Measures of Poverty and

Inequality
Prof. Tarun Das, IILM, New Delhi
prepared for the ISS Training Program

07/11/09 Poverty and Inequality- Prof. T. Das 1

Contents of this presentation
1. Conceptual Issues
2. Properties of An Ideal Measure of
Inequality
3. Positive Measures of Inequalities
4. Normative Measures of Inequalities
5. Decomposition of Inequality
6. Theoretical Income Distributions
7. Measures of Poverty

07/11/09 Poverty and Inequality- Prof. T. Das 2

1.1 Conceptual Issues- Equality and
Equity
1. Inequality and Equity- Inequality is a
mathematical concept, whereas equity
is a concept of justice and
jurisprudence.
2. Measure of inequality is the degree by
which existing income distribution
(Y1,Y2 ….Yn) differs from equal
distribution (µ, µ, … µ).
3. An equal income distribution may not
be an equitable distribution.
4. An equitable distribution may justify
unequal distribution due to differences
of needs, capabilities, skill, education,
experience etc.
5. Even Gods are
07/11/09 not
Poverty and equal.
Inequality- Prof. T. Das Hindu religion3
accepts gradation of Gods and
 1.2 Conceptual Issues- Poverty
1. Similarly, poverty has many
dimensions
2. Poverty as measured by income
3. Poverty measured by expenditure
4. Poverty measured by calorie
intake
5. Poverty measured by entitlements
6. Poverty measured by human
development
7. Poverty measured by social
welfare
07/11/09 Poverty and Inequality- Prof. T. Das 4
 1.3 Four Basic Problems
1. (a) What should be the income
receiving/ demographic units?
(b) How is income to be defined?
(c) Over which period should we take
income?
(d) How can we measure the degree of
inequality and poverty?
2. Who should be made equal?
In what respects?
Over which period?
By which standards?
3. First three questions are economic in
nature, while the last one is statistical.
07/11/09 Poverty and Inequality- Prof. T. Das 5
 1.4 Choice of Income Receiving Unit
1. Various concepts- Individuals, adult
equi-valent units, economically active
population (age group of 15-65), income
receiving units, families and households
2. More the heterogeneity, more the
inequality.
Gini=0.784*–0.050*logY–12.184*/Y+
0.051*D1
(0.016) (0.015) (4.144) (0.016)
+0.129*D2–0.033*D3 –0.007 D4
R2=0.37
(0.021) (0.018) (0.016)
D1=1 for income recipients, 0 otherwise
D2=1 for economically active population, o
else
D3=1 for rural sector, 0 otherwise
D4=1
07/11/09 for urban Poverty
sector, 0 otherwise
and Inequality- Prof. T. Das 6

If all Di’s are zero, equation stands for all

 1.5 Simple Questions but no Easy
Answers
1. Income units should be easily
identifiable, inclusive and distinctly
independent
2. Concept of income- Expenditure and
incomes surveys, Monetary and in-kind,
pre-tax and post-tax, pre and post
transfer, tradable and non-tradable,
home produced, capital gains, fringe
benefits, current and life time income.
3. Time period- Week? Month? Year? Life
Time?
4. “We need to make compromise between
what is theoretically desirable and what
is empirically practicable. We simply
have to take what we are given by the
statisticians, who have usually collected
data for other
07/11/09 reasons”
Poverty and Inequality- Prof.(Harold
T. Das Lydall 7
1979).
 1.6 Household Expenditure
and Family Expenditure Surveys
1. Concepts of Households and
Families
2. While UK and India conduct households
expenditure surveys, USA conducts
family expenditure surveys
3. Conversion of single person households
and higher household sizes into Adult
Equivalent Units (AEUs)
4. Sample size- sampling and non-sampling
errors
5. Approximation of income from
expenditure Poverty
07/11/09
surveys and Inequality- Prof. T. Das 8
 2.1 Properties of an ideal inequality
index
(a) It must depend on all income levels.
I = f (Y1, Y2, Y3 ……. Yn), Yi ≥ 0.
(b) Income homogeneity: It is homogeneous
of degree zero in all incomes i.e. if all
incomes rise or fall equi-proportionately,
then the inequality index remains
unchanged. It also implies that it is
independent of the units of
measurement, and depends on relative
income .
I=λº I =f (λ Y1, λ Y2, λ Y3 ……. λ Yn), λ >0
(c) It ranges in between zero (in the case of
perfect equality) and unity (in the case
of absolute inequality, when one person
has all national income and others have
no income). Poverty and Inequality- Prof. T. Das
07/11/09 9
 2.2 Properties of Ideal Inequality
(d) Population homogeneity: Index It remains
invariant w.r.t. equi-proportionate change
in the number of units in all income
brackets.
(e) Pigou-Dalton criterion: A transfer of
income from the rich to the poor should
reduce the degree of inequality and vice
versa.
(f) Anonymity: It is unaffected by any
permutation of incomes i.e. We do not
want to know the identities of income
earners. It is called the property of
anonymity or impartiality.
(g) An equal absolute increase of all incomes
leads to reduction of inequality, and an
equal absolute reduction of incomes leads
to an increase Poverty
07/11/09 of inequality.
and Inequality- Prof. T. DasAn imposition10
of head tax increases inequality, while
 2.3 Properties of Ideal Inequality
Index
(h) It should be subject to simple economic
interpretation.
(i) It should be easily calculated from
available data, computer programs and
algorithms.
(j) Should be subject to statistical tests of
significance.
(k) It should be statistically decomposable.

Grand inequality = Weighted Mean of

group inequalities + Inequality of group
mean incomes
= Within Group Inequality + Between
Group
07/11/09
Inequality
Poverty and Inequality- Prof. T. Das 11
 3.1 Inequality Measures
1. Positive Measures (pure statistical
measures, no utility functions) - Gini
Lorenz ratio, CV, VARLOG, Theil Entropy
Measure
2. Normative Measures- Atkinson Index
(assumes utility functions)
3. Let us assume that there are n persons
with incomes (Y1, Y2, Y3, ……Yn) arranged
in ascending order i.e. Y1 ≤Y2 ≤ Y3 ≤ …. ≤
Yn.
Qj = Share of the j-th person in total
income
= Yj/ TY = Yj / ΣYj
Where TY = Y1
07/11/09 +andY2+
Poverty Inequality- Y3+….+Yn
Prof. T. Das = ΣYj 12
 3.2 Size Distribution of Income
Average No. of Pj= nj/N Qj = CPj CQj
income recipient PjYj/ µ

Y1 n1 P1 Q1 CP1 CQ1

Y2 n2 P2 Q2 CP2 CQ2

Yj nj Pj Qj CPj CQj

Total N= ΣPj ΣQj

Σnj =1 =1
07/11/09 Poverty and Inequality- Prof. T. Das 13
 3.3 Lorenz Concentration Curve
• Both CPj and CQj range in between 0
and 1.
• A Lorenz curve is drawn within a unit-
square box diagram.
• The 45 degree radius vector is called
the egalitarian line as on it CPj equals
CQi for each i=1, 2, 3 ….. n.
• The area between the Lorenz curve
and the egalitarian line is called the
area of concentration (A).
• Gini-Lorenz ratio equals the area of
concentration (A) divided by the area
of the triangle below the egalitarian
line.
07/11/09 Poverty and Inequality- Prof. T. Das 14
 3.4 Gini-Lorenz ratio
(1) A Lorenz curve is the locus of all points
(CPj, CQj). It is positively sloped and
convex to the horizontal axis, where
CPj = Cumulative proportion of persons
up to j-th income in ascending order
and
CQj = Cumulative shares of income of
these individuals
(2) Lorenz ratio = 1 - Σ Pj (CQj+ CQj-1)
(3) Gini coefficient = Σ Σ Pi Pj IYi – YjI / 2µ
(4) It can be proved that LR = GC, so we
can call it Gini-Lorenz ratio.
07/11/09 Poverty and Inequality- Prof. T. Das 15
 3.5 CV, Var (Log), RMAD
• Coefficient of variation = σ / µ
where σ is the standard deviation and
µ
is the arithmetic mean of incomes
µ = ΣPjYj, σ² =VAR = ΣPj (Yj-µ)²,
2. Variance of logarithms- It is the
variance of the logarithms of incomes
of individuals
= Σ Pj(log Yj– λ)²= Σ Pj(log Yj– logGM)²
= Σ Pj [log (Yj/GM)]²
where λ =AM(LogY)=ΣPj
07/11/09 Poverty and Inequality- Prof.logYj
T. Das = log (GM)16
 3.6 TDM and Theil Entropy
Measure
3. Kuznets Total Disparity Measure (TDM)
TDM = Σ I Pj – Qj I
4. RMAD = Σ Pj I Yj- µ I / µ
= Σ IPjYj – Pj µI / µ
= Σ IQj –PjI = TDM
5. It can be proved that
[corrected]
LR ≤ RMAD ≤ CV
6. Theil entropy measure
= Σ Qj ln (Qj / Pj) = Σ Qj ln (Yj /µ)

07/11/09 Poverty and Inequality- Prof. T. Das 17

 3.7 Characteristics of Inequality
Measures
• All measures are ordinal in nature (1st,
2nd, 3rd), and not cardinal numbers (1, 2,
3).
• Lorenz curves provides many information
about income distribution, while others
are summary measures. They conceal
more facts than they reveal.
• There does not exist an ideal measure of
inequality.
• Due to differences in concepts on
income, demographic units, period,
sample designs and size, and the
inequality index, it is very difficult to
draw valid inter-country and inter-
temporal differences of inequality.
• So minor differences
07/11/09 inProf.inequalities
Poverty and Inequality- T. Das 18
should be ignored.
 4.1 Normative Measures of Inequality
Based on utility functions U(Yj),
dU/dY >0, d²U/ dY² <0 (Diminishing MU)
Maximize W = Σ U(Yj) subject to Y° = ΣYj
Z = Σ U(Yj) + λ [Y° - ΣYj ]
First order condition δU/ δY = 0 ⇒ dU/dYj = λ
For all j implying that Yj = µ, ∀=j=1,2,….n
Dalton inequality measure = 1- Σ U(Yj) / n U(
µ)
Atkinson measure of inequality A= 1 –Ye/ µ
Ye is equally distributed equivalent income,
which enjoyed equally by all would
generate the same social welfare as the
existing
07/11/09
social welfare.
Poverty and Inequality- Prof. T. Das 19
 4.2 Various Normative Measures
1. Ye is the generalized mean of order β
=Mβ(Y)
where β = (1 - ε), ε is the inequality
aversion parameter. Properties of Mβ(Y)
indicated below:
(a)Mβ(Y) is an increasing function of β.
(b)Mβ(Y) is homogeneous of degree unity in
Y.
(c) Mβ(Y¹) > Mβ(Y²) if Y¹ > Y²
(d) If β>1, Mβ(Σ Yj) < Σ Mβ(Yj)
(e) If β<1, Mβ(Σ Yj) > Σ Mβ(Yj)
2. Sen’s development index adjusted by
inequality = µ (1- G)
07/11/09 Poverty and Inequality- Prof. T. Das 20
3. Allingham distinguishes between income
 5.1 Decomposition of Inequality
Measures
1. Statistically, there are two types of
decomposition:
(a) Additive decomposition
µ = Σ Pj µj, σ²= Σ Pj σ² + Σ Pj (Yj - µ)²
(b) Multiplicative decomposition
GM = Π (GMj)ª where a =Pj
2. Economically there are three types:
(a) Sectoral/ regional decomposition
(b) Functional decomposition by income
sources- wages, rents, interests, profits
(c) Factor decomposition by income
generating factors such as age, sex,
education, experience etc.
07/11/09 Poverty and Inequality- Prof. T. Das 21
 5.2 Purpose of Decompositions
• It helps us to determine relative
importance of factors, sources of income
and regional pockets determining
inequality or poverty.
• Kuznets distinguishes between
warranted and unwarranted inequalities.
There is a secular trend of inequality
induced by demographic factors,
existing laws and regulations, which is
justifiable. Any thing above that is
undesirable.
• Public policy should deal with
unwarranted inequality.
• Decomposition helps to estimate
warranted and unwarranted inequalities.
07/11/09 Poverty and Inequality- Prof. T. Das 22
5.3 Sectoral/regional Decompositions

Sectors AM Var Inequalit

1 µ1 σ1² y
I1
2 µ2 σ2² I2
j µj σj² Ij
k µk σk² Ik
Total µ σ² I

07/11/09 Poverty and Inequality- Prof. T. Das 23

 5.4 Sectoral/regional
Decompositions
Within Group inequality (WGI) = Weighted
mean of group inequalities = Σ Pj Ij
Between Group inequality (BGI) =
Inequality in group means = I(µ1, µ2, µ3
…. µk)
Grand
Sector Inequality
CV² Gini= VarLN
WGI +Theil
BGIAtkinson
+ R TDM
Rural 0.26 0.28 0.32 0.13 0.87 0.40
Urban 0.27 0.29 0.42 0.14 0.93 0.44
All 0.27 0.29 0.36 0.14 0.89 0.42
WGI 0.26 0.28 0.35 0.13 0.89 0.42
BGI 0.01 0.04 0.01 0.00 0.04 0.08
WGI+BGI 0.27 0.32 0.36 0.14 0.93 0.50
R 0 ±0 0 0 ±0 ±0
07/11/09 Poverty and Inequality- Prof. T. Das 24
 5.5 Sectoral/regional Decompositions
Theorem-1: Inequality of a group of sectors/
regions cannot be less than weighted
average of the inequalities of sectors/
regions.
I (ÜYi) ≥ Σ Qi Ii
Corollary-1: Grand inequality ≥ WGI
Corollary-2: Even when all sectors are
equally unequal (Ii=β), grand inequality is
greater than weighted average of sectoral
inequalities (β).
Corollary-3 If each sector is perfectly equal
i.e. Ii=0, then grand inequality equals
between group inequality.
Corollary-4 If there is no between group
inequality i.e. all sectors have same µ, then
07/11/09
grand inequalityPoverty
equalsand Inequality- Prof. T. Das
within group 25
 5.6 Functional Decompositions
Let Yi = Wi + Ri + INTi + Pi ∀ =1, 2, 3 …..
n
Shares Φw Φr Φint Φp
Φw = ΣWi/ ΣYi, Φr = ΣRi/ ΣYi
Φint = ΣINTi/ ΣYi Φp = ΣWi/ ΣYi
Grand I ≤ [Φw I(W)+ Φr I(R)
+ Φint I(INT)+ Φp I(W)]
Theorem-1: Inequality of a sum of income
components cannot exceed weighted
average of the inequalities of components.
I(ΣYi) ≤ Σ Φi Ii
Theorem-2: Equality holds good only when
all income components are equi-
proportional for all income receiving units
Ri=α Wi, INTi =β Wi, Pi = δWi
07/11/09 Poverty and Inequality- Prof. T. Das 26
 5.7 Functional Decompositions
Corollary-1: Even when all components are
equally unequal, inequality of income is
less than weighted average of inequalities
of components.
Corollary-2: Inequality of a sum of income
components is less than sum of inequalities
of components.
Corollary-3: Yt = Past income + change
So I(Yt) ≤ [ I(Yt-1) + I(change)]
Corollary-4: I(Yt) - I(Yt-1) ≤ I(change)
Change of inequality is less than inequality
of change.

07/11/09 Poverty and Inequality- Prof. T. Das 27

 6.1 Theoretical Income Distributions
(1) f(y) = Probability distribution function of
y
(2) F(y) = Distribution function
y
= ƒ f(y) dy
0
(6) Φ(y) = incomplete first moment of y
y ∝
= ƒ y dF(y) / µ , µ = ƒ y f(y) dy
0 0
1 1 1
(4) LR= 1- 2 ƒ Φ dF = ƒ F dΦ - ƒ Φ dF
0 0 0
(5) dΦ/dF = y/ µ >0,
d² Φ/ dF² = 1/
07/11/09
[µ f(y)]>0
Poverty and Inequality- Prof. T. Das 28
 6.2 Pareto Distribution
First extensive study on income distribution
was done by Vilfredo Pareto (1948-1923), a
discipline of Leon Walras (1834-1910).
Pareto Curve:
Nx = A Xªwhere a = -α, α ≅ 1.5
Nx = Number of units having income y ≥ x
α is called Pareto Coefficient.
Lorenz curve Φ = 1 – (1-F)^β, β= (α-1)/α
Gini-Lorenz ratio = 1/(2α-1)
Pareto’s law: According to Pareto, α ≅ 1.5
and GLR =0.5 represents a stable macro
economic situation. Any social reform
attempting to reduce inequality below 0.5
is doomed to be a failure.
Harold Davis agreed and proposed theories
of natural abilities and least efforts. Lange
did not agree and
07/11/09 Povertyargued that
and Inequality- Prof. T. Das Pareto law 29
does not hold good for wage incomes.
 6.3 Lydall’s Pyramidal Income
Distribution
People in any grade (except the bottom)
control a fixed number of staff in the next
lower grade
Ni / Ni+1 = K
Total income paid to any grade is
proportional to that in the next lower
grade.
Ni+1 . Yi+1 / (Ni Xi ) = P
These assumptions lead to a Paretian tail
with Pareto coefficient
α = logK / logKP = logK / (logK + logP)
Gini-Lorenz ratio = 1/(2α-1)
= (logK + logP)/ (logK-logP)
= logKP/ log
07/11/09 Poverty(K/P)
and Inequality- Prof. T. Das 30
 6.4 Stochastic Distribution and Markov
Process
Champernowne’s theory leading to Pareto
distribution:
• Income intervals follow a geometric
progression- y, ry, r²y, r³y ……
• Transitional probabilities Tij
(probability of a person in income
range i to move to income range j in
the next period) depends on the
spread of classes Tij = f (i-j)
• No individual can move up more than
one interval in a period, but can move
down several intervals.
• Incomes will not increase indefinitely.
• For every income recipient who dies or
exits for some reasons, there is a
successor to his/her income in the next
period.
07/11/09 Poverty and Inequality- Prof. T. Das 31
 6.5 Log normal distribution
If LogY is distributed normally with mean µ
and variance σ², y is said to be log
normally distributed with the same mean
and variance.
Pdf f(Y)=1/[σ y sqrt(2π)] exp[-(lnY-λ)/2σ²]
Lorenz curve tcq = tcp - σ
Lorenz ratio= 2 Φ(σ/sqrt(2)) -1
Tcq is the value of z such that area under
the standard normal variate up to tcq is
CQ, and Φ(x) is the area under the
standard normal distribution up to x.
Special case-1: In the case of perfect
equality, Φ=0, so LR = 2 Φ(0) –1 =1-
1=0
Special case-2. In the case of
extreme
07/11/09 inequality, σ→
Poverty and Inequality- Prof. T.∝,
Das LR = 2-1 = 32
 6.6 Theories of Random Walk
1. Brownian Process and Gibrat’s law of
proportionate effect: Level of income of
any individual at any point of time is a
random multiple of income already
achieved.
Yt = (1+ R1)(1+ R2)(1+ R3)….. (1+ Rt)
Yo
2. Atchison and Brown theory:
•Income classes are in arithmetic
progression
•Transition probabilities Tij depend on
ratio of classes. Tij = f (i/j)
Both these theories lead to log-normal
distribution.
07/11/09 Poverty and Inequality- Prof. T. Das 33
 7.1 Measurement of Poverty
•In September 2000, at the UN Millennium
Summit 189 nations adopted the
‘Millennium Declaration’ to eradicate
extreme poverty and hunger by 2015 and
set targets on education, health,
environment etc. These are called the
“Millennium Development Goals (MDG)”.
•Multilateral agencies are providing funds
and helping the developing countries to
prepare Poverty Reduction Strategy
Papers (PRSPs) for meeting MDG targets.
•Measurement and analysis of poverty has
thus become the central point for
planning and assume special significance.
07/11/09 Poverty and Inequality- Prof. T. Das 34
 7.2 Properties of an Ideal Measure of
Poverty
• Monotonocity criterion: Given other
things, a poverty measure must
increase (decrease) if the income of a
poor family is reduced (increased).
• Transfer criterion: Given other things,
the poverty measure must increase
(decrease) with any transfer of income
from a poor household to a non-poor
household (with reverse transfer)
• Transfer sensitivity: Greater the
transfer from the richer to the poor
persons, greater the magnitudes of
poverty reduction.
07/11/09 Poverty and Inequality- Prof. T. Das 35
7.3 Poverty Ratio and Sen Poverty Index
Let there are n individuals with incomes
Y1 ≤Y2 ≤ Y3 ≤ …. ≤ Yn.
µ is Mean income, and Z = Poverty line
m is the number of people below Z.
Poverty gap = Z -Yi for people below the
poverty line.
Headcount ratio (H) = m / n
Poverty gap ratio (PG) = ∑(Z – Yi)/ m Z
Sen Poverty Index = H [ PG + (1 – PG) Gini
]
where Gini is the Gini Lorenz ratio of the
poor.
• If everyone has income above the
poverty line, H = 0, so Sen Poverty Index
=0.
•If all has no income,
H=PG=SenIndex=Gini=0
07/11/09 Poverty and Inequality- Prof. T. Das 36
 7.4 Foster-Greer-Thorbecke Index (FGT)
Foster-Greer-Thorbecke (FGT) family of
poverty measures:
z
P = ∑ [(1– Yi/Z]ª / n
i=1
a=0 Headcount ratio = m / n
a=1 Poverty gap ratio = ∑(Z – Yi)/ nZ
a=2 FGT P2 measure

FGT satisfies all criteria of an ideal

measure of poverty. It also can be
decomposed.

07/11/09 Poverty and Inequality- Prof. T. Das 37

 7.5 Hamada-Takayama Index
Actual income distribution Y1 ≤Y2 ≤ …. ≤
Yn.
Censored income distribution is one in
which each income above the poverty line
is made equal to the poverty line.

Yi* = Yi if Yi < z
Yi* = z if Yi ≥ z
The Gini ratio, CV, Theil Entropy measure
or any relative measure of dispersion of
the censored income distribution can be
taken as measures of poverty.

07/11/09 Poverty and Inequality- Prof. T. Das 38

 Thank you
Have a Good Day

07/11/09 Poverty and Inequality- Prof. T. Das 39