# EC 320 PS 2 answers - Economic Development EC 320 Problem...

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Economic Development EC 320 Problem Set 2 October 19, 2010 1. Draw and explain a Lorenz curve. What is a Gini coefficient? [5 points] A Lorenz curve has cumulative percent of the population along the horizontal axis and cumulative percent of income (or wealth or education) along the vertical axis. The curve traces out the percent of income received by the bottom 1%, 5%, 10%, 20%, etc up to 100%. If everyone receives the same income, the Lorenz curve is a 45° straight line from the origin to the upper right corner of the diagram. A Gini coefficient is the ratio of the area between the Lorenz curve and the 45° line to the entire area under the 45° line. 2. Explain the following poverty measures [5 points] a. Headcount = number of people below the poverty line b. Incidence = number of poor people/total population c. Poverty gap (draw diagram and give formula) = ∑ (Y p – Y i )/Y p where Y p = poverty line Y i = income of ith poor person

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3. Does economic growth reduce poverty (draw diagram)? When does growth not reduce poverty? [5 points] Economic growth generally reduces poverty. A diagram with per capita income on the horizontal axis and per capita income of the bottom quintile for a cross section of countries shows a high correlation between the two. Diagrams with per capita income for specific countries and for the bottom quintile over time also usually show a high correlation. The exceptions are a small number of small resource rich countries, usually oil exporters, that discover oil and experience a very large increase in GDP, almost all of which is stolen or otherwise expropriated by a small number of very wealthy families. 4. Does economic growth reduce inequality (draw diagram)? [5 points] Economic growth does not reduce inequality. Many countries over time tend to have the same level of inequality even as their per capita incomes rise. For the US, inequality increased for many years until about 1929, then fell until about 1975, and has risen considerably over the past 35 years, even though during all these periods the US economy and per capita income were growing. Simon Kuznets thought that economic development first increased inequality and then decreased it, leaving to an upside down U shaped relation between per capita income and inequality, shown below. This turns out not to be true.
5. Does high inequality reduce economic growth? [5 points] High inequality may reduce economic growth by increasing social and political tensions. For instance if high inequality leads to a high rate of kidnapping, burglaries, and armed robberies, which in turn leads to large expenditures on police protection and private security by the rich, economic growth may be reduced. Inequality may also lead to intense political disputes and an inability for different political groups to work together to solve their country’s problems. This could also reduce economic

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EC 320 PS 2 answers - Economic Development EC 320 Problem...

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