The presence of high inequalities in income distribution and the persistence of extreme poverty (defined as living on less than US$1 a day) are not only contrary to economic and human development, but can also work against the achievement of economic growth.
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(Total 25 marks)
2. (a) Measurement of national income in an economy is very important because it gives an estimation of the welfare of the economy. National income is the total of the value of the goods and the services which are produced in an economy during a given time period (usually 1 year). The basic measures of national income include Gross Domestic Product (GDP), Gross National Product (GNP), Gross National Income (GNI) and Net National Income (NNI). There are three approaches through which national income can be calculated including; output approach, income approach and expenditure approach.
The expenditure method adds up all spending on final goods and services produced within a country in a given time period. Final goods and services are those that are ready for final use, and can be contrasted with intermediate goods and services, which are those purchased as inputs for the production of final goods. For example, food items such as meat and vegetables are intermediate goods for a restaurant that uses them to prepare a meal, and the meal is the final good. Total spending can be broken down into four components: consumption, investment, government purchases, and net exports.
- Consumption spending (C) – includes all purchases by households on final goods and services in the course of a year.
- Investment spending (I) – includes all spending by firms on capital goods (machinery, equipment, etc) and all spending on new construction (housing, etc).
- Government purchases (G) – refers to all spending on goods and services by governments at levels within a country. (national, regional, etc) It also includes purchases by the government of factors of production, including labor services.
- Net exports (exports minus imports, i.e. X-M) – refers to the value of all exports minus the value of all imports.
If we add together the four components of spending we obtain a measure of aggregate output known as gross domestic product (GDP), i.e. C + I + G + (X-M) = GDP
The income method adds up all income earned by the factors of production in the course of producing all goods and services within a country in a given time period: wages earned by labor, rent earned by land, interest earned by capital, and profits earned by entrepreneurship. When all factor incomes are added up, the result is national income. Whereas national income is often used as a measure of the level of economic activity, it is not the same as GDP arrived by the use of expenditure approach. To arrive at GDP using the income approach, it is necessary to make some adjustments to national income.
The output method measures the value of each good and service produced in the economy over a particular time period (usually a year) and then sums them up to obtain the total value of output produced. It measures the value of all final goods and services, in order to avoid the double counting that would arise from including the values of intermediate goods and services. The method used to obtain the value of only final goods and services is to count only the value added in each step of the production process. The output approach calculates the value of output by economic sector, such as, for example, agriculture, manufacturing, etc. The value of output of each sector is then added up to obtain the total value of output for the entire economy.
Although the three approaches give rise to the same result, there are many problems while measuring national income. The following are the problems:
- No common unit of measurement- In some countries they use their domestic currency to measure the national income where as some countries use US dollars to measure national income. Since there are no standard unit of measurement it leads to inconsistency.
- Problem of double counting- This is where the output of one production process become input to another process leading to double counting the value of the good. To avoid this problem the added value at each production process is used to calculate the national income figure.
- Non marketed goods such as service of a housewife are not counted in national income calculation.
- When second hand goods are sold the value of the product is double counted.
- Black economy- The goods and services produced and sold in black economy in illegal manner is not counted in the national income calculation.
- Services of volunteers and self provided services are not accounted for when calculating national income.
- The government can easily manipulate the national income figures.
- There is no common method of calculation and different countries use different methods and policies in calculating national income.
- When it comes to expenditure method, defense expenses could lead to higher government expenditure if there is a war in the country misleading user by giving a high national income figure.
(12)
(b) A composite indicator is a summary measure of several dimensions or goals of development. Human Development Index (HDI) and Human Poverty Index (HPI) are two of the composite indicators we are focusing on. HDI is a summary measure of human development and measures average achievement in three dimensions: (i) a long and healthy life, measured by life expectancy at birth; (ii) knowledge, measured by adult literacy and the combined primary, secondary and tertiary enrolment ratio; and (iii) a decent standard of living, measured by GDP per capita (in US$). The HDI is very useful tool for countries and governments wishing to devise policies that focus on development.
HPI is based on the concept of human poverty as distinct from income poverty. There are actually two human poverty indices: one is for less developed countries, and the other is for more developed countries. Human poverty refers to deprivations and the lack of opportunities and choices that allow individuals to lead a long, healthy and creative life with a decent standard of living, freedom and dignity. The HPI in developing countries uses the following indicators:
- deprivation in longevity, measured by the probability at birth of not surviving to age 40
- deprivation in knowledge, measured by percentage of illiterate adults
- deprivations in the standard of living, measured by the percentage of people who do not have sustainable access to safe water, health services, and percentage of children under age five who are underweight for their age.
The HPI in developed countries uses the following indicators:
- probability at birth of not surviving to age 60
- percentage of adults lacking functional literacy skills
- percentage of people living below the nationally determined poverty line
- the long-term underemployment rate
Many economists prefer to use HDI and HPI to indicate living standards because HDI measures the better standard of living and HPI measures the lower standard of living in countries. Higher the HDI value is, better the standard of living is. On the other hand, higher the HPI is, worse the standard of living is. Both these indicators help economists to determine which countries have better standards of livings which do not.
As it is mentioned in 2 a) one of the basic ways to measure national income include Gross Domestic Product (GDP). GDP however is a poor measure in terms of people’s welfare. When a country has a higher GDP per capita than another country, it does not necessarily means that the country with the higher GDP per capita provides a better standard of living to his people. In almost every country there is uneven distribution of wealth. Thus, having a high GDP does not mean that everybody in that country experiences the same amount of wealth, but the bigger portion of wealth is concentrated in the pockets of small proportion of population. As a conclusion, having a high GDP in a country does not mean that everybody lives in the same good way as the others.
(13)
(Total 25 marks)
3. Use production possibility curve diagrams to explain the differences between actual output and potential output and between economic growth and economic development.
Production possibilities curve (PPC) represents all combinations of the maximum amounts of two goods that can be produced by an economy, given its resources and technology, when there is full employment of resources and productive efficiency.
Actual output is the quantity of output produced, which is always at a point inside the PPC, because in the real world all economies have some unemployment of resources and some productive inefficiency.
Potential output is the economy's maximum sustainable output level (a point on the PPC curve)., given the supply of resources, the state of technology, and the underlying economic institutions; the output level when there are no surprises about the price level.
Economic growth refers to increases in the quantity of output (goods or services) produced over a period of time (usually a year) per capita.
Economic development refers to raising the standard of living and well-being of people, particularly in less developed countries (LDCs). It involves increasing income levels and reducing poverty, reducing income inequalities and unemployment, and increasing the provision of basic goods and services, like shelter and food.
Merit goods are goods that are held to be desirable for consumers, but which are underprovided by the market.
The production possibilities model can be used to illustrate an economy’s choice between economic growth without economic development, and economic growth with economic development. This is shown in the figure below; where the vertical axis measures industrial goods production and the horizontal axis represents merit goods production.
Assume that a country is initially at point A on PPC1. A rightward shift of its production possibilities curve to PPC2 shows an increase in production possibilities. The country can choose to move to point B or point C on PPC2. (We are assuming for simplicity that the economy is producing at some point on its PPC.) Both moves indicate that economic growth has occurred, because in both cases the economy is capable of producing a greater volume of output. Moving to point B indicates growth without development because the country has chosen to produce relatively more industrial goods than merit goods. Moving to point C shows growth with development, since the country has made a choice to place a relatively greater emphasis on the production of merit goods rather than industrial goods. Note that the production possibilities model can illustrate that economic development is occurring only with respect to increased merit goods production, which is only one aspect of development. It cannot illustrate other aspects of development (such as poverty reduction, improved income distribution, etc).
(Total 10 marks)
4. Explain why economic growth is likely to generate external costs, which are a threat to sustainable development.
Economic growth refers to increases in the quantity of output (goods or services) produced over a period of time (usually a year) per capita.
Sustainable development is defined as “development which meets the needs of the present without compromising the ability of future generations to meet their own needs.”
External cost is a consequence of an economic activity that is experienced by unrelated third parties. An externality can be either positive or negative. (Example: pollution emitted by a factory).
Sustainable development focuses on four main objectives: (1) social progress, (2) effective protection of the environment, (3) prudent use of natural resources, (4) maintenance of high and stable levels of economic growth and employment.
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In order to experience economic growth people establish many factories which emit dangerous gases and cause pollution. That is of course against the objective of social progress that states everyone should share in the benefits of increased prosperity and a clean and safe environment.
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Trying to achieve economic growth people pollute the environment and cause to environmental threats, such as climate changes. Plus, they do not protect the things that other people need or value, like wildlife while aiming for a growth. But these oppose the principal of effective protection of the environment because it intends people to limit environmental threats.
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Resources should be used efficiently and alternatives should be developed to replace them in course in order not to endanger the resource or cause serious damage or pollution in the environment, which is against the principles of sustainable development.
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While making economic growth, there should be the maintenance of high and stable levels of economic growth and employment so that everybody will have a high standard life and the future generations will live in prosperity, too.
(Total 10 marks)
5. Poor people in less developed countries often derive little benefit from economic growth. Why might this be so?
Less Developed Country (LDC) is a country that is considered lacking in terms of its economy, infrastructure and industrial base. The population of a lesser-developed country often has a relatively low standard of living, due to low incomes and abundant poverty.
Economic growth refers to increases in the quantity of output (goods or services) produced over a period of time (usually a year) per capita.
Gross Domestic Product (GDP) refers to the market value of all goods and services produced within a country in a given period.
A lesser-developed country is usually poor, as measured by per capita gross domestic product, and unmodernized. LDCs rely primarily on agriculture as a source of income and industrial practices usually contribute to less than 10% of the nation's GDP. Many African and Arab nations are considered to be lesser-developed countries. As LCDs have very low income and low GDP, an economic growth would have a minimal effect on people’s lives in terms of financial benefits. The benefit the poor would derive is so little that, they would barely notice that there was an economic growth in their country. Also, in less developed countries there is highly unequal distribution of income and wealth, in which the wealth is concentrated in the hands of a small proportion of education. This is the primary reason for LDCs to be not able to benefit the poor in them.
(Total 10 marks)
6. Define the following terms:
(i) opportunity costs – the concept of opportunity cost, or the value of the next best alternative that must be sacrificed to obtain something else, is central to the economic perspective of the world, and results from the condition of scarcity that forces a choice between competing alternatives.
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(ii) Gross Domestic Product or GDP is defined as the market value of all final goods and services produced within a country during a given time period (usually a year). It includes spending by the four components, Consumption spending + Investment spending + Government purchases + (Exports-Imports). It is the most commonly used measure of the value of aggregate output.
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(iiI) GDP per capita – an approximation of the value of goods produced by a person in the country, equal to the country’s GDP divided by the total number of people in the country.
(2)
(Total 6 marks)
HUMAN DEVELOPMENT IS THE END, ECONOMIC GROWTH IS A MEANS
❶ Many policy-makers assume that a rapidly expanding economy will sweep poverty and deprivation away and that the solution to people’s needs is growth. They believe the benefits of economic growth will always ‘trickle down’ into people’s lives. As a result, a central priority is given to the measurements of growth and an understanding of its dynamics. The common indicators are those of GNP and GDP, often on a per capita basis.
❷ Policy-makers are often preoccupied by the quantity of growth rather than with its structure and quality. While in the countries belonging to the Organisation for Economic Cooperation and Development (OECD) economic growth in 1993 coexisted with an average unemployment rate of 8%, in developing countries ‘jobless growth’ meant long hours and very low incomes for hundreds of millions of people in low productivity work in agriculture and the informal sector.
❸ It is evident that some societies are experiencing negative growth, the growth rates of others are falling, while others are failing to distribute the benefits of growth. Critics question the effects of growth, whether growth is sustainable and whether conventional criteria of growth such as GDP per capita remain appropriate.
❹ Some economists believe that in the early stages of growth the benefits will inevitably accrue to the rich. But the view that economic growth in its early stages is inevitably associated with a deteriorating distribution of income has been disproved by recent evidence of a positive correlation between economic growth and income equality (as represented by the share of the poorest 60% of the population). The new insight is that an equitable distribution of public and private resources can enhance the prospects for further growth.
❺ The 1996 Human Development Report (HDR) asserts that human development is the end, economic growth is a means. So, the purpose of growth should be to enrich people’s lives and human development should not be measured by the abundance of commodities. For the authors of the HDR, new indicators of progress must be used and in their construction we should heed Gandhi’s dictum: ‘The earth provides enough to satisfy every man’s need but not every man’s greed’. The Human Development Index (HDI) is a relatively recent indicator of development, constructed by the UNDP (United Nations Development Programme) to capture a wider conception of human development and to explore the relationship between growth and human development.
Adapted from the Human Development Report 1996. Published for the United Nations
Development Programme
8. Explain what is meant by the following terms used in the passage:
(i) the Human Development Index (HDI) (paragraph ❺)
It is the best-known and most widely used index of the UNDP. It is a summary measure of human development and measures average achievement in three dimensions: a long and healthy life, measured by life expectancy at birth; knowledge, measured by adult literacy and the combined primary, secondary and tertiary enrolment ratio; and a decent standard of living, measured by GDP per capita.
(2)
(ii) ‘jobless growth’ (paragraph ❷)
The term “jobless growth” is used when a country experiences growth while maintaining or decreasing its level of employment. According to the passage, “jobless growth” also means, in developing countries, that there are long hours of working with very low incomes for hundreds of million people in low productivity work in agriculture and the informal sector.
(2)
(Total 4 marks)
9. What is the difference between negative and falling rates of growth? (paragraph ❸)
Negative growth is a contraction in a country's economy, as evidenced by a decrease in its gross domestic product (GDP) during any quarter of a given year. Negative growth is typically expressed as a negative percentage. Recurring periods of negative growth are one of the most commonly used measures to determine whether an economy is experiencing a recession or depression.
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10. What are the weaknesses and strengths of the Human Development Index (HDI) as an indicator of progress in comparison to GDP/GNP per capita? (paragraph ❺)
Human Development Index (HDI): The first Human Development Report introduced a new way of measuring development by combining indicators of life expectancy, educational attainment and income into a composite human development index, the HDI.
Gross Domestic Product (GDP): Gross domestic product is the most commonly used single measure of a country's overall economic activity. It represents the total value of final goods and services produced within a country during a specified time period, such as one year
GDP per capita is total GDP of a country divided by its population.
Gross National Product (GNP): Value of all goods and services produced in a country in one year, plus income earned by its citizens abroad, minus income earned by foreigners in the country.
GNP per capita is total GNP of a country divided by its population.
Economic development is a complex multifaceted process that is not accurately reflected in accounting aggregates like GDP and GNP per capita. Because of its many dimensions, the level of economic development of any one country cannot be reflected in any single measure. Individual attributes and characteristics of economies are measured by use of indicators. An indicator is a measurable variable that is being measured. For example, GDP per capita is an indicator of the level of output or income per person. The number of years of life expectancy is an indicator of the state of the health of a population. The degree of literacy is an indicator of the level of education in the country. All these are attributes of economic or human development.
Human Development Index (HDI) is a summary measure of human development and measures average achievement in three dimensions: (i) a long and healthy life, measured by life expectancy at birth; (ii) knowledge, measured by adult literacy and the combined primary, secondary and tertiary enrolment ratio; and (iii) a decent standard of living, measured by GDP per capita (in US$). The HDI is very useful tool for countries and governments wishing to devise policies that focus on development. However, it should be noted that the HDI, too, has its shortcomings as a measure of development. This is because economic and human developments are much broader concepts with more dimensions than are reflected in the HDI. The HDI does not provide us with information about income distribution, malnutrition, demographic trends, gender inequalities, political participation, etc.
Strengths and weaknesses of HDI
Strengths:
- Promotes human dimensions of well being of individuals
- Some countries with low levels of income can still achieve moderate levels of human development, and vice versa
- Widely used summary measure of human development that has stood test of time
Weaknesses:
- Includes only 3 dimensions of human development and ignores some key human rights
- HDI does not show inequities
- Not directly amenable to policy prescriptions
Using GDP as a measure of a nation's economy makes sense because it's essentially a measure of how much buying power a nation has over a given time period. GDP is also used as an indicator of a nation's overall standard of living because, generally, a nation's standard of living increases as GDP increases.
But there are a number of shortcomings to using GDP and they are:
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GDP doesn't count unpaid volunteer work: GDP doesn't take into account work that people do for free.
- Disasters can raise GDP: Wars require soldiers, oil spills require cleanup, and natural disasters require health workers, builders, and all manner of helping hands.
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GDP doesn't account for quality of goods: Consumers may buy cheap, low-quality, short-lived products repeatedly instead of buying more expensive, longer-lasting goods.
Strengths and weaknesses of GNP
Strengths:
- It allows us to add together a wide range of very different behaviors (building roads and cars, teaching, serving meals, doctoring, etc).
- It is empirically associated with a wide variety of significant social changes (urbanization, industrialization, changes in reproductive behavior, and increased physical quality of life.
- It allows us to disaggregate wealth by its source and its uses
Weaknesses:
- It is an estimate, and thus contains errors; past estimates are constantly being revised.
- It only counts behavior that is given a market value. Thus much subsistence output, or the work of women in a household, is not counted.
- Most important weakness for environmental change:
- GNP does not value natural resources (forests, fish in lakes and rivers) unless they are used; and GNP counts the resources put into pollution clean-up, crime prevention and medical treatment for pollution-related diseases as part of wealth.
(5)
(Total 8 marks)
11. (a) Suggest reasons for the existence, identified in paragraph ❹, of a ‘positive correlation between economic growth and income equality’.
Economic growth refers to increases in the quantity of output (goods or services) produced over a period of time (usually a year) per capita.
Income inequality is a term that is used to describe an even distribution of wealth within a defined geographic area.
If economic growth increases that would mean that people will experience a faster increase in their financial standard of living. They would be able to consume more goods and services. Higher rates of economic growth would create higher levels of employment, reducing unemployment. Thus, when there is an increase in economic growth, the wealth in the country would be less unevenly distributed. In other words, there would be a more even distribution of wealth. Moreover, as the economic growth increases, the income equality will also increase because people, in every income class, will have more money to spend on goods and services.
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(b) Discuss the view that the benefits of economic growth will always ‘trickle down’ into people’s lives. (paragraph ❶)
Trickle-down theory is an economic theory which states that investing money in companies and giving them tax breaks is the best way to stimulate the economy. Proponents of this theory believe that when government helps companies, they will produce more and thereby hire more people and raise salaries. The people (lower-income individuals), in turn, will have more money to spend in the economy. This theory was used in 1950s. By the late 1960s and early 1970s, it was becoming increasingly apparent that many less developed countries were not performing according to expectations. First, it was noted that the GNP per capita gap between rich countries and poor countries had more than doubled on average in the period 1950-1975. Growth rates were highly uneven: while some less developed countries were growing rapidly (especially the oil-rich countries in the Middle East), others were experience very low or even negative growth rates (especially in Africa). Second, it became apparent that the number of people living in extreme poverty (defined as living on less than US$1 per day) was increasing rather than decreasing. A major study of 43 countries published in 1973 showed that economic growth in the early years benefited only the wealthiest groups, and in a later phase benefited middle income groups, while the position of the poorest 40% of the population grew worse both relatively and absolutely. In other words, the benefits of economic growth were not “tricking down” to the poorest members of society. Because economic growth cannot eliminate widespread poverty, it can be concluded, based on the this fact, that the benefits of economic growth will not always “trickle down” into people’s lives, especially not into poor people’s lives.
(8)
(Total 13 marks)