Monday, November 03, 2008

Beware Aggregation

From CAFE HAYEK an illustration by Pietro Poggi-Corradini:
"Research on inequality usually keeps track of percentiles. So let's look at the following simple example. A society at the beginning consists of 10 individuals, 9 of which make 1 dollar and 1 who makes 10 dollars. Social scientists decide to keep track of the top 20%. So the top 20% makes an average of 5.5 dollars while the bottom 80% makes an average of 1 dollar. Now suppose that after 1 year there are now 8 people making 1 dollar and 2 people making 10 dollars. The top 20% now makes an average of 10 dollars. Dividing 4.5 by 5.5 this represents an 82% increase for the top quintile. The bottom 80% on the other hand sees a 0% increase in income. One would like to conclude that 'inequality has risen'. But if you were given a choice to live in a society like the earlier one with 9 people making the same income of 1 dollar and one very rich person making 10 dollars, or live in the latter society where less people make 1 dollar and more people make 10 dollar, what would you choose? A simple calculus of probability tells me that the latter society might be more appealing to most people."
I offer this just as another illustration of my warning to beware the stories told based upon aggregation.

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