Chapter 4-Poverty and Inequality

ECO 3101:
DEVELOPMENT
ECONOMICS
POVERTY AND INCOME DISTRIBUTION
MEASURING POVERTY AND
INEQUALITY
• Economists usually distinguish between two principal measures of
income distribution for both analytical and quantitative purposes:
i. the personal or size distribution of income
ii. the functional or distributive factor share distribution of income.
1. Size Distributions
• Size distribution of income deals with individual persons or households and

the total incomes they receive.
• The way income was received is not considered but how much each earns
irrespective of whether the income was derived solely from employment or
came also from other sources such as interest, profits, rents, gifts etc
• Individuals are arranged in ascending order in terms of personal incomes and
then divide the total population into distinct groups, or sizes.
• A common method is to divide the population into successive
quintiles (fifths) or deciles (tenths) according to ascending income levels and
then determine what proportion of the total national income is received by
each income group.
• Common measure of income distribution are
i. Kuznets rations
ii. Lorenz curve and gini coefficient
Kuznets Ratios
• The first quintile represents the bottom 20% of the population on the income
scale.
• This group receives only 5% (i.e., a total of 5 money units) of the total
national income.
• The second quintile (individuals 5 through 8) receives 9% of the total income
• more detailed breakdown of the size distribution of income,
decile (10%) shares are listed in column 4.
• We see, for example, that the bottom 10% of the population (the two poorest
individuals) receives only 1.8% of the total income, while the top 10% (the two
richest individuals) receives 28.5%.
Kuznets Ratios
• Based on table 5.1
• measure the degree of inequality between high- and low-income
groups in a country.
• In our example, this inequality ratio is equal to 51(received by top
20%) divided by 14 (received by bottom 40%), or approximately 3.64
• Finally, if we wanted to know what the top 5% receives, we would
divide the total population into 20 equal groups of individuals (in our
example, this would simply be each of the 20 individuals) and
calculate the percentage of total income received by the top group.
Lorenz Curve and Gini coefficient
• The Lorenz curve has:

The numbers of income recipients are plotted on the horizontal axis in
cumulative percentages
The vertical axis has share of total income received by each
percentage of population starting from lowest to highest
• It is also cumulative up to 100%, meaning that both axes are the same
length. The entire figure is enclosed in a square, and a diagonal line is
drawn from the lower left corner (the origin) of the square to the upper
right corner.
• The curve has a line which passes through 45% called the line of
perfect equality
• This line basically depict the situation whereby the percentage of
people is equal to percentage of income received (eg 10% has control
of 10% of income
• The more the Lorenz line curves away from the diagonal (line of
perfect equality), the greater the degree of inequality represented.
• The extreme case of perfect inequality (i.e., a situation in which one
person receives all of the national income while everybody else
receives nothing) would be represented by the congruence of the
Lorenz curve with the bottom horizontal and right-hand vertical axes.
The Lorenz curve shows the actual quantitative relationship between
the percentage of income recipients and the percentage of the total
income they did in fact receive during, say, a given year.
• Gini Coefficient is obtained by calculating the ratio of the area
between the diagonal and the Lorenz curve divided by the total area of
the half square in which the curve lies
• In Figure 5.3 below, this is the ratio of the shaded area A to the total
area of the triangle BCD.
• Gini coefficients are aggregate inequality measures and can vary
anywhere from 0 (perfect equality) to 1 (perfect inequality).
2. Functional Distributions
• Functional or factor share distribution of income, attempts to explain

the share of total national income that each of the
factors of production (land, labor, and capital) receives.
• Instead of looking at individuals as separate entities, the theory of
functional income distribution inquires into the percentage that labor
receives as a whole and compares this with the percentages of total income
distributed in the form of rent, interest, and profit (i.e., the returns to land
and financial and physical capital).
• Although specific individuals may receive income from all these sources,
that is not a matter of concern for the functional approach.
Measuring Absolute Poverty
• The two measure looked at were basically relative measures as the focus on
what inequality is there between the rich and the poor.
• Absolute poverty measure the number of people who are unable to command
sufficient resources to satisfy basic needs
• They are counted as the total number living below a specified minimum level
of real income—an international poverty line.
• That line knows no national boundaries, is independent of the level of national
per capita income, and takes into account differing price levels by measuring
poverty as anyone living on less than $1.25 a day or $2 per day in PPP dollar
• Absolute poverty is sometimes measured by the number, or “headcount,”
H, of those whose incomes fall below the absolute poverty line, Yp.
• When the headcount is taken as a fraction of the total population, N, we
define the headcount index, H/N.
• The poverty line is set at a level that remains constant in real terms
so that we can chart our progress on an absolute level over time.
• The idea is to set this level at a standard below which we would consider
a person to live in “absolute human misery,” such that the person’s health
is in jeopardy
• Sometimes this is captured by calculating a total poverty
gap (TPG) that measures the total amount of income necessary to
raise everyone who is below the poverty line up to that line,
• This is basically the difference between individual/household income
and the poverty line.
Multidimensional Poverty
• Poverty cannot be adequately measured with income

• Multidimensional poverty looks at other things apart from income
alone
• This is a poverty measure that identifies the poor using dual cut-offs
for levels and numbers of deprivations, and then multiplies the
percentage of people living in poverty times the percent of weighted
indicators for which poor households are deprived on average
• MPI takes
into account that there are negative interaction effects when people have
multiple deprivations—worse poverty than can be seen by simply adding up
separate deprivations for the whole country, taking averages, and only then
combining them.
• In the multidimensional poverty approach, a poor person is identified through
what is called the “dual cutoff method”: first, the cutoff levels within each of
the dimensions (analogous to falling below a poverty line such as $1.25 per
day if income poverty were being addressed), and second, the cutoff of the
number of dimensions in which a person must be deprived (below the line) to
be deemed multidimensionally poor.
Malawi Multidimensional Poverty
POVERTY, INQUALITY AND SOCIAL
WELFARE
• social welfare depends positively on the level of income per capita
• Social welfare is negatively related to level of poverty and negatively
on the level of inequality.
• The level of income, social welfare and inequality brings the issue of
absolute poverty and relative poverty.
• If we alleviate absolute poverty should we be worried with relative
poverty?
• Three reasons we should be concerned with inequality:
extreme income inequality leads to economic inefficiency.
extreme income disparities undermine social stability and solidarity
extreme inequality is generally viewed as unfair.
KUZNET’S INVERTED-U HYPOTHESIS
• Simon Kuznets suggested that in the early stages of economic growth,
the distribution of income will tend to worsen; only at later stages it
will improve.
• This observation came to be characterized by the “inverted-U”
Kuznets curve
FIGURE ON NEXT SLIDE

• Kuznets did not specify the mechanism by which his
inverted-U hypothesis was supposed to occur but other
economist believe that it will occur through “trickle down
effect”
MULTI-DIMENSIONAL POVERTY
• Measures of poverty that go beyond monetary measures have been
motivated by concepts such as social exclusion and inclusion, basic
needs, social cohesion, capability poverty, multidimensional poverty,
and clustered disadvantage, among others.
• While each concept is distinct, each articulates human well-being or
disadvantage directly, and generates the implication that measures of
human disadvantage should include non-monetary aspects.
• There are various dimensions which differ from country to country

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ECO 3101:

• Size distribution of income deals with individual persons or households and

• The Lorenz curve has:

• Functional or factor share distribution of income, attempts to explain

• Poverty cannot be adequately measured with income

FIGURE ON NEXT SLIDE

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