Causes and consequences of inequality

Causes within countries

• Differences in skills and education: wages reflect productivity; skilled workers earn a premium, increased by technology.
• Wealth and inheritance: assets generate income and pass down generations.
• Labour market factors: weaker trade unions, minimum wage levels, discrimination, part-time and informal work.
• The tax and benefit system: less progressive taxes and lower benefits widen gaps.
• Globalisation and technology: raise returns to capital and skills relative to unskilled labour.
• Regional and structural change: industries decline in some areas.

Causes between countries

• Differences in capital, technology and productivity.
• Human capital: education and health.
• Institutions and governance: property rights, rule of law, corruption.
• Primary product dependency and falling terms of trade.
• Geography, conflict and colonial history.
• Access to trade and finance.

Impact of inequality

• Enterprise and incentives: some inequality rewards effort, risk-taking and education; too much may block opportunity.
• Savings: the rich save a larger share of income, so inequality can raise saving (funding investment) but reduce consumption and AD.
• Education: poor families may not afford schooling, reducing social mobility and long-run growth.
• Migration: large gaps between countries encourage migration; within countries, from rural to urban areas.
• Life expectancy: lower incomes are linked to worse health and shorter lives.

Also: social tension, crime and political instability.

Development, economic change and capitalism

• Economic change and development: in early industrialisation, inequality often rises as some workers move to higher-paid urban industry; later it may fall as education spreads and welfare states develop (the Kuznets curve idea, an inverted U shape). The evidence is mixed: inequality has risen again in many developed economies.
• The free market (capitalism): markets reward factors by their productivity and scarcity, so unequal ownership of skills and capital produces unequal incomes. Some inequality creates incentives that drive growth; but markets do not ensure a fair distribution, so governments redistribute through taxes, benefits and public services.

Worked example

Explain how high inequality might reduce long-run economic growth.

1. Poor households cannot afford education or health care.
2. Human capital is lower than it could be and talent is wasted.
3. Productivity and long-run aggregate supply grow more slowly.

Answer: Through lower investment in human capital (and possibly through political instability).

Check yourself

1. Technological change that raises demand for skilled workers is most likely to
   • widen the wage gap between skilled and unskilled workers
   • reduce inequality automatically
   • lower wages for skilled workers
   • remove the need for education
   Show answer

   widen the wage gap between skilled and unskilled workers. Higher demand for skilled labour raises its wage relative to unskilled labour.

2. Why might greater inequality reduce aggregate demand?
   • Poorer households save more of their income
   • Taxes always rise
   • Richer households have a lower marginal propensity to consume
   • Exports fall
   Show answer

   Richer households have a lower marginal propensity to consume. Moving income to the rich, who spend a smaller share, lowers consumption.

3. Explain one way in which some inequality may benefit an economy.
   Show answer

   Higher rewards for skills and risk give incentives to work, train and set up businesses (enterprise), which raises productivity and growth.. Incentives are the main argument for some inequality.

4. The Kuznets curve suggests that as a country develops, inequality
   • falls steadily
   • rises steadily
   • stays constant
   • first rises and then falls
   Show answer

   first rises and then falls. An inverted U: rising in early industrialisation, falling later.

5. Explain one cause of inequality between countries.
   Show answer

   Differences in physical and human capital mean productivity differs, so output and incomes per head are much higher in countries with more capital, education and technology (or with better institutions and less conflict).. Link the cause to productivity and incomes.

6. Explain why higher inequality is linked to lower life expectancy for the poor.
   Show answer

   Low-income households have less access to nutritious food, good housing and health care, so they suffer more illness and die younger.. Income buys the inputs to health.

7. Why does a free market economy tend to produce income inequality?
   • Governments set all wages
   • Factors are rewarded according to their productivity and scarcity, and ownership of skills and capital is unequal
   • Prices are fixed by the state
   • Markets always share income equally
   Show answer

   Factors are rewarded according to their productivity and scarcity, and ownership of skills and capital is unequal. Unequal endowments plus market rewards give unequal incomes.

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Sources

• Pearson Edexcel International Advanced Level in Economics specification (issue 2)

Last updated 8 November 2026. Spotted a mistake? Tell us.