ea Chapter 3 | O€ Inflation, Unemployment fo and Poverty Inflation, unemployment and poverty belong to the group of the crucial endogenous rnaeroeconomic variables. While a gentle, positive rate of inflation may be desir- able, high as well as negative values of it pose serious economic problems {vide Chapter 1, Section 1.5). Unemployment costs are heavy, not only in terms of the Joss of income and output, but also in terms of human psychology. Poverty, both absolute (poor) as well as relative (income inequalities), are unwelcome as the former leads to deprivation from even the basic needs and the latter causes envy, jealousy and violence (thefts, loots, terror and wars). While these direct features are fairly well-known, these concepts are not quite clear. ‘Also, their measurements do not have international standards. The chapter therefore’ gocs into details in terms of each of these three concepts and their measurements, particularly with reference to India. 3.1 INFLATION inflation is discussed under three broad heads: meaning and measurervent, price indices in India and their measurement, and inflation rates across countries. 3.1.1 Meaning and Measurement of Inflation 1 1 Inflation means a continuous (not just once or on few periods) increase in the general (macro) price level. Thus, if the general price was, say 100 (we do not ; denote this as Rs, the reason would be clear a little later) in 1990 and 110 in 1991, there is inflation at the rate of 10 per cent in 1991. However, if the price remains at 110 in 1992, which is higher than in 1990, there is no inflation in 1992. Before going further into the formal definition/formula, let us ‘understand the meaning of this general price. Price, in a monetary economy, is the exchange value ofa unit of a commodity or service expressed in terms of money. Thus, if the price of a Maruti 800cc car is, say, Rs 2,50,000, means a person could buy one car of this model for the said amount. Similarly, if the tuition fee of a college for one yeat js Rs 20,000, a student could attend that college for a year for Rs 20,000. In some other cases, like electricity,Inflation. Unemployment and Poverty 51 telephone or hotel accommodation charges, this Price is often referred to as tariff. In still other cases, like payments for the purchase of irrigation water from govern- ment agencies, the price is referred to as cess; payment for services of | ‘professionals like consultants, doctors and advocates, is called fee; for the use of a house, price is called rent; and payment for transportation services, is called fare. However, in essence, all these terms are synonymous. The major difference in these terminolo- gies is that while fee is often independent of the amount of use, the others pertain to a fixed utilisation. For example, college fees allows any level of utilisation of the corresponding facilities of the college, car price means the exact cost of a unit of the particularly well-defined (including accessories, free servicing, guarantee, if any) car. Economists distinguish the exchange value from the use value, the latter refers to the utility or the satisfaction the consumer derives from the use of the commodity in question. The two values are very much different and Adam Smith cited the water-diamond paradox to explain the same. While water is highly useful, it has a small exchange rate. In contrast, diamond is of a little use but commands a very high exchange value. Further, while the exchange value is objective, the use value is highly subjective as it varies not only over time, as docs the exchange value, but also from the person to person, place to place and so on. Thus, while the car price of Rs 2,50,000 is the same for all buyers at a point of time, the utility of water to a thirsty person or a person in a desert is much more thau that for a not so thirsty one or for a person in a water rich place. ‘There are as many prices as there are goods and services. All these individual ' (micro) prices are combined into one, which is called the general (macro) price, price of a unit of all goods and services. General price is obtained as a weighted average of the individual goods’ (micro) prices: Ga) where P, = General price in period 1 P,,= Price of good i in period ¢ w, = Weight of good i : n = Number of goods and services in the economy : w,20 ; _ Zw, =1 : For example, if there werc ouly three goods in an economy, with their prices in ;, 2003 and weights as follows: c ee ee eee ce 7 Goods Price Weight Rice Rs 15hkg 060 Shict Rs 200/piece 0.30 House (room) Rs 1000/month 0.10 The general price in 2003 would be Pag = 0.6 (15) + 0.3 (200) + 0.1 (1000) =Rs 169 ‘ F ij52 Macroeconomics Incidentally, note that there is nothing in particular which you could buy for Rs 169. Thus, the general price is merely a concept, whose significance would be understood later. ‘The weights for the various component items are determined by the relative significance of that item in all the items during the base period Qu Fo We ee ; 220 Fg where Q,, and P,, are the quantity and price of the commodity i in the base period, -respectively. Weights in formula (3.2) are based on the relative monetary value, thich is the most popular weighing scheme, However, there are price weighted and the equally weighted indices as weil. General price is the price of ‘all goods’ but since there is no one unit of ‘all goods’, there is nothing that could be purchased at this price. Thus, general price per se has little significance. Its only significance lies in the computation of the inflation rate, which is betler approached through a price index. A price index expresses the current price in relation to its value in the base period. Thus, price index for period ¢ (P£,) is defined as 1 A PLB G3) Thus, if the price of shirt in the base year, say, 1995 was Rs 120 and in 2003, it was Rs 200, the price index for 2003 would be 200 Pleas = 5p, 7 1-87 (3.2) ‘An index compares the data without worrying about the unit of measurement. Price index at 1.67 indicates that between 1995 and 2003, the shirt price has increased by 67 pet cent. Index numbers are normally written with a base value = 100 and, if so, the above number must be multiplied by 100. Equation (3.3) is good for the price of an individual item. For general price, which is a weighted average of various prices, the price index is computed as follows: substituting for w, from equation (3.2), we get pre y| Lote |) Be. L2Qin Fo MN Pio solution of this yield PI, (L) = (3.4)Inflation, Unemployment and Poverty 53 Since the weighing pattem in equation (3.4) was suggested by Laspeyre, it is known as the Laspeyre’s Index. There is another index, called the Paasche’s Index, which is defined as below: ZO a LO Po : ‘A comparison of equations (3.4) and (3.5) would indicate that the only differ- ence between the Laspeyre’s and Paasche’s indices is that while the former takes the base year quantities the latter works with the current year quantities. Since quantities of various items do vary over time, the two methods of computation could very well yield different results. In practice, Laspeyre’s method is more popular, though as we shall see later that Paasche’s formula is used for computing the GDP deflator. To illustrate their calculations, consider the following three products economy: PI, (P) = Period Rice Shirt House (room) Price Quantity “Price ‘Quantity Price Quantity 1998 10 10,000 120 400 780 30 2006 15 12,000 200 500 1000 78 For this example, the price indice’ for 2006 would be eee ea 15x 10,000 + 200x 400 +1000%50 _ | jo, Laspeyre's price index = 719,000 +120x 400+ 780x50 she’s price index = 15 12,000 + 200 x 500 +1000 x 75 = 1.489 Peasche's price index = 9-79 ,000 +120 x 500+ 78075. The two indices give different rates of price increase in eight years, viz., 49.7 per cent and 48.9 per cent. In this example, the difference is small but it could be large if the price/quantity of some product increases while that of other products de- creases, or vice versa. The Laspeyre’s index measures the changes in the cost of a fixed basket of goods from a base period and thus assumes no substitution duc to the relative price changes, and thereby, it usually overestimates the true index. On the other hand, the Paasche’s index assigns weights by current consumption patiem and thereby tends to overstate the substitution and understate the price index rela- tive to an earlier base period. Needless to say, the consumption basket does change over time and this can be, well illustrated by recourse to the 1970s, during which period gas price rose significantly and hence consumers shifted to small cars, public transport, cut in travels, energy saving machines, and resorted to other means of conserving gas. Such a big change obviously would have serious repercussions on the magnitude of the two weighing systems under discussion. Currently, we do have superlative indices like the Fisher Ideal Index and Marshall-Edgeworth Index, which try to approximate some of the substitution effect that separates a ‘cost of living’ index from a ‘basket price’ index such as the Laspeyre and Paasche indices. The former is the geometric mean (square root of the product) of the Laspeyre and ‘54 Macroeconomics Paasche indices, and the latter uses the sum of the quantities of both the periods instead of the either. However, none of these two methods have yet become popular anywhere in the world, least of all, India. 4 ‘Now we aré ready to give a formal definition of inflation. It means the rate of change in the general price (P or P) per year, expressed in percentages. Thus, the (simple) inflation rate in period ¢ over the last one year is given by fi-fi- R= x 100 G6) if it is compounded once in a year only. However, if compounding is done on a continuous basis, the formula changes to 7 iam P= Inj ——~| x 100 7 Ra | 7 where, In stands for the natural logarithm. in case the gap between the two periods is more than one year, then the annual, continuous compounding annual and the semi-log (regression) trend rates of inflation become relevant and they are com- puted by formulas (3.8), (3.9) and (3.10), respectively: : py Be [4] -| x 100 (3.8) A BR B= 4hin—-| x 100 G9) " fon In P,= a+ BT, + 4, (67 by 2, A) 3.10) where T refers to the time period and n to the number of periods. Thus, 7, = | for period 1, 7, =2 for period 2, ....., 7, =m for period n. Equation (3.10) is a simple regression equation, which calls for the estimation of the parameters a and b using the data on P, and T,. The estimate of the parameter b measures the annual semi-log growth rate. ‘Thus, if the general price index rises from, say, 150 in 2005 to 160 in 2006, the 160 - simple’ inflation rate during 2005-06 would be 6.67 per cent (338 x00} and the continuous compounded inflation rate would be 6.45 per cent (1 160 x 100}. Similarly, the price increase of 48.9 per cent between 1998 and 2006 (as per the Paasche’s index above) implies the simple annual inflation rate of 5.10 per cent L fa 4898 — ihe 106 and continuous compounding inflation rate of 4.98 per cent [dn 1 a9) 100, For computing the semi-log trend inflation rate, one needs data for each year of the period, viz. 1998 to 2006. Thus, if the price indices during 1998 virough 2006 were 100, 105, 110, 120, 125, 120,130, 140 and 148.9, respec- tively, the semi-log growth function would beinflation, mpluyment and Poverty 55 In P = 4.56 + 0.0465 T G11) R? = 0.952 and the semi-log annual inflation rate would be 4.65 per cent. Equation (3.11) was obtained by running a simple regression function on the price index data against the time period 1, 2, 3, ..., 9. Incidentally, note that the continuous compound rate is always lower than the annual compounding rate of change. In practice, the annual compounding rate is often used. Between the compound rate and the semi-log rate, the latter is a better measure when the price data do not reflect a monotonous rising or falling trend. ‘When the price changes are uni-directional, the two rates would be approximately equal. 3.1.2 Price Indices in India and their Measurement ‘There are five price index series in India: GDP Deflator A © Wholesale price Index ¢ Consumer price index for industrial workers ¢ Consumer price index for urban non-manual employees © Consumer price index for agricultural labourers A discussion of each of these follows, GDP Deflator Gross domestic product (GDP) deflator refers to the index of the average price of the goods and services produced in the economy. It includes the prices of all (only) final goods produced in the economy and thus excludes those of intermediate goods and raw materials. The producers and buyers of these goods are immaterial. Thus, whether they are produced by foreigners or locals operating in the country, and bought by local consumers, firms, the government, or even foreigners, all are included. {t ignores the prices of imported goods, which enter our consumip- tion basket and list of inputs in production. It is computed as the ratio of the nominal (current price) GDP in a given year to the real (constant price) GDP of that year. Since the nominal GDP is the value of the current production valued at the current price and real GDP is the value of current production valued at the base year price, the GDP deflator is based on the Paasche’s method of computation (equation 3.5 above). To illustrate its computation, we could go back to the above example of the three-product economy. In that economy, the nominal and real GDP for 1998 and 2006, and hence the GDP deflator for the two years, would be as follows: , Year Nominal GDP Real GDP ODP deflator (base21998=1) 1998 10 x 10,000 + 120 x 400-10 x 10,000 + 120 x 400 i + 780 x 50 = 1,87,000 + 780 x 50 = 1,87,000 2006 = 15 x 12,000 200 x 500-10 x 12,000 + 120 x 500 1.489 + 1000 x 75 = 3,55,000 + 780 x 75 = 2,38,50056 Macroeconomics For India, the GDP data are available on an annual basis only and roughly on two years lag, and thus the GDP deflator data are also available on an apnual basis only and on two years lag. Since the time lag is long and the frequency ig just once ina year, this index is considered as a poor indicator for the true (current) inflation rate. Further, even from the policy point of view, it is the most up to date data, which alone can help formulate the appropriate policies to manage the same. Wholesale Price Index The wholesale price index (WPI) refers to the index of the average price of all commodities produced and/or transacted in the economy at the wholesale level. Thus, it includes the prices of raw materials and semi- finished goods, as well as of imported tangible goods, besides the prices of tangible goods included in the GDP, if they are transacted at the wholesale level in the country. However, it excludes the prices of all services, such as education, health, banking, transport and communication. ‘The WPI series is currently available for the base year of 1993-94. This new series is an improvement over its old versions of 1981-82, 1970-71, 1961-62, 1952-53 and August 1939 bases in terms of the appropriate weights and selection of products. In terms of the number of items and the number of price quotations, the 1981-82 series had the maximum coverage. The 1993-94 broad position in these respects is as given in Table 3.1. ‘The comparable data for the 1981-82 base for significant items are also included in the table within parentheses. Table 3.1 Measurement of WPI with Base 1993-94 Major Group ights Number -Natiaber of of items quotations 1. Primary articles 22.025 98 455 2.295) 93) (519) Food 15.402 34 340 (17.386) a) 620) Non-food 6.138 25 96 (10.081) (28) . (32) Minerals 0.485 19 19 (4.828) ey 67) 2. Fuel, power, light and fubricants 14.226 19 n f (10.663) (20) 73) 3. Manufactured products 63.749 318 1391 (57.042) (334) (1779) Food products 11,538 41 168 (10.143) (45) (231) Beverages, tabacco and tobacco products 1.339 n 49 Textiles 9.800 29 100 (41.545) en (120) Wood and wood products 0.173 2 9 Paper and paper products 2.044 u 67 Leather and leather products 1.019 1 9 Rubber and plastic products 2.388 15 55 Chemicals and chemical products 14.931 6 276 (7.355) (7?) (428)inflation, Unemployment and Poverty 57 (Contd) ‘Non-metallic mineral products 2.516 9 42 Basic metals, alloys and metat products 8.342 53 203 (7.632) ($7) (235) Machinery and machine tools 8.363, 56 312 (6.268) (44) (266) ‘Transport equipment and parts 4.295 2 101 Other miscellaneous manufacturing Industries 0.0 0 0 (0.972) “@ G0) 4. All commodities _ 390 435 1918 (100) (447) (371) Note: Numbers in parentheses indicate the corresponding position as in 1981-82 based index. Sources: Economic and Political Weekly, (September 18, 1993): 2015. Monthly Bulletins, Reserve Bank of India. __ The series since the 1981-82 are based mostly on the marketed surplus ratios for agricultural commodities in contrast to the use of the marketable surplus ratios for ‘these commodities by earlier series. This was the major reason for a drastic reduc- tion in the weight of the ‘primary articles’ group from 41.7 in 1970-71 to 32.295 in 1981-82, and to 22.025 in the 1993-94 series. A comparison of the weights as- signed to the various items over time would reveal that while the weight for the primary articles has declined that for both fuel and manufactured products have increased over time. Currently, the primary articles occupy about 22 per cent fuel, power, light and lubricants together account for 14 per cent and the remaining weight of 64 per cent is taken by manufactured products. Within the primary ar- ticles, the weights for all the three groups of products have declined over time. ‘Under the manufactured products group, while the weights for textiles has gone down, that for chemicals, basic metals and machinery groups have gone up with time. The said trends obviously reflect the changing significance of these items in the wholesale market. The weights are assigned on the basis of the relative value of wholesale transac- tions in various products in the economy. All major items are covered and price . quotations are taken from a cross-section of markets all over the country. The weighted arithmetic mean and Laspeyre’s formula are used for the computation. The series is prepared for the all-India Jevel only. However, it is available for afl commodities as well as for major groups, sub-groups and individual commodities, and is regularly published on a weekly basis by the office of the Economic Adviser, Ministry of Industries, Government of India. It is these characteristics that make WPI as an ideal measure of the inflation rate, particularly from the managerial point of view. As the data is available for different commodity groups, policy makers can casily pin down the source of inflation’ and then suggest the policy measures to deal with it. Since the WPI ignores the prices of the non-commodity produging sectors (viz. services), which have tended to outgrow the commodity producing sectors in recent years (vide Chapter 2 table 2.2) and which currently constitute close to 60 per cent of GDP, its use is questioned. However, the prices of services are influenced directly by the prices of inputs coming from the commodity sector, and vice versa. Further, there is no better measure for this purpose. Hence, variations in the WPI are considered as acceptable indicators of change in the :58 Macroeconomics general price in the Indian economy. Incidentally, note that WPI stands for the index of prices paid by producers for their inputs and thus it is akin to the Produc- ers? Price Index (PPI) of many countries, including the United States. Consumer Price Indices A consumer price index (CPI) refers to the index of the average relail price of the goods and services contained in the consumption basket of the relevant group of consumers. It thus excludes the prices of capital goods (plant and equipments), raw materials and intermediate goods, and includes the prices of services as well as of imported goods. The consumption basket de- pends on the {evel of income/wealth, rural-urban living, type of work/profession the family is engaged in, habits, customs and so on. Thus, it varies practically from the family to family. However, no country could have too many CPIs and thus signifi- cant differences in the consumption pattem alone are considered in preparing CP's. In India, we have three such indices: © CPI for industrial workers (CPI-IW) CPI for urban non-manual employces (CPI-UNME) CPI for agricultural labourers (CPI-AL) ‘The Labour Bureau of the Ministry of Labour compiles and publishes data on CPI-IW and CPI-AL, while that on the CPI-UNME is carried out by the Central Statistical Organisation. Unlike WPI, which is prepared only at the all India level, CPI-AL is first prepared at the state level, CPI-IW and CPI-UNME at the selected centres’ levels, and then they are aggregated to all India levels. The aggregation is carried out as the weighted arithmetic average of the respective indices, with weights taken as proportionate to aggregate estimated expenditure of the state/centre in the all India figure. Laspeyre's forraula is used for the computation. For deciding the weights for individual good/service, surveys of the relevant families are carried Gut in various centres spread out af] over the country. The CPI-IW is currently available at 2001 = 100 base. This series has succeeded: the one at 1982 = 100 base and is constructed on the basis of the weights deter- mined through a detailed consumer expenditure survey conducted by the National Sample Survey Organisation (NSSO) in 1999-2000 with the help ‘of Labour Bureau, Simla, The weighing diagram, at the all India level, is the weighted average of the weights of 78 centres. The weights of 1982 based index were ‘based on a compre- hensive family survey carried out in 1981-82 at 70 selected centres. The exact weights assigned to each group of items are provided in Table 3.2. Table 3.2 Weight Structure of Various CPls Product group CPLIW——-CPI-UNME ——_CPL-AL 2001 = 100 1960 = 100* 1961 = 100° T. Food aei9ATAS 78.12 2. Pan, supari, tobacco and intoxicants 221 159 0 3. Fuel and fight 6.43 AB 7.96 4. Housing 15.27 10.49 * 0 8. Clothes, bedding and footwear 658 9.66 6. 6. Miscellaneous 23.26 26.08 783 All 100 100 100 Note: *Weight structure for new basc year not known. : Source: Economic and Political Weckly, (September 18, 193): 2017, Economic Survey 2005-06,Inflation, Unemployment and Poverty 59 ‘The CPI-UNME was first constructed with the base 1960 = 100, using the consumption pattern findings from the middle class living family survey of 1958-59 in 45 selected centres. It included 180 items from various shops, both in the open market as well as ‘fair price’ and cooperative stores, in each centre. To account for changes in the consumption basket, a new survey was conducted in 1982-83, cover- ing the hitherto surveyed 45 centres plus an additional 14 selected urban centres. Currently, this index is published with the base 1984-85 = 100, using the weights from the 1982-83 survey. Since the government has not published the new weight structure, Table 3.2 contains 1960 based weights only. The CPI-AL series is currently published for the base 1986-87 = 100. The details on the requisite survey, coverage and weights for this base are not available. However, the weights of various items in its previously based index (1961 = 100) are available, and the same are included in Table 3.2 above. These weights were derived from the Second Agricultural Labour Enquiry conducted during August 1956 through August 1957, which covered 422 villages spread over 39 zones in 15 states or group of states, The number of items of consumption entering the index basket of a state varied from 27 to 38. 7 ‘The various CPIs indicate the cost of living index for the respective group of consumers. The time series data on various price indices are provided in Table 3.3. Table 3.3 Price Indices In India Year ; GDP Wholesale Consumer price index for + Deflator price index (average of months) - (average “Industrial Urban non- Agricultural of weeks) workers manual employees , - labour 1993-94 1993-94 2001 1984-85 1986-87 = 100 = 100 = 100 = 100 = 100 1950-51 68 17 4S fe io 1960-61 79 83 55 18.7 18 1970-71 143 14.6 8.1 32.2 33 1980-81 325 39.4 18.5 ne Fie matt 1990-91 3.3 738 417 161 - 146 1991-92 84.1 83.9 473 183 178 1992-93 2 92.3 51.8 202 179 1993-94 100.0 100.0 55.7 216 260 1995-96 119.3 194 67.6 259 237° 1998-99 149.2 142.3 89.5 337 293 2000-01 158.8 155.7 959 371 “304 2001-02 165.3 161.3 100.1 390+ 309 2002-03 169.7 166.8 104.1 405 319 2003-04 176.1 175.9 108.1 420 331 2004-05 185.1 187.2 112.2 436 342 2005-06 193.0 195.6 117.2 456 338 2006-07 202.1 206.1 121.0 486 395 Annual growth 6.274 6.064 6.112 7,347.6 6.847 rate (%)* Note: “Yearly compounded. Sources: National Accounts Statistics, (CSO) RBI Bulletins Monthly Abstract of Statistics, (CSO) Indian Labour Journal, Labour Bureau60 Macroeconomics The daia in the table above reveal a rather interesting phenomenon, viz., the annual inflation rate during the last 56 years comes to around 6.3 per cent in all indices. Thus, no matter which index is used, one gets approximately the same rate of inflation. However, this is generally true when the time horizon is long. For year to year fluctuations, various indices could very well produce significantly different rates of inflation. For example, the inflation rate in 2001-02 over 2000-01 comes to ahigh of 5.1 per cent by CPI-UNME and to a low of 1.3 per cent by CPI-AL. In India, the official inflation rate is announced on the basis of WPI, which gives the inflation rate at 3.6 for 2001-02. The said rate is lower than the one given by all other indices, barring the CPJ-AL. Thus, it really underestimates the rate. For com- puting deamess allowances, CPI-[W is used, and this gives the rate of inflation at 4.4 per cent for 2001-02. The latter, thus, provides a poor compensation against inflation for urban non-manual employees. A further analysis of the data in Table 3.3 would reveal that the long-term rate of inflation is the maximum under the CPI-UNME and the minimum under the WPI. This implies that the services in the consumption basket, and particularly for urban non-manua! employees, have become relatively more costly than the commodities traded in the wholesale market during the period of the analysis. Why do various indices yield different rates of inflation and which index is the most relevant for a particular purpose?: The answer to the first part of this question could be found in the following factors: (a) Prices of various items do not always change in the same direction and same proportion. For example, while the prices of most goods have gone up, those of computers and many other electronic Boos have, in fact, fallen during the last decade. (b) Prices of some items, like fruits and vegetgbles, are highly seasonal. {c) Retail prices are generally more volatile tian wholesale prices. (@) Prices of commodities usually fluctuate more than thosc of services. Since the different indices cover different sets of items, usc different weighing diagrams, and prices at different sales’ levels (wholesale versus retail), because of the four above factors, these indices yield different rates of inflation. Obviously, each of the five indices is useful and the choice among them is dictated by the purpose. Due to its high frequency (weekly), short time-lag (two weeks) and com- modity/group-wise availability (which facilitates continuous monitoring for policy decisions), the WPI is used to measure the official rate of inflation in the country. Since industrial workers are the most organised group of people, CPI-IW is used for the purpose of measuring the cost of living, and thus, determining the deamness allowances, though each of the three CPIs is a measure of the cost of living for the specific group of consumers. The CPI-UNME has a limited use. It is used basically for determining deamess allowances of employees of some forcign companies work- ing in India. Also, it is used under the Income Tax Act to determine capital gains and by the CSO (or deflating selected service sectors’ GIP at current prices to get the corresponding GDP at constant prices. The CPI-AL is basically used for revis- ing minimum wages for agricultural labour in different states. Since the GDP defla- tor alone includes the prices of all conumodities and services produced in the economy, and its weighing pattern reflects the implicit sector-wisc shares of the nominal andInflation, Unemployment and Poverly’ 64 real value added, it is the most general/ideal measure of the overall price situa- tion in the economy. Fe Incidentally, note that neither any of the three CPis is a perfect measure of the cost of living, nor is the WPI a true measure of the inflation rate, as they use the weights of the corresponding base year,-which change every year, and there have always been new products and quality improvements in the existing products in any economy. Furthermore, these indices are based on the Laspeyre’s measure, which does not allow any substitution between goods, and resultant overstating of the inflation rate. They assume that the goods are homogeneous. The Boskin Com- mission has estimated that the effect of such factors on the measurement of inflation rate in the United States in 1996 was at plus 1.1 per cent, that is, true inflation was 1.1 per cent less than what was reported, 3.1.3 Inflation Rates in Select Countries The data on inflation for select countries are provided in Table 3.4. There are three measures of inflation for each country, viz., based on the GDP deflator, CPI and Food Price Index. Table 3.4 Inflation Rate in Select Countries Ce ee eee eee eee cerca Country Inflation (annual average) rate based on GDP deflator Consumer price index Wholesale price index 7990 2000 ~ 1990, 2000 ° — 1990 2000 -2000 06 = -2000 04» «2000 04 india 66 39 73 39 63 a7 USA 19 21 26 23 14 23 UK 27 28 2.7 +23 17 09 Japan -05 -15 03 05 -10 “U4 Singapore 06 05 13 06 00 08 Indonesia 16.1 19 135 9.1 152 59 Brazil 102.7 106 983 96 1054 183 Republic of Korea 4.5 29 44 34 29 17 China 55 27 55 10 NA NA Pakistan 10.2 5. 17 40 84 54 Sri Lanka 89 85 95 91 16 89 Australia 20 3 24 31 13 16 Nigeria 23.2 153 24.5 149 NA NA Russian Federation 94.7 158 594 153379 13.3 Source: World Development Indicators, World Bank, 2006. A careful penusal of the above data would indicate that: (a) The long term inflation rate is about the same no matter which of the three price indices is used to measure it, barring Russian Fed for which WPI gives a relatively lower rate. (b) The inflation rate was, in general, lower in 2000-04 than in 1990s. This suggests a downward trend in the said rate.§2 Macroeconomics (©) Japan has witnessed the lowest inflation rate (in fact the country has experi- enced deflation) during the lest one and a half decade among all the countries included here. Singapore comes next in this respect. The United States, UK and Australia take the next position on this criterion. The highest inflation rate countries would include the Russian Federation and Brazil. The nly other countries in the table which experienced two-digit inflation rate sometime during the period are Indoncsia and Pakistan. India’s inflation rate has moved within a narrow range of 3.9 per cent fo 7.5 pr cent but the rate has been larger than in China. Before ending this section it would be instructive to mention that world over the inflation rate was rather high during the 1970s and it is uader control for the past few years. Though this is not the place to analyse its causes in detail, a few observa- tions are in order. The formation of the Organisation of Petroleum Exporting Coun- tries (OPEC) was the single most important factor for the former and the partial movement of production from the high cost countries to low cost ones was perhaps an important factor for the latter. A better understanding, and use of the fiscal and monetary polices, as discussed later, could be the other factor for controlling inflation. ‘1 3.2 UNEMPLOYMENT Unemployment is discussed under four heads: meaning, kinds, full employment and micasurement. 3.2.1 Meaning of Unemployment Unemployment is perhaps the most worrisome macroeconomic problem in any” country. The opposite of this viz. employment, is a must for a person to have some source of income for livelihood, and it is this which proves the manhood of a man and the identity of a woman. While temporary unemployment may not be that bad (in fact, sometimes it may even be good, atleast psychologically), chronic unem- ployment is a luxury, which even a millionaire can ill afford. Furthermore, willfal (voluntary) unemployment may be okay but forced (involuntary) unemployment is doubly bad leading to loss of income/output and feeling of desperation. Neverthe- less, unemployment is a fact of life in the present world and this is considered as the worst example of both, market and government failures. Not only there exists a pocket of unemployed people in almost every country today, but there is also a great degree of unemployment of capital resources (structures and equipments) as well. We do sec a host of residential, factory and office buildings, a large number of tools, equipment and machines, as well as inventories of raw materials, semi-fio- ished and finished goods lying idic. Obviously, a reduction in such unemployment would go a long way in improving the well being of the world. While all unemploy- ment is bad, unemployment of manpower is the worst of all. Accordingly, unem- ployment is often equated to that of human beings only, and this is the major concem of macroeconomics.ee ee ee ee ee ee eee ee ere ere ee ee tet eee eet Inflation, Unemptoyment and Poverty 63 Unemployment could be defined both in physical (U,) as well as in economic (Ug= U) terms. In the former, : Up = Population — Binployed people (3.12) and in the latter, U = Work force - Employed people 3.13) where Workforce = Population ~ People not in workforce People not in the workforce include children in the pre-school age group, full- time students in schools/colleges/universities, chronically sick people and retired persons. Accordingly, there is a concept called the work (labour) participation rate, which equals the workforce as a proportion of the population. It is alternatively defined as the workforce as @ proportion of adult population. Given these, the unemployment rate is defined as U Workforce ie Thus, the unemployment rate is given by the proportion of the unemployed persons in the total work force. Conceptually, a person is employed if he is working for a paid job, unemployed if not employed and is looking for a job and not in workforce if not employed and not looking for a job. A worthwhile point to note here is that if more people decide to go for higher education, ceteris paribus, both the workforce as well as the number of people employed falls by that number (assuming all new college students had jobs before), and since the unemployment rate is always positive, the unemployment rate goes up. This is true but the problem is temporary and it would be reversed (with better pay packets) soon those students graduate. There is one more method for a better measurement of unemployment rate. Since people employed in defence corps and such other services are always 100 per cent employed, to compute a more meaningful definition, such people are netted out from the work force and employed people for the purpose of computing the true unemployment rate, While equation (3.14) is good enough to define the (general) unemployment rate, there is a unique unemployment rate, called the Nate- ral Rate of Unemployment (U,), which is also known as the Non-Accelerating Inflation Rate of Unemployment (NAIRU). This is a very relevant concept from the point of view of stabilisation policies and accordingly it is elaborated later in the text, Suffice to point out that NAIRU is that rate of unemployment that alone is consistent with a stable (constant) rate of inflation. If inflation in 1991 was at 5 per cent and it remains at 5 per cent in all years, say until 1995, then the inflation rate was stable between 1991 and 1995. However, if the inflation rate of 5 per cent in 1991 goes up to 6 per cent in 1992 and to 7 per cent in 1993, then we have the accelerating inflation rate and so on. 3.2.2 Kinds of Unemployment Unemployment is distinguished as © Voluntary and involuntary © Open and hidden Voluntary unemployment meagg willful unemployment while the involuntary unemployment means forced unemployment. To be more precise, a person who is64 Macroeconomics willing and able to work, and is looking for a job but does uct find one, is involun- tary uncinployed. The other unemployed people are voluntarily unemployed. The former might arise due to the laziness, obsession with wealth and/or with Icisure. Since this is voluntary, it poses no serious economic problem. Involuntary unem- ployment is caused by the paucity of employment opportunities and hence it is an economic issue. ‘The distinction between these two kinds of unemployment is not that water tight as it is hard to define the term voluntary. Some people want jobs only of 2 particular kind, on particular terms and at a particular place, and unless this is forthcoming they may pretend to be involuntarily unemployed. Others may sincerely be seeking jobs, but if not found for long, may pretend to be voluntarily unemployed to save themselves from embarrassment. Also, there is genuine diffi- cully,in terms of distinguishing the two. For example, consider an MBA from a fairly prestigious institution and assume that he/she receives just one offer, which carries a salary of say, Rs 8000 per month and the job is in a costly city. If this person declines the offer, is he/she involuntarily or voluntarily unemployed? The answer is clearly ambiguous. For this reason, some economists have argued that the distinction, which is due to John Maynard Keynes, is improper. Nevertheless, this is a very convenient and important classification and it would be respected through out this book. ‘Open unemployment is @ frictional © cyclical e structural While hidden unemployment can be © disguised ® seasonal @ underemployment The frictional or turnover unemployment arises in between two jobs, the first Job which a person has quit in order to find the second (better) job. Such unemploy- ment is quite prevalent in developed countries where jobs are very demanding and are available in plenty for capable persons. People take off from their current jobs to be available full time to find move suitable jobs and thus remain unemployed during the course of such searches. It is obvious that his kind of unemployment is indeed healthy and it creates no serious economic problems. However, during reces- sions, like the one that started in 2001 and is still continuing, some workers are retrenched from their job and, consequently join the group of frictionally unem- ployed persons. Also, in developing countries, many students do not find job soon after their graduation and thus they are frictionally unemployed during the period between graduation and joining the job. Such unemployment, though temporary, is universally bad. Cyclical unemployment is caused by business cycles and economic fluctua- tions. During droughts and floods, farmers may be left unemployed, and during strikes or lockouts, industrialists and workers may remain unemployed. When the economy slows down due lo any such events, calamities or general recession, people lose their purchasing power, which reduces sales, and thereby production and em- ployment, Quite the opposite happens during prosperity or upswings in business.Tee ee eee ee eee ee, Inflation, Unemployment and Poverty 65 Structural unemployment is caused by the mismatch of vacancies and skills of unemployed people. With the booming of information technology and sophistica- tion in production of goods and services, and the changing structure of economies away from the primary sector and towards the secondary and tertiary sectors, tradi- tional jobs are disappearing and jobs requiring ‘new’ training are emerging. This leads to structural unemployment until traditional workers are retrained and reem- ployed. Mismatch of locations of the unemployed and vacancies also cause the structural unemployment, The latter'is compounded by poor infrastructure in rural and less deve'oyed areas. Disguised vnemployment could arise when several people share a particular work at a given time and/or when such work is spread over time. For example, consider a 10-member farmer family which owns just one acre of land and none of its members has an outside job. All family members may share the work of farming that one acre of land, and thus technically all are employed. However, if one or two or even more members do not work on their farm, the production will remain the same. This means the marginal product of these withdrawn workers is zero, and hence their unemployment is hidden; this is called disguised unemployment. Vari- ous family members may work together but lightly all the time or they may take tums and work sincerely. In either case, such a case unemployment is disguised. For example, in the retail business in India, many fathers look after their respective businesses during early morning hours, late evenings and holidays, and the sons run the business during the peak hours, . Some occupations are seasonal. For example, farmers are occupied a lot during the Kharif (June-October) and Rabi (December-March) seasons and have a little work during the off (other) times. Unless, these farmers diversify and take up some other activities during the off seasons, they would be seasonally unemployed. Such off seasons arise even for industries based on inputs coming from agriculture, e.g., sugar, textiles, tea, coffee, food processing etc. Underemployment is the situation where the work available is for lesser than the full employment hours’ or for periods lesser than the full working days in a given period (year/month/week). Part-time workers in industries and services, and the full time workers in agriculture suffer from this malady. Such unemployment is rampant in developing countries and among females and other racially discrimi- nated people. : 3.2.3 Full Employment Full employment is an ambiguous concept and accordingly it has no unique defini- tion. Literally, it means zero unemployment. But economists regard voluntary un- employment as no unemployment, and frictional and structural unemployment as ‘not bad’. Thus, when the unemployment rate is close to, say 3-4 per cent, econo- mists’ call it a ‘full employment’ situation. Voluntary unemployment is hard to quantify, and the frictional and structural unemployment together is estimated to be around 3-4 per cent, particularly in developed countries. Since both the demand for and supply of labour are sensitive to the wage rate, full employment is also defined as the situati.n where the demand for labour-equals the supply of labour in the66 Macroeconomics economy at a given wage rate. This definition suffers from the problem of the immobility of labour as well as the non-uaiform wage rates across occupations and places. The excess demand for labour in one occupation accompanied by the equiva- lent excess supply for labour in another occupation does not mean full employment in the economy. Similarly, the excess demand in one market or geographical place and the equivalent excess supply in another market or place may not mean full employment. Yet another definition, that defines full employment as a situation where the number of people unemployed equals the number of vacancies, is unten- able. This is so because of the mismatch of skills needed and skills available, and such a situation exists in the present world. This is structural unemployment, and its correction calls for retraining and deployment. 3.2.4 Measurement of Unemployment Measurement of unemployment is difficult and accordingly the unemployment data across nations and even time are not quite comparable. To appreciate their signifi- cance, we must discuss the various criteria suggested for the measurement of unem- ployment. These are lingness. © productivity : The willingness to work criterion will nile out a voluntarily unemployed person as an unemployed person. There are rules and regulations, which may vary over time and space, which define a certain number of hours per day/week as full em- ployment. If a person works for hours less than this rule, he/she is partly unem- ployed. Vor example, if 40 hours a week is the norm and a particular person works for 30 hours @ week, he is one-fourth unemployed. The income criterion could stipulate a certain minimum income per period and unless the income is no less than that stipulated figure, the person concemed is partly unemployed. Similarly, the productivity criterion would stipulate a certain minimum level of productivity (out- put per worker per period), and unless this is so, the employment would be less than full employment. Income is difficult to measure by time in case of the self-employment and pro- ductivity is, ambiguous in a highly specialised method of production, Thus, the unemployment data have ignored these two criteria and they rely merely on the willingness and time criteria. Though the measurement of any variable must be uniform in all countries, unemployment data remains an exception. In India, the National Sample Survey Organisation (NSSO) is the agency responsible for the colleotion and publication of the data on workforce, employment and unemploy- ment. The NSSO bas been conducting the periodical rounds of socio-economic survey since 1950-51. The first survey on employment and unemployment was conducted in the 27 Round (September 1972-October 1973) and the second quin- quennial survey was carried out in the 32™ Round (July 1977-June 1978). More Surveys have been carried out since then. In these surveys, the respondents are asked to indicate their employment status, viz. employed, unemployed and lookingInflation, Unemployment and Poverty 67 for or availablity for job, or neither of these two categories (i.e., out of labour force). The respondents have to choose one of these three categories, and so it does create problems for those who belong to more than onc status. To overcome this problem, two norms are followed: © Priority Rule © Three Reference Periods Under the priority rule, in case of more than one status, ‘employed’ will have Priority over ‘unemployed’, and the latter over out of work force. Thus, only one Status gets reported in this regard. Further, the status is asked for cach of the three teference periods, viz. ‘usually’ (a long past period), ‘current weekly* and ‘current daily’ (in fact, half days). While it is difficult to identify a unique status over the long period (year) and even over the week, it is easier to do so for half days. Usually the major status during the year alone is recorded. For weekly siatus, if a person is gainfully occupied for at least an hour on any day during the week preceding the date of the survey the period is considered ‘employed’, Under the daily status, if the interviewee works for four hours or more, he is considezed fully employed and if he works for one to three hours, he is deemed half-employed. Due to the above measurement procedure, and the relatively high proportion of under-employment and disguised wfémployment in India, the reported Indian nem.” ployment rate is quite low. According to the various NSSO employment-untmploy- ment survey rounds, the unemployment rates in India under different statuses for rural and urban categories, and separately for male and female are as shown below in Table 3.5. Table 3.5 Unemployment Rates in int (Percentages) ee Percontagesy Status Rural Urban Mate Female Maie Female Usual July-June (993-94 2.0 L4 45 83 July-June 1999-00 2.1 15 48 7A * JulyJune 2001-02 1.4 20 42 49 Jan-June 2004 24 22 46 89 Current Weekly JulyJune 1993-94 3.0 3.0 52 84 JulyJune 1999-00 3.9 37 5.6 13 July-June 2001-02 2.6 26 46 48 Jan-Juve 2004 47 4s 57 9.0 Current Daily July-June 1993-94 5.6 56 67 105 July-June 1999-00 7.2 7.0 13 94 July-June 2001-02 — _ a a Jan—June 2004 90 8 Ml Source: Economic and Political Week! ecember 31, 2005, 5523. The usual status projects our best labour market face and the daily status the worst face. This is so because, as per our definition, the former are subject to more serious underestimation than the latter. Obviously, the daily status data are more&8& Macroeconomics reliable than the other two. This puts the current unemployment rate in India be- tween 8.1 and 11.7 per cent. The cross-country data on unemployment were pre- sented in Chapter 1, Table 1.1 and the readers may refer to them for a comparative look. A careful perusal of them would reveal a puzzle: the unemployment rate (four year average) is higher in developed countries (USA, UK, Japan, etc.) than in some developing countries (India, China, etc), even though the per capita GDP and mis- ery are less in the former than the latter. Why? The answer is easy to find. One could cite several reasons for the puzzle. First, developing countries ha¥e a larger proportion of their population engaged in agriculture than developed countries, and agriculture is more subject to seasonal, disguised and underemployment (which is hidden ard thus not included in unemployment) than manufacturing or services. In this respect. it may be noted that the World Development Report (2002) of, UNDP states “the concept of unemployment is not always meaningful in developing coun- tries”, Second, rich countries have strict minimum wage regulations, which induces less qualified and lazy persons to not to take up employment, and the firms to hire less worke7s as the minimum required marginal physical productivity is accordingly high. Third, social security benefits, including unetnployment compensation exists only in the developed world and this makes unemployment a somewhat affordable luxury. Since European countries have a better social security system than the West, the uncmployment rate is usually higher in the former than the latter. On these grounds one can conclude that the unemployment rate in India is not as low as indicated by the above data. Further, the low rate may be because the poor countries like India have little social security and thus can not afford unemployment. The above data in comparison to data for earlier years suggest that the unem- ployment rate in India has only increased over the last decade. To conclude this section, The following points may be noted about the Indian labour market: Low open but high hidden unemployment Poor mobility across places and occupations Mismatch of skills between ‘vacancies’ and “unemployed persons* Presence of domestic servants. bonded and child labour Low wages, no strict minimum wage regulations and hardly any social secu- rity system eose India may not be the only country having such unwarranted facts and surely ail these features are on decline over time. 3.3. POVERTY Poverty is the other economic problem facing most nations in the world. There is no unique definition of poverty and accordingly international data give alternative figures for the proportion of the people below the poverty line. These are based on the national definition, as well as the international standards of US $1/day/per person and US $2/day/person. Lately, poverty definition is changed to US $4/day/ person, Incidentally, note that the dollar figures are at the official exchange rate and not at the PPP exchange rate. It is estimated that roughly one-fifth (1.3 billion) ofinflation, Unemployment and Poverty 69 the world population lives on US $1 per day and one-half (3 billion) on US $2 per day. Jn general, the wealthier a country is, the lower the incidence of poverty. Education and health indicators are also better on an average for richer countries. In terms of its control, growth has served a powerful force, particularly during the 1980s and 1990s. The world’s poorest live in Africa and the progress in its reduc- tion is also the slowest there. India and China also have larger proportions of poor people but poverty is falling fairly rapidly in these countries. Estimates suggest that in 1970, 11 per cent of the world’s poor were in Africa and 76 per cent in Asia. In 1998, Africa had 66 per cent of them and Asia 15 per cent. In India, the subject of defining poverty was first posed at the Indian Labour Conference in 1957. The ‘working’ group of the planning commission recomunended Rs 25 per person per month for urban and Rs 18 per person per month for rural areas at 1960-61 prices as the minimum expenditure for providing the minimum nutritional diet of calories (2100 for urban and 2400 for rural per person per day) intake as well as to allow for a modest expenditure on items other than food (barring health and education, which were expacted to be provided by the govern- ment). This became the cut off amount and accordingly people having expenditure below this were bracketed as being ‘below the poverty line’. These figures have since been revised from time to time. While there are othcr estimates as well, those of the Planning Commission are as follows: (Rs/month/person) At price level of Poverty line : Urban Rural 1973-74 37 49 1976-77 ; 1 02 1977-78 5 65 1987-88 152 132 1993-94 264 29 1999-2000 454 327 2005-06 559 368 Source: Government of India: conomic Survey, Various Issues. Thus, the urban people whose expenditure falls below Rs 559 per person per month belong to the group of the people below the poverty line. Others whose experiditure exceeded this amount are above the said line. The NSSO data is used to classify people on this criterion and accordingly data is compiled and published on this variable. Accordingly to the Economic Survey, published by the Ministry of Finance, 26.1 per cent of Iridians were below the poverty line in 1999-2000; the numbers being 27.1 and 23.6 per cent, respectively, for rural and urban India. The ; said numbers stood at 36.0, 37.3 and 32.4 in 1993-94, respectively. It is instructive to note that the statistics of poverty in India are full of controversy among econo- mists, bureaucrats, politicians and social activists. However, most professionals subscribe to the view that the economic reforms of the 1990s have led to a radical improvement in the well being of the bottom half of the population. The United States government created the poverty line in 1960s. It is defined as the amount of income necessary to buy basic necessities, After adjusting for inflation, the 2002 poverty line is estimated at $8350 for a single adult and at70 Macroeconomics $17,050 for a family of two adults and two children. On this basis, roughly 1! per cent of Americans are poor. The Census Bureau is responsible for designing/revis- ing the poverty line. The time series data indicate that the poverty line rose steadily throughout the 1980s and then drifted down in the 1990s. The poverty definitions of ‘other countries and their data can similarly be analysed. The above measure of poverty is known as the Head-Count Ratio. This mea- sure ignores the size of the poverty gap as well as the relativ inequality among the poor. To incorporate these factors, new measures bave been designed, which in- clude the Poverty Gap, Squared Poverty Gap and the Sen Index. The Poverty Gap is defined as the mean sbortfall from the poverty line (counting the non-poor as having zero shortfall), expressed as a per cent of the poverty line. Thus, the said medsure reflects both the depth of poverty, and its incidence. While the Squared "Poverty Gap incorporates a squared coefficient of variation of the relative inequal- ity, the Sen index uses the Gini coefficient.among the poor population. The terms ; income inequality and the Gini coefficient are defined in the following section and for a detailed understanding of the new measures readers may refer to Sen (1976). Corresponding to the head count ratio, there is an interesting concept called the Head Count Elasticity. The said elasticity denotes the responsiveness of the head count poverty measure to the growth rate in the economy. It is expected to be negative, and its estimate for India is -1.3 and for the developing countries ~2.! 3.4 INCOME INEQUALITY In income inequality, one talks about the distribution of income among the inhabit- ants of the country. In a capitalist country, income is distributed not by needs but by contributions (efforts) to the production. Since different sections of society have varying abilities and desires to contribute, income differs across people. While income inequality may be a desirable feature of a modem capitalist society, particu- larly to encourage the acquisition of skills and to motivate the hard and smart work, too much of it is considered bad on the grounds of social justice. Reduction in it is obtained through programmes/facilities meant for the weaker sections of the society only and by progressive taxation. As mentioned in Chapter 1, this is an important activity of ahy government, : Income inequality is measured through the percentile distribution of national ~ income vis-é-vis population, which is!further reduced to one number, called the Gini coefficient. The data on these variables for a few countries are given below: Table 3.5 Income Inequality in Selected Countries (% share in income) eC eee ee cere eer cee eeeeee eee eee cree Country Survey Poputation Gini year Poorest. Second Third Fourth Richest coefficient i 20% 20% += 20% 20% «20% India 1999-2000 89 123. WO 22 433 0.325 USA 2000 $4107 157 2A 5B 0.408 (Contd) ‘vide Revalian and Dalt: World Sank Economic Review (January 1996): 1-25.Inflation, Unemployment and Poverty 74 (Contd) : UK 1999 6.1 4 160225440 0.360 Canada 2000 72° «127 «17.2238. 39.9 0.326 Russian Fed 2002 61 10.5 149-218 46.6 0,399 China 2001 47 90 142 224 30.0 0.447 Pakistan 2002 93 13.0 16.3002 403 0.306 Nigeria 2003 5.0 96 145 2749.2 0.437 Australia 1994 59 1200 17.2 23.6413 0.352 Brazil 2003 26 62107 184 62. 0.580 Source: World Development Indicators/Report, World Bank, 2006. ‘The data reveal that in India, the poorest 20 per cent of the population receives just 8.9 per cent of the India’s income, while the richest 20 per cent receives 43.3 per cent of the country’s income, and so on, This data could be plotted on the Edgeworth’s box diagram as follows: % of income % of population Fig. 3.1 Edgeworth’s Box Diagram for India ‘The curve OWXYZB is drawn on the basis of the cumulative share of population in national income. Thus, the poorest 20 per cent of the population receives 8.9 per cent of the national income and gives us point #’. The poorest 40 per cent of population receives 21.2 (8.9 + 12.3) per cent of income and gives point X, the poorest 60 per cent receives 37.2 (21.2 + 16.0) per cent of the income and gives * point ¥, the poorest 80 per cent receives 58.4 (37.2 + 21.2) per cent of income and gives point Z, and 100 per cent of the population receives 100 per cent of income and coincides with point B. Incidentally note that in case of India, the sum of the shares does not add exactly to 100 per cent and this could be due to some error. The straight line OB denotes the perfect equality (egalitarian) line, which is obviously the 45 degree angle on the graph. The farther the true line is from the egalitarian line, the more the income inequality. If all the income were pocketed by one person only, the income distribution curve will coincide with OCB, and the inequality will be the maximum.12 Macroeconomics Data in Table 3.5 measures income inequality but they are hard to’compress so as to be able to judge the extent of inequality in one country as, against another. For this purpose, the Gini coefficient (G) has been invented, which reduces this percen- tile distribution into one number. It is measured as __ Area of graph under OWXYZB (shaded part) Area of AOCB = 0.325 (or 32.5 per cent) for India It is not easy to compute the areas of the two regions in the numerator and denominator of the above formula. Explanation of this is beyond the scope of this book and interested readers may refer to Gupta and Singh (1984) for this purpose. ‘The denominator is fixed and thus the larger the area under the numerator graph, the larger the inequality. Thus, G lies between 0 and 100 per cent; the former denotes perfect equality and the latter, perfect inequality. Of the 10 countries for which the data are provided in Table 3.5, India has the second lowest (0.325) and Brazil (0.58) the most income. inequality. The Gini coefficient takes the lowest value of 0.19 for Azerbaijan and the highest value of 0.743 for Namibia, These extreme values are rare and thus Brazil is considered as having a rather high in- equality and India as moderate inequality. Here mentioned must be made of the Pareto Principle, which is also known as the 80-20 Rule, which states that a large percentage of the activity in a market is always accounted for by a small percentage of the operators. Thus, a large part of the national income is earned by a small part of the population, which is nothing but income inequality. Of course, as the data in the above table would reveal, the large part is less than 80 per cent (the highest is 62.1 4 per cent for Brazil) but the principle holds. As mentioned above, efforts have been made to go into the detail on the extent of the poverty among the poor and to design a comprehensive measure of poverty and inequality (vide Scn 1976). However, such details are outside the scope of a macro- economics text book such as this one. DEFERENS G 1, £PW Research Foundation, ‘Wholesale and Consumer Prices’, Economic and Political Weekly, (September 18, 1993): 2015-32. 2. Monthly Abstract of Statistics, “A Note on Revised Scrics of Consumer Price Index Numbers for Urban Non-Manual Employees on base 1984-85 =100”. (April, 1989): 15-21. 3. Reserve Bank Of India ‘New Series of Consumer Price Index Numbers for Industrial Workers (Base: 1982 =100)’, RBY Bulletin (May, 1989): 435-37. 4. Diewert W E, ‘Index Number Issucs in the Consumer Price Index’, Journal of Economic Perspectives XU, No. 1(Winter, 1998): 47--58. 5. Gupta G S, R D Singh ‘Income Inequality Across Nations Over time: How Much and Why’, Southern Economic Journal LI, No. | (July, 1984): 250-7. 6. Sen A K ‘Poverty: An Ordinary Approach to Measurement’, Econometrica 44, No. 2, (1976): 219-31Inflation, Unemployment and Poverty 73 AEVICW QUESTIONS 1. Which price index (indices) in India contains the prices of the following goods? « Commodities © Services © Intermediate goods © Imports © New products 2. Suppose the Freedesh economy produces only three goods and its production and price data for the two years are as follows: Year Good A Good B Good C Prod. Price Prod. Price Prod. Price 2000 100 10 so 100 200 30 2006 120 15 70 80 250 40 (a) Looking at the price data alone, compute the yearly compounded annualised rate of inflation, (b) Compute the GDP deflator and the corresponding yearly compounded annualised rate of inflation. (c) Compute the Laspeyre’s Price Index and the corresponding yearly annualised fate of inflation. . Aa) Connpene the dove thnce inflation sates ad. comment. BL Raaatse She Naous WES MANES AUTRE NES GTN, ‘© Inclusiowexclusion of goods and services © Weight structures © Method of averaging © Use in real life 4. Suppose your company has offices in Ahmedabad, Delhi and Mumbai, and you have the option of working in any one of these three cities on the same emoluments. If your decision was based purely on economic consideration, which location you would choose and why answer. 5. Suppose the Greenpur economy shows the fo lation, workforce and employment: Population = 150 million Woricforee nari: a ? Discuss the limitations of your lowing statistics about its popu-