2.12 The Market's Inability to Achieve Equity (HL)

Workings of the free market economy may result in an unequal distribution of income and wealth (AO2) (HL)

As firms and households aim to maximize their own utility over others', some are bound to earn more than others. This can lead to income and wealth inequalities (and is discussed more in the macroeconomics chapter).

But why does this occur? Well, this can be seen on the circular flow of income model:

The circular flow of income, illustrating how inequalities are created in the free market (AO4) (HL)

If the leakages and injections are not balanced, inequalities will occur.

• Net Savings: Some will earn more than others, increasing income and wealth inequality. 

• Investment: Institutions and firms that already have lots of savings will be able to invest more, leading to more development compared to smaller firms. 

• Taxes: Taxes can help lower wealth and income inequality, as the wealthy could pay more than the poor.

• Government Expenditure: The government can provide payments to struggling firms and households in an attempt to reduce inequality.

• Imports and Exports: Countries have different demands, and imports and exports can both increase the country's revenue as well as increase inequalities. If country A is a large exporter and country B almost only imports, A will earn more and an inequality between the two countries will be created.

^Most of this is taught much more clearly in Macroeconomics, so don't worry if it seems confusing now.