Distinguish between economic growth and economic development??
BASIS FOR
ECONOMIC GROWTH ECONOMIC DEVELOPMENT
COMPARISON
Meaning Economic Growth is the Economic Development involves rise in the level
positive change in the real of production in an economy along with the
output of the country in a advancement of technology, improvement in
particular span of time. living standards and so on.
Concept Narrow Broad
Scope Increase in the indicators like Improvement in life expectancy rate, infant
GDP, per capita income etc. mortality rate, literacy rate and poverty rates.
Term Short term process Long term process
Applicable to Developed Economies Developing Economies
How it can be Upward movement in national Upward movement in real national income.
measured? income.
Which kind of Quantitative changes Qualitative and quantitative changes
changes are
expected?
Type of process Automatic Manual
When it arises? In a certain period of time. Continuous process.
Explain the various theories of economic development?
Mercantilism
The earliest Western theory of development economics was mercantilism, which developed in the 17th century, paralleling
the rise of the nation state. Earlier theories had given little attention to development. The 16th- and 17th-century School of
Salamanca, credited as the earliest modern school of economics, likewise did not address development specifically.
Economic nationalism
In the 19th century related to the development and industrialization of the United States and Germany, notably in the policies
of the American System in America and the Zollverein (customs union) in Germany. A significant difference from mercantilism
was the de-emphasis on colonies, in favor of a focus on domestic production.
Forms of economic nationalism and neomercantilism have also been key in Japan's development in the 19th and 20th
centuries, and the more recent development of the Four Asian Tigers (Hong Kong, South Korea, Taiwan, and Singapore), and,
most significantly, China.
Post-WWII theories
The origins of modern development economics are often traced to the need for, and likely problems with the industrialization
of eastern Europe in the aftermath of World War II. The key authors are Paul Rosenstein-Rodan, Kurt Mandelbaum, Ragnar
Nurkse, and Sir Hans Wolfgang Singer. Only after the war did economists turn their concerns towards Asia, Africa and Latin
America.
Linear-stages-of-growth model
An early theory of development economics, the linear-stages-of-growth model was first formulated in the 1950s by W. W.
Rostow in The Stages of Growth: A Non-Communist Manifesto, following work of Marx and List. This theory modifies Marx's
stages theory of development and focuses on the accelerated accumulation of capital, through the utilization of both domestic
and international savings as a means of spurring investment, as the primary means of promoting economic growth and, thus,
development.
Structural-change theory
Structural-change theory deals with policies focused on changing the economic structures of developing countries from being
composed primarily of subsistence agricultural practices to being a "more modern, more urbanized, and more industrially
diverse manufacturing and service economy." There are two major forms of structural-change theory: W. Lewis' two-sector
surplus model, which views agrarian societies as consisting of large amounts of surplus labor which can be utilized to spur the
development of an urbanized industrial sector, and Hollis Chenery's patterns of development approach, which holds that
different countries become wealthy via different trajectories
International dependence theory
International dependence theories gained prominence in the 1970s as a reaction to the failure of earlier theories to lead to
widespread successes in international development. Unlike earlier theories, international dependence theories have their
origins in developing countries and view obstacles to development as being primarily external in nature, rather than internal.
These theories view developing countries as being economically and politically dependent on more powerful, developed
countries which have an interest in maintaining their dominant position.
Neoclassical theory
First gaining prominence with the rise of several conservative governments in the developed world during the 1980s,
neoclassical theories represent a radical shift away from International Dependence Theories. Neoclassical theories argue that
governments should not intervene in the economy; in other words, these theories are claiming that an unobstructed free
market is the best means of inducing rapid and successful development.
Explain the issue and impact of inflation? What are the different cause and measurements of inflation?
When prices rise for energy, food, commodities, and other goods and services, the entire economy is affected. Rising prices,
known as inflation, impact the cost of living, the cost of doing business, borrowing money, mortgages, corporate and
government bond yields, and every other facet of the economy.
Definition of Inflation
The simplest definition is Inflation is “a rise in the general level of prices”. By the term general, we mean if the price of one
good has gone up it is not inflation, it is inflation only if the prices of most goods have gone up. The opposite of inflation is
deflation which means a fall in the general level of prices.
How is Inflation Measured in India.
In India, inflation is measured on two price indices, viz, wholesale price index (WPI) and consumer price index (CPI). WPI
measures price rise or inflation at the level of seller or retailer who buy commodities in bulk or ‘whole sale’. CPI is also called
retail inflation since it measures inflation at the retail or consumer level. In India, WPI is the basis for determining the inflation
of the economy.
About Wholesale Price Index (WPI)
WPI is measured on weekly basis. The first index of wholesale prices commenced in India for the week January 10, 1942. The
base year of WPI is revised periodically. Till date, 5 revisions have take place. The current WPI base year is 2004-05 based on
prices of 670 commodities.
For determining WPI, commodities are divided into three categories – Primary Articles (102 items), Fuel & Power (19 items),
and Manufactured Products (555 items). As you can see, the weight assigned to manufacturing is highest at 82% followed by
primary articles like fruits and vegetables.
About Consumer Price Index (CPI)
Unlike WPI, there is not a single measure of CPI. In India, four CPI indices are used to determine inflation at the consumer
level. These are: CPI-IW (Industrial Worker), CPI-UNME (Urban Non-Manual Employees), CPI-AL (Agricultural Labourers), and
CPI-RL (Rural Labourers).
Causes of Inflation
There are two main causes of inflation: cost push and demand pull.
Cost-Push Inflation occurs when general prices of commodities increases due to increase in production cost.
Demand-Pull Inflation is the result of mismatch between demand and supply. Either the demand increases over the same
level of supply or the supply decreases with the same level of demand.
Types of Inflation
Inflation may be classified into three main categories.
Low Inflation
Such inflation is slow and on predictable lines which might be called small or gradual. It is sometimes also called ‘creeping
inflation‘. For example monthly inflation that increases in single digits like 2.3%, 2.8%, 3.2%, 3.5% etc.
Galloping Inflation
This is very high inflation running in double or triple digits like 20%, 100% or 200% a year. Such kind of inflation was observed
in certain Latin American countries like Argentina.
Hyper Inflation
This form of inflation is ‘large and accelerating‘ which might have annual rates in million or even trillion. Such rate of inflation
was recently observed in Zimbabwe. In such inflation not only range of increase is very large but the increase takes place in a
very short span of time and prices shoot up overnight.
Effects of Inflation
Inflation has multi-dimensional effects on an economy. Effects of inflation on different sectors and segments are explained
below.
On Creditors and Debtors
Inflation redistributes wealth from creditors to debtors i.e. lenders suffer and borrowers benefit from inflation. This is true
assuming that salaries would also increase due to price rise. This results in repaying the same amount of money with extra
money at hand due to wage hike or increase in Dearness Allowance (DA for government employees).
On Aggregate Demand
Rising prices usually results in higher demand as it comparatively lower supply. However if inflation results from higher input
costs (cost-push), aggregate may demand may or may not increase comparative to price rise.
On Investment
Inflation increases the investment in an economy in the short run as it encourages producers to expand or increase
production. Also, in the short run, higher the inflation lower is the cost of loan.
On Saving
In the short run, rising prices encourages people to deposit cash in hand with banks as money loses value so holding it does
not much sense. However in the long run, rising prices depletes the saving rate in an economy.
On Exchange Rate
Rising prices generally leads to depreciation of the currency which implies that the currency loses its exchange value in front of
a foreign currency. But this is relative to the pressure on the foreign currency against which the exchange rate is compared.
For instance, from 2013 till mid-2014, even though there was relatively high inflation in India, still it did not lose much value
vis-a-vis the US dollar since the dollar was also under inflationary pressure.
On Export
With inflation, exportable items of an economy gain competitive prices in the world market. This boost a country’s exports.
This happens since value of currency falls so it makes it cheaper for importing countries to buy the exporting countries
produce.
On Imports
Inflation gives an economy advantage of lower imports and import-substitution as foreign goods become costlier.
On Wages
Inflation increases the nominal or face value of the wages while its real value falls. Simply put, even though wages may
increase to offset inflation the actual value of money falls.
Q-2 An economic can be define as a integrated system of production, change and consumption. In carrying out
these economic activities people are involved in making transactions- they by and goods and services. “Elucidate
the above statement. In this context explain the relevant of the identity Y=C+I+G.
Q-4 What do you mean by business cycle? Explain the different phases and factors of business cycle. In this
context discuss the status of various leading indicators such as the national income, IIP, PMI and other indicators
during the different phases of business cycle.
The Business Cycle
The term “business cycle” (or economic cycle or boom-bust cycle) refers to economy-wide fluctuations in production, trade,
and general economic activity. From a conceptual perspective, the business cycle is the upward and downward movements of
levels of GDP (gross domestic product) and refers to the period of expansions and contractions in the level of economic
activities (business fluctuations) around a long-term growth trend.
Business Cycle Phases
Business cycles are identified as having four distinct phases: expansion, peak, contraction, and trough.
An expansion is characterized by increasing employment, economic growth, and upward pressure on prices. A peak is the
highest point of the business cycle, when the economy is producing at maximum allowable output, employment is at or above
full employment, and inflationary pressures on prices are evident. Following a peak, the economy typically enters into a
correction which is characterized by a contraction where growth slows, employment declines (unemployment increases), and
pricing pressures subside. The slowing ceases at the trough and at this point the economy has hit a bottom from which the
next phase of expansion and contraction will emerge.
Business Cycle Fluctuations
Business cycle fluctuations occur around a long-term growth trend and are usually measured in terms of the growth rate of
real gross domestic product.
In the United States, it is generally accepted that the National Bureau of Economic Research (NBER) is the final arbiter of the
dates of the peaks and troughs of the business cycle. An expansion is the period from a trough to a peak, and a recession as
the period from a peak to a trough. The NBER identifies a recession as “a significant decline in economic activity spread across
the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production. ”
This is significantly different from the commonly cited definition of a recession being signaled by two consecutive quarters of
decline in real GDP. If the economy does not begin to expand again then the economy may be considered to be in a state
of depression.
Impact on Business Operations
How the business cycle affects business operations may be best explained by looking at how one business responds to these
cycles. Normal Maintenance is a small business that provides a variety of construction services to homeowners. They
specialize in roofing, deck installations, siding, and general home maintenance. They employ three full-time workers, who
typically work forty hours per week for an average of twelve dollars per hour. The company has been in business in the same
town for than twenty years and has a solid reputation for quality work and reliability.
Expansion
Normal Maintenance is busy and has recently had to turn down jobs because it lacks the capacity to do all the work offered.
Homeowners now want to make home repairs and improvements which they had had to put off during the sour economy.
With the economy improving, others are fixing up their homes to sell. Faced with so much demand, the owner of Normal
Maintenance must decide whether to pay his existing workers overtime (which will increase the costs for each job and reduce
profits) or hire additional workers. The competition for qualified construction labor is steep, and he is concerned that he will
have to pay more than his usual rate of twelve dollars per hour or possibly get workers who are not as qualified as his current
crew. He is, however, able to charge higher prices for his work because homeowners are experiencing long waits and delays
getting bids and jobs completed. The owner purchases a new truck and invests in additional tools in order to keep up with the
demand for services. Customers are willing to pay more than usual so they can get the work done. Business is expanding to
such an extent that Normal Maintenance and its suppliers are starting to have trouble obtaining materials such as shingles and
siding because the manufacturers have not kept pace with the economic expansion. In general, business is great for Normal
Maintenance, but the expansion brings challenges.
Peak
At the peak of the business cycle, the economy can be said to be “overheated.” Despite hiring additional workers, the owner
and crews of Normal Maintenance are working seven days a week and are still unable to keep up with demand. They can’t
work any harder or faster. As a result, the crews are exhausted and the quality of their work is beginning to decline. Customers
leave messages requesting work and services, but the owner is so busy he doesn’t return phone calls. Jobs are getting started
and completed late as the crews struggle to cover multiple job sites. As a result, customer complaints are on the rise, and the
owner is worried about the long-term reputation of the business. Neither the business nor the economy can sustain this level
of activity, and despite the fact that Normal Maintenance is making great money, everyone is ready for things to let up a little.
Contraction
As the economy begins to contract, business begins to slow down for Normal Maintenance. They find that they are caught up
on work and they aren’t getting so many phone calls. The owner is able to reduce his labor costs by cutting back on overtime
and eliminate working on the weekends. When the phone does ring, homeowners are asking for bids on work—not just
placing work orders. Normal Maintenance loses out on several jobs because their bids are too high. The company begins to
look for new suppliers who can provide them with materials at a cheaper price so they can be more competitive. The building
material companies start offering “deals” and specials to contractors in order to generate sales. In general, competition for
work has increased and some of the businesses that popped up during the expansion are no longer in the market. In the short
term the owner is confident that he has enough work to keep his crew busy, but he’s concerned that if things don’t pick up, he
might have to lay off some of the less experienced workers.
Trough
On Monday morning, the crew of Normal Maintenance show up to work and the owner has to send them home: there’s no
work for them. During the week before, they worked only three days, and the owner is down to his original crew of three
employees. Several months ago he laid off the workers hired during the expansion. Although that was a difficult decision, the
owner knows from hard experience that sometimes businesses fail not because their owners make bad decisions, but because
they run out of money during recessions when there isn’t enough customer demand to sustain them. Without enough working
capital to keep the doors open, some are forced to close down.
Representatives from supply companies are stopping by the office hoping to get an order for even the smallest quantity of
materials. The new truck and tools that the owner purchased during the boom now sit idle and represent additional debt and
costs. The company’s remaining work comes from people who have decided to fix up their existing homes because the
economy isn’t good enough for them to buy new ones. The owner increases his advertising budget, hoping to capture any
business that might be had. He is optimistic that Normal Maintenance will weather this economic storm—they’ve done it
before—but he’s worried about his employees paying their bills over the winter.
The owner of Normal Maintenance has been in business for a long time, so he’s had some experience with the economic cycle.
Though each stage has its stressors, he has learned to plan for them. One thing he knows is that the economy will
eventually begin to expand again and run through the cycle all over again.
1. In the expansion phase, there is increase in economic activity such as production, employment, output, wages, profits,
demand and supply of products and sales.
2. The economy then reaches peak, where the maximum limit of growth is attained and economic indicators do not grow further. This
stage marks the reversal in trend of economic growth.
3. In the recession phase, the demand for goods and services starts declining rapidly. Prices tend to fall and economic indicators
such Prices tend to fall and economic indicators such as income, output and wages start to decline
4. The growth in the economy continues to decline and there is rise of unemployment in the depression phase.
5. Demand and supply of goods and services and their prices reach their lowest levels in the trough phase. There is extensive
depletion of national income and expenditure.
6. In the recovery phase, there is a turnaround from the bottom and the economy starts recovering from the negative growth rate.
Demand and supply pick up and there is a positive attitude towards investment and employment.
Discuss the assumption of says law and the principle of effective demand. In this context and relevance of multiplier and
Accelerator?
An initial change in aggregate demand can have a much greater final impact on the level of equilibrium national income. This is
known as the multiplier effect - the multiplier is explained in our short revision video below.
Explaining the multiplier in one video tutorial
What is the multiplier process?
The multiplier effect comes about because injections of new demand for goods and services into the circular flow of income
stimulate further rounds of spending – in other words “one person’s spending is another’s income”
This can lead to a bigger eventual final effect on output and employment
What is a simple definition of the multiplier?
It is the number of times a rise in national income exceeds the rise in injections of demand that caused it
Examples of the multiplier effect at work
Consider a £300 million increase in capital investment– for example created when an overseas company decides to build a
new production plant in the UK
This may set off a chain reaction of increases in expenditures. Firms who produce the capital goods and construction
businesses who win contracts to build the new factory will see an increase in their incomes and profits
If they and their employees in turn, collectively spend about 3/5 of that additional income, then £180m will be added to the
incomes of others.
At this point, total income has grown by (£300m + (0.6 x £300m).
The sum will continue to increase as the producers of the additional goods and services realize an increase in their incomes, of
which they in turn spend 60% on even more goods and services.
The increase in total income will then be (£300m + (0.6 x £300m) + (0.6 x £180m).
Each time, the extra spending and income is a fraction of the previous addition to the circular flow.
affects the size / coefficient of the multiplier
The Multiplier and links to Keynesian Economics
The concept of the multiplier process became important in the 1930s when John Maynard Keynes suggested it as a tool to
help governments to maintain high levels of employment
This “demand-management approach”, designed to help overcome a shortage of capital investment, measured the amount of
government spending needed to reach a level of national income that would prevent unemployment.
What determines the value of the multiplier?
The value of the multiplier depends on:
Propensity to import
Propensity to save
Propensity to tax
Amount of spare capacity
Avoiding crowding out
Key points
1.The higher is the propensity to consume domestically produced goods and services, the greater is the multiplier effect. The
government can influence the size of the multiplier through changes in direct taxes. For example, a cut in the rate of income
tax will increase the amount of extra income that can be spent on further goods and services
2.Another factor affecting the size of the multiplier effect is the propensity to purchase imports. If, out of extra income, people
spend their money on imports, this demand is not passed on in the form of fresh spending on domestically produced output. It
leaks away from the circular flow of income and spending, reducing the size of the multiplier.
3.The multiplier process also requires that there is sufficient spare capacity for extra output to be produced. If short-run
aggregate supply is inelastic, the full multiplier effect is unlikely to occur, because increases in AD will lead to higher prices
rather than a full increase in real national output. In contrast, when SRAS is perfectly elastic a rise in aggregate demand causes
a large increase in national output.
4.Crowding out – this is where (for example) increased government spending or lower taxes can lead to a rise in government
borrowing and/or inflation which causes interest rates to rise and has the effect of slowing down economic activity.
When will the multiplier effect be large?
In short – the multiplier effect will be larger when
The propensity to spend extra income on domestic goods and services is high
The marginal rate of tax on extra income is low
The propensity to spend extra income rather than save is high
Consumer confidence is high (this affects willingness to spend gains in income)
Businesses in the economy have the capacity to expand production to meet increases in demand
