Exploring Lognormal Incomes V1D 20 Nov, 2014

2014-Schield-Explore-LogNormal-Incomes-Slides.pdf 1

2014 NNN+1D 1

Milo SchieldAugsburg College

Editor: www.StatLit.orgUS Rep: International Statistical Literacy Project

www.StatLit.org/

pdf/2014-Schield-Explore-LogNormal-Incomes-Slides.pdf

XLS/Create-LogNormal-Incomes-Excel2013.xlsx

ExploringLognormal Incomes

2014 NNN+1D 2

A Log-Normal distribution is generated from a normal with mu = Ln(Median) and sigma = Sqrt[2*Ln(Mean/Median)].

The lognormal is always positive and right-skewed.

Examples:• Incomes (bottom 97%), assets, size of cities• Weight and blood pressure of humans (by gender)

Benefit: • calculate the share of total income held by the top X%• calculate share of total income held by the ‘above-average’• explore effects of change in mean-median ratio.

Log-Normal Distributions

2014 NNN+1D 3

“In many ways, it [the Log-Normal] has remained the Cinderella of distributions, the interest of writers in the learned journals being curiously sporadic and that of the authors of statistical test-books but faintly aroused.”

“We … state our belief that the lognormal is as fundamental a distribution in statistics as is the normal, despite the stigma of the derivative nature of its name.”

Aitchison and Brown (1957). P 1.

Log-Normal Distributions

2014 NNN+1D 4

Use Excel to focus on the model and the results.Excel has two Log-Normal functions:Standard: =LOGNORM.DIST(X, mu, sigma, k)

k=0 for PDF; k=1 for CDF.

Inverse: =LOGNORM.INV(X, mu, sigma)

Use Standard to calculate/graph the PDF and CDF. Use Inverse to find cutoffs: quartiles, to 1%, etc.Use Excel to create graphs that show comparisons.

Lognormal and Excel

2014 NNN+1D 5

Bibliography

.

2014 NNN+1D 6

.

Log-Normal Distribution of Units

0%

25%

50%

75%

100%

0 50 100 150 200 250 300 350 400 450 500

Incomes ($1,000)

Theoretical Distribution of Units by Income

Probability Distribution Function (PDF): as a percentage of the Modal PDF

Cumulative Distribution Function (CDF):Percentage of Units with Incomes below price

Mode: 20K

LogNormal Dist of Units  Median=50K; Mean=80K

Units can be individuals, households or families

Exploring Lognormal Incomes V1D 20 Nov, 2014

2014-Schield-Explore-LogNormal-Incomes-Slides.pdf 2

2014 NNN+1D 7

For anything that is distributed by X, there are always two distributions:

1. Distribution of subjects by X2. Distribution of total X by X.Sometime we ignore the 2nd: height or weight.Sometimes we care about the 2nd: income or assets.

Surprise: If the 1st is lognormal, so is the 2nd.

Paired Distributions

2014 NNN+1D 8

Suppose the distribution of households by income is log-normal with normal parameters mu# and sigma#.

Then the distribution of total income by amount has a log-normal distribution with these parameters: mu$ = mu# + sigma#^2; sigma$ = sigma#.

See Aitchison and Brown (1963) p. 158.Special thanks to Mohammod Irfan (Denver University) for his help on this topic.

Distribution of Households and Total Income by Income

2014 NNN+1D 9

.

Distribution of Total Income

0%

25%

50%

75%

100%

0 50 100 150 200 250 300 350 400 450 500

Unit Incomes ($1,000)

Distribution of Total Income by Income per Household

Probability Distribution Function (PDF): as a percentage of the Modal PDF

Cumulative Distribution Function (CDF):Percentage of Total Income below price

Mode: 50K

LogNormal Dist of Units by Income Median=50K; Mean=80K

Median: 128K

2014 NNN+1D

Distribution of Households and Total Income

10

0%

25%

50%

75%

100%

0 50 100 150 200

Percen

tage of Maxim

um

Income ($1,000)

Distribution of Households by Income;Distribution of Total Income by Amount

Log Normal Distribution of Households by Income Income/House: Mean=80K; Median=50K

Households by IncomeMode: $20K; Median: $50K

Mean=$80K

Distribution of Total  Income by Amount of Income

Mode: $50KMedian: $128K

Ave $205K

2014 NNN+1D 11

.

Lorenz Curve and Gini Coefficient

0%

20%

40%

60%

80%

100%

0% 20% 40% 60% 80% 100%

Percentage

 of Income

Percentage of Households

Pctg of Income vs. Pctg. of Households

Top 50% (above $50k): 83% of total IncomeTop 10% (above $175k: 38% of total IncomeTop 1% (above $475k): 8.7% of total IncomeTop 0.1% (above $1M): 1.7% of total Income

Log Normal Distribution of Households by Income Income/House: Mean=80K; Median=50K

Gini Coefficient:0.507

Bigger meansmore unequal

2014 NNN+1D 12

The Gini coefficient is determined by theMean#/Median# ratio.

The bigger this ratiothe bigger the Ginicoefficient and thegreater the economicinequality.

Champagne-GlassDistribution

0%

20%

40%

60%

80%

100%

0% 20% 40% 60% 80% 100%

Percentage

 of Households

Percentage of Income

Pctg of Households vs. Pctg of Income

Top 50% (above $50k) have 83% of total IncomeTop 10% (above $175k) have 38% of total IncomeTop 1% (above $475k) have 8.7% of total IncomeTop 0.1% (above $1M) have 1.7% of total Income

Log Normal Distribution of Households by Income Income/House: Mean=80K; Median=50K

Gini = 0.507

Bottom‐Up

Exploring Lognormal Incomes V1D 20 Nov, 2014

2014-Schield-Explore-LogNormal-Incomes-Slides.pdf 3

2014 NNN+1D 13

Conjecture: If household (HH) income is distributed log-normally and X% of households have below-average incomes, then X% of all income is earned by HH with above-average incomes.

Example: If 60% of HH have below-average incomes, then 60% of total income is earned by HH having above-average incomes.

Evidence using Excel spreadsheet: Suppose Mean# = 50K and Median# = 80K.• 68.61%: Percentage of HH having below-average income• 68.61%: Percentage of total income that is associated with

HH having above-average incomes. QED

Log-Normal Balance Conjecture

2014 NNN+1D 14

Log-normal distribution. Median HH income: $50K.

As Mean-Median Ratio Rich get Richer (relatively)

Top 5% Top 1%Mean# Min$ %Income Min$ %Income Gini

55 103 11% 138 2.9% 0.2460 135 15% 204 4.2% 0.3365 165 18% 270 5.5% 0.3970 193 20% 337 6.6% 0.4475 220 23% 406 7.7% 0.4880 246 25% 477 8.7% 0.5185 272 27% 549 9.7% 0.5390 298 29% 623 10.7% 0.56

2014 NNN+1D 15

.

Minimum Income versus Mean Income

y = 2.93 x

y = 5.4 x

0

100

200

300

400

500

600

700

800

900

60 70 80 90 100 110 120 130 140 150

Minim

um Income ($,1000)

Mean Income ($,1000)

Minimum Income for Top 5% and top 1%

Median Income: 50KLog Normal Distribution of Households by Income

2014 NNN+1D 16

US Median Income (Table 691*)• $46,089 in 1970; $50,303 in 2008

Share of Total Income by Top 5% (Table 693*)• 16.6% in 1970; 21.5% in 2008

Best log-normal fits: • 1970 Median 46K, Mean 53K: Ratio = 1.15• 2008 Median 50K, Mean 73K; Ratio = 1.46

* 2011 US Statistical Abstract (2008 dollars).

Which parameters best model US household incomes?

2014 NNN+1D 17

Conclusion

Using the LogNormal distributions provides a principled way students can explore a plausible distribution of incomes.

Allows students to explore the difference between part and whole when using percentage grammar.

2014 NNN+1D 18

Bibliography

Aitchison J and JAC Brown (1957). The Log-normal Distribution. Cambridge (UK): Cambridge University Press. Searchable copy at Google Books: http://books.google.com/books?id=Kus8AAAAIAAJ

Cobham, Alex and Andy Sumner (2014). Is inequality all about the tails?: The Palma measure of income inequality. Significance. Volume 11 Issue 1. www.significancemagazine.org/details/magazine/5871201/Is-inequality-all-about-the-tails-The-Palma-measure-of-income-inequality.html

Limpert, E., W.A. Stahel and M. Abbt (2001). Log-normal Distributions across the Sciences: Keys and Clues. Bioscience 51, No 5, May 2001, 342-352. Copy at http://stat.ethz.ch/~stahel/lognormal/bioscience.pdf

Schield, Milo (2013) Creating a Log-Normal Distribution using Excel 2013.www.statlit.org/pdf/Create-LogNormal-Excel2013-Demo-6up.pdf

Stahel, Werner (2014). Website: http://stat.ethz.ch/~stahelUniv. Denver (2014). Using the LogNormal Distribution. Copy at

http://www.du.edu/ifs/help/understand/economy/poverty/lognormal.htmlWikipedia. LogNormal Distribution.

2014 NNN+1D

Milo SchieldAugsburg College

Editor: www.StatLit.orgUS Rep: International Statistical Literacy Project

www.StatLit.org/pdf/2014-Schield-Explore-LogNormal-Incomes-Slides.pdf

XLS/Create-LogNormal-Incomes-Excel2013.xlsx

ExploringLognormal Incomes

1

2014 NNN+1D 2

A Log-Normal distribution is generated from a normal with mu = Ln(Median) and sigma = Sqrt[2*Ln(Mean/Median)].The lognormal is always positive and right-skewed. Examples:• Incomes (bottom 97%), assets, size of cities• Weight and blood pressure of humans (by gender)

Benefit: • calculate the share of total income held by the top X%• calculate share of total income held by the ‘above-average’• explore effects of change in mean-median ratio.

Log-Normal Distributions

2014 NNN+1D 3

“In many ways, it [the Log-Normal] has remained the Cinderella of distributions, the interest of writers in the learned journals being curiously sporadic and that of the authors of statistical test-books but faintly aroused.”

“We … state our belief that the lognormal is as fundamental a distribution in statistics as is the normal, despite the stigma of the derivative nature of its name.”

Aitchison and Brown (1957). P 1.

Log-Normal Distributions

2014 NNN+1D 4

Use Excel to focus on the model and the results.Excel has two Log-Normal functions:Standard: =LOGNORM.DIST(X, mu, sigma, k)

k=0 for PDF; k=1 for CDF. Inverse: =LOGNORM.INV(X, mu, sigma)Use Standard to calculate/graph the PDF and CDF. Use Inverse to find cutoffs: quartiles, to 1%, etc.Use Excel to create graphs that show comparisons.

Lognormal and Excel

2014 NNN+1D 5

Bibliography

.

2014 NNN+1D 6

.

Log-Normal Distribution of Units

0%

25%

50%

75%

100%

0 50 100 150 200 250 300 350 400 450 500Incomes ($1,000)

Theoretical Distribution of Units by Income

Probability Distribution Function (PDF): as a percentage of the Modal PDF

Cumulative Distribution Function (CDF):Percentage of Units with Incomes below price

Mode: 20K

LogNormal Dist of Units Median=50K; Mean=80K

Units can be individuals, households or families

2014 NNN+1D 7

For anything that is distributed by X, there are always two distributions:

1. Distribution of subjects by X2. Distribution of total X by X.Sometime we ignore the 2nd: height or weight.Sometimes we care about the 2nd: income or assets.

Surprise: If the 1st is lognormal, so is the 2nd.

Paired Distributions

2014 NNN+1D 8

Suppose the distribution of households by income is log-normal with normal parameters mu# and sigma#. Then the distribution of total income by amount has a log-normal distribution with these parameters: mu$ = mu# + sigma#^2; sigma$ = sigma#.

See Aitchison and Brown (1963) p. 158.Special thanks to Mohammod Irfan (Denver University) for his help on this topic.

Distribution of Households and Total Income by Income

2014 NNN+1D 9

.

Distribution of Total Income

0%

25%

50%

75%

100%

0 50 100 150 200 250 300 350 400 450 500Unit Incomes ($1,000)

Distribution of Total Income by Income per Household

Probability Distribution Function (PDF): as a percentage of the Modal PDF

Cumulative Distribution Function (CDF):Percentage of Total Income below price

Mode: 50K

LogNormal Dist of Units by Income Median=50K; Mean=80K

Median: 128K

2014 NNN+1D

Distribution of Households and Total Income

10

0%

25%

50%

75%

100%

0 50 100 150 200

Perc

enta

ge o

f Max

imum

Income ($1,000)

Distribution of Households by Income;Distribution of Total Income by Amount

Log Normal Distribution of Households by Income Income/House: Mean=80K; Median=50K

Households by IncomeMode: $20K; Median: $50K

Mean=$80K

Distribution of Total Income by Amount of Income

Mode: $50KMedian: $128K

Ave $205K

2014 NNN+1D 11

.

Lorenz Curve and Gini Coefficient

0%

20%

40%

60%

80%

100%

0% 20% 40% 60% 80% 100%

Perc

enta

ge o

f Inc

ome

Percentage of Households

Pctg of Income vs. Pctg. of Households

Top 50% (above $50k): 83% of total IncomeTop 10% (above $175k: 38% of total IncomeTop 1% (above $475k): 8.7% of total IncomeTop 0.1% (above $1M): 1.7% of total Income

Log Normal Distribution of Households by Income Income/House: Mean=80K; Median=50K

Gini Coefficient:0.507

Bigger meansmore unequal

2014 NNN+1D 12

The Gini coefficient is determined by theMean#/Median# ratio.

The bigger this ratiothe bigger the Ginicoefficient and thegreater the economicinequality.

Champagne-GlassDistribution

0%

20%

40%

60%

80%

100%

0% 20% 40% 60% 80% 100%

Perc

enta

ge o

f Hou

seho

lds

Percentage of Income

Pctg of Households vs. Pctg of Income

Top 50% (above $50k) have 83% of total IncomeTop 10% (above $175k) have 38% of total IncomeTop 1% (above $475k) have 8.7% of total IncomeTop 0.1% (above $1M) have 1.7% of total Income

Log Normal Distribution of Households by Income Income/House: Mean=80K; Median=50K

Gini = 0.507

Bottom-Up

2014 NNN+1D 13

Conjecture: If household (HH) income is distributed log-normally and X% of households have below-average incomes, then X% of all income is earned by HH with above-average incomes.

Example: If 60% of HH have below-average incomes, then 60% of total income is earned by HH having above-average incomes.

Evidence using Excel spreadsheet: Suppose Mean# = 50K and Median# = 80K.• 68.61%: Percentage of HH having below-average income• 68.61%: Percentage of total income that is associated with

HH having above-average incomes. QED

Log-Normal Balance Conjecture

2014 NNN+1D 14

Log-normal distribution. Median HH income: $50K.

As Mean-Median Ratio ↑Rich get Richer (relatively)

Top 5% Top 1%Mean# Min$ %Income Min$ %Income Gini

55 103 11% 138 2.9% 0.2460 135 15% 204 4.2% 0.3365 165 18% 270 5.5% 0.3970 193 20% 337 6.6% 0.4475 220 23% 406 7.7% 0.4880 246 25% 477 8.7% 0.5185 272 27% 549 9.7% 0.5390 298 29% 623 10.7% 0.56

2014 NNN+1D 15

.

Minimum Income versus Mean Income

y = 2.93 x

y = 5.4 x

0100200300400500600700800900

60 70 80 90 100 110 120 130 140 150

Min

imum

Inco

me

($,1

000)

Mean Income ($,1000)

Minimum Income for Top 5% and top 1%

Median Income: 50KLog Normal Distribution of Households by Income

2014 NNN+1D 16

US Median Income (Table 691*)• $46,089 in 1970; $50,303 in 2008

Share of Total Income by Top 5% (Table 693*)• 16.6% in 1970; 21.5% in 2008

Best log-normal fits: • 1970 Median 46K, Mean 53K: Ratio = 1.15• 2008 Median 50K, Mean 73K; Ratio = 1.46

* 2011 US Statistical Abstract (2008 dollars).

Which parameters best model US household incomes?

2014 NNN+1D

Conclusion

Using the LogNormal distributions provides a principled way students can explore a plausible distribution of incomes.

Allows students to explore the difference between part and whole when using percentage grammar.

17

2014 NNN+1D

Bibliography

Aitchison J and JAC Brown (1957). The Log-normal Distribution. Cambridge (UK): Cambridge University Press. Searchable copy at Google Books: http://books.google.com/books?id=Kus8AAAAIAAJ

Cobham, Alex and Andy Sumner (2014). Is inequality all about the tails?: The Palma measure of income inequality. Significance. Volume 11 Issue 1. www.significancemagazine.org/details/magazine/5871201/Is-inequality-all-about-the-tails-The-Palma-measure-of-income-inequality.html

Limpert, E., W.A. Stahel and M. Abbt (2001). Log-normal Distributions across the Sciences: Keys and Clues. Bioscience 51, No 5, May 2001, 342-352. Copy at http://stat.ethz.ch/~stahel/lognormal/bioscience.pdf

Schield, Milo (2013) Creating a Log-Normal Distribution using Excel 2013.www.statlit.org/pdf/Create-LogNormal-Excel2013-Demo-6up.pdf

Stahel, Werner (2014). Website: http://stat.ethz.ch/~stahelUniv. Denver (2014). Using the LogNormal Distribution. Copy at

http://www.du.edu/ifs/help/understand/economy/poverty/lognormal.htmlWikipedia. LogNormal Distribution.

18