Eco416/516 Economic Development Fall 2012 Homework Assignment 5

Matthew Foley 36421984

1. Question 2 from chapter 5: Distinguish between size and functional distributions of income in a nation. Which do you feel is the more appropriate concept? Explain your answer. There are two ways to measure inequality of income, the size distribution and functional distribution of income. In size distribution, the income of the population is gathered and arranged in ascending order. The data is separated into groups from here, typically 5 quintiles representing 20% each. From here the percentage of total income received by each quintile is calculated and determined. From here the Kuznets ratio can be calculated from this by taking the ratio of income of top 20% to income of bottom 40%. The theory of Functional Distribution of income explains how income is divided between groups that take part in the production process; usually the income earned by the "owners" of various factors or steps in production. This income can be determined by the supply and demand for the end goods produced by each of them. By looking at a large firm that requires multiple steps in production where the good passes through different departments before becoming a final good; each department will have individual costs, such as labor, materials, and overhead, but will share an overall fixed cost, profits will be used to pay for each departments individual costs. 2. Consider the following distribution of income in a 12-person economy, with the modern urban wage = 3, the traditional rural income = 1, and the informal urban wage = 2: (1,1,1,1,2,2,2,2,3,3,3,3). The poverty line = 1.25. Suppose rural incomes are raised to 1.5 through expanded agricultural exports. What happens to relative inequality? Absolute poverty? If the rural income rises to this new level then the relative inequality between the different income levels would be less immediately. This would not only increase income for the families who need it but also push them closer from poverty towards the middle class. The push to this new level would be .25 above the poverty line as opposed to being .25 below it before; this would significantly reduce the absolute poverty and increase the quality of life for these persons in the economy.

3. What conclusion can be reached from the following data on income shares?

Percentage of Income Received by Lowest 40% Highest 20% Bangladesh Indonesia 17.3 14.4 45.3 49.4

The data shows that in Indonesia, the size distribution of income is much more unequal than in Bangladesh.

4. Explain why a Lorenz curve can never lie to the left or above the 45 degree line. The Lorenz Curve shows the distribution of wealth on a curve to show the income distribution of the entire country; sitting in the middle of the graph is a 45 degree line called the Line of Equality. The closer the Lorenz Curve is to this line the more equal the income is across the economy. Because of this, the Lorenz Curve can get very close to 45 degrees in theory when all the incomes are very close to each other; however there is no way to be equal to or above 45 degrees in any normal economy with a spread of incomes. 5. What is the Multidimensional Poverty Index and how is it a more improved measure of poverty? MPI gives a more full measure of poverty by showing a more multidimensional picture of people living in poverty which help target development resources more effectively. The Multidimensional Poverty Index is like the HDI, in that MPI measures deprivations across three dimensions that are each made up of several different indicators and then shows the number of people who are poor in each of these dimensions. MPI can be constructed by regions, ethnicity and other ways such as by dimension so that different countries can be more fully compared to others.