Development Economics I

CHAPTER Income Inequality, Poverty and Development:

Interconnections
1. Measures of Income Inequality and poverty
1. Approaches to measures of Income Inequality
2. Approaches to Measures of Absolute Poverty

5 2. Economic Characteristics of poverty groups

3. Policies Options for Poverty Reduction and
enhance income Distribution

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 The Growth Controversy: Seven Critical
Questions
1. What is the extent of relative inequality, and how is this
related to the extent of poverty?
2. Who are the poor?
3. Who benefits from economic growth?
4. Does rapid growth necessarily cause greater income
inequality?
5. Do the poor benefit from growth?
6. Are high levels of inequality always bad?
7. What policies can reduce poverty?

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 Concepts of poverty
• The following three issues are needed for understanding
the concept of poverty
1. Conceptualization of Concept of poverty
2. Measurements
3. Determinants of poverty
• Poverty affects human conditions like;
Economic
Social
Physical
Moral and Political …….etc.
Generally, Poverty has Multidimensional impacts on human
condition
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 Concepts of poverty
• As world Bank (2001) there are four major dimensions of
poverty
I. Lack of opportunity or material deprivation(measured by
income and consumption)
II. Low capability ( low achieving in education and Health)
III. Vulnerability( Low level of security)
IV. Powerlessness( Voicelessness)
• The three alternative approaches used in setting poverty
line;
A. Absolute poverty – Basic need
B. Relative poverty - Capacity risk
C. Subjective poverty-
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 Concepts of poverty
1. Absolute poverty:
• inability to secure the minimum basic needs for the human
survive
– state of existence in which the overall needs of the individual is
not satisfied
– If he or she lacks resource to obtain enough food, clothing, and
shelter to maintain tolerable standard of physical health and
efficiency
Three approaches to decide absolute poverty
I. Food energy intake approach
 Usually 2100 calories per person per day
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 Concepts of poverty
Goat Row Enjera Enjera Enjera Enjera Dulet Milk Ambash
meat meat(85 (840 M) (780 B) (840 D) (714 T) (260) (160) a(470)
(920) 0)

Banana Apple Pasta Macaroni Ruth Chicken Beso(560 ……..

(80) (50) (880) ( 510) (870 with egg )
China) (350)

Facts: Study looses = 65 c. per 30 minutes

driver = 80 c. per 30 minutes
Teacher = 140 c. per 30 minutes

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 Concepts of poverty
• Drawbacks of this approach: It does not take into account
non food requirements and the cost of getting the basic
caloric requirements
II. Cost of basic needs approach
Comparison: 6 baskets of food items in D.R.C
545 baskets of food items per year in USA.
 Markable poverity line in (2015 = $1.90 Per day)
(2008 = $1.25 Per day)
(1991 = $1 Per day)
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 Concepts of poverty
2. Relative poverty:
It is state of having welfare level measured in income or
expenditure or other wellbeing indicators) less than others
3. Subjective poverty:
 its concept is based on the premises that people are the
best judges of their own situation and
 their opinions should ultimately be the decisive factor in
defying welfare and poverty.

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 Measures of Income Inequality
• Why income inequality is bad?
1) Extreme inequality leads to economic inefficiency and it limits
growth
2) Extreme in equality undermines social stability and solidarity
3) Extreme income inequality viewed as unfair

Income inequality : The disproportionate distribution of total national

income among households.
• Four main measurement approaches;
– Size distributions (quintiles, deciles)
– Lorenz curves
– Gini coefficients
– Functional distributions

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 Size Distributions
• The personal or size distribution of income
– The distribution of income according to size class of persons
– for example, the share of total income accruing to the poorest
specific percentage or the richest specific percentage of a
population— without regard to the sources of that income.
• What matters is; how much each earns
• What not matter is;
– whether the income is derived solely from employment or comes also
from other sources such as interest, profits, rents, gifts, or
inheritance.
– the locational (urban or rural) and occupational sources of the
income (e.g., agriculture, manufacturing, commerce, services) are
ignored.
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 Size Distributions(cont’d..)
• In this measurement approach , we arrange of all individuals
income according to ascending personnel income and then
divide the total population into distinct groups, or sizes.
• A common method to do this 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.
• Quintile
– A 20% proportion of any numerical quantity.
– A population divided into quintiles would be divided into five groups
of equal size.
• Decile
– A 10% portion of any numerical quantity; a population divided into
deciles would be divided into ten equal numerical groups.
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 Table 5.1 Typical Size Distribution of Personal Income in a
Developing Country by Income Shares—Quintiles and Deciles

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 What do we observe from Table 5.1 (cont’d..)
• 20 individuals,
– representing the entire population of the country, are arranged in order of
ascending annual personal income, ranging from the individual with the
lowest income (0.8 units) to the one with the highest (15.0 units).
• The total or national income of all individuals amounts to 100 units and is the
sum of all entries in column 2.
• In column 3,
– the population is grouped into quintiles of four individuals each.
– 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.
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 What do we observe from Table 5.1 (cont’d..)
• Alternatively,
– the bottom 40% of the population (quintiles 1 plus 2) is receiving
only 14% of the income, while the top 20% (the fifth quintile) of the
population receives 51% of the total income.
• So, how we can measure inequality?
– A common measure of income inequality that can be derived from
column 3 is the ratio of the incomes received by the top 20% and
bottom 40% of the population.
– This ratio, sometimes called a Kuznets ratio after Nobel laureate
Simon Kuznets, has often been used as a measure of the degree of
inequality between high- and low-income groups in a country.
– From table 1, this inequality ratio is equal to 51 divided by 14, or
approximately 3.64.
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 What do we observe from Table 5.1 (cont’d..)
• It provide a more detailed breakdown of the size
distribution of income ,decile (10%) shares are listed in
column 4.
• 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%.

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 Lorenz Curves
• Another common way to analyze personal income statistics
is to construct what is known as a Lorenz curve.
• On the Horizontally;
• The numbers of income recipients are plotted
– not in absolute terms but in cumulative percentages.
• The vertical axis shows
– the share of total income received by each percentage of
population
• Figure 5.1 shows how it is done.

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 Figure 5.1 The Lorenz Curve

For example, at point 20,

we have the lowest
(poorest) 20% of the
population; at point 60, we
have the bottom 60%; and
at the end of the axis, all
100% of the population
has been accounted for.

Lorenz curve which is

plotted using the decile data
contained in Table 5.1 Development Economics I © Thomas M.(MSc.)
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 Lorenz Curves(cont’d..)
• 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.
• Point A;
– shows that the bottom 10% of the population receives only 1.8% of
the total income,
• Point B;
– shows that the bottom 20% is receiving 5% of the total income, and
so on for each of the other eight cumulative decile groups.
• Note that;
– at the halfway point, 50% of the population is in fact receiving only
19.8% of the total income.
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 Lorenz Curves(cont’d..)
• 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 grater the cur venture of the Lorenz curve the higher the income
inequality
– Far from the origin is high income inequality
• Because no country exhibits either perfect equality or perfect
inequality in its distribution of income, the Lorenz curves for
different countries will lie somewhere to the right of the diagonal
The greater the degree of inequality, the greater the bend and the
closer to the bottom horizontal axis
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Figure 5.2 The Greater the Curvature of the Lorenz Line, the Greater the Relative Degree
of Inequality

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 Gini coefficient
• An aggregate numerical measure of income inequality
ranging from 0 (perfect equality) to 1 (perfect inequality).
• It is measured graphically by dividing the area between the
perfect equality line and the Lorenz curve by the total area
lying to the right of the equality line in a Lorenz diagram.
• The higher the value of the coefficient is, the higher the
inequality of income distribution; the lower it is, the more
equal the distribution of income.

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Figure 5.3 Estimating the Gini Coefficient

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 Figure 5.3 Estimating the Gini Coefficient
GC = shaded area/total area
A/BCD

let say A = shaded area

B = Unshaded area

A+B = 0.5
G = A/A+B
A/ 0.5
= 1/0.5
= 2A
= A/A+B = A
2(A+B) = 1
2A+2B = 1
2a = 1-2B
G= 2A = 1-2B
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 Functional distribution of income (factor share distribution
of income)
• Distribution of income to factors of production without regard to
the ownership of the factors.
– It attempts to explain the share of total national income that each of the
factors of production (land, labor, and capital) receives.
• Now, 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.

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 Functional distribution of income
• In this case, supply and demand curves are assumed to
determine the unit prices of each productive factor.
• When these unit prices are multiplied by quantities employed on
the assumption of efficient (minimum-cost) factor utilization,
we get a measure of the total payment to each factor.
• For example,
– the supply of and demand for labor are assumed to determine its
market wage.
• When this wage is then multiplied by the total level of
employment, we get measure of total wage payments, also
sometimes called the total wage bill.
– That is: Wage*employment = total wage bill= total wage payments
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Figure 5.5 Functional Income Distribution in a Market Economy: An Illustration

This concepts was historically

applied to capitalist economy:

The area:
• ER𝑊𝐸 profit earned by the
capitalist
• 0𝑊𝐸 wage earned by the labor

Here the assumption is

capital assumed to be fixed
and labor is the only factor
of production.
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 Measuring Absolute Poverty
• What is absolute poverty?
– The situation of being unable or only barely able to meet the
subsistence essentials of food, clothing, and shelter.
– They are counted as the total number living below a specified
minimum level of real income, an international poverty line.
• Poverty line
– The poverty threshold, poverty limit, poverty line or breadline, is
the minimum level of income considered adequate in a particular
country.
– The idea is to set this level at a standard below which we would
consider a person to live in ―absolute human misery/sadness,‖
such that the person’s health is in danger or risk.
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 Measuring Absolute Poverty
1. Headcount
– Counting head under $1.9 per day

2. Headcount Index:
HC= H/N
– Where H is the number of persons who are poor and N is the total number of people in
the economy
– For example H = 25,000,000 and N = 100,000,000
– HC = H/N = 25,000,000/100,000,000, = ¼ = 0.25 (25%).

Drawbacks of this approach:

o It ignores differences
o It does not show how far the poor are bellow the poverty line.
o It does not change if people bellow the poverty line become
poorer or better
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 Measuring Absolute Poverty
3. Poverty gap index: ( Total income Shortfall)
 Measure reflects the average distance (far or near) of the poor
bellow the poverty line,
 So, it gives a better idea of the depth of poverty.
4. Total poverty gap:

TPG   (Yp  Yi )
H

i1
Where Yp is the absolute poverty line; and Yi the income of
the ith poor person
 the sum of the difference

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 Measuring Absolute Poverty
 By adding or summing up all H – Yi ( If the data of 4
individual we have= 1.85,1.8,1.25,1.6)
 Solution: 1.9 -1.85+1.9-1.8+1.9-1.25+1.9-1.6
0.05+0.1+0.65+0.3
1.1
5. Average poverty Gap:
APG = TPG/N
1.1/4 = 0.25
Interpretation: Individual 1 far from poverty line by $0.05.

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Measuring Absolute Poverty(cont’d..)
6. normalized poverty gap
Where N is number of persons in the economy
– TPG is total poverty gap
– Note: normalized poverty gap,
NPG = APG/Yp

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 Measuring Absolute Poverty(cont’d..)
7. The Foster-Greer-Thorbecke (FGT) index:


1 H  Yp  Yi 
P 
N
 
i 1  Yp


– N is the number of persons, H is the number of poor persons, and α ≥0 is
a parameter
– When α=0, we get the headcount index measure
– When α=2, we get the ―P2‖ measure.

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 Measuring Absolute Poverty(cont’d..)
• The 𝑷𝟐 poverty measure, also known as the
squared poverty gap index,
–has become a standard of income poverty
measure used by the World Bank and other
agencies, and
–it is used in empirical work on income poverty
because of its sensitivity to the depth and
severity of poverty.
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 Measuring Absolute Poverty(cont’d..)
8. The Newly Introduced Multidimensional Poverty
Index
• It is identification of poverty status through a dual cutoff:
– First, cutoff levels within each dimension (analogous to falling
below a poverty line for example $1.25 per day for income
poverty);
– Second, cutoff in the number of dimensions in which a person
must be deprived (below a line) to be deemed multidimensional
poor.
– MPI focuses on deprivations in health, education, and
standard of living; and each receives equal (that is one-third of
the overall total) weight.
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 MPI Indicators
• Health
– two indicators with equal weight - whether any child has died in the family,
and whether any adult or child in the family is malnourished –weighted
equally (each counts as one-sixth toward the maximum deprivation in the
MPI)
• Education
– two indicators with equal weight - whether no household member
completed 5 years of schooling, and whether any school-aged child is out
of school for grades 1 through 8 (each counts one-sixth toward the MPI).
• Standard of Living,
– equal weight on 6 deprivations (each counts as 1/18 toward the maximum):
lack of electricity; insufficiently safe drinking water; inadequate sanitation;
inadequate flooring; unimproved cooking fuel; lack of more than one of 5
assets – telephone, radio, TV, bicycle, and motorbike.

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 Economic Characteristics of High-Poverty Groups
• But painting a broad picture of absolute poverty and
inequality is not enough.
• It is necessary to formulate effective policies and programs
to attack poverty at its source,
• But, before that we need some specific knowledge of
these high-poverty groups and their economic
characteristics.
– Rural Poverty
– Women and poverty
– Ethnic minorities, indigenous populations, and poverty

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 Rural Poverty
• Perhaps the most valid generalizations about the poor are
that they are disproportionately located in rural areas,
that they are;
– primarily engaged in agricultural and associated activities,
– more likely to be women and children than adult males, and
– often concentrated among minority ethnic groups and
indigenous peoples.

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Table 5.6 Poverty: Rural versus Urban

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 Rural Poverty(cont’d..)
• Research shows that: ,over the past several decades, in
developing countries
– The absolute poverty is concentrated in rural.
– But, the majority of government expenditures has been directed
toward the urban area and especially toward the relatively rich
modern manufacturing and commercial sectors.
• in the fields of education, health, housing, and other social services,
– For this matter, this urban modern-sector bias in government
expenditures is at the core of many of the development problems.
• But, economists recommended that, any policy designed to
alleviate poverty must necessarily be directed to a large extent
toward rural development in general and the agricultural sector
in particular.
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 Women and Poverty
• Women make up a substantial majority of the world’s poor.
• If we compared the lives of the inhabitants of the poorest
communities throughout the developing world, we would
discover that virtually everywhere women and children
experience the harshest deprivation.
• They are more likely to be poor and malnourished and less
likely to receive medical services, clean water, sanitation, and
other benefits
• The prevalence of female-headed households, the lower
earning capacity of women, and their limited control over their
spouses’ income all contribute to this disturbing phenomenon.

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 Women and Poverty(cont’d..)
• In addition, women have ;
– less access to education, formal-sector employment, social security,
and government employment programs.
– poor women’s financial resources are insufficient and unstable relative
to men’s.
– in many cases they are essentially barred from higher-paying
occupations.
• Policy recommendation: Women Mainstreaming
– Integrating women into development programs.
– To improve living conditions for the poorest individuals, women must
be drawn into the economic mainstream.
– This would entail increasing female participation rates in educational
and training programs, formal-sector employment, and agricultural
extension programs.

Development Economics I © Thomas M.(MSc.) @2023, Bonga University 41

 Ethnic Minorities, Indigenous Populations, and Poverty
• A final generalization about the incidence of poverty in the
developing world is that it falls especially heavily on minority ethnic
groups and indigenous populations.
• Study shows that, some 40% of the world’s nation-states have more
than five sizable ethnic populations, one or more of which faces
serious economic, political, and social discrimination.
• In recent years, domestic conflicts and even civil wars have arisen out
of ethnic groups’ perceptions that they are losing out in the
competition for limited resources and job opportunities.
• The poverty problem is even more serious for indigenous peoples,
whose numbers exceed 300 million in over 5,000 different groups in
more than 70 countries

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 Policy Options on Income Inequality and
Poverty: Some Basic Considerations
• Areas of intervention
– Altering the functional distribution
– Mitigating the size distribution
– Moderating (reducing) the size distribution at upper levels
– Moderating (increasing) the size distribution at lower levels
• Policy options
– Changing relative factor prices
– Progressive redistribution of asset ownership
– Progressive taxation
– Transfer payments and public provision of goods and services
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 Dear students!
I wish all the Best for You!
This is the End of
Development Economics I!

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