CHAPTER TWO: Economic Development and Economic Growth

Concepts of Economic Development vs. Economic Growth

 Though the study of economic development has attracted the attention of economists right
from Adam Smith down to Marx and Keynes, yet they were mainly interested in the problems
which were essentially static in nature and largely related to a Western European framework of
social and cultural institutions.

 After the Second World War, economists started devoting their attention towards analyzing the
problems of underdeveloped countries

 Their interest in the economics of development has been further stimulated by the wave of
political independence that swept the Asian and African countries after the second World War.
1
 Cont’d

The desire of new leaders in developing countries to promote rapid economic

development coupled with the realization on the part of the developed nations that
“poverty any where is a threat to property every where,” has aroused further interest for
economic development.

 But the interest of the wealthy nations in removing widespread poverty of the
underdeveloped countries has not been aroused by any humanitarian motive.

 The most convincing reason for aiding the underdeveloped countries has been the cold
war between Russia and the West. Each tries to enlist the support and loyalty of
underdeveloped countries by promoting larger aid than the other.
2
 Cont’d

Economic development has also an export value for both the aid-giving and aid-receiving
countries.

However, a study of the Poverty of Nations and the methods of removing poverty cannot
be based on the experience of the rich nations.

Underdeveloped countries should not accept our inherited economic theory uncritically but
remold it to fit their own problems and interests.

3
 Cont’d
Economic Development and Economic Growth:

Economic growth means more output, while economic development implies both
more output and changes in the technical and institutional arrangements by which it
is produced and distributed.

Economic growth measures an increase in Real GDP (real output). GDP is a measure of
the national income / national output and national expenditure. It basically measures the
total volume of goods and services produced in an economy.  does not reflect the
depletion of natural resources,

4
 Cont’d
• Measures of economic development

GNP per capita

Levels of literacy and education standards

Levels of healthcare e.g. number of doctors per 1000 population

Quality and availability of housing

Levels of environmental standards

Life expectancy

5
The basis of Comparison Economic Development Economic Growth
between Economic Growth and
Economic Development
Concept Economic development is a much broader concept than Economic Growth is a narrower concept
economic growth. Economic development = Economic than economic development.
Growth + Standard of Living

Scope Economic Development is considered as a Economic Growth is considered as a

Multidimensional phenomenon because it focuses on the single dimensional in nature as it only
income of the people and on the improvement of the living focuses on the income of the people of
standards of the people of the country. the country.

Term Long-term process Short-term process

measurement HDI (Human Development Index), gender-related Increase in real GDP
index, Human poverty index, infant mortality, literacy
rate etc.
Related to Economic Development is related to Underdeveloped and Economic Growth is related to
developing countries of the world. developed countries of the world.

Effect Qualitative and Quantitative Impact on the economy. Brings a quantitative impact on the
Improvement in life expectancy rate, infant, literacy rate, economy. Increase in the indicators like
poverty rates, and mortality rate. per capita income and GDP, etc.

Process Continuous process In certain period

 Cont’d
 It is possible to have economic growth without development. i.e. an increase in GDP, but most
people don’t see any actual improvements in living standards.

Economic growth may only benefit a small % of the population. For example, if a country
produces more oil, it will see an increase in GDP. However, it is possible, that this oil is only
owned by one firm, and therefore, the average worker doesn’t really benefit.

Corruption. A country may see higher GDP, but the benefits of growth may be syphoned into
the bank accounts of politicians

Environmental problems. Producing toxic chemicals will lead to an increase in real GDP.
However, without proper regulation, it can also lead to environmental and health problems. This
is an example of where growth leads to a decline in living standards for many.

7
 Cont’d
Core Values of Development Economics
Three core values serve as standards of development.

At least three basic components or core values serve as a conceptual basis and practical
guideline for understanding the inner meaning of development. These are sustenance, self-
esteem, and freedom

1. Sustenance: The ability to Meet Basic needs. All people have certain basic needs
without which life would be impossible. These life-sustaining basic human needs include
food, shelter, health, and protection.

8
 Cont’d
When any of these is absent or in critically short supply, a condition of “absolute
underdevelopment” exists. A basic function of all economic activity, therefore, is to
provide as many people as possible with the means of overcoming the helplessness and
misery arising from a lack of food, shelter, health, and protection.

Without sustained and continuous economic progress at the individual as well as the
societal level, the realization of the human potential would not be possible. One clearly has
to have enough in order to be more.

 Rising per capita incomes, the elimination of absolute poverty, greater employment
opportunities, and lessening income inequalities therefore constitute the necessary but not
the sufficient conditions for development.
9
 Cont’d
2. Self-esteem: to Be a Person

 A sense of worth and self-respect, of not being used as a tool by others for their own
ends.

 The quality of life is good when there is respect, trust, and self-value. Each person has
needs which can be achieved through the presence of respect, dignity, and a good
reputation in society.

 A country is developed if this unique need of the people is addressed.

3. Freedom from Servitude: To Be Able to Choose

A third and final universal value that should constitute the meaning of development
is the concept of human freedom
10
 Cont’d
Wealth can enable people

To gain greater control over nature and the physical environment (e.g., through the
production of food, clothing, and shelter) than they would have if they remained
poor.

It also gives them the freedom to choose greater leisure, to have more goods and
services, or to refute the importance of these material wants and choose to live a life
of spiritual contemplation.

11
 Cont’d
The concept of human freedom also encompasses various components of political
freedom  Including personal security, the rule of law, freedom of expression, political
participation, and equality of opportunity.

Although attempts to rank countries with freedom indexes have proved highly
controversial, studies do reveal that some countries that have achieved high economic
growth rates or high incomes, such as China, Malaysia, Saudi Arabia, and Singapore, have
not achieved as much on human freedom criteria.

 The challenge of Development Economics is in the formulation of economic theory and

in the application of policy in order to understand better and to meet those three core
components of development.
12
 Cont’d
Another notion of development is “Sustainable Development” which is defined as
development that meets the needs of the present without compromising the ability of future
generations to meet their own needs.

Measuring Economic Development: The HDI

Using the growth of GDP or per Capita income (PCI) to measure developments is
misleading because of the following reasons.

 GNP/GDP measures “productive” activity in a very narrow way, excluding, for

example, the non-marketed productive activities of the household, including those
produced by women and children. But, many goods and services produces in LDCs
fall in this (non-marketable) category.
13
 Cont’d
 GNP measure of development do not include non-monetary change variable in the
economy such as Life expectancy, affection, peace, and other variables capturing the
change in welfare.

 PCI tells us nothing about the distribution of the change income that has appeared in
GDP growth.

Quality of life, an important index of development. It is contended that such an

important index of development is not adequately reflected in the index of PCI growth.

14
 Cont’d
Several factors are involved in the measurement of such “quality” example.

 Education and literacy rates

 Life expectancy

 The level of nutrition as measured by calorie supply per head

 Consumption of energy per head

 Consumption of consumer durable per Capita

 The proportion of infant mortality per thousand of live population

15
 Cont’d
The quality to life could also be measured by an increase in investment, industrialization and
agricultural productivity

However, events, in many LDCs tend to suggest that a fast rate of economic growth has been
associated with greater inequality in income distribution and a decline in people’s
participation.

Human Development Index(HDI):

 An index measuring national socioeconomic development, based on combining measures of

education, health, and adjusted real income per capita.

The HDI currently ranks countries into four groups: low human development (0.0 to 0.535),
medium human development (0.536 to 0.711), high human development (0.712 to 0.799), and very
high human development (0.80 to 1.0).
16
 Cont’d
1. The longevity or life expectancy index (health proxy) (L):

Averagelife expactance - Minimum life expactance

LE 
Maximum life expactance - Minimum life expactance

 Maximum life expectance= 85 and

 Minimum life expectance= 25

2. The knowledge or education index (E):- It has two components:

 Adult literacy Adult literacy takes 2/3 of the weight and

 The combined gross enrollment ratio (GER) for primary, secondary and tertiary
education GER takes 1/3 of the ratio.

17
 Cont’d
Average adult literacy  Minimum adult lietarcy
a. Adult Literacy Index 
Maximimum adult literacy  Minimum adult literacy

Where:
 The maximum value for Adult Literacy is 100
 The minimum value for Adult Literacy is 0
AverageGER  Minimum GER
b. The combined GER Index 
Maximimum GER  Minimum GER

Where:
 The maximum value for the combined GER is 100
 The minimum value for the combined GER is 0

18
 Cont’d
The Education index =2/3 (the Adult Literacy Index) + 1/3(The combined GER Index)

Ln (actual GDPpercapita)  Ln ( Minimum GDP percapita)


3. The percapita GDP Index (Y) Ln (max ximum GDP percapita)  Ln ( Minimum GDP percapita)

Where:
 The maximum value for GDP percapita is $ 40,000
 The minimum value for GDP percapita is $100

The HDI is then:

 HDI = 1/3(L) +1/3(E) +1/3(Y)

19
 Cont’d
 Example1: Calculating HDI (in 2003) for South Africa
Given:

 Actual Adult literacy rate = 82.4%

 Actual Combined gross enrolment ratio = 78%

 Actual (average) per capita GDP is $10346

 Average life expectancy is 48.4

20
 Cont’d

 Life Expectancy Index = (48.4-25)/ (85-25) =0.391

 Adult literacy index = (82.4-0)/ (100-0) = 0.824

 Gross enrolment index = (78-0)/ (100-0) = 0.780

 Education Index = (0.824 x 2/3) + (0.780 x 1/3) = 0.5493 + 0.26 = 0.809.

 GDP Index = [ln (10346) – ln (100)]/ [ln (40000) – ln (100)] = 0.774

 HDI = (1/3 x 0.391) + (1/3 x 0.809) + (1/3 x 0.774)

 HDI = 0.1303+0.2698+0.258 = 0.6581

21
 Cont’d

Example2: Calculating HDI (in 2007) for Bangladesh

1. population life expectancy in 2007 was 65.7 years

 Life expectancy index=65.7-25/85-25=0.678

2. Education index

a. Adult literacy is estimated (rather uncertainly) at 53.5%,

 Adult literacy index=53.5-0/100-0 =0.535

b. For the gross enrollment index, for Bangladesh it is estimated that 52.1% of its

primary, secondary, and tertiary age population are enrolled in school

22
 Cont’d

Gross enrollment index=52.1-0/100-0=0.521

Education index=2/3(adult literacy index) +1/3(gross enrollment index)

 2/3 (0.535)+ 1/3 (0.521) = 0.530

3. GDP per capita was estimated by the UNDP to be $1,241, the income index is calculated
as follows:

 Ln (1241)- Ln (100) / (Ln (40000) – Ln (100)) = 0.420

 HDI= 1/3 (0.678) + 1/3 (0.530) + 1/3 (0.420) = 0.543

23
 Cont’d

HDI= 1/3 (0.678) + 1/3 (0.530) + 1/3 (0.420) = 0.543

Calculating the NHDI

• Where H stands for the health index, E stands for the education index, and I stands for the
income index. This is equivalent to taking the cube root of the product of these three
indexes.

• The HDI ranks countries into four groups: low human development (0.0 to 0.499), medium
human development (0.50 to 0.799), high human development (0.80 to 0.90), and very
high human development (0.90 to 1.0).
24
Example: Ghana
Indicators Value
Life expectancy at birth (years) 64.6
Mean years of schooling 7.0
Expected years of schooling 11.4
GNI per capita (PPP $) Indexes 1,684

64.6 - 20
Life expactance index   0.701
83.6  20
7.0 - 0
Mean years of schooling index   0.527
13.3  0
11.4 - 0
Expected years of schooling index   0.634
18.0  0

ln1684 - ln100
Income index   0.417
ln 87478  ln 100
0.527 ∗ 0.634
𝐸𝑑𝑢𝑐𝑎𝑡𝑖𝑜𝑛 𝑖𝑛𝑑𝑒𝑥 = = 0.596
0.971 − 0
3
𝑯𝒖𝒎𝒂𝒏 𝒅𝒆𝒗𝒆𝒍𝒐𝒑𝒎𝒆𝒏𝒕 𝒊𝒏𝒅𝒆𝒙 = 0.701 ∗ 0.596 ∗ 0.417 = 0.558
25
 Cont’d

Criticisms and possible drawbacks of the HDI.

Equal weight is given to each of the three components, which clearly has some value

judgment behind it, but it is difficult to determine what this is. Note that because the

variables are measured in very different types of units, it is difficult even to say precisely

what equal weights mean. Finally, there is no attention to the role of quality.

It should be noted that while one could imagine better proxies for health and education,

measures for these variables were chosen partly on the criterion that sufficient data must

be available to include as many countries as possible.

26
 Cont’d

The HDI measures do NOT tackle issues related to good governance, political freedoms,
etc….

A more serious issue of the HDI is the maximum and minimum values used and the weights
given to each of the 3 components of the HDI. There is no theoretical reasoning for why
life expectancy, education and GDP should be given equal weighting in the HDI?

By using arbitrary weightings and maximum and minimum values the HDI is always going
to be open to debate.

27
CHAPTER THREE: STRUCTURAL FEATURES AND COMMON
CHARACTERSTICS OF THIRD WORLD
1. STRUCTURAL FEATURES

ECONOMIC FEATURES

Low standards of Living

 A comparison of the per capita incomes of some of the underdeveloped

countries with those of the advanced countries shows the vast difference in
living standards.

 There is widespread poverty, with a large section of its population

 In adequate housing, poor health, limited or no education, unemployment and

malnutrition are prevalent among large sections of the population.
28
 Cont’d

 Law Rates of Growth of the Economy

 The rate of growth of the economy is very low. This low rate of growth

widens the existent large gap between the advanced and the

underdeveloped countries.

 The low rate of growth is due to a slow increase in the national income.

 The per capita income is also affected by a high growth of population.

29
 Cont’d

 Dominance of Agriculture

 In most underdeveloped countries agriculture is the main or dominant occupation giving

employment to the bulk of the population.

 For example in 1970, 68% of the population in India, 71% in Pakistan and 64% in Burma
were engaged in agriculture and related industries (i.e. agro-industries),

 While only 3% in the U.K., 4% in the USA and 8% in Canada were engaged in this sector.

 In Ethiopia 85% of the population is engaged in agriculture

 This shows that in the advanced countries the bulk of the production comes from the industrial
sector, and hence the greater importance of industry and manufacturing in the developed
countries.

 Low Levels of Productivity

30
 Cont’d

 Small scale (subsistence farming)

 Great dependence on rain fed agriculture

 Lack of (low level of)

• Cropping intensity (once per year)

• Use of modern methods of cultivation

• Crops rotation

• Lack of marketing facilities, and

• The presence of middle men

31
 Cont’d

 Use of Interior Techniques of Production

 labor intensive

 Techniques used are very old and outdated

 In advanced countries high output levels are achieved by the use of capital-
intensive techniques.

 Low Rates of Capital Formation

 Basic industries , Heavy machines and equipment, and Infrastructural

 In most underdeveloped countries these sectors are either absent or

growing at very low rates.
32
 Cont’d

 Since these factors form the foundation for the industrial development of
the economy, their rate of growth has to be stepped up or fastened.

 Low Rate of Investment

 Poverty

 Export of Primary Products (High dependency on primary product Export)

 Import expensive capital equipment

 Exports primary agricultural products

33
 Cont’d

DEMOGRAPHIC FEATURES
 Developing countries are characterized by both high birth rates and high death rates
 Compared with the developed countries, which often have birth rates near
or even below replacement (zero population growth) levels, the low-
income developing countries have very high birth rates.

 The death rate in the underdeveloped countries is as high as 17 to 20 per

thousand persons,

 While in the developed countries it is about 7 to 8 per thousand.

 Life expectancy in developing countries is about 50 to 52 years as against

70 to 75 years in the advanced countries.
34
 Cont’d

 High Growth of Population

 Before and during their early growth years, Western nations experienced a
very slow rise in population growth.

 As industrialization proceeded, population growth rates increased

primarily as a result of falling death rates and slowly rising birth rates.

 However, at no time did European and North American countries have

natural population growth rates in excess of 2% per annum, and they
generally averaged much less.

35
 Cont’d

 By contrast, the populations of many developing countries have

been increasing at annual rates in excess of 2.5% in recent

decades, and some are still rising that fast today.

 The high level of population growth reduces the growth of the

percapita income and will also be a burden to the services

sector, schools, hospitals, transportation facilities etc.

36
 Cont’d

 High Rates of Unemployment

 As population increases, the labor force increases but with a slower rate of
economic growth, employment opportunities do not appreciate by increase.

 Hence, the result is a great deal of unemployment in the underdeveloped

countries’ economies. This takes the form of disguised unemployment,
underemployment and open unemployment.

 There is inadequate or inefficient utilization of labour as compared to DCs. 30%

of the urban labour force is underutilized in LDCs.

 In addition, there is brain drain of the skilled labour (professionals) to DCs.

 Cont’d

SOCIO-POLITICAL FEATURES

 Inequalities of Income and consumption

 There is a very uneven and unequal distribution of national income in the

underdeveloped countries.

 The land and asset holding classes receive the bulk of the national income.

 The few rich class gets or receives the highest portion of the national

income while the majority, which is the lowest poor class gets the

minimum share and lives in miserable poverty.

38
 Cont’d

 This results in a great disparity in the living standards of the people with a
small section enjoying a very high standard of living and the rest living in
miserable poverty.
 There is thus a “dualistic” feature in the underdeveloped country with the
wealthy or affluence living side by side \with poverty. Thus, there is a
striking contrast between urban and rural standards and between one
region and another.
 Social Behavior
 Social inequalities of caste, rank and status are predominant in the
underdeveloped countries. This results in the suppression and exploitation
of the lowest classes.
39
 Cont’d

 Usually, employment is restricted to what is allowed within one’s caste –

and this kills initiative and enterprise
 Social and religious taboos and suppression are also prevalent to a large
extent in these countries.
 Illiteracy
 In the late 1990s, the literacy rate was 34% in India, 16% in Pakistan, 25%
in Ghana,
 While it was 98% in Japan and 99% in the USA and the UK.
 The low level of literacy spells traditional modes of behavior in respect of
a majority of the population, lack of knowledge of new methods of
production and so on. 40
 Cont’d

 Conspicuous Consumption
 Any surplus generated is used for conspicuous consumption, i.e., to show
off one’s status either by buying houses or property, jewelry, cars or
spending lavishly and wastefully on religious and social ceremonies like
weddings, festivals, etc.
 This boosts up the person’s prestige in society.
 Unfortunately, such expenditures are unproductive to a very large extent
in these countries.
HISTORICAL FEATURES
 Underdeveloped countries were former colonies of advanced countries like Britain,
France, Holland or Spain.
41
 Cont’d

2. COMMON CHARACTERSTICS OF THIRD WORLD

 General poverty

 Absolute -poverty The vast majority of the people in LDCs are ill fed, ill-
clothed, ill-housed and ill educated.

 Agriculture, the main occupation

 This heavy concentration in agriculture is a symptom of poverty

 It is carried on in an old fashion with obsolete and outdated methods of

production.

42
 Cont’d

 A dualistic economy

 Market economy and the other subsistence economy

 Existence of an advanced industrial system and an indigenous backward agricultural system

 The natural resources of an underdeveloped country are either unutilized or underutilized.

 Unemployment and Disguised Unemployment

 Economic Backwardness

 Lack of enterprise and initiative

 Insufficient capital equipment

 Technological Backwardness

 Foreign Trade Orientation

43
 Cont’d

3. Common Obstacles to Growth and Economic Development of Third World

Countries

 The Vicious Circle of Poverty

44
 Cont’d

 Low Rate of Capital Formation

 Physical  plant, machinery and equipment used

 Human capital  skills and expertise embodied in the labor force through
education and training

 Socio- Cultural Constraints  traditional belief’s and society’s attitudes, which

are not conducive to economic development.

 Agricultural Constraints

 Inappropriate government policies and strategies

45
 Chapter-4: Theories of Economic Development

The classical Theory

1. Adam smith’s Theory

 The crucial aspects of development theory as propounded by Adam Smith

are (1) Division of labour and (2) Capital accumulation.

 Increasing returns caused by division of labour

 Along with division of labour it is acceleration of investment or capital

accumulation that leads to the increase in growth of output and living
standards of people.

46
 Cont’d

(2) Capital accumulation.

 As a means of economic development, Adam Smith gave an important
place to saving and accumulation of capital
 Capitalist class behaves in such a manner and save a very large proportion
of their profits.
 Increase in capital formation leads to the production of different types of
specialized equipment which are operated by different classes of workers
who are skilled and specialized in various tasks.
 Thus, capital accumulation along with division of labour leads to the
increase in industrial output and employment
47
 Cont’d

 Development Process is Cumulative  It feeds upon itself

 First, increase in saving causes more accumulation of capital which in turn facilitates a great
degree of division of labour and thereby raising productivity of labour and levels of incomes
of the people.

 Second, the higher incomes due to the capital accumulation and a higher degree of division
of labour lead to the increase in the size of market or demand for goods.

 This expansion in demand for goods causes increase in national output and income which
brings about more saving and further investment and capital accumulation. In this way
spiral of economic growth rises higher and higher.

 Third, the increase in size of market and availability of capital induces improvement in
technology

48
 Cont’d

Sequence of Development  Agriculture, then industry and finally commerce

Stationary State  Further capital accumulation stops to take place and

therefore there is no more growth of the economy

 This happens because of two reasons. First, there is a limited amount of

natural resources at the disposal of the economy and after passing
through a phase of growth a point is reached when they are fully utilized
and do not permit further growth of output.

 The second factor responsible for occurrence of stationary state is

fall in profits which reduces inducement to invest further.
49
 Cont’d

 Profits tend to fall as a result of competition among the capitalists,

i.e., investors.

 This results in decrease in demand for more capital accumulation. With

slackening (Decreasing) of capital accumulation, demand for labor
decreases resulting in decline in wages.

 Thus, after a significant economic growth, stationary state of the

economy is reached where further capital accumulation ceases and
profits fall to a low level and with the further increase in population
wages become equal to the subsistence level.
50
 Cont’d

2. The Ricardian Theory

 Like that of Smith in Ricardo’s model growth and development depends on

capital accumulation

 Capital accumulation depends on reinvestment of profits

 However, according to Ricardo, the industrial sector cannot go on expanding

indefinitely.

 Agriculture is subject to diminishing returns

 The increase in industrial output and employment and the rise in the demand
for food-grains will cause the prices of food-grains to rise.

 The rise in prices of food-grains will bring about the increase in the wage
rate in the industrial sector. 51
 Cont’d

 If the wage rate rises, the net revenue or profits of the capitalist would be
reduced

 Thus, the occurrence of diminishing returns in agriculture and the

consequent rise in the prices of food-grains and the rise in wage rate, the
rate of profits made by capitalists will go on declining till it becomes zero.

 When the rate of profit is reduced to zero, further expansion in the stock
of industrial capital ceases to occur.

 As a result of this, the whole growth process of increase in output and

labour employment will stop.
52
 Cont’d

Stationary State

 The rate of profit goes on falling as more and more capital is accumulated and
invested. As the rate of profit falls, the accumulation of capital also slows
down. The economy reaches the stationary state when rate of profit is too low
to provide any incentive for any business enterprise.

 After the initial rise in wages as economy grows forward, the wages are
brought down to the subsistence level by the pressure of population.

 At this stage, the rents are high. The real wage rate is at its minimum and
population growth slackens. The rate of profit falls to near zero and further
expansion of capital ceases. These are all the symptoms of a stationary state
53
 Cont’d

 The Marxian Theory

 In Marxian theory, production means the generation of value. Thus economic

development is the process of more value generating. But high level of production is
possible through more and more capital accumulation and technological improvement

 At the start, growth under capitalism, generation of value and accumulation of capital
underwent at a high rate.

 After reaching its peak, there is a concentration of capital associated with falling rate of
profit. In turn, it reduces the rate of investment and as such rate of economic growth.

 Unemployment increases. Class conflicts increase. Labour conflicts start and there is
class revolts.

 Ultimately, there is a downfall of capitalism and rise of socialism

54
 Cont’d

 The Keynesian Theory

 In classical economy theory, it is assumed that output and prices will

eventually return to a state of equilibrium

 But the Great Depression seemed to counter this assumption. Output

was low and unemployment remained high during this time.

 The Great Depression inspired Keynes to think differently about the

nature of the economy. From these theories, he established real-world
applications that could have implications for a society in economic
crisis.
55
 Cont’d

 Keynes advocated increased government expenditures and lower

taxes to stimulate demand and pull the global economy out of the
depression.

 Keynesian economics is considered a "demand-side" theory that

focuses on changes in the economy over the short run.

 Keynes rejected the idea that the economy would return to a natural
state of equilibrium. Instead, he envisaged economies as being
constantly in change, both contracting and expanding.
56
 Cont’d

 In response to this, Keynes advocated a countercyclical fiscal policy

in which, during the boom periods, the government ought to increase

taxes or cut spending, and

 During periods of economic depression, decrease taxes or increase

spending

57
 Cont’d
 Lewis Theory of Unlimited Supplies of labor

 A theory of development in which surplus labor from the traditional

agricultural sector is transferred to the modern industrial sector, the
growth of which absorbs the surplus labor, promotes industrialization, and
stimulates sustained development

 Surplus labor refers to the portion of the rural labor force whose marginal
productivity is zero or negative

58
 Cont’d

In the Lewis model, the underdeveloped economy consists of two sectors:

 A traditional, overpopulated, rural subsistence sector characterized by

zero marginal labor productivity  a situation that permits Lewis to
classify this as surplus labor in the sense that it can be withdrawn from
the traditional agricultural sector without any loss of output and

 A high-productivity modern, urban industrial sector into which labor

from the subsistence sector is gradually transferred

59
 Cont’d

 This process of modern-sector self-sustaining growth and employment expansion is

assumed to continue until all surplus rural labor is absorbed in the new
industrial sector.

 Thereafter, additional workers can be withdrawn from the agricultural sector only at
a higher cost of lost food production because the declining labor-to-land ratio
means that the marginal product of rural labor is no longer zero.

 Thus, the labor supply curve becomes positively sloped as modern-sector wages
and employment continue to grow.

 The structural transformation of the economy will have taken place, with the
balance of economic activity shifting from traditional rural agriculture to
modern urban industry.
60
 Cont’d

 Another classical element important in the Lewis model is the connection

between savings and the distribution of income. Together with Adam Smith
and other classical economists, Lewis sees the basic problem as low savings.
The key to development is to be found in mechanisms which dramatically
increase the saving rate.

 The reason why savings are low in an underdeveloped economy relatively to

national income is not that the people are poor, but that capitalist’s profits are
low relative to national income. As the capitalist sector expands profit grows
relatively and an increasing proportion of national income is reinvested.
61
 Cont’d

Balanced Vs Unbalanced Growth Theory

Balanced growth

 Can be defined as the systematic and equal prioritization for all sectors
and regions of the economy.

 It focuses on balanced type of Investment and capital mobilization to

make the growth more balanced and distributed.

 Thus, the main objectives of balanced growth are to make the growth
of all sectors in balanced way as the same time.

62
 Cont’d

Criticism of the Balanced Growth Theory

 To undertake a vast program of simultaneous, coordinated investment requires

large sums of capital far beyond the reach of the ordinary LDC.

 If the LDCs had such resources, critics argue, they would not be
underdeveloped in the first place.

 To realize its goals, balanced growth obviously requires a team of trained

personnel (entrepreneurs, managers, technicians, skilled labor, etc) to
implement the comprehensive plan of investment. But, these are in scarce
supply in LDCs.

 Critics maintain that it a country had the resources to launch a program of

balanced growth; it would not be under developed in the first place.
63
 Cont’d

Unbalanced growth

 Is a situation in which the various sectors of a given economy are not

growing at a rate similar to one another.

 Specific sectors of the economy will be growing at a rapid rate, while other
sectors are either stagnant or experiencing a significantly reduced rate of
growth.

 When economic growth patterns such as unbalanced growth appear, the

phenomenon usually indicates that major in the overall economy are about
to take place.
64
 Cont’d

Assumption of unbalanced growth

 The best way of development to achieve in developing countries is unbalanced
growth. This means that unbalancing the economy makes the growth faster and
easier.

 The unbalance of economy is made by unequal investment patterns. This means the
investment is concentrated at the potential and selective sector only.

 The developing countries do not have the adequate capital to invest in all sectors of
economy. So, if they invest in the sectors advantage they can get the economy with
better growth.

 The unbalanced condition of economy creates the balanced condition because it is a

non-ending process.
65
 Cont’d

Dualistic Theories Dualism refers to the belief that developing economies

must be understood as having two sectors, traditional and modern, each with
peculiar characteristics and very different growth prospects.

 There are different theories which are of the view that the poverty and
underdevelopment of poor countries is attributed to their dualistic character.

 Social Dualism,

 Technological Dualism and

 Financial Dualism.

66
 Cont’d

 J.H. Boeke is a Dutch Economist who studied Indonesian Economy and presented his
theory of social dualism. He maintains that there are three characteristics of a society
in the economic sense. They are as:

 Social Spirit

 Organizational Form

 Techniques Dominating Them.

 Their inter-relationship and interdependence is called the social system or social style.

 A society is homogeneous if there is only one social system in the society. But the
society which has two or more social systems is known as dual or plural society.
67
 Cont’d

 Dr. Boeke says that the dual society is a society which has two full grown
social styles which represent pre-capitalism and post-capitalism.

 Such a dual society is furnished with the existence of an advanced imported

western system on the one side and endogenous pre capitalistic agricultural
system on the other side.

 Western system is under the western influence which uses the advance
techniques and where standard of living is high.

68
 Cont’d

 Pre capitalistic agricultural system is native and it is furnished with the

outdated techniques and low social and economic life.

 The imported social system is highly capitalistic and it may be socialistic as

well as communistic system.

 This is called social or sociological dualism and these two systems are
clashing.

Characteristics of Dualistic Society:

 Eastern Sector and

 Western Sector
69
 Cont’d

 Characteristics of eastern sector of a dualistic economy which distinguishes it from

western sector.

 The needs of eastern sector are limited.

 People work for social needs rather for economic needs.

 Goods are cultivated according to their prestige value rather on their use value.

 As a result of all above, the eastern economies are characterized with backward
bending supply curves of effort and the risk taking.

 The native industries have neither organization nor capital-Intensive and they are
ignorant of modern technology and market conditions.

70
 Cont’d

 People are indulged in speculative activities rather in business

enterprises.

 They do not take risk by making productive investment.

 They lack the initiative and organizational skill which is a feature

of western sector of dual economy.

 Labor is unorganized, passive and unskilled. They are reluctant to

leave their village and community. They are fatalist.

 The urban development takes place at the cost of rural life.

71
 Cont’d

 Due to these features of eastern society the western economic theory is not applicable
as far as UDCs are concerned.

 Thus Boeke says: we should not try to transplant the delicate houseplant of western
theory to tropical soils where an early death awaits for it.

Boeke refers to five kinds of unemployment in UDCs:

 Seasonal

 Casual

 Unemployment of regular workers

 Unemployment of white collard class

 Unemployment of Eurasians
72
 Cont’d

According to Boeke the govt., is unable to remove such unemployment because

of the reason that it will require the funds which the govt. cannot avail.

 Boeke says that limited wants and limited purchasing power in eastern sector
hamper economic development.

 If the food supply is increased or industrial goods are increased, it will bring a
glut of commodities in the market.

The prices will fall and economy will face depression.

73
 Cont’d

But this does not mean that Boeke is against industrialization, and agricultural
improvement.

Rather he is in favor of slow process of industrialization and agricultural

development on small scale which could have an adaptability with the
dualistic structure of eastern society.

The urge for development should come from the people themselves. New
leaders must emerge who should work for the goal of development with faith,
charity and patience.

74
 Cont’d

Professor Bengmin Higgins has criticized the social dualistic theory on the following grounds:

Wants are not Limited:

Casual Labor are not Unorganized: Boeke presented the version that casual workers are
unorganized and passive. But this may be true as far as agricultural sector is concerned but they are
not unorganized in coffee, tea, rubber and plantation etc.

Eastern Labor is not Immobile: Boeke thought that eastern labor is immobile. It is not so because of
attraction of modern facilities of life in the urban areas. Moreover the high income incentives force the
labor to move from rural areas to urban areas.

Dualistic Theory is not Particular To UDCs Only: The eastern society, according to Boeke, only
exists in UDCs. It is not true. It does exist in Canada, Italy and even in the United States.

75
 Cont’d

Applicability to Western Society: According to Professor Higgins most of the characteristics of

eastern society given by Boeke are present even in the western societies. For example, during hyper
inflation, speculation is preferred to investment. This means, the people in the western countries also
have a strong desire to keep their capital safe and in liquid form. The western society also believes in
conspicuous consumption as discussed by Veblin and Snob effects.

Not a Theory But a Description: It is objected that the Boeke's dualistic theory is merely a
description rather than a theory. His findings are based upon neo-classical theory which has the limited
applicability in the western world.

Does not Provide Solution to the Problem of Unemployment: Boeke's dualism centers more on
socio-cultural aspects rather on economic. He only says that govt. is not in a position to remove
unemployment. Moreover, he does not mention the situation of under employment.

76
 CHAPTER-5: ECONOMIC GROWTH MODEL

 The most influential and outspoken advocate of the stages-of-growth model of

development was the American economic historian Walt W. Rostow. Strong
advocate (supporter) of the doctrine of unbalanced growth

 According to Rostow, the transition from underdevelopment to development can be

described in terms of a series of steps or stages through which all countries must
proceed.

The Five Stages of Economic Growth

A. The traditional society

77
 Cont’d

• Traditional society means a society as one whose structure is developed within limited production
functions.

• The social structure of such societies was hierarchical in which family and clan connections played
a dominant role. Political power was concentrated in the regions, in the hands of the landed
aristocracy supported by a large soldiers and civil servants.

• More than 75 percent of working population was engaged in agriculture. Naturally, agriculture
happened to be the main- source of income of the state and nobles, which was dissipated on the
construction of temples and other monuments, on expensive funerals and weddings and on the
prosecution of wars.

78
 Cont’d

B. The pre-conditions for Take-off

 The pre-conditions for sustained growth were created slowly in Britain and western Europe, from
the end of the 15th and the beginning of the 16th centuries, when the medieval age ended and the
modern age began.

 The spirit of adventure which led to new discoveries and inventions and consequently the rise of
the elite in the new mercantile cities were realized.

 Thus, these forces were instrumental in bringing about changes in social attitudes, expectations,
structure and values. Investment increased, the scope of commerce widens, modern manufacturing
appears, banks appear and others.

 The idea spreads that economic progress is possible.

79
 Cont’d

C. The take-off
• Rostow defines the take-off as an industrial revolution tied directly to radical changes in
the methods of production, having their decisive consequence over a relatively short period
of time lasting for about two decades. The requirements of takeoff are:

• A rise in the rate of productive investment from 5% or less to over 10% of national income.

• The development of one or more substantial manufacturing sectors with a high rate of
growth.

• The existence of quick emergence of a political, social and institutional frame work which
exploits the impulses to expand the modern sector and gives to growth an outgoing
character. 80
 Cont’d

D. The Drive to Maturity

• Rostow defines this stage as the period when a society has effectively applied the range of

modern technology to the bulk of its resources. It extends well over focus decades.

• Rate of net investment is well high over 10% of national income.

• Work force becomes skilled; people prefer to live in urban areas rather than in rural, real

wages rise, efficient managers take over the rugged masters and the society feels bored

of the miracles of industrialization and wants something new leading to a further change.
81
 Cont’d

E. The Age of High Mass-consumption

 this stage has been characterized by the migration to suburban, the extensive use of the

automobile, the durable consumers' goods and household gadgets.

• In this stage, the balance of attention of the society is shifted from supply to demand,

from problems of production to problems of consumption and of welfare in the widest

sense.

82
 Cont’d

The Harrod-Domar Model

Every economy must save a certain proportion of its national income, if only to
replace worn-out or impaired capital goods (buildings, equipment, and material).

However, in order to grow, new investments representing net additions to the capital
stock are necessary.

If we assume that there is some direct economic relationship between the size of the
total capital stock and total GDP, Y.

For example, if $3 of capital is always necessary to produce a $1 stream of GDP- it

follows that any net additions to the capital stock in the form of new investment will
bring about corresponding increases in the flow of national output, GDP. 83
 Cont’d

If a country saves 30% and has an incremental capital

output ratio of 3, and the depreciation rate is 2%, what
rate will it grow at?
• Answer: s = 30%, v = 3, s/v – 𝛿= 30%/3 ‐ 2% = 8%

84
 Cont’d

Consider the Harrod-Domar relationship for an economy: ∆𝒀/𝒀= s/k.

Because of population growth, Ethiopia’s GNP must grow by 1.5 percent per year just
to avoid a decline in average standards of living.

With a capital/output ratio of 6.0,

achieving this minimum-growth target requires a saving rate of_________

85
 Cont’d

 Limitations
• All savings may not be transformed into investment. This is because of institutional or attitudinal
problems or problems of confidence.

• Saving and hence investment is only a necessary factor for growth but not a sufficient condition.
For instance, technological skills, infrastructures and other factors are there that affect growth.

• Overall, the task of estimating capital output ratio is difficult anywhere (LDCs or DCs). Even if the
data or the information is available in LDCs you can’t estimate such a ratio reliably. This is because
of the heterogeneous nature of capital. In Harrod-Domar model capital refers only physical capital
but not human capital. Human capital embodied in labor in the form of training is excluded. But,
this is very important in LDCs.
86
 Cont’d

Solow Model (Neo-Classical Growth Models)

 Developed in 1950s by Prof. Robert Solow of MIT, a Nobel Prize winner.

The key modification from the Harrod-Domar (or AK) growth model, is that the Solow
model allows for substitution between capital and labor.

In the process, it assumes that there are diminishing returns to the use of these inputs

Solow model assumptions: Closed economy, producing one good using both labor and
capital; technological progress is given (constant) and the saving rate is exogenously
determined
87
 Cont’d

 The Solow model focuses on four variables:

 Flow of output,; Y(t)

 Stock of capital, K(t)

 Number of workers, L(t)

 A(t) is technology at time t.

 𝒀(𝒕) = 𝑭(𝑲 (𝒕) , 𝑨 (𝒕), 𝑳 (𝒕))

88
 Cont’d

Cobb-Douglas Function (specific functional form) - A production function that satisfies

 1
Solow model characteristics: Y  F ( K , AL )  K AL ,0    1
 ϒY = F (ϒK,ϒL) ------ divide both side by ϒL
Y/L= F(K/L, 1) y=f(k)

y y= f(k)
Diminishing MPK

k
89
 Cont’d

 ∆k= 𝒔f(k) − (𝜹+n)k ------------ The Solow equation

The growth of the capital-labor ratio, k (known as capital deepening), and shows that the
growth of k depends on actual investment sf(k), after allowing for the amount of capital
required to service depreciation, δk, and after capital widening, that is, providing the existing
amount of capital per worker to net new workers joining the labor force, nk.

It has an interpretation that the savings per worker, sf(k*), is just equal to δk*, the amount of
capital (per worker) needed to replace depreciating capital, plus nk*, the amount of capital (per
worker) that needs to be added due to population (labor force) growth.

90
 Cont’d

Steady state: State in which output and capital per worker are no longer changing

Hence, ∆k=0  𝒔f(k) = (𝜹+n)k

 There are two reasons that some investment is needed to prevent the capital stock per
unit of effective labor from falling

 Existing capital depreciates & must be replaced

 The quantity of effective labor grows at a rate of (n + g) thus it is not enough

to keep the capital stock K constant.

 Instead, the capital stock must also grow at a rate of (n + g) to keep k constant
91
 Cont’d

y
y= f(k)= production function
(n+ δ)k

sf(k)

Actual investment

k* k
 Cont’d

 If k is initially below k*, the new investment per unit of labor s’f(k) is
greater than what is required to keep capital stock constant (the break-even
investment level), hence capital stock will grow.

 If k is initially above k*, the new investment per unit of labor is greater
than the break-even investment level . Thus, capital stock will decline toward
k*

 At k*, the new investment is just equal to the break-even investment level,
hence capital stock remain constant
 Cont’d

Numerical example on steady state

• Suppose that the production function of a country is given by Y = K0.5L0.5 and
assume that
s = 0.4, d = 0.1, and then
A. Find per worker production function
B. Solve for the steady-state values of k* & y*
 Cont’d

 What happen for steady state if saving rate increased?

 What happen to steady state if population increased?

 Cont’d

 Some Limitations of the Solow model

 The following are the critics of Solow growth theory

 Full employment

 Capital and labor are substitutes (could they be compliments?)

 Diminishing returns to capital

 Technology is exogenous

 Capital and labor are homogenous

 And what about the role of institutions, history, social and political systems and so on?
 Cont’d

Empirical evidence (observation)

 A key prediction of neoclassical growth models is that the income levels of poor
countries will tend to catch up with or converge towards the income levels of rich
countries. Since the 1950s, the opposite empirical result has been observed on
average.

 Whether convergence occurs or not depends on the characteristics of the country or

region in question, such as:

 Institutional arrangements

 Free markets internally, and trade policy with other countries.

 Education policy
 Cont’d
Some stylized facts of economic growth

The Kuznets facts

 A well-known characteristic of modern economic growth is structural change:

unbalanced sectorial growth. There is a massive reallocation of labor from

agriculture into industry (manufacturing, construction, and mining) and further

into services (including transport and communication).

 The shares of total consumption expenditure going to these three sectors have
moved similarly.
 Differences in the demand elasticities with respect to income seem the main
explanation.
 These observations are often referred to as the Kuznets facts
 Cont’d
USA Employment Shares By Sector, 1869-1998 (Share of total employment)

Service sector-
increased

Manufacturing-
Stable

Agriculture-
declined
 Cont’d
U.S. Consumption Shares by Sector, 1940-1999 (Share of total consumption expenditure )
 Cont’d

 Kaldor’s stylized facts

 Surprisingly, in spite of the Kuznets facts, the evolution at the aggregate level in
developed countries is by many economists seen as roughly described by what is
called Kaldor “stylized facts”

 Real output per man-hour grows at a more or less constant rate over fairly long
periods of time. (of course, there are short-run fluctuations superposed around
this trend.)

 The stock of physical capital per man-hour grows at a more or less constant rate
over fairly long periods of time.
 Cont’d

 The ratio of output to capital shows no systematic trend.

 The rate of return to capital shows no systematic trend.

 The income shares of labor and capital (in the national accounting sense,
i.e., including land and other natural resources), respectively, are nearly
constant.

 The growth rate of output per man-hour differs substantially across

countries. These claimed regularities do certainly not fit all developed
countries equally well.
 Cont’d

 Although Solow’s growth model (Solow, 1956) can be seen as the first successful
attempt at building a model consistent with Kaldor’s “stylized facts”, Solow once
remarked about them: “There is no doubt that they are stylized, though it is possible to
question whether they are facts” (Solow, 1970).

 But the Kaldor “facts” do at least seem to fit the US and UK quite well
 Cont’d

 Kaldor also proposed hypotheses about the links between growth in the different.

1. Productivity growth in the manufacturing and construction sectors is enhanced

by output growth in these sectors (this is also known as Verdoorn’s Law).
Increasing returns to scale and learning by doing are the main factors behind
this.

2. Productivity growth in agriculture and services is enhanced by output growth in

the manufacturing and construction sectors
Chapter six: History, Expectation and Development

Complementarities

If the fact that other people in society are taking a certain action makes it more
beneficial (higher pay off or less costly) for me to take the same action, the
actions are said to be complementary.

When we have choices between complementary actions, we have the possibility of

multiple equilibria, meaning that society may coordinate around any one of the
possible actions, and exclude others.

These societal choices often are influenced by accidents of history

 Cont’d
Complementary (The Relationship between Agriculture and Industry)

The earlier confrontation of industrial development with agricultural development

has been shown to be a false issue, and the concern now is rather with the
interrelationship between industry and agriculture and the contribution that each
can make to the other.
 When there is an agricultural progress, the income of the rural people rises and
this in turn raises the demand for industrial products
Once agriculture emerges from its stationary, subsistence state and starts to
specialize and produce goods for export, and industry develops under the impact
of growth in the agricultural sector, the two sectors, agriculture and industry
become interdependent.
 Cont’d

The industrial sector adds to the demand for goods produced by agriculture and
absorbs surplus labor, which may raise productivity in agriculture.

In turn, the agricultural sector provides a market for industrial goods out of rising
real income, and make a factor contribution to development through the release of
resources if productivity rises faster than the demand for commodities.

The transfer of resources from agriculture to industry may be capital or labor or

both. Since labor is an abundant supply in most low-income countries, there is
generally no difficulty in releasing labor for industry, except during harvest time.
In any case, labor will tend to migrate naturally in response to seemingly better
opportunities in the industrial sector and higher real incomes.
 Cont’d

If the industrial sector to be guaranteed an adequate supply of labor, some wage
differential is inevitably required to offset the higher real living costs in an urban
environment, to compensate for the forfeit of non-monetary benefits of rural life,
and to compensate for greater job uncertainty in the industrial sector.

Industrialization favorably affects agricultural development in a number of ways:

Increases the demand for agricultural commodities.

 Industrialization increases the availability of capital for the agricultural sector

which helps in modernizing agriculture and raising farm outputs.
 Cont’d

Job opportunities to the rural people.

Industrialization provides a wide and extending range of consumer goods which

encourages the agriculturalists to increase farm produce.

Thus, both agriculture and industrial development are interrelated and each affects
the growth of the other so that we should achieve a harmonious development in
the two sectors.

 Complementarities are a special kind of externalities

 Cont’d
Coordination failure

According to this view, economic underdevelopment is the outcome of a massive

coordination failure, in which several investments do not occur simply because
other complementary investments are not made, and these latter investments are
not forthcoming simply because the former are missing.

Linkages: Mean that relationships and interactions between tasks, functions, departments

and organizations etc, that promote flow of information, ideas and integration in
achievement of shared objectives

 Forward linkage-supply side

 Backward linkage-demand side

 Cont’d

Policy: The set of basic principles and associated guidelines, formulated and
enforced by the governing body of an organization, to direct and limit its actions
in pursuit of long-term goals.

-Big Push: Policy of balanced growth

simultaneous coordinated investment in many critical industries to

“jump start” the economy.

-Unbalanced growth: selectivity promote the development of certain key

sectors
 Cont’d

How would key or leading sectors be chosen

 The number of linkages that a given sector possesses is certainly

an important factor

 Not only the number but also the strength of each linkage is matter

 Investing in least profitable activities the government maximizes the

chance of overcoming coordination failure
 Cont’d

 History

The equilibrium reached by the economy depends on its initial conditions

 Expectation

every body wants every body else to go first (taking economic losses). There is
no solution to the problem.

 Increasing returns

 during the transitional period where customers are progressively switching to the
new product, our producer must function at a loss.
 Cont’d

 Losses would not be a problem if capital markets were perfect. Our producer
could get a loan to cover the interim losses.

 However , if capital markets are imperfect or missing, we cannot gain access to

such credit and the whole (socially worthwhile) project may be scuttled.

What caused this problem? Three things:

(1) There are increasing returns to scale in production,

(2) Credit markets are missing or incomplete, and

(3) Customers switch slowly, so that it takes time to build a new market .
 Cont’d

 But the increasing returns are the critical feature.

 In absence of increasing returns, firm with lower costs (better technology) can
enter the market and sell a small quantity and make a profit

 International trade
Chapter seven: Growth, Poverty, and Income Distribution

 Income distribution: It is how a nation’s total national income distributed

amongst its population.

 Income inequality: The disproportionate distribution of total national income

among households.

 Lorenz curve is a common way of analyzing personal income statistics and it is

associated with measures of income inequality

 The Kuznets hypothesis

 in the early stages of economic growth income inequality increases, stabilizes

for a time and then inequality decline in the later stages. This is known as the
inverted U-shaped hypothesis of income distribution.
Cont’d

kkuu Kuznet’s inverted U-shape

 Cont’d

Measurement of Income Inequalities

(1) Proportion of income received by distinct size groups

 Quintile (5 groups) or A 20% proportion of any numerical quantity. A

population divided into quintiles would be divided into five groups of
equal size.

 deciles (ten groups) or 10%

• For example, Table above shows a hypothetical but fairly typical distribution of income for a developing
country.

• In this table, 20 individuals, representing the entire population of the country, are arranged in order
of ascending annual personal income, ranging from the individual with the lowest income (0.8 units) to the
one with the highest (15.0 units). The total or national income of all individuals amounts to 100 units and is
the sum of all entries in column 2.

• In column 3, the population is grouped into quintiles of four individuals each. The first quintile represents
the bottom 20% of the population on the income scale.

• This group receives only 5% (i.e., a total of 5 money units) of the total national income. The second quintile
(individuals 5 through 8) receives 9% of the total income. Alternatively, the bottom 40% of the population
(quintiles 1 plus 2) is receiving only 14% of the income, while the top 20% (the fifth quintile) of the
population receives 51% of the total income.
• A common measure of income inequality that can be derived from column 3 is the ratio of the incomes received by the
top 20% and bottom 40% of the population.

• This ratio, sometimes called a Kuznets ratio after Nobel laureate Simon Kuznets, has often been used as a measure of the
degree of inequality between high- and low-income groups in a country.

• In our example, this inequality ratio is equal to 51 divided by 14, or approximately 3.64.

• To provide a more detailed breakdown of the size distribution of income, decile (10%) shares are listed in column 4.

• We see, for example, that the bottom 10% of the population (the two poorest individuals) receives only 1.8% of the total
income, while the top 10% (the two richest individuals) receives 28.5%.

• Finally, if we wanted to know what the top 5% receives, we would divide the total population into 20 equal groups of
individuals (in our example, this would simply be each of the 20 individuals) and calculate the percentage of total income
received by the top group.

• In Table above we see that the top 5% of the population (the twentieth individual) receives 15% of the income, a higher
share than the combined shares of the lowest 40%.
 Cont’d

(2) Lorenz Curve: A graph depicting the variance of the size distribution of income
from perfect equality.

 The more the Lorenz line curves away from the diagonal (line of perfect equality),
the greater the degree of inequality represented.

 The extreme case of perfect inequality (i.e., a situation in which one person
receives all of the national income while everybody else receives nothing) would
be represented by the congruence of the Lorenz curve with the bottom
horizontal and right-hand vertical axes.

 Because no country exhibits either perfect equality or perfect inequality in its

distribution of income, the Lorenz curves for different countries will lie
somewhere to the right of the diagonal.
 Cont’d

(2) Lorenz Curve: A graph depicting the variance of the size distribution of income
from perfect equality.
 Cont’d

A B
 Cont’d

 Two representative distributions are shown in Figure A, one for a relatively equal
distribution and the other for a relatively unequal distribution (Figure B).
 Cont’d

(3) Gini coefficient:

 An aggregate numerical measure of income inequality ranging from 0 (perfect

equality) to 1 (perfect inequality).

 highly unequal income distributions typically lies between 0.50 and 0.70
Relatively equal distributions, it is on the order of 0.20 to 0.35
Cont’d
 Cont’d

 Gini coefficients are aggregate inequality measures and can vary anywhere from
0 (perfect equality) to 1 (perfect inequality).

 In fact, as you will soon discover, the Gini coefficient for countries with highly
unequal income distributions typically lies between 0.50 and 0.70, while for
countries with relatively equal distributions, it is on the order of 0.20 to 0.35
 Cont’d

(4) Absolute poverty.

 It entails the idea that there are a set of minimum necessities or essentials for
living.

 A measure of absolute poverty quantifies the number of people whose income

falls below a certain fixed level called poverty line (the level of income below
which one can not afford to purchase for living).
 There are a number of ways of measuring absolute poverty:
Head count index: is the most widely used measure which simply measures
the proportion of the population that is counted as poor. i.e how many people
are poor(below poverty line) as a percentage of total population.

It is easy to understand but does not reflect the depth of poverty.

 Cont’d
Poverty gap index: The measure of poverty that shows the extent to which individuals
fall below the poverty line and express it as a percentage of the poverty line. But it does
not show income disparity

Even though in both country A and country B, 50% of the population falls below the same poverty line,
the TPG in country A is greater than in country B. Therefore, it will take more of an effort to eliminate
absolute poverty in country A.
 Cont’d

Sen index: a measure of poverty that considers 1) head count of people living below the
poverty line.2) the income short falls of the poor. 3) The inequality of income among the
poor. Thus sen index is distribution sensitive because the redistribution of income from
an intensely poor person to a less poor person always increases relative inequality among
the poor and this is captured by the index.
 Cont’d

 Economic characteristics of poverty groups

 Relative poverty: takes in to consideration individual, social and economic

statues compared to the rest of society

 Absolute poverty (destitution): refers to the lack of means necessary to meet

basic needs such as food, clothing and shelter.

 Women and poverty:

 Cont’d

 Women make up a substantial majority of the world’s poor.

 If we compared the lives of the inhabitants of the poorest communities throughout

the developing world, we would discover that virtually everywhere women and
children experience the harshest deprivation.

 They are more likely to be poor and malnourished and less likely to receive
medical services, clean water, sanitation, and other benefits.

 The prevalence of female-headed households, the lower earning capacity of

women, and their limited control over their spouses’ income all contribute to this
disturbing phenomenon.
 Cont’d

women have less access to education, formal-sector employment, social security,

and government employment programs. These facts combine to ensure that poor
women’s financial resources are meager and unstable relative to men’s.