Lecture on Income and Income Distribution: Lecture on Income and Income Distribution Howard Leathers


General Outline: General Outline How can we compare average level of prosperity from country to country? Averages don’t tell the whole story. How can we measure distribution of income within a country? Quality of life measures. What is happening over time to average incomes, to poverty, to quality of life?


Gross National Income: Gross National Income How do we measure the state of average economic well-being in a country. The value of all goods and services produced in a country. This used to be called “Gross Domestic Product” or GDP. Recently, the term “gross national income” or GNI has come into use. Sometimes, you see the term “Gross National Product” or GNP. This is measure of the value of all goods and services consumed in a country. It adds transfer payments from abroad to GDP. For example, in countries where a lot of people have relatives who have emigrated to the US, those relatives may send money or goods “home”, and people in those countries can consume more than they produce.


International comparisons:GNI per capita in $ terms: International comparisons: GNI per capita in $ terms The World Bank has undertaken an effort to see that all countries use the same kind of rules in measuring gross national income. To have numbers that provide meaningful comparisons among countries, we need: To adjust for different population sizes of countries, we look at GNI per capita To translate GNI in different countries into a single currency, two approaches are taken Exchange rates Purchasing Power Parity


Exchange rate comparisons : Exchange rate comparisons Suppose we measure GNI per capita in England and France and find that it is 10,000 pounds in England and it is 200,000 francs in France. Which is higher? One way to answer that question is to use exchange rates; the standard way is to translate everything into US dollar terms. If each English pound is worth $2, then the GNI per capita in England would be $20,000. If each French franc is worth $0.10, then GNI per capita in France is also $20,000. If each French franc is worth more than $0.10, then GNI per capita in France is higher than $20,000. These measures are the most commonly reported measures of wealth in a country.


Some of the poorest and richest countries in GNI per capita per year, 2000: Some of the poorest and richest countries in GNI per capita per year, 2000 Malawi $ 170 Eritrea $ 170 Sierra Leone $ 130 Burundi $ 110 Ethiopia $ 100 … United States $34,100 Norway $34,530 Japan $35,600 Switzerland $38,140


Purchasing Power Parity comparisons: Purchasing Power Parity comparisons The exchange rate comparisons have been criticized for failing to take into account the fact that cost of living is different in different countries. The purchasing power parity comparisons attempt to adjust for these differences.


An amusing example of how exchange rates don’t reflect cost of living: the Big Mac Index: An amusing example of how exchange rates don’t reflect cost of living: the Big Mac Index Country Big Mac price Country Big Mac Price Switzerland 3.97 US 2.43 Denmark 3.58 Taiwan 2.11 Israel 3.44 Mexico 2.09 Britain 3.07 Canada 1.98 France 2.87 Indonesia 1.66 Germany 2.72 Russia 1.35 Chile 2.60 China 1.20 South Korea 2.46 Malaysia 1.19 Japan 2.44 US 2.43 The US price is the average of prices in NY, Chicago, SF, and Atlanta SOURCE: THE ECONOMIST, 4/1/99 P. 66 How about comparing average income in terms of how many Big Macs you could buy with the average income in that country?


Some of the poorest and richest countries in GNI per capita per year, 2000: Some of the poorest and richest countries in GNI per capita per year, 2000 Exch. Rate PPP Malawi $ 170 $ 600 Eritrea $ 170 $ 960 Sierra Leone $ 130 $ 480 Burundi $ 110 $ 5 80 Ethiopia $ 100 $ 660 … United States $34,100 $34,100 Norway $34,530 $29,630 Japan $35,600 $27,080 Switzerland $38,140 $30,450


Cost of living is lower in poor countries and higher in rich countries.: Cost of living is lower in poor countries and higher in rich countries. So, generally speaking, PPP measures are higher for poor countries and lower for rich countries. Notice that the US is the basis of comparison so its GNI measure is the same under PPP or exchange rate.


Measuring income distribution, or income inequality within a country: Measuring income distribution, or income inequality within a country FOUR MEASURES OF INCOME INEQUALITY 1. DECILES OR QUINTILES OF DISTRIBUTION 2. LORENZ CURVES (DERIVED FROM 1) 3. GINI COEFFICIENT (DERIVED FROM 2) 4. VARIANCE OF INCOME DISTRIBUTION COMPARED TO ITS MEAN (DERIVED FROM 1)


Slide15: LORENZ CURVE 50 50 20 equality inequality


Slide16: LORENZ CURVE-GINI COEFFICIENT A B GINI COEFFICIENT = A/(A+B)


QUALITY OF LIFE MEASURES: QUALITY OF LIFE MEASURES Human Development Index includes: Longevity (life expectancy) Knowledge (literacy and enrollment) Prosperity (PPP GNI per capita)


Income per capita is not the same thing as human development: Income per capita is not the same thing as human development


What’s happening over time?: What’s happening over time? Generally improvements Eastern Europe, Former Soviet Union had troubles in the 1990s SubSaharan Africa is a concern Good Progress in China and India mean good worldwide figures.


Slide20: GNI (GDP) Population GNI (GDP)


Recent paper by Sala-i-Martin: Recent paper by Sala-i-Martin The World Distribution of Income estimated from individual country distributions, May 2002. On line at http://www.econ.upf.es/deehome/what/wpapers/postscripts/615.pdf


Slide25: 163,000 60,000 22,000 8,100


Explanatory Notes : Explanatory Notes The income is in “natural logs”. The actual dollars are shown below the axis. For example the natural log of $163,000 is 12. The “less than $1 and $2” per day lines do not correspond to $365 and $730 as you might think. That’s because the $1 and $2 a day standards were first proposed and reported for 1985 data. Therefore, the study here uses the 1998 equivalent to $1 and $2 per day in 1985, namely, $532 and $1064 per year.


Slide28: Worldwide, Income is becoming more equally distributed, as reflected in a drop in the worldwide Gini coefficient


Slide29: ___ PERCENT EARNS LESS OF THE WORLD’S THAN POPULATION _______ $ 50 2,801 65 4,632 75 7,189 80 9,516 85 13,324 90 19,963 95 33,714 98 56,037 99 76,434 99.5 100,334 Calculations based on 1995 data, but expressed in 2001 Dollars.


Comparison of Leathers to Sala-i-Martin: Comparison of Leathers to Sala-i-Martin Sala-i-Martin (data for 1998 estimated from CDF): 40% earn less than $2100 60% earn less than $3640 80% earn less than $8955 98% earn less than $59,674 Leathers (data for 1995): 50% earn less than $2801 80% earn less than $9516 98% earn less than $56,037


Slide32: FOR ACADEMIC YEAR 2000-2001 EACH STUDENT CONSUMES ABOUT $10,000 WORTH OF EDUCATIONAL GOODS (INCLUDING ROOM AND BOARD, BUT NOT INCLUDING CIGARETTES, BEER, CONCERTS, CD’S, MOVIE TICKETS, ETC.) EACH SEMESTER OR OVER $20,000 WORTH OF GOODS EACH YEAR . THIS IS ABOUT 4 TIMES THE WORLD AVERAGE CONSUMPTION AND IT MEANS THAT YOUR CONSUMPTION IS GREATER THAN OVER 90% OF THE WORLD’S POPULATION.