ECO 3101:

DEVELOPMENT
ECONOMICS
POVERTY AND INCOME DISTRIBUTION
By.
D. Thomo
(MSc AAE, BSc Agri, UCE)
I. Introducing Poverty and Inequality
• Poverty refers to the condition where individuals or communities lack
the resources necessary for basic needs such as food, shelter, and
healthcare.
• Inequality, on the other hand, refers to the unequal distribution of
resources, opportunities, and wealth within a society.
• Understanding these concepts is essential as they have profound
implications for social justice, economic development, and political
stability.
• Poverty and inequality can exacerbate social tensions, hinder
economic growth, and undermine overall well-being.
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
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
• So Kuznets ratios measure the degree of inequality between high- and
low-income groups in a country.
• Using the Kuznets ratio to measure inequality between high- and low-
income groups involves dividing the share of income received by the
top 20% by the share received by the bottom 40%.
• 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
Lorenz Curve and Gini coefficient In
simpler terms
• Imagine you have a group of people, and they all have different amounts of
income. Now, if we lined up these people from the poorest to the richest and
plotted a graph, we'd have what's called a Lorenz curve.
• In this graph, there's a special line called the line of perfect equality. If every
person had the same amount of income, this line would be diagonal, meaning if
10% of people have 10% of the income, it would be a perfect match.
• But, in reality, this line is often curved away from the diagonal, showing that some
people have more income than others.
• The further away the curve is from the diagonal, the more unequal the income
distribution is.
• If it completely hugs the bottom and right edges of the graph, it means one person
has all the income, and everyone else has nothing.
• Now, the Gini Coefficient is a number we get from this graph. It measures
how unequal the income distribution is.
• It's calculated by comparing the area between the diagonal and the Lorenz
curve to the total area of the triangle formed by the axes and the curve.
• The Gini Coefficient can range from 0 to 1. If it's 0, it means everyone has
the same income, which is perfect equality.
• If it's 1, it means one person has all the income, which is perfect inequality.
• So, the closer the coefficient is to 1, the more unequal the income
distribution.
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
• Multidimensional poverty is a way of understanding poverty that goes beyond just
looking at income.
• It recognizes that being poor means more than just not having enough money.
• Instead, it considers various aspects of people's lives, like health, education, and
living standards.
• Imagine you're trying to understand poverty in a community.
• Instead of only looking at how much money people have, you also consider things
like whether they have access to clean water, if they can read and write, and if
they have proper shelter.
Multidimensional poverty
• In multidimensional poverty, you use what's called a "dual cutoff method" to
figure out who is poor.
• First, you set cutoff levels for each aspect you're looking at.
• For example, you might say that someone is considered poor if they don't have
access to clean water or if they can't read and write.
• Second, you decide how many of these aspects someone needs to be deprived
in to be considered poor.
• Let's say you set the cutoff at not having access to clean water and not being
able to read and write.
• If someone falls below these cutoffs, they're considered multidimensionally
poor
• The Multidimensional Poverty Index (MPI) takes this approach further by
considering that when people lack multiple things, it makes their poverty
worse.
• It's not just about adding up each deprivation separately.
• Instead, it looks at how different deprivations interact and impact someone's
overall poverty.
• So, the MPI calculates poverty by looking at the percentage of people who
are poor based on these cutoffs and how deprived they are across different
aspects of their lives.
• This gives a more comprehensive understanding of poverty beyond just
income.
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.