If X is a random variable with a Pareto (Type I) distribution, then the probability that X is greater than some number x, i.e. the survival function (also called tail function), is given by
where xm is the (necessarily positive) minimum possible value of X, and α is a positive parameter. The Pareto Type I distribution is characterized by a scale parameterxm and a shape parameterα, which is known as the tail index. When this distribution is used to model the distribution of wealth, then the parameter α is called the Pareto index.
When plotted on linear axes, the distribution assumes the familiar J-shaped curve which approaches each of the orthogonal axes asymptotically. All segments of the curve are self-similar (subject to appropriate scaling factors). When plotted in a log-log plot, the distribution is represented by a straight line.
The conditional probability distribution of a Pareto-distributed random variable, given the event that it is greater than or equal to a particular number exceeding , is a Pareto distribution with the same Pareto index but with minimum instead of . This implies that the conditional expected value (if it is finite, i.e. ) is proportional to . In case of random variables that describe the lifetime of an object, this means that life expectancy is proportional to age, and is called the Lindy effect or Lindy's Law.
The characteristic curved 'long tail' distribution when plotted on a linear scale, masks the underlying simplicity of the function when plotted on a log-log graph, which then takes the form of a straight line with negative gradient: It follows from the formula for the probability density function that for x ≥ xm,
Since α is positive, the gradient −(α + 1) is negative.
There is a hierarchy  of Pareto distributions known as Pareto Type I, II, III, IV, and Feller–Pareto distributions. Pareto Type IV contains Pareto Type I–III as special cases. The Feller–Pareto distribution generalizes Pareto Type IV.
Pareto types I–IV
The Pareto distribution hierarchy is summarized in the next table comparing the survival functions (complementary CDF).
In this section, the symbol xm, used before to indicate the minimum value of x, is replaced by σ.
The shape parameter α is the tail index, μ is location, σ is scale, γ is an inequality parameter. Some special cases of Pareto Type (IV) are
The finiteness of the mean, and the existence and the finiteness of the variance depend on the tail index α (inequality index γ). In particular, fractional δ-moments are finite for some δ > 0, as shown in the table below, where δ is not necessarily an integer.
The Pareto distribution is a special case of the generalized Pareto distribution, which is a family of distributions of similar form, but containing an extra parameter in such a way that the support of the distribution is either bounded below (at a variable point), or bounded both above and below (where both are variable), with the Lomax distribution as a special case. This family also contains both the unshifted and shifted exponential distributions.
The Pareto distribution with scale and shape is equivalent to the generalized Pareto distribution with location , scale and shape . Vice versa one can get the Pareto distribution from the GPD by and .
The bounded (or truncated) Pareto distribution has three parameters: α, L and H. As in the standard Pareto distribution α determines the shape. L denotes the minimal value, and H denotes the maximal value.
The purpose of Symmetric Pareto distribution and Zero Symmetric Pareto distribution is to capture some special statistical distribution with a sharp probability peak and symmetric long probability tails. These two distributions are derived from Pareto distribution. Long probability tail normally means that probability decays slowly. Pareto distribution performs fitting job in many cases. But if the distribution has symmetric structure with two slow decaying tails, Pareto could not do it. Then Symmetric Pareto or Zero Symmetric Pareto distribution is applied instead.
The Cumulative distribution function (CDF) of Symmetric Pareto distribution is defined as following:
The corresponding probability density function (PDF) is:
This distribution has two parameters: a and b. It is symmetric by b. Then the mathematic expectation is b. When, it has variance as following:
The CDF of Zero Symmetric Pareto (ZSP) distribution is defined as following:
The corresponding PDF is:
This distribution is symmetric by zero. Parameter a is related to the decay rate of probability and (a/2b) represents peak magnitude of probability.
Malik (1970) gives the exact joint distribution of . In particular, and are independent and is Pareto with scale parameter xm and shape parameter nα, whereas has an inverse-gamma distribution with shape and scale parameters n − 1 and nα, respectively.
Occurrence and applications
Vilfredo Pareto originally used this distribution to describe the allocation of wealth among individuals since it seemed to show rather well the way that a larger portion of the wealth of any society is owned by a smaller percentage of the people in that society. He also used it to describe distribution of income. This idea is sometimes expressed more simply as the Pareto principle or the "80-20 rule" which says that 20% of the population controls 80% of the wealth. However, the 80-20 rule corresponds to a particular value of α, and in fact, Pareto's data on British income taxes in his Cours d'économie politique indicates that about 30% of the population had about 70% of the income. The probability density function (PDF) graph at the beginning of this article shows that the "probability" or fraction of the population that owns a small amount of wealth per person is rather high, and then decreases steadily as wealth increases. (The Pareto distribution is not realistic for wealth for the lower end, however. In fact, net worth may even be negative.) This distribution is not limited to describing wealth or income, but to many situations in which an equilibrium is found in the distribution of the "small" to the "large". The following examples are sometimes seen as approximately Pareto-distributed:
The sizes of human settlements (few cities, many hamlets/villages)
File size distribution of Internet traffic which uses the TCP protocol (many smaller files, few larger ones)
In Electric Utility Distribution Reliability (80% of the Customer Minutes Interrupted occur on approximately 20% of the days in a given year).
Relation to Zipf's law
The Pareto distribution is a continuous probability distribution. Zipf's law, also sometimes called the zeta distribution, is a discrete distribution, separating the values into a simple ranking. Both are a simple power law with a negative exponent, scaled so that their cumulative distributions equal 1. Zipf's can be derived from the Pareto distribution if the values (incomes) are binned into ranks so that the number of people in each bin follows a 1/rank pattern. The distribution is normalized by defining so that where is the generalized harmonic number. This makes Zipf's probability density function derivable from Pareto's.
where and is an integer representing rank from 1 to N where N is the highest income bracket. So a randomly selected person (or word, website link, or city) from a population (or language, internet, or country) has probability of ranking .
Relation to the "Pareto principle"
The "80–20 law", according to which 20% of all people receive 80% of all income, and 20% of the most affluent 20% receive 80% of that 80%, and so on, holds precisely when the Pareto index is . This result can be derived from the Lorenz curve formula given below. Moreover, the following have been shown to be mathematically equivalent:
Income is distributed according to a Pareto distribution with index α > 1.
There is some number 0 ≤ p ≤ 1/2 such that 100p % of all people receive 100(1 − p)% of all income, and similarly for every real (not necessarily integer) n > 0, 100pn % of all people receive 100(1 − p)n percentage of all income. α and p are related by
This does not apply only to income, but also to wealth, or to anything else that can be modeled by this distribution.
This excludes Pareto distributions in which 0 < α ≤ 1, which, as noted above, have an infinite expected value, and so cannot reasonably model income distribution.
Relation to Price's law
Price's square root law is sometimes offered as a property of or as similar to the Pareto distribution. However, the law only holds in the case that . Note that in this case, the total and expected amount of wealth are not defined, and the rule only applies asymptotically to random samples. The extended Pareto Principle mentioned above is a far more general rule.
Lorenz curve and Gini coefficient
Lorenz curves for a number of Pareto distributions. The case α = ∞ corresponds to perfectly equal distribution (G = 0) and the α = 1 line corresponds to complete inequality (G = 1)
The Lorenz curve is often used to characterize income and wealth distributions. For any distribution, the Lorenz curve L(F) is written in terms of the PDF f or the CDF F as
where x(F) is the inverse of the CDF. For the Pareto distribution,
and the Lorenz curve is calculated to be
For the denominator is infinite, yielding L=0. Examples of the Lorenz curve for a number of Pareto distributions are shown in the graph on the right.
According to Oxfam (2016) the richest 62 people have as much wealth as the poorest half of the world's population. We can estimate the Pareto index that would apply to this situation. Letting ε equal we have:
The solution is that α equals about 1.15, and about 9% of the wealth is owned by each of the two groups. But actually the poorest 69% of the world adult population owns only about 3% of the wealth.
The Gini coefficient is a measure of the deviation of the Lorenz curve from the equidistribution line which is a line connecting [0, 0] and [1, 1], which is shown in black (α = ∞) in the Lorenz plot on the right. Specifically, the Gini coefficient is twice the area between the Lorenz curve and the equidistribution line. The Gini coefficient for the Pareto distribution is then calculated (for ) to be
^ abFeller, W. (1971). An Introduction to Probability Theory and its Applications. Vol. II (2nd ed.). New York: Wiley. p. 50. "The densities (4.3) are sometimes called after the economist Pareto. It was thought (rather naïvely from a modern statistical standpoint) that income distributions should have a tail with a density ~ Ax−α as x → ∞."
^Lomax, K. S. (1954). "Business failures. Another example of the analysis of failure data". Journal of the American Statistical Association. 49 (268): 847–52. doi:10.1080/01621459.1954.10501239.
^Schroeder, Bianca; Damouras, Sotirios; Gill, Phillipa (2010-02-24). "Understanding latent sector error and how to protect against them"(PDF). 8th Usenix Conference on File and Storage Technologies (FAST 2010). Retrieved 2010-09-10. We experimented with 5 different distributions (Geometric,Weibull, Rayleigh, Pareto, and Lognormal), that are commonly used in the context of system reliability, and evaluated their fit through the total squared differences between the actual and hypothesized frequencies (χ2 statistic). We found consistently across all models that the geometric distribution is a poor fit, while the Pareto distribution provides the best fit.