ECONOMIC GROWTH AND DEVELOPMENT

Economic Growth

The phenomenon of a sustained increased in the real per capita income of a country over a period of time is known as economic growth. Economic growth is only concerned with the production aspect of the economic activity and not considering the distribution aspect

Economic Development

Till 1960 the term ‘economic development’ was often used as a synonym of ‘economic growth’ in economic literature. But now the entire concept of economic development has changed. It is considered to mean growth plus progressive changes in certain crucial variables which determine the well being of the people. According to UNO economic development concerns not only man’s material needs, but also the improvement of social conditions of his life. As per the World Bank reports, economic development means ‘the improvement in quality of life.’ The improvement in quality of life is measured on the basis of the following factors.

(1) Reduction in absolute poverty (2) Reduction in unemployment (3) Improvement in health standard(4) Improvement in educational standard(5) Access to clean environment, and(6) Greater individual freedom

Difference between Economic Growth and Development

(1) Economic Growth is a quantitative change but ED is a qualitative change

(2) EG is a one dimensional process but ED is a multi-dimensional process.

(3) EG is a necessary condition for ED but is not a sufficient condition for ED

 Measures of Quality changes

1. Physical Quality of Life Index (PQLI)

It is developed by Morris.D.Moris in 1979.He uses three important variables

Like Life expectancy at age 1,Infant Mortality Rate and adult literacy

A country’s rank in PQLI is based on its performance in the above three areas. The Overseas Development Council (ODC), a US based research council is the nodal agency to construct the PQLI

2. Human Development Index (HDI)

HDI was developed in 1990 by Pakistan economist Mahabub-ul-Haq and Indian economist Amartya Sen.HDI has three important variables such as life expectancy, literacy, education and standard of living for countries world wide. It is used to measure the impact of economic policies on quality of life. HDI is prepared by UNDP in every year in its Human Development Report (HDR)

3. Gender Development Index (GDI)

GDI is same as HDI, but adjusted to reflect gender in equalities.  It is also a comparative measure of longitivity, literacy and standard of living.  But while calculating GDI separate index for each of the dimension are separately calculated for men and women and then two are club together to calculate the GDI

4.Gender Empowerment Measure(GEM): 

GEM measures the opportunities available to a woman in a society the capability of political participation and decision making, economic participation and decision making and command over resources

5. Human Poverty Index (HPI)

It tell us the extent of deprivation in a society, ie What percentage of the population is deprived of a longer life, literate life and decent standard of living.

6. Technology Achievement Index (TAI)

It is introduced in 2001.It measures the capacity of a nation to create and diffuse technology and to create human skills based on that technology.

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HECKSHER OHLIN THEORY

  The Hecksher Ohlin model is a general equilibrium mathematical model of international trade developed by Eli Hecksher and Bertil Ohlin. It builds on David Ricardo‘s theory of comparative advantage. By predicting pattern of commerce and production based on factor endowments of a trading region.

     Ricardian theory of comparative advantage has trade ultimately motivated by differences in labour productivity using different technologies. Hecksher Ohlin did not require production technologies to vary between countries; Hecksher Ohlin model has identical production technology anywhere. Ricardo considered single factors of production and would not have been able to produce comparative advantage without technological differences between countries. Hecksher Ohlin model removed technology variations but introduced variable capital endowments.

           The H-O model assumed that the only difference between countries was the relative abundances of labor and capital. The Heckscher–Ohlin model contained two countries, and had two commodities that could be produced. Since there are two (homogeneous) factors of production this model is sometimes called the "2×2×2 model".

The model essentially says that countries will export products that use their abundant and cheap factors of production and import factors that use the countries scares factors.

ASSUMPTIONS

• There are two nations, two commodities, two factors of production.

• Both nations use same technology in production.

• Commodity X is labour intensive and commodity Y is capital intensive in both nations.

• Both commodities are produced under constant returns to scale.

• Tastes are equal in both nations.

• There is perfect competition in both commodities and factor markets in both nations.

• There is incomplete specialization in production in both nations.

• There is perfect factor mobility with in each nation but there is no international factor mobility.

• There are no transportation costs, tariffs, or other obstructions to the flow of international trade.

• All resources are fully employed in both nations.

• International trade between two nations is balanced.

• Relative endowments of the factors of production determine a country’s comparative advantage.

       Nations have access to and use the same general production techniques, factor price were same in both nations, producers in both nations would use exactly the same amount of labour and capital in the production of both commodity. Producers will use more of the relatively cheaper factor in the nation to reduce cost of production.

           K/L ratio is relatively higher in commodity Y lower in commodity X and L/K ratio is higher for X lower for Y in both nations. Constant returns to scale prevail in the economy, which means that if we increase the amount of labour and capital. It leads to an increase in output in the same proportion. There are no other special products will not be produced, even if there is a free trade in the economy, they continue to produce both commodities in both nations.

       There is Capital and Labor mobility within countries capital and labor can be reinvested and re-employed to produce different outputs. Like the comparative advantage argument of Ricardo, this is assumed to happen costlessly. If the two production technologies are the arable industry and the fishing industry it is assumed that farmers can shift to work as fishermen with no cost, and vice versa.

      Relative endowments of factors of production determine a countries comparative advantage. Countries have comparative advantage in those goods for which the required factors of production are relatively abundant locally. This is because the profitability of goods is determined by input costs. Goods that require inputs that are locally abundant will be cheaper to produce than those goods that require inputs that are locally scares.

      The Ricardian model of comparative advantage has trade ultimately motivated by differences in labour productivity using different technologies. Heckscher and Ohlin didn't require production technology to vary between countries, so the H-O model has identical production technology everywhere. Ricardo considered a single factor of production and would not have been able to produce comparative advantage without technological differences between countries. The H-O model removed technology variations but introduced variable capital endowments, recreating endogenously the inter-country variation of labour productivity that Ricardo had imposed exogenously. With international variations in the capital endowment and goods requiring different factor proportions, Ricardo's comparative advantage emerges as a profit-maximizing solution of capitalist's choices from within the model's equations. The decision capital owners are faced with is between investments in differing production technologies: The H-O model assumes capital is privately held.

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LIQUIDITY PREFERENCE THEORY

In macroeconomic theory liquidity preference refers to the demand for money considered as liquidity. The concept was first developed by John Maynard Keynes in his book the general theory of employment, interest and money to explain determination of the interest rate by the supply and demand for money.

The demand for money as an asset was theorized to depend on the interest foregone by not holding bonds. He argues that interest rate cannot be a reward for saving as such because, if a person holds his saving in cash, keeping it under his mattress he will receive no interest. Keynes defines the rate of interest as the reward for parting with liquidity for a specified period of time. According to him, the rate of interest is determined by the demand for and supply of money.

Liquidity preference means the desire of the public to hold cash. According to Keynes, there are three motives behind the desire of the public to hold liquid cash: (1) the transaction motive, (2) the precautionary motive, and (3) the speculative motive.

1: Transaction motive: people prefer to liquidity to assure basic transactions, for their income is not constantly available. The amount of liquidity demanded is determined by the level of income. The higher the income the more money demanded for carrying out increased spending.

2: The precautionary motive: people prefer to have liquidity in the case of social unexpected problems that need unusual costs. The amount of money demanded for this purpose increases as income increases.

3: speculative motive: people retain liquidity to speculate that bond price will fall. When the interest rate decreases people demand more money to hold until the interest rate decreases, which would drive down the price of as existing bond to keep its yield in line with the interest rate. Thus the lower the interest rate, the more money demanded and vice versa.

According to Keynes, the higher the rate of interest, the lower the speculative demand for money, and lower the rate of interest, the higher the speculative demand for money. Algebraically, Keynes expressed the speculative demand for money as

M₂ = L₂ (r)

Where, L₂ is the speculative demand for money, and

r is the rate of interest.

Geometrically, it is a smooth curve which slopes downward from left to right.

Now, if the total liquid money is denoted by M, the transactions plus precautionary motives by M₁ and the speculative motive by M₂, then

M = M₁ + M₂. Since M₁ = L₁ (Y) and M₂ = L₂ (r), the total liquidity preference function is expressed as M = L (Y, r).

Supply of Money: The supply of money refers to the total quantity of money in the country. Though the supply of money is a function of the rate of interest to a certain degree, yet it is considered to be fixed by the monetary authorities. Hence the supply curve of money is taken as perfectly inelastic represented by a vertical straight line.

Determination of the Rate of Interest: Like the price of any product, the rate of interest is determined at the level where the demand for money equals the supply of money.  In the following figure, the vertical line QM represents the supply of money and L the total demand for money curve. Both the curve intersects at E₂ where the equilibrium rate of interest OR is established.

If there is any deviation from this equilibrium position an adjustment will take place through the rate of interest, and equilibrium E₂ will be re-established.

At the point E₁ the supply of money OM is greater than the demand for money OM₁. Consequently, the rate of interest will start declining from OR₁ till the equilibrium rate of interest OR is reached. Similarly at OR₂ level of interest rate, the demand for money OM₂ is greater than the supply of money OM. As a result, the rate of interest OR₂ will start rising till it reaches the equilibrium rate OR.

It may be noted that, if the supply of money is increased by the monetary authorities, but the liquidity preference curve L remains the same, the rate of interest will fall. If the demand for money increases and the liquidity preference curve sifts upward, given the supply of money, the rate of interest will rise.

Criticisms: Keynes theory of interest has been criticized on the following grounds:

1. It has been pointed out that the rate of interest is not purely a monetary phenomenon. Real forces like productivity of capital and thriftiness or saving by the people also play an important role in the determination of the rate of interest.

2. Liquidity preference is not the only factor governing the rate of interest. There are several other factors which influence the rate of interest by affecting the demand for and supply of investible funds.

3. The liquidity preference theory does not explain the existence of different rates of interest prevailing in the market at the same time.

4. Keynes ignores saving or waiting as a means or source of investible fund. To part with liquidity without there being any saving is meaningless.

5. The Keynesian theory only explains interest in the short-run. It gives no clue to the rates of interest in the long run.

6. Keynes theory of interest, like the classical and loanable funds theories, is indeterminate. We cannot know how much money will be available for the speculative demand for money unless we know how much the transaction demand for money is.

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INPUT-OUTPUT ANALYSYS

          the concept of input output analysis was first developed by Quesney in 18^th century in the name of Tableau economique.In modern times, American economist pro: ww.Leontief has developed input-output analysis to give a practical shape to the general equilibrium analysis of Walras. Leontief explained input-output analysis in his famous work “structure of the American Economy” in which he explained inter relationship and interdependence of various sectors of the economy. Input output analysis is a very helpful tool for economic forecasting in developed countries and economic planning in the developing countries. (Economic forecasting is the activity of estimating the quantity that the consumers may purchase In future, making predictions for capacity requirements, price decisions, entering in to new industry. Input-output analysis is a very helpful tool for analyzing how an industry undertakes production by using output of other industries and the out-put of the given industry is used-up in other industries and sectors. So the various industries are mutually interdependent. Which means out-put of an industry is input of others Eg: wheat and Horlicks or steel and construction. So input out-put analysis is also known inter industry analysis.

FEATURES OF INPUT-OUTPUT ANALYSIS

input-output analysis is concerned with only production:- it does not consider what determines final demand for goods and services, thus the theory of consumer’s demand does not have any place in input-output analysis. It explains the technological problems; it describes the use of the amount of various inputs in industries and possible output of them.

Input-output analysis is based upon only empirical facts: - Estimates of quantities of the various inputs and outputs of various industries are made on the basis of the empirical facts or data.

Input-output analysis is based on the concept of general equilibrium:- it gives the practical shape to the theoretical framework of general equilibrium analysis.(general equilibrium analysis seeks to explain the behavior of supply, demand and price in whole economy with several interacting markets by seeking to prove that a set of price exists that may result in an overall equilibrium.

ASSUMPTIONS OF THE THEORY

It assumed that available resources, the demand for final products and price of all inputs and outputs are given and remain constant, the main purpose is to analyze the relationship between the changes in the physical outputs.

It is assumed that the technical coefficients of production ie:- input ratios or factors of production to produce a given output of various products are completely fixed. Possibilities of technical substitution among various factors to produce a product or changes in the techniques of production are not considered in this analysis.

it is assumed that the constant returns to scale prevails in the economy:- this implies that a fixed quantities of inputs are presumed. Thus one percent change in input would result one percent change in output.

It is assumed that the demand for final products is enough to keep the system working at its full production capacity which means there are no inputs remains unutilized or underutilized.

SETTING UP OF INPUT-OUTPUT ANALYSIS

To setup input-output analysis we have to divide economy in to manageable number of sectors each sector is assumed to produce only one product and each sector contains several industries and producing closely related products.

After dividing the system in to sectors, next step is to frame number of equations which will establish relation between various inputs of each sector to the outputs of its product and number of equations also framed which will relate the output of one sector to the other sector which uses the products of that sector as inputs.

Establishment of necessary equations and technical coefficients of production are taken on the basis of empirically obtained data. In this way the final output for consumption demand or for making addition to the capital stock is determined.

There is constant returns prevails in the economy so there will be linear relationship between inputs and output of any product.

There will be as many numbers of equations as there are outputs, therefore unique mathematical solution can be obtained from a given set of simultaneous equations.

Input output table (transaction matrix)

Input-output table represents the flow of a given in to various industries and final demand and the requirements of various inputs for that output. Input –output table is also call as transaction matrix.

Here output X1 of industry 1 follows in to its own output X1and also into the out of other industries such as X2,X3….Xn as input and the remaining parts of outputs may be used to meet the final demand D1 Similarly X11,X21,Xnn also used in the same way.(each output of one industry will be used as input for other industries or it may be directed to meet the final demand.

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