Engineering Economics and Finance

Unit 5
Economic Growth and Development
Visible Indicators of Economic Change
Households able to afford better material comforts

Better infrastructure is available for all

Incomes derived from industry than agriculture

Definition: Economic Growth
• An increase in the amount of goods and services produced per head of
the population over a period of time

• Measurable indicator: Gross Domestic Product (GDP)

Gross Domestic Product (GDP)
• Def: Market value of all final goods and services produced within a
country in a given period of time
• Market price used to add up different goods and services
• All goods and services included, other than a) products sold illegally and b)
unpaid g&s produced and consumed at home
• ‘Intermediate goods’ is not added
• Both tangible goods and intangible services are included
• Transactions regarding items produced in past not included, ex: resale
• Items included if produced domestically
• Measure of production within a specific interval of time
MEASURES OF GDP
GDP: Simple Economic Setup
Assumptions:
a) No savings/Investment b) No export or import c) No expenditure by government d) Production of only
consumption products

• Product market: Computers, food, courier services

etc.

• Factor market: Land, Labour, Entrepreneurship etc.

• Consumption exp: $ spend on goods and services

• Income Payments: Wages, rents, profits etc.

Circular Flow of Income

Alternative Approaches for Measuring GDP
Flow-of-Product Approach Earnings or Income Approach
GDP is value of final goods and services bought GDP is total earnings of households or cost of
by consumers producing the final goods

GDP = (Number of Computers * Price) + GDP = (Number of Labourers * Wages) + (Acres

(Number of Cakes * Price) + ….. of Land * Rent per acre) + …..

Example: In a barbershop economy, only labour is required for cutting hair. One barber does 10 haircuts in a
day, and charges Rs. 50 for each haircut
GDP (Flow-of-Product Approach): Haircuts x Price of one haircut = 10 x 50 = Rs. 500
GDP (Earnings Approach): Wages and Profits of barber = Rs. 500

In a simple economic setup, GDP measured through both approaches will be exactly the same
Adding Other Components of GDP
• Consumption
• Investment
• Addition to nation’s capital stocks
• Buildings, equipment, software and industries
• Government purchases
• Output purchased by central, state and local governments
• Excludes ‘transfer payments’
• Net exports
• Difference between exports and imports
GDP: Expenditure Method

GDP = C + I+ G + NX
Where:
C: Consumption: spending by HH on goods and services
I: Gross Investment: purchase of ‘capital goods’ and inventories
G: Government purchases: spending on G&S by local, state or national government,
excluding transfer payments
NX: Net Exports: exports minus imports
GDP: Income Method

GDP = W + R + I + P + IT+ DD + Tc + D + Up - Tp
Where:
W: Wages (Payment made to labour)
R: Rent (Payment made for land)
I: Interest (Payment made for investments)
P: Profits (Payment for entrepreneurial risk taking)
IT: Indirect taxes (Taxes levied on goods and services)
DD: Dividends (Payment made to shareholders by companies out of profits)
Tc: Corporate taxes (Levy on profit of a firm)
D: Depreciation (Monetary value of asset that decreases overtime due to use)
Up: Undistributed corporate profits (Corporate profits not paid as taxes or dividends)
Tp: Transfer payments (Income received not in exchange for goods and services, like subsidy)
Nominal Vs Real GDP
• Nominal GDP: (Units of A) x (Price of A)

• Problem: Includes growth in both prices and volume

Nominal Vs Real GDP: Example
Impact of nominal GDP:
• Assume that in 1990, price of a shirt was Rs. 100 and production was 100 shirts. In 2000,
production is still 100 shirts but price of shirt has risen to Rs. 200. Compute change in
GDP and production.
• Change in GDP: (Rs. 200 x 100) - (Rs. 100 x 100) = 10000
• Change in real product: 100 – 100 = 0

• Real GDP:
• Calculated to nullify the effect of price rise or fall on goods
• Computed by taking prices of ‘base year’ in GDP computation of other years
Nominal Vs Real GDP (Contd..)
• Real GDP preferred to Nominal GDP

• Use of base year for calculating real GDP

• A ‘normal’ year to be taken for base year
• Base year should be revised every 4-5 years
Other Measures of National Income
• Gross National Product (GNP): GDP + incomes of citizens from
abroad – incomes of foreigners from own country
• Net National Product (NNP): GNP - depreciation
GDP and Well Being
• Excludes factors like environmental damage
• Excludes measures like leisure, state of health etc.
Other Indicators of Development
• Human Development Index (HDI)
• Measure of socio-economic development
• Combined measure of education, health, and adjusted real income per capita
Comparing Nations: GNI and HDI
Nation Life Mean years of GNI per capita GNI per capita HDI Rank
Expectancy schooling ($) rank
Qatar 78.3 9.8 1,16,818 1 36
Comparing Nations: GNI and HDI
Nation Life Mean years of GNI per capita GNI per capita HDI Rank
Expectancy schooling ($) rank
Qatar 78.3 9.8 1,16,818 1 36

Norway 82.3 17.9 68,012 9 1

Comparing Nations: GNI and HDI
Nation Life Mean years of GNI per capita GNI per capita HDI Rank
Expectancy schooling ($) rank
Qatar 78.3 9.8 1,16,818 1 36

Norway 82.3 17.9 68,012 9 1

United States 79.5 13.4 54,941 10 13

Comparing Nations: GNI and HDI
Nation Life Mean years of GNI per capita GNI per capita HDI Rank
Expectancy schooling ($) rank
Qatar 78.3 9.8 1,16,818 1 36

Norway 82.3 17.9 68,012 9 1

United States 79.5 13.4 54,941 10 13

India 68.8 6.4 6,353 102 129

Comparing Nations: GNI and HDI
Nation Life Mean years of GNI per capita GNI per capita HDI Rank
Expectancy schooling ($) rank
Qatar 78.3 9.8 1,16,818 1 36

Norway 82.3 17.9 68,012 9 1

United States 79.5 13.4 54,941 10 13

India 68.8 6.4 6,353 102 129

Tajikistan 71.2 10.4 3,317 130 127

Kyrgyzstan 71.1 10.9 3,255 132 121

WHEELS OF ECONOMIC GROWTH
Factors of Growth
1) Human resources 3) Capital
• Labor supply • Factories
• Education • Machinery
• Skills • Roads
• Discipline • Intellectual property
• Motivation

4) Tech Change and Innovation

2) Natural resources
• Science
• Land
• Engineering
• Minerals
• Fuels • Management
• Environmental quality • Entrepreneurship
DEVELOPED VS DEVELOPING COUNTRY
Classification in Terms of National Income
• Low income: GNI per capita of $1005 or less
• Middle income: GNI per capita > $1005 but =< $ 12235
• Lower middle income economies
• Upper middle income economies
• High income economies: GNI per capita > 12235

• Developed countries = High income economies

• Developing countries = Low + Middle income economies
Other Classifications of Economies
• First and Third World
• Political classification at time of Cold War

• Newly Industrializing Countries

• Higher economic growth than other developing countries
• Example: India, China, South Africa, Brazil

• Least developed countries

• Low income, low human capital, high economic vulnerability economies
• 49 countries, 34 in Africa

• Emerging markets
• Some characteristics of developed markets
• India and China largest emerging markets
Common Features in Developing Countries
1) Lower levels of living and productivity
2) Lower levels of human capital
3) Higher levels of inequality and absolute poverty
4) Higher population growth rates
5) Greater social fractionalization
6) Larger rural populations but rapid rural-to-urban migration
7) Lower levels of industrialization
Common Features in Developing Countries
1) Lower levels of living and productivity
2) Lower levels of human capital
3) Higher levels of inequality and absolute poverty
4) Higher population growth rates
5) Greater social fractionalization
6) Larger rural populations but rapid rural-to-urban migration
7) Lower levels of industrialization
Lower Levels of Living and Productivity

• Vicious circle of poverty

• Low income leads to poor investment in:

• Education
• Health
• Plant and equipment
• Infrastructure
Common Features in Developing Countries
1) Lower levels of living and productivity
2) Lower levels of human capital
3) Higher levels of inequality and absolute poverty
4) Higher population growth rates
5) Greater social fractionalization
6) Larger rural populations but rapid rural-to-urban migration
7) Lower levels of industrialization
Lower Levels of Human Capital

• Developing countries lag in avg

nutrition, health and education
• Under-5 mortality:
• 17 times of high income countries
• Pupil-Teacher Ratio:
• One-third of high income countries
• Complementary progress of health
and education
Common Features in Developing Countries
1) Lower levels of living and productivity
2) Lower levels of human capital
3) Higher levels of inequality and absolute poverty
4) Higher population growth rates
5) Greater social fractionalization
6) Larger rural populations but rapid rural-to-urban migration
7) Lower levels of industrialization
Higher Levels of Inequality and Absolute Poverty

• Poorest 20% receive 1.5% of world income

• High income inequality in developing
countries
• Extremes in relative incomes of rich and poor
• Observed in resource-rich countries
• High extreme poverty in developing nations
• Lack income for food, clothing, shelter etc.
Common Features in Developing Countries
1) Lower levels of living and productivity
2) Lower levels of human capital
3) Higher levels of inequality and absolute poverty
4) Higher population growth rates
5) Greater social fractionalization
6) Larger rural populations but rapid rural-to-urban migration
7) Lower levels of industrialization
Higher Population Growth Rates

• Most population growth in

developing world
• >5/6 people in developing countries
• Higher birth rates in developing
countries
• Dependency burden: More children
to support
Common Features in Developing Countries
1) Lower levels of living and productivity
2) Lower levels of human capital
3) Higher levels of inequality and absolute poverty
4) Higher population growth rates
5) Greater social fractionalization
6) Larger rural populations but rapid rural-to-urban migration
7) Lower levels of industrialization
Greater Social Fractionalization

• Social divisions more pronounced in low-income countries:

• Ethnic‘
• Linguistic
• Caste
• Religion
• Could result in internal strife, political instability and violent conflict
• Progress in culturally homogenous societies
• South Korea, Taiwan, Singapore, Hong Kong
• Exceptions
• Malaysia, Mauritius, United States
Common Features in Developing Countries
1) Lower levels of living and productivity
2) Lower levels of human capital
3) Higher levels of inequality and absolute poverty
4) Higher population growth rates
5) Greater social fractionalization
6) Larger rural populations but rapid rural-to-urban migration
7) Lower levels of industrialization
Larger Rural Populations

• Rural people suffer from:

• Missing markets
• Limited information
• Social stratification
• Massive migration puts pressure on
urban resources
Common Features in Developing Countries
1) Lower levels of living and productivity
2) Lower levels of human capital
3) Higher levels of inequality and absolute poverty
4) Higher population growth rates
5) Greater social fractionalization
6) Larger rural populations but rapid rural-to-urban migration
7) Lower levels of industrialization
Lower Levels of Industrialization

• Small share of agriculture in

employment and output in
developed countries

• Higher dependence on primary

exports in developing nations