Engineering Economics

Course code-SM300
Lecture-15
Economic Growth and Human
Development
 Human Development Index
Human Development Index (HDI):A composite of several social
indicators that is useful for broad cross-country comparisons.
Even though it yields little specific
information about each country. First used in the Nations
United
Development Programme's Human Development Report 1990.
HDI is a summary index, designed to reflect average achievements in
three basic aspects of human development .

(Source: http://hdr.undp.org/sites/default/files/hdr2020_technical_notes.pdf)
 Human Development Index
What does HDI tell us? (contd.)
• Emphasizes people and their capabilities as ultimate criteria for
assessing the development of a country, not economic growth
alone.
• Can also be used to question national policy choices,
How 2 countries with the same level of GNI per capita have different
human development outcomes or a country with higher GNI per
capita has lower human development outcomes.
Eg. In 2019, United Arab Emirates’ GNI per capita (66,912) > Japan’s
GNI per capita (40,799) but…
Life expectancy at birth is 77.8 as compared to 84.5 in Japan and
both mean years of schooling and expected years of schooling is
lesser than those prevailing in Japan
Japan has a much higher HDI value than UAE.
These contrasts can stimulate debate about government policy
priorities.
 Human Development Index
( Steps in Human Development Index (HDI) Calculation:
• Minimum Step
and 1. Creating
maximum the(goalposts)
values dimension indices-
are set in order to transform
the indicators expressed in different units into indices between 0 and 1.
• These goalposts act as the ‘natural zeroes’ and ‘aspirational
goals’,
respectively, from which component indicators are standardized.
For 2020 HDI they are:
Step 1. Creating the dimension indices (Contd.)-
•For Health dimension, Life Expectancy (years) is used where,
Life expectancy at birth: Number of years a new-born infant could expect
to live if prevailing patterns of age-specific mortality rates at the time of
birth stay the same throughout the infant’s life.
• For the education dimension, index is first applied to each of
the two indicators, and then the arithmetic mean of the two
resulting indices is taken. Here,
Mean Years of Schooling [for adult population] = Average number of
years of education received by people ages 25 and older,
converted from education attainment levels using official
durations of each level
Expected years of schooling [for children of school-entrance age] =
Number of years of schooling that a child of school entrance age
can expect to receive if prevailing patterns of age-specific
enrolment rates persist throughout the child’s life.
For Income dimension
• It is believed that each additional dollar of income has a smaller
effect on expanding capabilities. Hence, for income, the natural
logarithm of the actual, minimum and maximum values is used.
• Further, Income (i.e. GNI) is represented in Purchasing Power
Parity terms
Market Exchange Rate & Purchasing Power Parity (PPP) exchange
Rate
Market Exchange Rate: Balances the demand and supply for
international currencies. They are the basis for international
trade.
Eg. If a company wants to import a equipment from US that has a
price of US$ 10,000 and the market exchange rate is US$1 = Rs. 61,
then the cost of the equipment in Rupee terms will be Rs. 61 *
10,000 = Rs. 610,000
Purchasing Power Parity (PPP) exchange rates capture the differences between
the cost of a given bundle of goods and services in different countries.
The rate at which the currency of one country would have to be converted into
that of another country to buy the same amount of goods and services in each
country.
Typically, a PPP for a country is expressed in terms of the currency of a base
country, with the US dollar commonly being used.
Used as deflators, they enable cross-country comparisons of GDP and its
expenditure components.
(Reading Source: International Monetary Fund or IMF, “PPP Versus the Market: Which Weight Matters? https://www
.imf.org/external/pubs/ft/fandd/2007/03/basics.htm)

Eg: If a burger is selling in London for £2 and in New York for $4, this would
imply a PPP exchange rate of 1 pound to 2 U.S. dollars.
This PPP exchange rate may be different from that prevailing in financial markets
(so that the actual dollar cost of a burger in London may be either more or less
than the $4 it sells for in New York).
To facilitate price comparisons across countries, the International
Comparisons Program (ICP) was established by the United Nations
and the University of Pennsylvania in 1968.
Under the authority of the United Nations Statistical Commission,
the 2011 round of ICP covered 199 economies. The ICP 2011
provides estimates of real expenditure on GDP and its major
aggregates for 177 countries.
The ICP divides GDP aggregates into 155 categories (referred to as
“basic headings”).
Prices were collected during 2011 for individual products within each
basic heading to compute national annual average prices for each
product for 2011.
These products cover all aspects of each country’s expenditure on
GDP, ranging from food, clothing and footwear to hospital
equipment and compensation of government employees, etc.
Step 2. Aggregating the dimensional indices to produce the
Human Development Index
The HDI is the geometric mean of the three dimensional indices:
HDI = (IHealth . IEducation . IIncome) 1/3

Eg…. Sudan
 Human
Development
Index (contd.)
HDI Index and Its Components for Select Countries
 Sustainable Development
According to the United Nations World Commission on
Environment and Development (1987), sustainable
development is "development that meets the needs of the
present without compromising the ability of future
generations to meet their own needs.“

World Bank Definition: "a process of managing a portfolio

of assets to preserve and enhance the opportunities people
face."

Sustainable development includes economic,

environmental, and social sustainability, which can be
achieved by rationally managing physical, natural, and
human capital.
Concepts of Cost
 THE VARIOUS MEASURES OF COST

Manufacturing Costs- In converting raw materials into

finished goods, a manufacturer incurs various costs
associated with operating a factory.
Divided into-
✓Direct materials- Eg. Steel in bridge construction.
✓Direct labor- Eg. Labor cost of assembly-line
workers.
✓Manufacturing Overhead- Eg. Maintenance &
repairs on production equipment; Overtime
premiums.
Non-manufacturing Costs- Additional costs incurred in
supporting any manufacturing operation.
Divided into-
✓Non-Manufacturing Overhead- Eg. Heat and light .
✓Marketing- Eg. Advertising; Sales travel; Sales
commission.
✓Administrative- Eg. Public relations.
 Direct, Indirect, Standard Cost

• Direct Costs: Costs that can be reasonably measured

and allocated to specific output or work activity.
• Eg. Labour and Material costs directly associated
with production/service delivery.
• Indirect Costs: Costs that are difficult to attribute or
allocate to a specific output or work activity.
Sometimes may also be called as overhead cost or
burden cost.
• Eg. General Repair costs, Costs of common tools and
other general supplies.
• Standard Costs: Planned costs per unit of
output that are established in advance of
actual production or service delivery. They are
developed from anticipated direct labour
hours, materials, and overhead categories.
 Cash Cost V/S Book Cost
Cash Cost: A cost that involves payment of cash.
• This results in a cash flow.
• It is often the future expenses incurred for the alternatives
being analyzed from the perspective established for the
analysis.
• In Engineering Economics, only those costs that are cash flows
or potential cash flows need to be considered for the analysis.
Book Cost: A cost that involves non-cash transactions.
Eg. • Depreciation charged for the use of assets like plant and
machinery.
Note: Although, not a cash flow, it is important when it affects
other cash flows like income tax.
• Sunk Cost
• Definition: Cost that has already been incurred in the
past and has no relevance to estimates of future
costs and revenues related to an alternative course
of action.
• Sunk cost is common to all alternatives, is not part of
the future (prospective) cash flows, and can be
disregarded in an engineering economic analysis. Eg.
• While deciding the selling price for an old car, the
cost of repair service two years back is a sunk cost.
Opportunity Cost
Definition: It is the cost of the best rejected (i.e. foregone)
opportunity and is often hidden or implied.
• Opportunity cost is incurred because people face tradeoffs
and hence making decisions requires comparing the costs
and benefits of alternative courses of action.
What is the opportunity cost of studying in school/college?
…. Maybe a job!
Opportunity cost of going to School/College = Fees paid +
Salary earned from the job
 Some more concepts on cost
Costs of production may be divided into fixed costs and
variable costs.
•Fixed costs are those costs that do not vary with the
quantity of output produced. Eg. Rent for Land/Building,
Salaries to Employees, Investments on machinery.
•Variable costs are those costs that vary with the quantity
of output produced. Eg. Raw material costs, Electricity
charges to run machinery.
•Total Costs (TC) is the sum total of fixed and variable costs
Total Costs = Total Fixed Costs + Total Variable Costs TC =
TFC + TVC
•Average Costs : Average costs can be determined by
dividing the firm’s costs by the quantity of output it
produces.
The average cost is the cost of each typical unit of
product.
Average Total Costs (ATC)
= Total Cost / Number of Units
= (Fixed Costs + Variable Costs) / Number of Units
= Average Fixed Costs (AFC) + Average Variable Costs
(AVC)
• Marginal Cost
The change in total production cost due to making or
production of one additional unit.
MC = (change in total cost) = ∆TC
(change in quantity) ∆Q

Reasons for U shape in short term cost curve,

(i) On the Basis of AFC and AVC.
(ii)ii) On the Basis of the Law of Variable
Proportions.
Short term average cost curve