How do we Measure Poverty?

We hear statements like "45 million Americans are Poor;" yet we should think how we measure poverty in the US? Or in other parts of the world?

The Nobel-prize winning economist Amartya Sen mentions that there are two issues faced when measuring poverty - one is how to identify the poor, and the second is to use a mathematical function to measure the intensity of poverty (Sen, 1976). In order to identify who is poor, we use a metric called the 'poverty line' - anyone who earns/consumes an amount below that poverty line is said to be in poverty. There are two ways we come up with the poverty line:

1. The Absolute Measure: In this measure, we create a bundle of goods that is deemed to provide the minimum amount of standard of living, and then convert that to dollar amount, which is the poverty line. Anyone earning or consuming less than that dollar amount is said to live in poverty. One famous absolute measure of poverty is the $1/day (now $1.25/day). Anyone earning less than $1.25 a day in the developing world is said to be living in extreme poverty. About 1.2 billion people earn below this level in 2013. Another common way of measuring poverty in developing countries is to measure the cost of purchasing 2200 calories of food per person. That cost is the poverty line, and anyone earning less than that is said to be in poverty.

2. The Relative Measure: This sets the poverty line based on the standard of living in a certain area. For example, in the EU, poverty line is set to be 60 percent of the median of national income. So, if median income is 60,000 Euros, then the poverty line is 36,000 Euros, and anyone earning less than that is said to be in poverty.

The United States uses the absolute measure to set the poverty line. Mollie Orshansky came up with the current method the US uses to measure poverty. Orshansky found out that in the 1960s, a typical family spent one-third of their income on food. Following this rule, if one calculates the minimum amount needed to purchase a fixed basket of food for a family, and then multiply that number by 3, then one can arrive at the minimum amount needed to sustain a family in the US. Since the 1960s, the US has been using this method to calculate the poverty line.

This poverty line is sensitive to the size of a family. In 2015, the poverty line for a family of 4 is about $24,000. So, a family of 4 that earns less thank $24,000 a year is considered to be poor. Under this definition, about 45 million Americans are living in poverty.

An advantage of the absolute measure is that the poverty rate can be compared from one year to the next, since we are using the same metric to measure poverty. However, a drawback of the absolute poverty measure of the US is that it does not adjust for regional price differences. So, a family of 4 in New York City earning $25,000 a year is not considered poor, but a family of 4 earning $24,000 in Mississippi is; although cost of living is much more expensive in New York than in Mississippi (housing, food and clothing are much more expensive in New York than in Mississippi). Another criticism of the US poverty line is that food expenditure is no longer one-third of one family's income, so a new definition is needed to calculate the poverty line.

Now after establishing the poverty line, the proportion of people earning less than the poverty line is the poverty rate of a country or the headcount ratio. In 2013, the poverty rate in the US is 14.5%.