Genuine%20 %2002%20-%20 national%20income%20accounting

DEPARTMENT OF FINANCEDEPARTMENT OF FINANCE
University Of Dar Es SalaamUniversity Of Dar Es Salaam
Business SchoolBusiness School
FN 101: Principles of Macroeconomics
Lecture 2:
National Income
Accounting
Genuine Martin
B. Com, M.A. (Economics)

2
Measures of OutputMeasures of Output
 Total output: array of produced goods and
services.
 Prices are used to measure value.
 National Income Accounting: process of
measuring aggregate economic activity
(national income and its components).
 How possible to add oranges and mangoes?
 Using monetary terms (prices), aggregates
all output produced in the economy.

3
 National income and product accounts -
data collected and published by government to
describe various components of national
income and output in the economy.
 The data is collected and compiled by the
National Bureau of Statistics (NBS).

4
 GDP: total market value of all final goods and
services produced within national borders in
given time period.
 GDP – output within Tanzanian borders.
 GNP – output produced by Tanzanians
anywhere they are located.
 GNP calculation is complex and less
dependable. Why?
 Factors of production and ownership move
across borders in global economy.
 GDP is geographically focused.

5
 GDP aids international comparison.
 GDP per Capita: national GDP divided by
population size.
 What a single person shares in national GDP.
 Suggests standard of living.
 However, comparison among nations is
abstract and lifeless.
 Lack: how GDP is distributed, access to
education, health, infrastructure, water,
electricity, quality of environment, peace and
security.

6
 Per capita would be a measure of relative
standard of living: when countries are similar
in structure, institutions, and above items.

7
 GDP in Tanzania was 23.87 billion USD in
2011.
 It is 0.04% of the world output.

8
Measures of Output, GDPMeasures of Output, GDP
(IMF, 2012 Data)(IMF, 2012 Data)
Rank Country GDP PPP ($ Billion) Share (%)
— World 82,762 100
— European Union 16,074 19.4
1 United States 15,653 18.9
2 China 12,383 15.0
3 India 4,711 5.7
4 Japan 4,617 5.6
5 Germany 3,194 3.9
6 Russia 2,512 3.0
7 Brazil 2,366 2.9
8 United Kingdom 2,316 2.8

9
Measures of Output, GDPMeasures of Output, GDP
(IMF, 2012 Data)(IMF, 2012 Data)
Rank Country GDP PPP ($ Billion) Share (%)
— World 82,762 100
— European Union 16,074 19.4
9 France 2,253 2.7
10 Italy 1,834 2.2
80 Tanzania 67.9 0.1
182 Tuvalu 0.037 0.000045

10
Measures of Output, GDP perMeasures of Output, GDP per
Capita (IMF, 2010-11 Data)Capita (IMF, 2010-11 Data)
Rank Country GDP per Capita ($)
1 Qatar 98,948
2 Luxembourg 80,559
3 Singapore 59,710
4 Norway 53,396
5 Brunei 49,536
— Hong Kong 49,417
6 United States 48,328
7 United Arab Emirates 47,729
8 Switzerland 44,452

11
Measures of Output, GDP perMeasures of Output, GDP per
Capita (IMF, 2010-11 Data)Capita (IMF, 2010-11 Data)
Rank Country GDP per Capita ($)
9 San Marino 43,090
10 Netherlands 42,023
160 Tanzania 1,610
185 Congo, Dem. Rep. 349

12
Measures of Output (GDP inMeasures of Output (GDP in
Billion $ for Tanzania, WB)Billion $ for Tanzania, WB)

13
Measures of Output (GDP perMeasures of Output (GDP per
Capita $ for Tanzania, WB)Capita $ for Tanzania, WB)

14
Measurement ProblemsMeasurement Problems
 Nonmarket activities – produced but not sold
in markets, e.g. works of homemaker,
housewives, friend’s help, etc.
 Unreported income – tax evasion
(underground economy, e.g. mow lawns, clean
houses, paint walls, childcare) and illegal
activities (drug dealers, prostitution, gambling,
organized crime).

15
Value AddedValue Added
 GDP – market value of final goods/services.
 If every stage of production is counted, same
commodity would be counted twice (double
counting).
 How do we measure final value?
 1) Include only final market values.
 2) First stage value plus added value each
next stage (intermediate goods).
 Intermediate goods – purchased for use of
producing final goods.

16
Value AddedValue Added
 Value added – increase in market value of
product at each stage of production.
No Stages of Production Value of
Transaction
Value
Added
1 Farmer grows wheat, sells it to a miller Tshs. 192 Tshs. 192
2 Miller converts wheat to flour, sells it to
baker
448 256
3 Baker bakes bagel, sells it to bagel store 960 512
4 Bagel store sells bagel to consumer 1,200 240
Total Tshs. 2,800 Tshs. 1,200

17
Real vs Nominal GDPReal vs Nominal GDP
 Nominal GDP = Sum of Price x Output for all
goods/services.
 Sources of change in GDP: change in output
(level of production) and change in prices.
 Changes in prices distort real/actual changes
in level of production.
 Rise in GDP could result from increasing
prices, not production.
 To take off this price distortion, we use real
GDP.

18
 Nominal GDP – value of final output
measured in current prices.
 Real GDP – value of final output measured in
constant prices.
 To get Real GDP from Nominal GDP, we
deflate Nominal GDP using GDP Deflator.
 GDP Deflator is the general average price
level for whole economy.
 Note: For base year, real and nominal GDP
are same.

19
 The percentage change in GDP Deflator gives
inflation rate for whole economy.
DeflatorGDP
NGDP
RGDP t
t =
100X
RGDP
NGDP
DeflatorGDP
t
t
=

20
Item 2007 2008
1 Nominal GDP in trillion shillings 81.11 84.99
2 Change in nominal GDP 3.88 (4.78%)
3 Change in price level from 2007 to 2008 4.0%
4 Real GDP in 2007 shillings 81.11 81.72
5 Change in real GDP 0.61 (0.75%)
)
04.1
99.84
(=

21
 Nominal GDP in 2008 – Tshs. 2,679 billion
 Nominal GDP in 2009 – Tshs. 3,004
Product A B C D Total
Output Q (mns) 18 12 38 59
Price Q (thousands) 17 40 11 25
P x Q (billions) 306 480 418 1,475 2,679
Output Q (mns) 20 19 31 48
P x Q (billions) 420 741 403 1,440 3,004

22
 Real GDP in 2009 – Tshs. 2,641.
 Real GDP declined by -1.42% (recall: nominal
GDP increased by 12.13%).
Output Q (mns) 20 19 31 48
P x Q (billions) 340 760 341 1,200 2,641
100X
RGDP
NGDP
DeflatorGDP
t
t
=
7.113100
2,641
3,004
== XDeflatorGDP

23
 2008 base year, GDP Deflator 100; 2009 GDP
Deflator is 113.7.
100
08
0809
X
DeflatorGDP
DeflatorGDPDeflatorGDP
Inflation
−
=
%7.13100
100
1007.113
=
−
= XInflation

24
GDP Deflators used by NBSGDP Deflators used by NBS

25
Real vs Nominal GDP Data inReal vs Nominal GDP Data in
Tanzania (NBS, Tshs. Billion)Tanzania (NBS, Tshs. Billion)
Type 2009 2010 2011
Nominal GDP 28,213 32,293 37,533
Real GDP 14,664 15,700 16,712
GDP Deflator 192.40 205.69 224.59
Inflation Rate - 6.9 9.2

26
Net Domestic Product (NDP)Net Domestic Product (NDP)
 Real GPD changes show how output is
growing.
 Production uses factors of production and
technology, leaving us with fewer resources to
use for next year’s production.
 Future production possibilities shrink.
 Plant and equipment used wears and tears
(depreciation).
 Thus reducing next year’s resources.
 NDP is amount of output within next year’s
production possibilities.

27
 Thus NDP = GDP – depreciation.
 To maintain same production possibilities,
replace capital by producing new plant and
equipment (gross investment).
 When this stock depreciates, we are left with
net investment.
 Net investment = Gross investment –
Depreciation.
 To maintain same stock of capital, net
investment should be positive, i.e. gross
investment > depreciation.

28
 Stock of gross capital at a time is given as:
 G.Capitalt = G.Capitalt-1 + G.Investmentt –
Depreciation

29
Uses of OutputUses of Output
 Where GDP is used/spent – mix of output
selected.
 Used by four market participants: consumers,
firms, government, and foreigners.
 1) Consumption (C) – goods and services
purchased by households in product markets.
 2) Investment (I) – plant, machinery and
equipment produced, net changes in
inventories and residential constructions.

30
Uses of OutputUses of Output
 3) Government Spending (G) – central and
local government purchases and spending,
e.g. police, teachers, law making, building
infrastructure, etc.
 4) Net Exports (X-M): exports – imports.
Exports are goods/services sold to foreigners,
and imports are bought from foreigners.
 GDP can be computed as:
 GDP = C + I + G + (X – M)
G D P C I G X M= + + + −( )

31
Share of GDP by ExpenditureShare of GDP by Expenditure
Category (NBS)Category (NBS)
Expenditure Category 2001 2006 2011
GDP at market Prices 100 100 100
Final consumption expenditure 75.0 68.0 66.1
Government expenditure 11.9 17.5 16.4
Gross capital formation 17.5 27.6 36.7
Exports 17.0 22.6 31.1
Imports -21.3 -35.7 -50.2

32
Share of GDP by EconomicShare of GDP by Economic
Activity (NBS, 2011)Activity (NBS, 2011)

33
 Every transaction has buyers and sellers.
 In exchange, shilling spent by buyers is
income to sellers.
 Thus, Income = Expenditure.
 GDP accounts have two sides.
 Expenditure – demand side.
 Income – supply side.
 Factors of production (factor markets) are
supplied to firms, and owners get paid income.

34
 i.e. Labourers (wage & salaries), Landlords
(rent), Lenders (interest), Business Firms
(profit and depreciation allowance) &
Government (taxes).
 They in turn spend their income buying goods
and services in product markets.

35
 i.e. GDP can be computed in two ways:
 The expenditure approach: A method of
computing GDP that measures the amount
spent on all final goods during a given period.
 The income approach: A method of
computing GDP that measures the income—
wages, rents, interest, and profits—received
by all factors of production in producing final
goods.

36
The Income ApproachThe Income Approach
 i.e.i.e. GDP can be computed in two ways:GDP can be computed in two ways:
 National Income - tNational Income - the total income earned by
the factors of production owned by a country’s
citizens.
 Income approach breaks downIncome approach breaks down GDPGDP into fourinto four
income components: rents, interest, wages,income components: rents, interest, wages,
and profits.and profits.

37
Product
market
Factor
market
Consumer spending
VALUE OF OUTPUT
Investment spending
Government spending
Net exports
Profits
Wages
Interest
Rent
VALUE OF INCOME
Sales Taxes
Depreciation

38
 Table gives summary of expenditure and
income sides.

39
Expenditure (billion of shillings) Income (billion of shillings)
Consumer goods and services 5808 Wages and salaries 4981
Investment in plant, equipment,
and inventory
1367 Corporate profits 825
Government goods and services 1487 Proprietors’’ income 548
Exports 959 Farm income 29
Imports (1110) Rents 163
Interest 449
Sales taxes 608
Depreciation 908

40
 Who actually gets these Tshs. 8511 billion of
income???
 GDP is Tshs. 8511
 How is it distributed then?
 1) Depreciation – sales revenue is
immediately diverted in form of depreciation
charges (wear and tear of capital plant &
equipment).
 NDP = GDP – Depreciation.

41
• 2) Indirect Business Taxes – when goods are
sold in market, sales tax are paid to
government (VAT, Cess tax).
• The remaining income goes to factors of
production, i.e. National Income (NI).
• NI = NDP – Indirect Business Taxes.
• National Income is earned by households
(consumers) and corporations (households are
shareholders).
• Diversions continue.

42
 First, corporations pay corporate tax to
government on profit (30% in Tz).
 Second, part of profit is retained back to
businesses (retained earnings, RE) for
further expansion and cash needs.
 The remaining balance goes to consumers.
 Consumers pay Social Security Tax (NSSF,
PPF, PSPF).
 Again, consumers receive some payment from
government (transfer payments, added back)

43
 Lastly, consumers receive interest payment in
excess of what they pay (own capital, and
borrowers; net interest).
 What is left is Personal Income (PI).
 PI = NI – Corporate Taxes – RE – Social
Security Taxes + Transfer Payments + Net
Interest
 Out of Personal Income, consumers pay
personal income taxes (PAYE).
 Amount left is called Disposable Income (DI).
 DI = PI – Personal Taxes.

44
 Lastly, DI can be spent (consumed) or saved
(S).
 DI = C + S

45
Composition of Net DisposableComposition of Net Disposable
Income at 2001 prices (NBS)Income at 2001 prices (NBS)

46
Income flow Amount (billion shillings)
Gross domestic product (GDP) 8511
Less depreciation (908)
Net domestic product (NDP) 7603
Less indirect business taxes (608)
National income (NI) 6995
Less corporate taxes (240)

47
Income flow Amount (billion shillings)
Less retained earnings (299)
Less Social Security taxes (768)
Plus transfer payments 1122
Plus net interest 316
Personal income (PI) 7126
Less personal taxes (1098)
Disposable income (DI) 6028

48
Variable Billion Shillings
GDP 9,299.2
Plus: receipts of factor income from the rest of the world + 305.9
Less: payments of factor income to the rest of the world - 316.9
Equals: GNP 9,288.2
Less: depreciation - 1,161.0
Equals: net national product (NNP) 8,127.1
Less: indirect taxes minus subsidies plus other - 675.5
Equals: national income 7,469.7
Less: corporate profits minus dividends - 485.7
Less: social insurance payments - 662.1
Plus: personal interest income received from the government and consumers + 456.6
Plus: transfer payments to persons +1,011.0
Equals: personal income 7,789.6
Less: personal taxes - 1,152.0
Equals: disposable personal income 6,637.7

49
Circular Flow of IncomeCircular Flow of Income
 Every shilling spent on goods/services flows
into somebody’s hands (income).
 This is summarized in circular flow of income.
 One half explain income flow, and another
half – expenditure flow; in monetary terms.
 Flow of income, starting as GDP ends up in
market as consumption, investment,
government purchases, and net exports.
 Simplified Version

50
Households
(Ownersof
Factorsof
Production)
Firms
(Producersof
Goodsand
Services)
Markets for Factors
of Production
Markets for Goods
and Services
Consumption
Income FactorPayments
FirmRevenues

51
 Households (owners of land, labour, capital,
entrepreneurship) supply factors to firms
(factor markets), and get paid income (rent,
wages, interest, profit).
 Firms use factors to produce goods/services,
sell them to households and get paid revenue
income.
 Shades boxes represent economic actors
(households, firms).
 Un-shaded boxes represent types of markets
(product and factor markets).

52
 Arrows represent flow of money.
 More Realist Circular Flow

53
Households
Firms
(Producers
of Goods
and
Services)
Investment (IA)
Governments
Government
Purchases (G)
Government
Borrowing
Aggregate
Income = GDP
Transfer
Payments
Taxes (T)
Consumption (C)
Rest of the
World
Financial
MarketsSaving (S)
1
Disposable Income
Yd=GDP-NT
2
10
9
7
6
5
4
3
C+IA+G+(X-M)=GDP
Imports (M)
Exports (E)
8

54
 Households supply labour, capital, land, and
entrepreneurship to firms and get paid wages,
interest, rent and profit (1).
 Out of that return, government collects taxes
and returns transfer payment (2 & 3).
 Amount left is disposable income.
 Yd = GDP – NT
 That is income side.
 In expenditure side, out of disposable income,
households consume some (4) and save others
(S).

55
 Yd = C + S
 Savings flow in financial markets which pool
them and lend to firms, governments, and
households (6 & 7).
 Firms borrow and make investment (IA).
 Governments spend money received from
taxes and borrowing (8).
 Households, firms and government spend on
imports 9).
 Rest of world spend on our goods and services

© 2002 Prentice Hall Business Publishing© 2002 Prentice Hall Business Publishing Principles of Economics, 6/ePrinciples of Economics, 6/e Karl Case, Ray FairKarl Case, Ray Fair
The Components of theThe Components of the
MacroeconomyMacroeconomy
Everyone’sEveryone’s
ExpendituresExpenditures
GoGo
somewhere.somewhere.
EveryEvery
transactiontransaction
must havemust have
two sides.two sides.

57
Injections-Leakages EqualityInjections-Leakages Equality
 Leakage – diversion of income from domestic
spending stream (savings, taxes, imports).
 Injections – any payment of income other than
by firms or any spending other than by
domestic households (investment, government,
exports).
 Economic equilibrium: Expenditure = Income
 Leakages = Injections
 Intuitions?
 Savings divert income and investment brings it
back.

58
 Imports divert income, and exports bring it
back.
 Government taxes divert income and
government spending brings it back.
 Economic equilibrium: Expenditure = Income
 Y = AE = C + I + G + X – M, subtract taxes both
sides,
 Y – T = C + I + G – T + X – M, bring the
consumption variable to the left,
 Y – T – C = I + G – T + X – M, recall Y – T = Yd,
and Yd – C = S.

59
 S = I + G – T + X – M, bring the negative terms
to the left hand side,
 S + T + M = I + G + X.

60
Real GDP and EconomicReal GDP and Economic
Well-BeingWell-Being
 GDP captures goods/services ONLY priced
and sold to markets.
 Thus imperfect measure of economic well-
being.
 Many factors that contribute to economic well-
being are omitted.
 1) Leisure time – time spent by workers on
family and friends, sports & hobbies, cultural
and educational activities are not priced in
markets and included in GDP.

61
 2) Nonmarket economic activities – e.g.
unpaid housekeeping, volunteer services,
underground activities e.g. informal babysitting,
part-time house cleaners, painters (legal) and
organized crime (illegal) are not captured.
 3) Environmental quality and resource
depletion – economic growth is accompanied
by severe decline in air and water quality,
exploitation of finite resources not taken into
account in GDP computation.

62
 Efforts to conserve environment and benefits of
quality environment are not priced.
 4) Quality of life – low crime rate, minimal
traffic congestion, active civic organizations,
open spaces are not sold in markets and
included in GDP.
 5) Aggregation problem – GDP is expressed
in aggregate money terms, doesn’t distinguish
a shilling spent on books & cigarettes/military.

63
 6) GDP ignores depreciation – wear and tear
in capital is not taken into account, takes gross
values BUT NDP does.
 Recall: NDP = GDP – depreciation.
 However, depreciation is a not a very precise
measure, thus ignored.
 7) Poverty and economic inequality – GDP
does not tell about income distribution.

64
Business CyclesBusiness Cycles
 Ups and downs in economic activities.
 Affect jobs, prices, economic growth,
international trade, and balances.
 Before the Great Depression (1929-33),
economists thought market economy was
inherently stable and no need of government
intervention.
 After it, macroeconomics was born.
 Much interest to understand causes, nature,
effects and management of business cycles
arose.

65
 Business Cycles – economy-wide short-term
fluctuations in production, trade, economic
activity in general over several months/years,
occurring around a long-term trend, and tends
to recur after certain length of time.
 Measured using growth rate of real GDP.
 Have four phases: boom, recession,
depression, and recovery.
 1) Boom – real GDP is at the peak.
 Economy operates at or beyond full capacity.
 Shortage of skilled people and raw materials.

66
 Period of excess demand.
 Prices rise faster than costs, profits and
investors are optimistic.
 If people don’t replace capital used, economy
turns into slump and lead to fall in spending.
 2) Recession – real GDP growth rate declines
and unemployment rises.
 Signalled by two quarters of consecutive output
decline.
 Output and employment declines from peak to
trough.

67
 Job creation rate is typically slower, than
number of people entering job markets.
 3) Depression/Trough - real GDP is at the
bottom.
 A severe form of recession.
 A prolonged and deep recession becomes a
depression.
 Depression results when there is financial panic
during recession.
 .

68
 Associated with high unemployment and
unused productive capacity (unemployed
capital).
 Capacity utilization rates drop significantly.
 Business profits are low, and investors are
pessimistic.
 4) Recovery – real GDP climbs from trough to
peak.
 Output and employment rises.
 After depression, capital wears out and
households and businesses start to replace it.

69
 Spending picks up and we enter a recovery.
 As sales and profits pick up, investors become
more optimistic.

70

71
Figure 1 A Look At Short-Run Economic
Fluctuations
Billions of
1996 Dollars
Real GDP
(a) Real GDP
$10,000
9,000
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1965 1970 1975 1980 1985 1990 1995 2000
Copyright © 2004 South-Western

72
 Issue – does recurring exist? What causes it?
 Three major facts about business cycles:
 1) Irregular and unpredictable.
 2) Most macroeconomic variables fluctuate
together.
 Income or production measures.
 May fluctuate at different amounts.
 3) As output falls, unemployment rises.
 Changes in real GDP are inversely related to
changes in unemployment rate.

73
Real GDP, 1970 I-1997 IIReal GDP, 1970 I-1997 II

74
Unemployment Rate, 1970 I-1997 II

75
Percentage Change in the GDP PricePercentage Change in the GDP Price
Index (Four-Quarter Average), 1970 I-Index (Four-Quarter Average), 1970 I-
1997 II1997 II

76
Indicators of CyclesIndicators of Cycles
 Issue – does recurring exist? What causes it?
 Capacity utilization rates - show the
percentage of factory capacity being used in
recession.
 In normal times, 15% of capital is being
repaired or replaced and the average utilization
rate is around 85%.
 During boom times the capacity utilization rate
rises to as high as 92%.
 Recession, falls to as low as 70%.

77
Real GDP and Unemployment Rates,
1929-1933
Real GDP and Unemployment Rates, 1929–1933Real GDP and Unemployment Rates, 1929–1933
THE EARLY PART OF THE GREAT DEPRESSION, 1929–1933THE EARLY PART OF THE GREAT DEPRESSION, 1929–1933
PERCENTAGEPERCENTAGE
CHANGECHANGE
IN REALIN REAL
GDPGDP
UNEMPLOYMENTUNEMPLOYMENT
RATERATE
NUMBER OFNUMBER OF
UNEMPLOYEDUNEMPLOYED
(MILLIONS)(MILLIONS)
19291929 3.23.2 1.51.5
19301930 −−8.68.6 8.98.9 4.34.3
19311931 −−6.46.4 16.316.3 8.08.0
19321932 −−13.013.0 24.124.1 12.112.1
19331933 −1−1.4.4 25.225.2 12.812.8
Note:Note: Percentage fall in real GDP between 1929 and 1933 was 26.6 percent.Percentage fall in real GDP between 1929 and 1933 was 26.6 percent.

78
Real GDP and Unemployment Rates,Real GDP and Unemployment Rates,
1980-19821980-1982
Real GDP and Unemployment Rates, 1980–1982Real GDP and Unemployment Rates, 1980–1982
THE RECESSION OF 1980–1982THE RECESSION OF 1980–1982
PERCENTAGEPERCENTAGE
CHANGECHANGE
IN REALIN REAL
GDPGDP
UNEMPLOYMENTUNEMPLOYMENT
RATERATE
NUMBER OFNUMBER OF
UNEMPLOYEDUNEMPLOYED
(MILLIONS)(MILLIONS)
CAPACITYCAPACITY
UTILIZATIONUTILIZATION
(PERCENTAGE)(PERCENTAGE)
19791979 5.85.8 6.16.1 85.285.2
19801980 −−0.20.2 7.17.1 7.67.6 80.980.9
19811981 2.52.5 7.67.6 8.38.3 79.979.9
19821982 −−2.02.0 9.79.7 10.710.7 72.172.1
Note:Note: Percentage increase in real GDP between 1979 and 1982 was 0.1 percent.Percentage increase in real GDP between 1979 and 1982 was 0.1 percent.
Sources: Historical Statistics of the United StatesSources: Historical Statistics of the United States and U.S. Department of Commerce, Bureau of Economic Analysis.and U.S. Department of Commerce, Bureau of Economic Analysis.

79
Economic Growth – AverageEconomic Growth – Average
Growth of Real GDP at 2001 pricesGrowth of Real GDP at 2001 prices

80
Economic GrowthEconomic Growth
 Most rich countries grow at 1.5 to 2% per year.
 It takes 40-50 years to double income per
person.
 There are growth miracles with growth rates
above 5%.
 It takes 12 years to double income per person.
 All of the growth miracles were middle income
countries in 1960.
 There are growth disasters with negative
growth rates.
 All of these are in Africa and South America.

81
GDP Growth Rate forGDP Growth Rate for
Tanzania, WBTanzania, WB

82
Countries Growth Rate of RealCountries Growth Rate of Real
GDP, CIA World Fact Book, 2012GDP, CIA World Fact Book, 2012
Rank Country Growth Rate in %
1 Ethiopia 11.2
2 Panama 8.5
3 Laos 8.3
4 Ghana 8.2
5 Cote d'Ivoire 8.1
24 Tanzania 6.5
205 Greece -6.0
206 Anguilla -8.5 (2009 est.)
207 Sudan -11.2
208 South Sudan -55.0

83
 Economic growth – expansion of a country’s
potential GDP or national output.
 Central objective of national policy.
 PPF shifts outwards.
 Measured by growth rate of real GDP.
 Also considers percentage change in GDP per
capita which suggests growth in living
standards.
 GPD per capita grows when growth rate of real
GDP exceeds growth rate of population.

84
 For most countries, the engine of economic
growth rides on four wheels: labour, land,
capital, and technology/entrepreneurship.
 Britain, Japan, China, India, USA, South East
Asia etc. needed these four wheels.
 The issue is how to coordinate wheels
movement.
 1) Human resources – labour supply,
education, discipline, & motivation.
 2) Natural resources – land, minerals, fuels,
environmental quality.

85
 3) Capital formation – machines, factories,
roads, electricity, well developed financial
sector.
 4) Technology and entrepreneurship –
science, engineering, management; initiative &
risks taking; creative and innovative manpower.
 How to drive the four wheels? Combine factors
of production?
 Production function - technical combination of
inputs and maximum possible output to be
produced.

86
 Micro-foundation, aggregation of production
functions gives national output (GDP).
 Q = A.F(K, L, R)
 Q = output, K = capital, L = labour, R = natural
resources, A = technology.
 Technology auguments productivity of inputs
(output to weighted average of inputs).
 With technology improvement, more output is
produced using same level of inputs.
 Policies to raise rate of economic growth:

87
 1) Increase human capital – support
education, training, & skills development.
 Skilled and well-educated workforce is more
productive.
 2) Promote saving and investment – capital
improves labour productivity.
 Encourage saving and investment using tax
code, invest in infrastructure (roads, bridges,
airports, dams, energy and communication
networks).

88
 3) Research and Development – technology
enhances productivity, basic scientific
knowledge, management skills, military and
space (GPS), entrepreneurship,
industrialization, agri-technology.
 4) Legal and political framework – conducive
environment for private sector operations,
property rights, legal system, political stability,
motivating entrepreneurship, free and open
exchange of ideas.

• The productionThe production
possibility frontier showspossibility frontier shows
all the combinations ofall the combinations of
output that can beoutput that can be
produced if all society’sproduced if all society’s
scarce resources arescarce resources are
fully and efficientlyfully and efficiently
employed.employed.
• Economic growthEconomic growth
shifts society’sshifts society’s
production possibilityproduction possibility
frontier up and to thefrontier up and to the
right.right.

90
 Is growth good or bad?
 Pro-Growth Arguments:
 Advocates of growth believe growth is
progress.
 New technologies and production methods lead
to new and better products.
 Capital accumulation and new technology
improve the quality of life.
 In 1995, real GDP per capita was more than
twice what it was in 1950. Since the 1950s,
incomes have grown twice as fast as prices.

91
 Growth saves the most valuable commodity—
time.
 Growth produces jobs and higher incomes.
With higher incomes we can better afford the
sacrifices needed to help the poor.
 Anti-Growth Arguments:
 When population growth is not accompanied by
growth in output, unemployment and poverty
increase.
 Growth has negative effects on the quality of
life.

92
 Growth encourages the creation of artificial
needs (consumerism).
 Growth means the rapid depletion of a finite
quantity of resources.
 Growth requires an unfair income distribution
and propagates it.

93
Economic DevelopmentEconomic Development
 Economic development – sustained socio-
economic growth that promotes standard of
living and economic health of a specific area.
 Reflects quantitative and qualitative changes
in an economy.
 It cuts across areas of human capital,
infrastructure, competitiveness, environment,
sustainability, social inclusion and income
distribution, health, safety literacy, and other
initiatives.
 How does it differ from economic growth?

94
 Economic growth reflects market productivity
and a rise in real GDP.
 Economic development reflects economic and
social well-being of people.
 Economic development parameters classify
countries into developed, developing, or less
developed countries.
 Developing countries (LDC) – low per capita
income, low living standard, low HDI relative to
others, poor health, short life expectancy, low
levels of literacy, malnutrition, etc.

95
 Economic development indicators combine
economic and social parameters.
 E.g. Human Development Index (HDI)
developed by UNDP (Amartya Sen & Gustav
Ranis).
 It includes four indices; per capital real GDP,
life expectancy at birth, school enrolment,
and adult literacy.
 Intuition: economic growth should enrich
people’s health and education.

96
Country Ranks by HDI inCountry Ranks by HDI in
2013 (Source: UNDP)2013 (Source: UNDP)
Rank Country HDI Group
1 Norway 0.955 Very High
2 Australia 0.938 Very High
3 United States 0.937 Very High
4 Netherlands 0.921 Very High
8 Bahrain 0.796 High
49 Bahamas 0.794 High
50 Belarus 0.793 High

97
Country Ranks by HDI inCountry Ranks by HDI in
2013 (Source: UNDP)2013 (Source: UNDP)
Rank Country HDI Group
51 Uruguay 0.792 High
95 Tonga 0.710 Medium
96 Belize 0.702 Medium
96 Dominican Republic 0.702 Medium
96 Fiji 0.702 Medium
142 Congo 0.534 Low
143 Solomon Islands 0.530 Low
144 São Tomé and Príncipe 0.525 Low
145 Kenya 0.519 Low
152 Tanzania 0.476 Low

98
 As table suggests, a strong connectionAs table suggests, a strong connection
between economic and social parameters exist.between economic and social parameters exist.

99

100
 Economic development occurs if there is a
reduction in poverty, inequality, and
unemployment.
 Also increase in access to improved food,
shelter, health and protection under law.

101
Categories of CountriesCategories of Countries
Based on Economic DevptBased on Economic Devpt
 Data Source: World Economic Situation and
Prospects (WESP).
 Income Classification: based on Per Capita
GNI.
 Low-Income Countries: PCGNI < $1005.
 Lower Middle Income Countries: $1,006 <
PCGNI < $3,975.
 Upper Middle Income Countries: $3,976 <
PCGNI < $12,275.
 High-Income Countries: PCGNI > $12,276.

102
 Developed Economies:
 EU-15: Austria, Belgium, Denmark, Finland,
France, Germany, Greece, Ireland, Italy,
Luxembourg, Netherlands, Portugal, Spain,
Sweden, and United Kingdom.
 New EU Members: Bulgaria, Cyprus, Czech
Republic, Estonia, Hungary, Latvia, Lithuania,
Malta, Poland, Romania, Slovakia & Slovenia.
 Other Europe: Iceland, Norway, & Switzerland.
 Other Countries: Australia, Canada, Japan,
New Zealand, & United States.

103
 Developed Economies:
 G7: Canada, Japan, France, Germany, Italy,
United Kingdom, & United States.
 Economies in Transition:
 South-Eastern Europe: Albania, Bosnia and
Herzegovina, Croatia, Montenegro, Serbia, &
Macedonia,
 Commonwealth of Independent States: Armenia,
Azerbaijan, Belarus, Georgia, Kazakhstan,
Kyrgyzstan, Republic of Moldova, Russian
Federation, Tajikistan, Turkmenistan, Ukraine, &

104
 Per Capita GNI:
 High-Income: Australia, Austria, Bahrain,
Barbados, Belgium, Brunei Darussalam,
Canada, Croatia, Cyprus, Czech Republic,
Denmark, Equatorial Guinea, Estonia, Finland,
France, Germany, Greece, Hong Kong SAR,
Hungary, Iceland, Ireland, Israel, Italy, Japan,
Kuwait, Montenegro, Luxembourg, Malta,
Netherlands, New Zealand, Norway, Oman,
Poland, Portugal, Qatar, Republic of Korea,
Saudi Arabia, Singapore, Slovakia, Slovenia,

105
 Per Capita GNI:
 High-Income: Switzerland, Taiwan Province of
China, Trinidad and Tobago, United Arab
Emirates, United Kingdom, & United States.
 Upper-Middle Income: Albania, Algeria,
Argentina, Azerbaijan, Belarus, Bosnia and
Herzegovina, Botswana, Brazil, Bulgaria, Chile,
China, Colombia, Costa Rica, Cuba, Dominican
Republic, Ecuador, Gabon, Iran, Jamaica,
Jordan, Kazakhstan, Latvia, Lebanon, Libya,
Lithuania, Malaysia, Mauritius, Mexico,

106
 Per Capita GNI:
 Upper-Middle Income: Papua New Guinea,
Namibia, Panama, Peru, Romania, Russian
Federation, Serbia, South Africa, Thailand, The
former Yugoslav, Republic of Macedonia,
Tunisia, Turkey, Uruguay, & Venezuela.

107
 Per Capita GNI:
 Lower-Middle Income: Angola, Armenia,
Bolivia, Cameroon, Cape Verde, Congo, Côte
d’Ivoire, Djibouti, Egypt, El Salvador, Georgia,
Ghana, Guatemala, Guyana, Honduras, India,
Indonesia, Iraq, Lesotho, Mauritania, Morocco,
Nicaragua, Nigeria, Pakistan, Paraguay,
Philippines, Republic of Moldova, Sao Tome
and Principe, Senegal, Sri Lanka, Sudan,
Syrian, Turkmenistan, Ukraine, Uzbekistan,
Viet Nam, Yemen, & Zambia.

108
 Per Capita GNI:
 Low-Income: Bangladesh, Benin, Burkina
Faso, Burundi, Central African Republic, Chad,
Comoros, DRC, Eritrea, Ethiopia, Gambia,
Guinea, Guinea-Bissau, Haiti, Kenya,
Kyrgyzstan, Liberia, Madagascar, Malawi, Mali,
Mozambique, Myanmar, Nepal, Niger, Rwanda,
Sierra Leone, Somalia, Tajikistan, Togo,
Uganda, Tanzania, & Zimbabwe.

109
 LDCs:
 Africa: Angola, Benin, Burkina Faso, Burundi,
Central African Republic, Chad, Comoros,
DRC, Djibouti, Equatorial Guinea, Eritrea,
Ethiopia, Gambia, Guinea, Guinea-Bissau,
Lesotho, Liberia, Madagascar, Malawi, Mali,
Mauritania, Mozambique, Niger, Rwanda, Sao
Tome and Principe, Senegal, Sierra Leone,
Somalia, Sudan, Togo, Uganda, Tanzania &
Zambia.
 East Asia: Cambodia, Kiribati, Lao People’s

110
 East Asia: Solomon Islands, Timor Leste,
Tuvalu, & Vanuatu.
 South Asia: Afghanistan, Bangladesh,
Bhutana & Nepal.
 West Asia: Yemen.
 Caribbean: Haiti.

111
Income DistributionIncome Distribution
MeasuresMeasures
 Lorenz curve - measures the percent of
income received by a given proportion of the
population.
 Generally divides the population into quintiles
(20%) and portray the income earned by the
bottom 20% up to the top 20%.
 The percentage of households is plotted on the
x axis, the percentage of income on the y axis.
 A perfectly equal income distribution in a
society would be one in which every person
has the same income.

112
MeasuresMeasures
 In this case, the bottom 20% of society would
always have 20% of the income.
 Thus a perfectly equal distribution can be
depicted by the straight line which is called the
line of perfect equality (AB).
 A perfectly unequal distribution, by contrast,
would be one in which one person has all the
income and everyone else has none.
 In that case, the curve would be at income =0
for 99% of the population, and income would
equal 100% for the last person.

113
MeasuresMeasures
 This would give rise to the line of perfect
inequality (ACB).
 It is impossible for the Lorenz curve to rise
above the line of perfect equality, or sink below
the line of perfect inequality, which means the
curve must always be increasing (it is below the
line of perfect equality).
 In the diagram you can see that the bottom
20% of the population only receives 10% of the
income.

114
MeasuresMeasures
2 0 % 1 0 0 %P o p u l a t i o n
Income
A
B
C
2 0 %
1 0 %
1 0 0 %
L o r e n z c u r v e

115
MeasuresMeasures
 Gini coefficient - provides a measure of
inequality and is usually expressed as a
number between 0 and 1.
 Where 0 means perfect equality (everyone has
the same income).
 Where 1 means perfect inequality (one person
has all the income, everyone else has nothing).
 The Lorenz curve can provide us with a useful
way of calculating the Gini coefficient.
 Take the area between the Lorenz curve and
the line of perfect equality (AB).

116
MeasuresMeasures
 Divide this by the triangular area: ABC.
 If there is perfect equality, the area between the
line of perfect equality and the Lorenz curve
would be equal to zero and the calculation
would yield 0.
 If there was perfect inequality, the area
between the Lorenz curve and the line of
perfect equality would be exactly the same and
the calculation would yield 1.
 We express Gini coefficient as a decimal or
percentage.

117
Gini Coefficient of Countries inGini Coefficient of Countries in
2010 (CIA World Fact Book)2010 (CIA World Fact Book)
Rank Country Gini Index Year
1 Namibia 70.7 2003
2 South Africa 65.0 2005
3 Lesotho 63.2 1995
4 Botswana 63.0 1993
5 Sierra Leone 62.9 1989
53 Kenya 42.5 2008 est.
54 Burundi 42.4 1998
89 Tanzania 34.6 2000
90 Egypt 34.4 2001
127 Malta 26.0 2007

118
Gini Coefficient of Countries inGini Coefficient of Countries in
2010 (CIA World Fact Book)2010 (CIA World Fact Book)
Rank Country Gini Index Year
128 Slovakia 26.0 2005
129 Czech Republic 26.0 2005
130 Iceland 25.0 2005
131 Norway 25.0 2008
132 Denmark 24.0 2005
133 Slovenia 24.0 2005
134 Sweden 23.0 2005

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