14.3 Income Inequality

“By some estimates, income and wealth inequality are near their highest
levels in the past hundred years, much higher than the average during
that time span and probably higher than for much of American history
before then.” Janet Yellen, then chair of the Board of Governors of the
Federal Reserve in the United States, made this statement in a speech in
October 2014. The issue of rising income inequality has become one of
great concern, not only to economists and politicians, but to many
citizens. While there is little doubt that inequality is rising, there is much
debate about its causes, the extent to which it matters, and what
governments can do about it. So far in this chapter we have studied how
wages and employment are determined in labour markets. Now we ask
how a nation’s total income is distributed among different segments of
the population, and what kinds of things lead to changes in this
distribution. To begin, we must first understand how the distribution of
income is measured.

Measuring Income Inequality

The founders of Classical economics, Adam Smith (1723–1790) and
David Ricardo (1772–1823), were concerned with the distribution of
income among what were then the three great social classes: workers,
capitalists, and landowners. They defined three factors of production as