2.12 The market’s inability to achieve equity (HL only)

The line of perfect equality on a Lorenz curve diagram is the 45-degree diagonal. It represents the situation where every percentage of the population receives exactly that same percentage of total income.

If perfect equality holds, the poorest 60% of households would receive exactly 60% of total income. This follows directly from the definition: the cumulative income share always equals the cumulative population share along the diagonal.

The actual Lorenz curve sags below the line of equality because the poorest households earn a smaller share of income than their population share. The 25% figure describes the real, unequal distribution — not what would happen under equality.

The answer is 60% — equal to the population share — because that is the precise definition of the line of perfect equality from which Lorenz curves always deviate downward in real economies.

The question asks what income share the poorest 60% would receive under perfect equality, not under the actual distribution.

'25%, because that is the amount the poorest 60% can realistically earn' is the actual distribution shown by the Lorenz curve, not the hypothetical equal distribution. This confuses the real curve with the line of equality.

'40%, because the top 40% always retain the majority of income' reflects a misunderstanding — under perfect equality, no group dominates. The top 40% would also receive exactly 40%, leaving 60% to the bottom 60%.

'50%, because income is split evenly between the upper and lower halves' applies only to a 50/50 population split, not to the 60% figure given in the question. It conflates a different ratio with the concept of equality.

'60%, because each percentage of population would receive an equal percentage of income' correctly applies the definition of perfect equality, where cumulative income share equals cumulative population share at every point on the diagonal.

In the circular flow model, households supply factors of production (land, labour, capital, enterprise) to firms via factor markets and receive factor payments (rent, wages, interest, profit) in return. The size of the income flow into a household depends entirely on what factors it owns and their market-determined price.

Household X owns land (rental properties) and capital (shares), earning rent and interest/dividends — large, passive income streams. Household Y owns only its unskilled labour, which is in abundant supply, so the equilibrium wage is low. The market has no mechanism to compensate Household Y for its greater effort.

Factor markets are driven by supply and demand, not by need or effort. A household that owns scarce, high-value factors receives large income flows; one that owns only abundant, low-skilled labour receives small flows. This is the structural reason free markets fail to achieve equity.

The correct answer is that factor markets reward ownership quantity and type, not effort or need — this is precisely the mechanism the circular flow model reveals as the source of market-generated income inequality.

The question asks for the best explanation of the income gap between an asset-rich, non-working household and an asset-poor, working household within the circular flow framework.

'Household X has greater need for income to maintain its properties' is incorrect because markets do not allocate income based on need. Property maintenance costs are a separate matter from how factor income is determined.

'Household Y deliberately chose a low-paying occupation' shifts blame to the worker and ignores structural factors. The circular flow model explains inequality through factor ownership, not occupational choice.

'Household Y pays more tax, which reduces its net income' is factually implausible — low-wage workers typically pay lower tax rates than high-income households — and also does not explain the pre-tax income difference.

'Factor markets reward the quantity and type of factor ownership, not the effort or need of the household' correctly identifies the circular flow mechanism through which unequal asset ownership translates into unequal income.