ECON2262: Economic Development

Homework 1 (Due Wednesday Feb. 10, 2020)

Guidelines

You are free to work on this assignment in groups but you are strongly encouraged to work out
these problems individually before discussing answers with your group. Each group should submit
a single copy of answers to these questions onto Moodle. Write your student ID and the names of
any students you worked with on this assignment. See the Syllabus for relevant data links.

Questions

1. GDP and Poverty [6 points]

(a) Using data from 2015 as reported by the World Bank (World Development Indicators), compare
the “GDP at market prices (current US$)” to the “GDP, PPP (current international $)” for your
group’s country. Compare the difference between those two measures to the same difference for the
Germany. Is your country’s PPP difference larger or smaller than the difference for Germany?
Explain why.

(b) Using data from the World Bank, compare the annual growth rate of “GDP per capita (constant
2010 US$)” from 1995-2004 to the growth rate from 2005-2014. Has growth slowed down or
increased in the twenty years through 2014? Hint: use the exponential growth formula from lecture.

(c) Based on the growth rate g from 2005-2014, how many years will it take for your country to
double its GDP per capita?

2. Income Distribution [15 points]

Suppose that in country A the “bottom” 40% of the population receives 10% of the country’s
income. The “top” 60% receives the remaining 90% of the country’s income. What is the Gini
index in country A?

Now suppose that in country B the bottom 20% of people receives 5% of the country’s income, and
the top 20% of people receives 55% of the country’s income. What is the Gini index in country B?

(a) Which country has greater inequality? Graph the Lorenz curves (connecting points using straight
lines) and show your algebra.

(b) Would your answer change if country A was ten times richer than country B (i.e., total income
in country B equaled ten times the total income in country A)? Explain.

(c) Some people argue that the difference between the maximum and minimum income (i.e., the
range: ymax – ymin) in a given country would be a good measure of relative inequality. However, this
principle violates one of the four principles of inequality we discussed in class. Which one? Why?
Hint: consider four distinct incomes (y1 < y2 < y3 < y4) and a redistribution of income among the two
middle incomes.
(d) In country C with a population of 5,000 households, 800 households have expenditure levels
below the poverty line, which equals $1,500. What is the poverty headcount ratio for this country?

Now suppose that 300 immigrant households arrived in country C. 200 of those households have
expenditures greater than $1,500, and 100 households have expenditures less than $1,500. Has the
poverty rate increased or decreased? Show your work.

(e) Suppose that the 100 immigrant households below the poverty line are the only households to
pay taxes, some of which are then transferred to the 4,400 households above the poverty line.
However, the poverty rate does not change. This example shows why the poverty headcount is not a
proper measure of relative inequality. Why?

(f) The poverty gap index (PGI) captures the average percentage shortfall in income from the
poverty line. It is defined as follows:

where N is total population, q is the number of poor, z is the poverty line, and yj is the income for
person j living below the poverty line. Explain one benefit of this measure relative to the poverty
headcount. Explain one shortcoming of this measure. Hint: Use the transfer principle for both
examples.

3. Human Development and GDP [3 points]

Using data from the Human Development Report (see Moodle), compare the rank of your country’s
Human Development Index (HDI) to its rank in terms of GNI per capita. What explains the
difference? Be specific.

How has the HDI in your country changed between 1990 and 2014? Graph the evolution of HDI for
1990, 2000, 2010 and 2014, and discuss the trends. Then, compare the rank of your country’s HDI
in 1990 to its rank in 2014. What might explain this change?

4. Growth Models [8 points]

Suppose an economy follows the Solow growth model, with constant investment, depreciation, and
population growth rates. Please explain your answers.

(a) Suppose that the government withdraws an investment tax credit leading to a permanent
drop in the investment rate. Discuss the effect on the level and growth of per capita income
(PCI) in the short run. What happens to the level and growth of PCI in the long-run?

(b) Suppose that the economy is below its steady state level per capita income. Now suppose
there is a one-time influx of immigrants that increases the population. What happens to the
levels of per capita income and capital per worker in the short run? Will the economy start
 growing faster or slower after the arrival of the immigrants?

(c) Suppose that the new immigrants bring with them technologically innovative ideas, which
lead to an increase in TFP growth (i.e., growth in technology, which is sometimes referred to
as total factor productivity or TFP). What is the effect on PCI levels and growth in the short
run? in the long run?