Q#1: Explain Kuznets Inverted U hypothesis. Do you agree that it holds?

Name any three exceptions

from developed countries.
Simon Kuznets hypothesized that during the earlier stages of a countrys growth, the inequality of
income will increase and will eventually decrease at a later stage. He studied a number of cases of
countries whose gini coefficients when plotted against their GNI expansion, all seemed to follow an
inverted U shaped curve.
The reason as to why inequality rises as growth occurs maybe because of the structural change most
countries undergo to bring about growth. This growth mainly occurs in the modern sector which is why
distribution of income is not equal across all sectors. As labour from the traditional sectors shifts to the
modern sector, their incomes rise too as a result of the increased expansion in the modern sector. This
might lead to greater equality at a later stage of growth.
In my opinion, Kuznets study did not represent a true enough picture of all the economies of the world
to form a generalized hypothesis. His research focused mainly on Latin American countries which had a
history of high income inequality. When the same observation is applied to non-latin amercian countries
and plotted on a time series graph, the position does not hold true.
Countries such as Japan, Singapore and hong kong have seen rapid growth periods in which inequality
has decreased instead of increasing in the intial years. This is because the initial benefits of growth were
immediatedly reinvested in the economy in the form of land reforms (increasing rural productivity and
incomes etc.)
Q#2: Explain the concept of income inequality using Lorenz curve and Gini Coefficient. Show diagram.
The Lorenz curve depicts the variance of size distribution of income from perfect equality. The y axis
displays the percentage of income and and the x axis displays the percentage of receipients of that
income. The diagonal on the graph is the line of perfect equality which means that the percentage of
inome at every point is equal to the percentage of receipients. The more the Lorenz line curves away
from the diagonal, the greater the level of inequality it represents.
The gini coefficient is a measure of the relative degree of inequality in a country. It is measured by
calculate ng the ratio of the area between the diagonal and the lorez curve divided by the total area of
the half square in which the curve lies. It can vary from 0 (perfect equality) to 1(perfect inequality) for
different economies.

Q#3: Identify and briefly explain key five policy steps to improve income distribution.
1. Fixing factor price distortions
the relative price of labour is higher in the modern sector as a result of institutional
constraints and faulty govt policies than would be determined by the forces of demand
and supply. If the prices were lower as they usually are when the market is allowed to
operate freely then most capitalist would subsititue labour for capital and thus increase
employment. This would increase the incomes of the poor who had previously been
excluded from the modern sector employment. On the contrary setting higher minimum
wages have also been reported to reduce poverty.
On the other hand distortions in the capital markets artificially pull down the prices of
capital as a result of investment incentives, tariff free imports of such goods etc. if such
priveleges were removed, the prices of capital would rise and then again capitalists
would resort ot employing more labour instead of machinery. This would also help to
set the balance of income distribution right.
Lowering the relative price of labour and raising the relative price of capital would also
help in reducing the artificially high incomes of the capital owners.

2. Increasing assets of the poor

The most basic reason of inequality in most countries is the highly concentrated
patterns of the asset ownership. The physical and financial asset ownership as well as
education is highly concentrated. Land reforms help to set the balances straight by
transferring tenant cultivators into smallholders so they have greater incentive to raise
production and improve their incomes. They may also be provided with critical inputs
such as credit, seeds, fertilizers, marketing facilities and agricultural education.

Microfinancing schemes also help. There should be wider access to educational

opportunities to increase income earning potential.
3. Progressive income and wealth taxes
This is a major source of revenue for the governments for development finance.
According to this form of taxation, the rich are required to py a larger proportion of
their total income in taxes as compared to the poor. The burden of tax is designed to fall
most heavily on the upper income groups. However the implementation of this is crucial
to the success of such a program. It often turn in to a regressive tax system when the
poor pay more than the rich. This is because most the incomes of the rich go unreported
and the rate of tax evasion is fairly high with little or no accountability.
4. Direct transfer payments
The government can carry out direct money transfers for the poor and provide
subsidized low prices of essential food stuffs. However care must be taken that these
are directed only towardas those who are genuinely poor. They should not become
unduly dependent on such transfer payments. It must not discourage those who are
productively contributing to the economy to start enjoying these benefits for cheap. A
way around these issues is to focus in areas which the non-poor do not consume or
need.
5. Public provision of goods and services
The government can provide the poorer communities with certain facilities in kind sucha
as building schools in their localities, health care clinics, nutrition paks for mothers and
children etc. they can be provided with electricity and other necessities so they can
overcome social distress and build their self esteem to be able to perform productively.