POVERTY

AND

MEASURE OF

INEQUALITY

INTRODUCTION

Poverty is general scarcity or dearth, or the state of one who lacks a certain amount of

material possessions or money. Absolute poverty or destitution refers to the

deprivation of basic human needs, which commonly includes food, water, sanitation,

clothing, shelter, health care and education. Relative poverty is defined contextually

as economic inequality in the location or society in which people live.

After the industrial revolution, mass production in factories made production goods

increasingly less expensive and more accessible. Of more importance is the

modernization of agriculture, to provide enough yields to feed the population. The

supply of basic needs can be restricted by constraints on government services such as

corruption, tax avoidance, debt and loan conditionality's and by the brain drain of health

care and educational professionals. Strategies of increasing income to make basic

needs more affordable typically include welfare, economic freedoms, and providing

financial services.

Poverty reduction is a major goal and issue for many international organizations such

as the United Nations and the World Bank. The World Bank estimated 1.29 billion

people were living in absolute poverty in 2008. Of these, about 400 million people in

absolute poverty lived in India. Extreme poverty is a global challenge; it is observed in

all parts of the world, including developed economies; UNICEF estimates half the

world's children (or 1.1 billion) live in poverty.

MEASURING INEQUALITY

There are two measures of income distribution for both analytic and quantitave

purposes:

01. The personal or size distribution of income

02. The functional or distributative factor share distribution of income

Size Distributions

Personal or size distribution of income deals with the individual persons or households

and the total income they receive. The way of income received is not considered. How

much is earned irrespective of the sources from where it is derived matters. The

geographical and occupational sources are neglected.

Quantiles and Deciles

a. The statisticians arrange all individuals by ascending personal incomes and

divide the total population into distinct groups or sizes.

b. Divide the population into successive quintiles or deciles according to ascending

income levels and then determine the proportion of N.I received by each income

group

c. Common measure of income inequality is the ratio of incomes received by the

top 20% and bottom 40% of the population.

Lorenz Curve

The Lorenz curve is a graphical representation of the cumulative

distribution function of the empirical probability distribution of wealth, and

was developed by Max O. Lorenz in 1905 for representing inequality of the

wealth distribution.

The curve is a graph showing the proportion of the distribution assumed

by the bottom y% of the values, although this is not rigorously true for a

finite population (see below). It is often used to

represent income distribution, where it shows for the bottom x% of

households, what percentage y% of the total income they have.

The percentage of households is plotted on the x-axis, the percentage of

income on the y-axis. It can also be used to show distribution of assets. In

such use, many economists consider it to be a measure of social

inequality.

The concept is useful in describing inequality among the size of individuals

in ecology, and in studies of biodiversity, where cumulative proportion of

species is plotted against cumulative proportion of individuals. It is also

useful in business modeling: e.g., in consumer finance, to measure the

actual delinquency Y% of the X% of people with worst predicted risk

scores.

They show the actual quantitative relationship between the percentage of

income recipients and the percentage of total income they received

during a time period (year).They also depict the variance of the size

distribution of income from perfect equality .

The more the lorenz curve is away from the diagnol, the greater the degree of

inequality represented. The extreme case of perfect inequality( where a erson

receives all the national income while everybody else receives nothing would be

represented by congruence of Lorenz Curve with bottom horizontal and right

hand vertical axes. The greater the degree of inequality , the greater the bend

and the closer to the bottom horizontal axis the Lorenz Curve will be.

Gini Coefficient

The Gini coefficient ,also known as the Gini index or Gini ratiois

a measure of statistical dispersion intended to represent the income

distribution of a nation's residents. It was developed by

the Italian statistician and sociologist Corrado Gini and published in his

1912 paper "Variability and Mutability.

The Gini coefficient measures the inequality among values of a frequency

distribution. A Gini coefficient of zero expresses perfect equality, where all

values are the same (for example, where everyone has the same income).

A Gini coefficient of one (or 100%) expresses maximal inequality among

values, for example where only one person has all the income. However,

a value greater than one may occur if some persons have negative

income or wealth. For larger groups, values close to or above 1 are very

unlikely in practice.

Gini coefficient is commonly used as a measure

of inequality of income or wealth. For OECD countries, in the late 2000s,

considering the effect of taxes and transfer payments, the income Gini

coefficient ranged between 0.24 to 0.49, with Slovenia the lowest

and Chile the highest. The countries in Africa had the highest pre-tax Gini

coefficients in 2008–2009, with South Africa the world's highest at 0.7. The

global income inequality Gini coefficient in 2005, for all human beings

taken together, has been estimated to be between 0.61 and 0.68 by

various sources.

Gini coefficient is among other measures which satisfy four highly

desirable properties : the anonymity, scale independence, population

independence, and transfer principles.

Principle of anonymity means that our measure of inequality must not

depend on who has a higher income.

Scale Independence Scale means that our measure of inequality shouldn't

depend on size of our economy or the way we measure its income.

Population Independence Principle states that measure of inequality

should not be based on number of income recipients.

Coefficient of variation is a measure of dispersion which is the sample

standard deviation divided by sample mean .

Functional Distribution

Functional distribution of income is a theory explaining how income is divided

between different groups involved in the production process, specifically, the

income earned by the "owners" of various factors or steps in production; namely

land, labor , capital. This income is determined by the supply and demand for

the end goods produced by each of them.

Basically, like the departments of a large firm that makes potato chips, there is

going to be a department that processes the potatoes, another department that

peels them, another that slices them, another that fries the slices, another that

salts them, and another that packages them. Each department has individual

costs, such as labor, materials, and overhead, and they share the overall fixed

costs. The profits then are needed to pay for each departments individual costs

We assume that there are only two factors of production: capital, which is a fixed (given) factor, and labor, which is the only variable factor. Under competitive market

assumptions, the demand for labor will be determined by labor’s marginal product (i.e., additional workers will be hired up to the point where the value of their marginal product

equals their real wage). But in accordance with the principle of diminishing marginal products, this demand for labor will be a declining function of the numbers employed. Such a negatively sloped labor demand curve is shown by line DL in the figure above.

With a traditional neoclassical upward-sloping labor supply curve SL, the equilibrium

wage will be equal to WE and the equilibrium level of employment will be LE. Total national output (which equals total national income) will be represented by the area 0RELE. This national income will be distributed in two shares: 0WEELE going to workers

in the form of wages and WERE remaining as capitalist profits (the return to owners of capital). Hence in a competitive market economy with constant-returns-to-scale

production functions (a doubling of all inputs doubles output), factor prices are determined by factor supply and demand curves, and factor shares always combine to exhaust the total national product. Income is distributed by function— laborers are paid

wages, owners of land receive rents, and capitalists obtain profits. It is a neat and logical theory in that each and every factor gets paid only in accordance with what it

contributes to national output, no more and no less. This model of income distribution is at the core of the Lewis theory of modern-sector growth based on the reinvestment of rising capitalist profits.

Unfortunately, the relevance of the functional theory is greatly diminished by its failure to

take into account the important role and influence of nonmarket forces such as power in determining these factor prices—for example, the role of collective bargaining between employers and trade unions in the setting of modern-sector wage rates and the power

of monopolists and wealthy landowners to manipulate prices on capital, land, and output to their own personal advantage.

Absolute Poverty

Absolute poverty refers to the ability of the person or family to get the basic necessities of life, such as shelter, food, clean water, clothes, medicine. It is

measured based upon the ability to purchase or otherwise garner these things regardless of the relative wealth in the neighborhood, province, country, or world. Relative poverty refers to the purchasing power a person or family has relative to

the people in the same society. For example, a family living in a very small but clean house, who must walk or ride a bus to travel, who can get enough food to

maintain normal weight and activity, but no more than that, and who can buy decent clothes, but only if they are used, would be considered to be fairly well off in many African countries, but would be living in relative poverty if they resided in

San Francisco, or Tokyo. The idea of relative poverty is politically charged, since it can be used to argue for a change in political and social structure by showing the

large disparity in wealth, and using the emotionally loaded word "poverty" to describe people who, in real terms, may live quite well. If absolute poverty were the scale, than very few people in the Western world could be considered to live in

poverty, because almost everyone there has access to safe water, plenty of food, decent clothing, etc.

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.

Poverty Gap measures the total amount of income necessary to raise

everyone who is below the poverty line up to that line. The extent to which teh incomes of the poor lie below teh poverty line is shown by Total Income Shortfall, or total poverty gap(TPG) which is defined as

TPG=∑( Yp - Yi)

The Foster-Greer-Thorbecke Measure

We are also often interested in the degree of income inequality among the poor,

such as the Gini coefficient among those who are poor, Gp, or alternatively, the coefficient of variation (CV) of incomes among the poor, CVp. One reason that the

Gini or CV among the poor can be important is that the impact on poverty of economic shocks can differ greatly, depending on the level and distribution of resources among the poor. For example, if the price of rice rises, as it did in 1998

in Indonesia, low-income rice producers, who sell a little of their rice on local markets and whose incomes are slightly below the absolute poverty line, may find

that this price rise increases their incomes to bring them out of absolute poverty. On the other hand, for those with too little land to be able to sell any of the rice they grow and who are net buyers of rice on markets, this price increase can

greatly worsen their poverty. Thus the most desirable measures of poverty would also be sensitive to the distribution of income among the poor. A well-known poverty index that in certain forms satisfies all four criteria is the Foster-Greer-Thorbecke (FGT) index, often called the Pα class of poverty measures. The Pα

index is given by