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[Economic and social issues]

Chapter 1

Economic Growth and development

A country's economic health can usually be measured by looking at that country's economic
growth and development.
Let's take a separate look at what indicators comprise economic growth versus economic

Economic Growth

A country's economic growth is usually indicated by an increase in that country's gross domestic
product, or GDP. Generally speaking, gross domestic product is an economic model that
reflects the value of a country's output.

In other words, a country's GDP is the total monetary value of the goods and services produced
by that country over a specific period of time.

Factors of economic growth:

Economic growth is caused by two main factors:

1. an increase in aggregate demand

2. an increase in aggregate supply ( productive capacity)

Short term economic growth

In the short term, economic growth is caused by an increase in aggregate demand (AD). If
there is spare capacity in the economy then an increase in AD will cause a higher level of real

AD= C + I + G + X- M

 C= Consumer spending
 I = Investment
 G = Government spending
 X = Exports
 M = Imports Page 1
AD can increase for the following reasons:

 Lower interest rates – Lower interest rates reduce the cost of borrowing and so encourage
spending and investment.
 Increased wages. Higher real wages increase disposable income and encourages consumer
 Increased government spending (G).
 Fall in value of sterling which makes exports cheaper and increases quantity of exports(X).
 Increased consumer confidence, which encourages spending (C).
 Lower income tax which increases disposable income of consumers and increases consumer
spending (C).
 Rising house prices, which create a positive wealth effect and encourages homeowners to
spend more.

Q: - Which of the following factor is not a contributing factor in economic growth?

A. Increased wages

B. Increased government spending

C. Lower income tax

D. Higher interest rates

Answer: D

Long Term Economic Growth

This requires an increase in the long run aggregate supply (productive capacity) as well as AD.

LRAS or potential growth can increase for the following reasons:

1. Increased capital. E.g. investment in new factories or investment in infrastructure, such as roads
and telephones.
2. Increase in working population, e.g. through immigration, higher birth rate.
3. Increase in Labour productivity, through better education and training or improved technology.
4. Discovering new raw materials.
5. Technological improvements to improve the productivity of capital and labour e.g.
Microcomputers and the internet have both contributed to increased economic growth. Page 2
How to measure economic growth

Economists usually measure economic growth in terms of gross domestic product (GDP) or
related indicators, such as gross national product (GNP) or gross national income (GNI) which
is derived from the GDP calculation.

GDP is calculated from a country's national accounts which report annual data on incomes,
expenditure and investment for each sector of the economy. Using these data it is possible to
estimate the total income earned in the country in any given year (GDP) or the total income
earned by a country's citizens (GNP or GNI).

GNP is derived by adjusting GDP to include repatriated income that was earned abroad, and
exclude expatriated income that was earned domestically by foreigners. In countries where
inflows and outflows of this sort are significant, GNP may be a more appropriate indicator of a
nation's income than GDP.

There are three different ways of measuring GDP-

a) The income approach

b) The output approach
c) The expenditure approach Page 3
The income approach, as the name suggests measures people's incomes, the output approach
measures the value of the goods and services used to generate these incomes, and the
expenditure approach measures the expenditure on goods and services. In theory, each of
these approaches should lead to the same result, so if the output of the economy increases,
incomes and expenditures should increase by the same amount.

Note: Higher GDP means an increase in National Output and National Income but it doesn’t
necessarily lead to economic development,

This is for the following reasons:

 Investment takes Time. It takes time for improvements in statistics like

education and literacy rates. Higher GDP can be used to increase spending on
education. But, it will take many years before education standards actually
improve. Other types of investment like infrastructure and health care will also
take a long time
 Inequality. Higher GDP may not ‘trickle down’ to the rest of society. Often
increased GDP tends to benefit a small section of society. This problem is worse
if corruption is a serious problem
 Environment. If Higher GDP causes environmental problems, living standards
can seem to worsen, rather than improve.
 What is GDP spent It depends on how the proceeds of Growth are used. There
is no guarantee that the proceeds of growth will be used in areas which benefit
economic development like education and infrastructure. If GDP is used for
military spending or debt repayments, there may be little improvement.

Harod Domar Model

The Harod Domar Model suggests that economic growth rates depend on two things:

a) Level of Savings (higher savings enable higher investment)

b) Capital Output Ratio (efficiency of investment)

Formula for Harod Domar

g=s/c (1)

– g is the economic growth rate
– s=S/Y is the ratio of saving S to income,Y,
– c is marginal capital-output ratio

It is argued that in developing countries saving rates are often low, if left to the free market.
Therefore, there is a need for governments to increase the savings rate in an economy. Page 4
Alternatively, developed countries could step in and transfer capital stock to the developing
countries, which would increase the productive capacity.

Warranted Growth Rate

Roy Harrod introduced a concept known as the warranted growth rate.

This is the growth rate at which all saving is absorbed into investment. (e.g. £80bn of saving =
£80bn of investment.

Let us assume, the saving rate is 10%. the Capital output ratio is 4. In other words £10bn of
investment, increases output by £2.5bn

In this case the economy’s warranted growth rate is 2.5 percent (ten divided by four).

This is the growth rate at which the ratio of capital to output would stay constant at four.

The Natural Growth Rate

The natural growth rate is the rate of economic growth required to maintain full employment.

If the labor force grows at 3 percent per year, then to maintain full employment, the economy’s
annual growth rate must be 3 percent.

This assumes no change in labour productivity which is unrealistic.

Criticisms of Harod Domar Model

Developing countries find it difficult to increase saving. Increasing savings ratios may be
inappropriate when you are struggling to get enough food to eat.

Harod based his model on looking at industrialized countries post depression years. He later
came to repudiate his model because he felt it did not provide a model for long term growth

The model ignores factors such as labour productivity, technological innovation and levels of
corruption. The Harod Domar is at best an oversimplification of complex factors which go into
economic growth.

There are examples of countries who have experience rapid growth rates despite a lack of
savings, such as Thailand.

It assumes the existences of a reliable finance and transport system. Often the problem for
developing countries is a lack of investment in these areas.

Increasing capital stock can lead to diminishing returns. Domar was writing during the aftermath
of the Great Depression where he could assume there would always be surplus labour willing to
use the machines, but, in practice this is not the case. Page 5
The Model explains boom and bust cycles through the importance of capital, (see accelerator
theory) However, in practice businesses are influenced by many things other than capital such
as expectations.

He assumed there was no reason for the actual growth to equal natural growth and that an
economy had no tendency to full employment. However, this was based on assumption of
wages being fixed.

Economic Development

A country's economic development is usually indicated by an increase in citizens' quality of life.

'Quality of life' is often measured using the Human Development Index, which is an economic
model that considers intrinsic personal factors not considered in economic growth, such as
literacy rates, life expectancy and poverty rates.

While economic growth often leads to economic development, it's important to note that a
country's GDP doesn't include intrinsic development factors, such as leisure time, environmental
quality or freedom from oppression. Using the Human Development Index, factors like literacy
rates and life expectancy generally imply a higher per capita income and therefore indicate
economic development.

Measuring economic development is not as precise as measuring GDP, because it depends

what factors are included in the measure.

There are several different measures of economic development, such as the Human
development index (HDI)

Human development index (HDI)

The HDI combines:

a) Life Expectancy Index. Average life expectancy compared to a global expected life
b) Education Index mean years of schooling, expected years of schooling
c) Income Index (GNI at PPP)

Question: Which of the following is used for calculating Human development Index?

A. Life expectancy index

B. Education index
C. Income index
D. Growth in GDP

Answer: D Page 6
Factors affecting economics growth in developing countries

 Levels of infrastructure – e.g. transport and communication

 Levels of corruption
 Educational standards and labour productivity
 Labour mobility
 Flow of foreign aid and investment
 Level of savings and investment

Economic growth without development

It is possible to have economic growth without development. i.e. an increase in GDP, but most
people don’t see any actual improvements in living standards.

Economic growth may only benefit a small % of the population. For example, if a country
produces more oil, it will see an increase in GDP. However, it is possible, that this oil is only
owned by one firm, and therefore, the average worker doesn’t really benefit.

Corruption. A country may see higher GDP, but the benefits of growth may be siphoned into
the bank accounts of politicians

Environmental problems. Producing toxic chemicals will lead to an increase in real GDP.
However, without proper regulation it can also lead to environmental and health problems. This
is an example of where growth leads to a decline in living standards for many.

Congestion. Economic growth can cause an increase in congestion. This means people will
spend longer in traffic jams. GDP may increase but they have lower living standards because
they spend more time in traffic jams.

Production not consumed. If a state owned industry increases output, this is reflected in an
increase in GDP. However, if the output is not used by anyone then it causes no actual increase
in living standards.

Military spending. A country may increase GDP through spending more on military goods.
However, if this is at the expense of health care and education it can lead to lower living
standards. Page 7
Indian economy at a glance:
The Economy of India is the ninth-largest in the world by nominal GDP and the third-
largest by purchasing power parity (PPP).

The country classified as newly industrialized country, one of the G-20 major economies, a
member of BRICS and a developing economy with approximately 7% average growth rate for
the last two decades. India's economy became the world's fastest growing major economy from
the last quarter of 2014, replacing the People's Republic of China.

The long-term growth prospective of the Indian economy is moderately positive due to
its young population, corresponding low dependency ratio, healthy savings and
investment rates, and increasing integration into the global economy.

Question: Which of the following factor might not be responsible for positive prospective
of India’s long-term growth?

A. Having young population

B. Low dependency ratio
C. Increasing integration into the global economy
D. Not having healthy savings

Answer: d

Currency Indian rupee (INR) ₹1 = 100 Paise

Fiscal year 1 April – 31 March

Trade organisations WTO, WCO,WFTU, G-20 and others


GDP $2.439 trillion (nominal; 2017)

$9.446 trillion (PPP; 2017)

GDP rank 6th (nominal); 3rd (PPP)

GDP growth 7.2% (Q3, 2017-18)(MOSPI)

GDP per capita $1,852 (nominal est.; 2017) Page 8
$7,173 (PPP est; 2017)

GDP per capita rank 141st (nominal) / 123rd (PPP)

GDP by sector Agriculture: 17.32%

Industry: 29.02%
Services: 53.66% (2016 est.)

Inflation (CPI) 4.44% (February 2018)

Base borrowing rate 6.25% (as on 26 Jan. 2018)

Population 21.2% live less than $1.90/day

below poverty line
58% live less than $3.10/day
(2011; World bank estimate)

Gini coefficient 33.9 (2013)

Human Development 0.624 (2015) medium (131st)


Labour force 520.4 million (2017)

Labour force by Agriculture: 47%

Industry: 22%
Services: 31% (FY 2014 est.)

Unemployment 4.9% Urban

5.1% Rural
5.0% National
(2016, Labour Bureau)

Average net salary ₹82,269 / $1,284 annually (2016-17)

Main industries  Textiles

 chemicals
 food processing
 steel
 cement Page 9
 mining
 petroleum
 machinery
 software
 pharmaceuticals
 transportation equipment
Ease-of-doing-business 100 (2017)


Exports $275.8 billion (2017)

Export goods  Agricultural products 13.2%

 Fuels and mining products 15.7%
 Manufacturers 68.4%
 Others 2.7%
Main export partners European Union 17.6%
 United States 16.1%
 United Arab Emirates 11.5%
 Hong Kong 5.1%
 China 3.4%
 Other 46.3%
Imports $384.3 billion (2017)

Import goods  Agricultural products 7.1%

 Fuels and mining products 33.1%
 Manufacturers 47.8%
 Other 12%
Main import partners China 17%
 European Union 11.3%
 United States 5.7%
 United Arab Emirates 5.4%
 Saudi Arabia 5.2%
 Other 55.5%
FDI stock Inward: $318.50 billion Page 10
Outward: $144.13 billion (2016)

Current account 0.7% of GDP (2016–17)

Gross external debt $471.9 billion (31 March 2017)

Net international -$404.8 billion (Sept. 2017)

investment position

Public finances

Public debt 67.7% of GDP (2017)

Revenues ₹35.41 trillion (US$540 billion) (2017)

Expenses ₹46.25 trillion (US$710 billion) (2017)

Economic aid $3.16 billion (2015)

Credit rating  Standard & Poor's:

BBB− (Domestic)
BBB− (Foreign)
BBB+ (T&C Assessment)
Outlook: Stable
 Moody's:
Outlook: Stable
 Fitch:
Outlook: Stable
Foreign reserves $421.914 billion ( 02 February 2018)(8th) Page 11
Indian economy in different sectors:

Indian economy is classified in three sectors —

 Agriculture and allied,

 Industry and
 Services.

Agriculture sector includes Agriculture (Agriculture & Livestock), Forestry &

Logging, Fishing and related activities.

Industry includes 'Mining & quarrying', Manufacturing (Registered & Unregistered),

Electricity, Gas, Water supply, and Construction.

Services sector includes 'Trade, hotels, transport, communication and services related
to broadcasting', 'Financial, real estate & prof servs', 'Public Administration, defence
and other services'. Services sector is the largest sector of India.

All the best by GKmojo Page 12