often a trade-off between equity and efficiency. Policies that redistribute income (like high taxes and welfare) can improve equity but may create disincentive effects that harm efficiency by discouraging work and investment.