The conflict over income inequality, the rich versus the poor, is a tale as old as time. The relevant and modern policy question is what, if anything, should be done about it. Is it exploitative that Bill Gates has extravagant homes and private planes while some people are struggling to find their next meal? Are there systemic distortions built into market economies that allow the rich to perpetuate their wealth at the expense of the poor?

These are important questions. To do well by the world, we must first understand the world’s problems; only then can economic thinking help us craft a better way forward.

Is Income Inequality Bad?

Income inequality is measured with a statistical tool called the Gini index, which shows how income is held across a group of individuals. We could measure the Gini in a college classroom, a neighborhood, a town, or a country. Most often, economists use national data for income inequality and compare it across countries.

If we were to measure the income inequality in a classroom, we might see that incomes are close to being equal. This is because most college students have similar incomes (or perhaps none) because they have similar backgrounds and are at similar stages in life. Once we broaden our measure to include more people who are different in experience and skill, the Gini index will reflect greater levels of inequality.

Whether or not income inequality is bad depends on the institutions within the society, and whether they support entrepreneurship or exploitation.

The Gini index is measured on a scale from zero to one. A score of zero indicates perfect income equality, so everyone being measured makes exactly the same income. A score of one indicates perfect income inequality: one person has all the income and everyone else has none. At first glance, we might desire equal income outcomes. We might want to live in a society with a Gini index of zero, or at least close to zero; it seems fairer. On the other hand, it’s easy to see why living in a society with a Gini index of one is not desirable at all, unless you are the one making all the income. All others must fend for themselves; thuggery and cronyism will be the only means for everyone else to survive.