Eco Dev 2 Summer 2011

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The Development Gap and

the Measurement of Poverty

Chapter Two

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Economic Growth versus Economic

Development:

1- Economic Growth:

• An increase in the real income (GDP) of an

economy.

• Economic growth has both benefits and costs.

• It can be measured by GDP growth rates or

GDP percapita growth rates.

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Economic Growth Benefits and costs:

Benefits:Increases in economic growth should :

• enable more of everything to be produced.

•

Increases possibility of providing consumer goodsfor all.

• More consumer goods, etc. could be equated withan increase in living standards

• Wealth generated may eventually ‘trickle down’ tothose who are poor by means of incomedistribution – taxes and benefits, etc.

• Improvement in Welfare.

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Costs:

Economic growth can bring with it costs:

• Not all income is distributed equally.

• Wealth is often concentrated in the hands ofa few.

• ‘Trickle down’ does not always seemto work in practice.

• Corruption may reduce redistribution

effects.• Environmental Impact.

• Opportunity Cost of Growth.

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Opportunity Cost of Growth:

• Resource allocation

–Consumer Goods?

–

Capital Goods?• Necessity of generating growth through

allocating resources to the sources of growth –

capital goods.

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http://www.bized.co.uk

Copyright 2007 – Biz/ed

Growth and Production Possibility

Frontiers

C1

Capital Goods

Consumer Goods

A

B

1. Economic growth when acountry is operating belowcapacity – more of both capital

and consumer goods are madeavailable as the economymoves from point A to point B

K1

K2

C2

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Growth and Production Possibility Frontiers

C1

Consumer Goods

A

B

K1

K2

C2

2. Country operating at fullcapacity but discovers newresources or find ways ofimproving the efficiency of

existing resources, for example,education of the population toimprove the quality of humancapital.

Capital Goods

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Growth and Production Possibility

Frontiers

C1 Consumer Goods

A B

K1

K2

C2

3. Disproportionate shift in PPF caused byinvestment in resources suitable for

producing certain types of goods – forexample, investment from overseas maygenerate growth in the production of

consumer goods as opposed to capital goods– is such investment of long term benefit to adeveloping country?

Capital Goods

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Growth and Production PossibilityFrontiers

C2Consumer Goods

A

BK2

K1

C1

Capital Goods

4. Disproportionate shift in PPF as aresult of investment in resources thatfavour generation of capital goods –may not initially seem to have majorimpact on the standard of living of thecountry but may have long termbenefits in enabling more sustainablelong term growth.

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Measurement of Economic Growth:

A- GDP or GDI:• The market value of all final goods and services

produced within a nation in a given year• basic measure of a country's economic performance .

i.e. the total value produced within a country

• GDP = private consumption + gross investment + government spending + ( exports − imports ),

• GDP = C + I + G + (X − M).• GDP = total output X market price

http://en.wikipedia.org/wiki/Consumption_(economics)

http://en.wikipedia.org/wiki/Investment

http://en.wikipedia.org/wiki/Government_spending

http://en.wikipedia.org/wiki/Export

http://en.wikipedia.org/wiki/Import

http://en.wikipedia.org/wiki/Import

http://en.wikipedia.org/wiki/Export

http://en.wikipedia.org/wiki/Government_spending

http://en.wikipedia.org/wiki/Investment

http://en.wikipedia.org/wiki/Consumption_(economics)

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B- GDP or GPI percapita:

Per capita income means how much eachindividual receives, in monetary terms, of the

yearly income generated in the country.

GDP percapita = GDP/ population

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When using per capita income (PCY)

figures to measure economic growth and

as an index of development in different

countries , we face 2 difficulties:

1. problem of national income accounting

in developing countries .

2. problem of converting each countries per capita income (PCY).

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1- National income accounting :

• Only goods produced & sold in market are

included in the value of national income, most ofthe output in developing countries does not reach

the market particularly in rural sector , where

production for subsistence purposes .

• Growth rates is biased by using prices weights

when compiling national income totals from the

output statistics of different sectors of economy .

•

What price index to use as a deflator of moneynational income in order to obtain an index of real

income .

GDP deflator = nominal GDP / real GDP × 100

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2- Problem of converting each countries

per capita income (PCY):

PCY in domestic currency has to be

converted into a common unit of account

( that is US $) so as to be able to makemeaningful international comparisons of

living standards . this lead to topic of

purchasing power parity (PPP) estimatesof (PCY).

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Purchasing Power Parity:• A nation's GDP at purchasing power parity

(PPP) exchange rates is the sum value of allgoods and services produced in the countryvalued at prices prevailing in the United States.

• The most common way of constructing a PPPratio between two countries is to revalue thenational incomes of the two countries byselecting a comparable basket of goods andservices in each country and estimating thepurchasing -power equivalent of each item in

country A relative to country B.

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Purchasing-Power Equivalent:

• IF “Pia “ is the price of item i in country “a”.

• “ Pib “ is the price of item i in country “b”.

• the purchasing power equivalent of item “i“ incountry “a” relative to country “b” is:

Pia/Pib

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• By extending this calculation to all goods

and applying the price ratios to theaverage quantities consumed of each item

in the two countries, we obtain a formula

for the overall purchasing powerequivalent in country A relative to

country B.

∑QiPia / ∑QiPib

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Suppose.....

• In the year 2008

– Turkish GNP=800 million TL

– Population=74 million

– Exchange rate:

1 USD = 1.6TL

National per capita income in USD =GNP/population ‚ exchange rate

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Turkish real GNP per-cap in 2008 at

current US dollars will be;

800 / 74 ‚ 1.6 = 6,750

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2- Economic Development:

A continuous and sustained rise in GDP of aneconomy in addition to major social and

political transformations in order to achieve

the three core values of development:• Life Sustenance.

• Self-Esteem.

• Freedom.

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Measuring Economic Development:

United Nations Development Program(UNDP) has 2 alternative indexes tocompare the level of development & the

progress of countries :

• Human Development Index (HDI)

• Human Poverty Index ( HPI)

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Human Development Index (HDI)

The HDI is a measure to summarize human

development.

It measures the average achievements in a

country, considering three basic dimensions of

human development (UNDP 2003):

• Health Indicator.

• Knowledge Indicator.

• Economic Growth Indicator.

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A long and healthy life, as measured by lifeexpectancy at birth (Life Expectancy Index -LEI);

• Knowledge (Educational Attainment Index - EAI),as measured by the adult literacy rate (AdultLiteracy Index - ALI), which account for 2/3, and

the combined primary, secondary and tertiarygross enrolment ratio (ERI), which account for1/3 of the total amount;

• A decent standard of living, as measured by

GDPI (Gross Domestic Product per capita Index)given as Purchasing Power Parity US$ (PPPUS$).

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• Before the HDI is calculated, an index needs to

be created for each of these dimensions. To

calculate these three dimension indices,minimum and maximum values are chosen for

each underlying indicator. Performance in

each dimension is expressed as a valuebetween 0 and 1.

•

The HDI is then calculated as a simple averageof each dimension indices.

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• The life expectancy index (LEI ) measures the

relative achievement of a country in life

expectancy at birth.• The education index (EAI ) measures a

country’s relative achievement in both adult

literacy and combined primary, secondary andtertiary gross enrolment. First, an index for

adult literacy (ALI) and one for combined

gross enrolment (ERI) are calculated (data arereferred to the school year 2000/2001).

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Then, these two indices are combined to create

the education index, adult literacy accounting

for 2/3 and the combined gross enrolmentaccounting for 1/3. For an example, with an

adult literacy rate of 85.3% and a combined

gross enrolment ratio of 69%, the education

index was 0.799.

Gross Domestic Product Index (GDPI)

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Once the dimension indices have been

calculated, determining the HDI isstraightforward. It is a simple

average of the three dimension

indices

Eco Dev 2 Summer 2011

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