In a paper presented at the 1985 Conference of this Society [Kruijk and Leeuwen (1985)] we described some structural changes in poverty and income inequality in Pakistan during the 1970s. All inequality measures and poverty indicators pointed to the conclusion that poverty has declined while at the same time inequality has increased. However, the paper did not go deep enough into the reasons why inequality has increased. It did appear that neither the urban/rural distinction nor interprovincial income differences are important determinants of overall income inequality in Pakistan 1 so that these elements cannot contribute much to explaining changes in inequality. In his comments, Kernal, (1986) suggests to extend the applied decomposition technique by decomposing income also into its sources. This is precisely the purpose of the present paper. In fact, total income of a household (or any other unit) is the sum of income derived from various sources like labour, property, remittances, etc. Accordingly, income inequality is the aggregate of inequalities of these sources and changes in overall inequality are made up of changes in its components. Decomposition analysis is a clear and consistent framework to investigate these issues. It provides a sense of proportion and avoids to suggest – as some authors do – that overall inequality may have decreased because inequality of one single component has decreased. This kind of speculation is not possible within a decomposition framework because the relative importance of that particular component is taken into account and related to the importance of other components together with their development over time.