Solution Manual for Development Economics 1st Edition

by Gerard Roland ISBN 0321464486 9780321464484

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Chapter 2
Poverty and Inequality

1. One calculates the income necessary to purchase 2000 calories of food taking into
account people’s food habits.

2. The poverty gap counts people below the poverty line in a country but weighs them
according to their distance from the poverty line. In practice, one does not have exact
data on the income of all those below the poverty line. One therefore computes the
poverty gap by multiplying the poverty headcount Q by the average distance of the poor
from the poverty line, in proportion to the poverty line. Calling yq the average income of
the poor who are below the poverty line and z the poverty line, the poverty gap PG is thus
calculated as follows: PG = Q.(z- yq)/z
The advantage of this measure over the poverty line is that the latter does not take
into account the distance of a poor person’s income to the poverty line. Somebody just
below the poverty line and somebody just above the poverty line have roughly the same
income but the former is counted in the poverty line and not the latter. The poverty gap
gives a very small weight to the former but weighs more people who are significantly
below the poverty line.

3. Here is how to compute it. Twenty percent have an average income between 0 and 10
cents, i.e. an average of 10 cents. Their weight is thus 1-0.1 = 0.9. Fifteen percent has an
average income between 20 and 40 cents, i.e. an average of 30 cents. Their weight is thus
1-0.3=0.7. One follows the same reasoning for the other groups and one obtains: 0.2x0.9
+ 0.15x0.7 + 0.15x0.5 + 0.1x0.3 + 0.2x0.1= 0.41. Remembering that 80% of the
population is below the poverty line, the poverty gap tells us that one would have to give
to 41% of the population $1 a day so that nobody would be below the poverty line.

4. A first problem is related to exchange rates. If one takes the poverty line in one country
and converts it to that of other countries using market exchange rates, the results are
likely to be wrong because exchange rates only reflect the prices of internationally traded
goods. A large part of the consumption basket of people below the poverty line is
composed of goods that are not traded internationally. To compute internationally
comparable data, it is better to use purchasing power parity exchange rates. This solution
is better, but not perfect, because purchasing power parity is computed by taking into
account an average consumption basket in a country. it would be even better to calculate
purchasing power parity exchange rates using the consumption basket of the poor.
A second problem is that surveys on poverty are done differently in different

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 countries. In some countries, information is collected on people’s income, in others on
their expenditures. In some countries, people are asked to report expenditures over the
past week, in other countries they are asked to report expenditures over the past month.
This can lead to different results.

5. The Lorenz curve is constructed by plotting the income of each income quantile, starting
by the lowest quantile and ending with the highest income quantile.

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 Here is a Lorenz curve representing a relatively egalitarian income distribution
based on deciles. Note that the Lorenz curve is not far below the diagonal line
representing perfectly egalitarian income distribution.

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Here is a Lorenz curve representing a much more inegalitarian income

distribution. As one can see, the Lorenz curve is further away from the diagonal line.

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6. The Gini coefficient is calculated using data from the Lorenz curve. It is calculated as
twice the surface between the diagonal line and the Lorenz curve. It there is low income
inequality, that surface will be small, and the Gini coefficient will also be small. If on the
other hand, there is high inequality, the surface will be large, and so will be the Gini
coefficient.

7. The two Lorenz curves are in the figure below. One can see that overall, country A has a
more inegalitarian income distribution than country B even though the poorest decile in
country B is poorer than the poorest decile in country A. This is why the Lorenz curve for
country A is below that of country B at that point but it crosses the curve for country B at
the second decile to stay above.

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8. Economic theory has identified the following reasons for why inequality may be bad for
growth:
1) Credit market imperfections may make it impossible for the poor to borrow and
thus to invest in profitable businesses, leading to lower growth for countries
having higher inequality and thus more poor people unable to borrow.
2) Distortionary costs of redistribution. If inequality is high, there will be more
pressures for redistribution. With distortionary taxation, a higher level of
redistribution under a more unequal society may lead to lower growth.
3) Political instability. High inequality may lead to political instability, which can
deter investment, and thus growth.

9. The Milanovic-Ersado paper mentions the following reasons why inequality has
increased in transition countries.
First, economic growth has benefited the higher deciles but not the two bottom
deciles whose income has grown less than average. Second, inflation has been bad for the
poorer 50% but has benefited the richer deciles. Third, economic reforms have increased
inequality as they benefited the rich, but less the poorer parts of society. They note that
government expenditures did not reduce inequality, which is often the case for other
countries. They note however that democracy was very good to reduce inequality.

10. For 2005 and $45 for the monthly poverty line, we get 29.25% for the poverty headcount
and 11.69% for the poverty gap. For 2008 and $45 per month, we get 26.89% for the
poverty headcount and 10.66% for the poverty gap. We thus see a reduction. If we take
2005 and $60 for the monthly poverty line, we get 39.48% for the poverty headcount and
17.81% for the poverty gap. Taking the difference between 39.48% and 29.25% (equal to

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10.23%), we conclude that 10.23% of the world population had in 2005 a monthly
income between $45 and $60.

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