CONCEPTS AND MEASUREMENTS

OF ECONOMIC GROWTH AND

DEVELOPMENT
MODULE 1
 CONCEPTS OF GROWTH AND
DEVELOPMENT
• Economic growth is referred to the increase of per
capita real gross domestic product over a period
of time.
• Real GDP is productive capacity in an economy,
which leads to rising national output, incomes
and living standards over time.
• According to Kindle Berger, “economic growth
means more output and economic development
implies more output and changes in the technical
and institutional arrangements, by which it is
produced”
• Economic growth can occur from two main
factors:

• 1. The increased use of resources such as land,

labour, capital and entrepreneurial resources due
to improvements in technology.
• 2. The increased productivity of existing
resources use through increased labour and
capital productivity.
• economic development is a qualitative process and refers
to structural change of economic and social infrastructure in
an economy, which allows an increase in the standard of
living in a nation’s population.
• Economic development is a broader concept than economic
growth.
• Development reflects social and economic progress and
requires economic growth.
• Growth is a vital and necessary condition for development,
but it is not a sufficient condition as it cannot guarantee
development.
• According to Amartya Sen, development is about
creating freedom for people and removing obstacles
to greater freedom.
• it is difficult to imagine development without
economic growth.
• Development is not possible in the absence of
increase per capita output, particularly when
population is growing rapidly.
 INDICATORS OF ECONOMIC
DEVELOPMENT
Traditional Method:

Gross Domestic Product

• most popular and simple method of measuring
economic development of a country.
• Value of final goods and services produced in a
country
• According to A C Pigou “the economic
development can be measured in terms of
changes in national income over time”.
• Increase in real national income leads to increase in
per capita income.
• Criticism:
• GDP only counts money transactions in the
economy.
• Exclude indians working outside of India, and
includes foreigners working in india
• do not show how equitably a country’s income is
distributed.
• do not account for pollution, environmental
degradation, and resource depletion.
• do not register unpaid work done.
Per Capita Income

• Avg income earned by each person in a country

• Income of individuals

• does not account for improving the longevity of

human life nor the quality of the environment
such as pollution, environmental degradation,
health, education, etc.,
• An increase in PCI may not raise the real standard
of living of the masses.
• fails to take in to account problems associated
with basic needs like nutrition, health, sanitation,
housing, water and education.
• The real PCI estimates fail to measure adequately
changes in output due to changes in the price
level.
• Modern or comprehensive method:

• Physical Quality of Life Index (PQLI)

• mid-1970s
• by Morris David Morris,
• According to Morris: Physical Quality of Life Index (PQLI) is a
measurement of the most basic needs of the people.
• As per this approach, development should be reflected in
the improved economic status or the higher Physical
Quality of Life of the people.
• The value is the average of three statistics:
• basic literacy rate,
• infant mortality
• life expectancy at age one,
• all equally weighted on a 0 to 100 scale.
• For each indicator, the performance of individual country is
ranked on a scale of 1 to 100
• 1 - worst performance 100 - best performance
Criticisms:
• It does not measure economic growth
• does not explain the changing structure of
economic and social organization.
• does not measure total welfare
• Many societal and psychological factors like
security, justice, human rights, etc. are excluded.
• The Human Development Index (HDI)
• 1990
• United Nations Development Programme (UNDP)
• By Muhabul ul Haq and Amartya Sen
• to provide a means of measuring economic
development in three broad areas - per capita
income, health and education
• The introduction of the index was an explicit
acceptance that development is a considerably
broader concept than growth, and should include a
range of social and economic factors.
• The HDI has two main features:
• A scale from 0 to 1
• 0- no dvlpmnt
• 1 – dvlpmnt
• Index:
• Longevity
• Knowledge
• Standard of living,
• HDI is used to distinguished whether the country is
developed, developing and under developed.
• On the basis of HDI values, countries are classified into three
groups, namely:
• a) High human development countries with HDI 0.80 and above,
• b) Medium human development countries with HDI 0.500to 0.799
• c) Low human development countries with HDI value below0.50.
• Human Poverty Index
• is an indication of the standard of living in a
country,
• developed by the United Nations (UN) to
complement the Human Development Index (HDI)
• It was considered to better reflect the extent of
deprivation in developed countries compared to
the HDI.
• The HPI concentrates on the deprivation in the
three essential elements of human life already
reflected in the HDI:
Gender-related Development Index

• (GDI) was introduced in 1995

• by the United Nations Development Program.
• The aim of these measurements is to add a gender sensitive
dimension to the Human Development Index (HDI).
• The first measurement
• “distribution-sensitive measure that accounts for the human
development impact of existing gender gaps in the three
components of the HDI”.
• Distribution sensitive means that the GDI takes into account
not only the average or general level of well-being and wealth
within a given country, but focuses also on how this wealth
and well-being is distributed between different groups within
society.
• It measures economic development as HDI does, but
take into account the ‘inequality between men and
women’.
• It addresses gender-gaps in life expectancy,
education, and incomes.
• same set of basic capabilities as included in the
HDI – life expectancy, educational attainment and
income – but adjusted the HDI for gender
inequality.
• Deprivation Index
• Studying the social inequalities in health and wellness
has long been a challenge due to the lack of
socioeconomic information in administrative databases.
• deprivation takes two forms:
• material
• social.
• material deprivation: reflects the lack of everyday
goods and commodities
• Social deprivation: refers to the fragility of an
individual’s social network, from the family to the
community.
• The index is intended to support health and
wellness planning.
• It could be used to monitor social inequality,
evaluate services, develop policies and programs,
and allocate resources.
• Human deprivation index :
• Income
• health
• educational deprivations.
• For the analysis human deprivation index gives
equal weightage for these three deprivations.
• .
 INEQUALITY

• A situation where people are not equal in terms of

their economic condition and opportunities

• There are various ways to accomplish this, including

graphical and mathematical approaches
• that range from simplistic to more intricate methods.
• All of these can be used to provide a complete
picture of the concentration of income, to compare
and rank different income distributions,
• and to examine the implications of alternative policy
options.
 MEASURES OF INEQUALITY

• Kuznets Inverted U hypothesis

• Prof. Kuznets
• first economist to study the relationship between
economic growth and income distribution
• Kuznets observes that in the early stages of
economic growth relative income inequality
increases, stabilizes for a time and then decline in
the latter stages.
• It was in his 1963 study
• by taking the data of 18 countries
• tendency for income inequality to increase first,
and then to be reduced as countries developed
from a low leve countries.
• Diagram:

• income inequalities were higher in under

developed countries than in developed countries.
• Used Gini coefficient
Causes of increase in inequality with less development

• in the early stages of development in LDC’s. When the

process transition from a traditional agricultural society to
modern industrial economy begins, it increases inequalities
in income distribution.
• There are structural changes, which lead increasing
employment opportunities, exploitation of new resources,
and improvements of technology.
• All these leads to increase in per capita income in the
industrial sector. The income of workers, managers,
entrepreneurs etc, in urban areas increase more rapidly.
• capita of workers agricultural and non- agricultural
occupations in rural areas does not rise due to subsistence
agriculture, defective land tenure system and rural
backwardness.
• Causes for reduction in inequality with
development:

• Kuznets give two reasons for decrease in

inequality of income distribution when the
country reaches high income level in the latter
stages of development
• the per capita income of the highest income
groups falls because their share of income from
property decreases.
• the per capita income of lowest income groups
rises when the government takes legislative
decisions with respect to education and health
services, inheritance and income taxation,
social security, full employment and economic
relief to either whole group or individuals.
Lorenz Curve

• simplest representations of inequality.

• On the horizontal axis the cumulative number of income recipients
ranked from the poorest to the richest individual or household.
• The vertical axis displays the cumulative percentage of total
income.
• curve reveals the percentage of income owned by x per
cent of the population.
• It is usually shown in relation to a 45 degree line that represents
perfect equality where each x percentile of the population
receives the same x percentile of income.
• , the farther the Lorenz curve is in relation to the 45-degree line,
the more unequal the distribution of income.
• Diagram:
• Gini-coefficient
• most widely cited measure of inequality
• it measures the extent to which the distribution within an
economy deviates from a perfectly equal distribution.
• The index is computed as the ratio of the area between the
two curves (Lorenz curve and 45-degree line) to the area
beneath the 45-degree line.
• In the figure above, it is equal to A/(A+B).
• A higher Gini coefficient represents a more unequal
distribution.
• The coefficient allows direct comparison of two populations’
income distribution, regardless of their sizes.
• The Gini’s main limitation is that it is not easily decomposable
or additive.
• Atkinson Index
• most popular welfare-based measure of inequality.
• It presents the percentage of total income that a
given society would have to forego in order to have
more equal shares of income between its citizens.
• This measure depends on the degree of society’s
inequality
• higher value entails greater social utility or
willingness by individuals to accept smaller incomes in
exchange for a more equal distribution.
Theil Index

• The values vary between zero and infinity

• 0- perfect equality infinity or 1 - inequality
• A key feature of these measures is that they are fully decomposable
• inequality may be broken down by population groups or income
sources or using other dimensions, which can prove useful to policy
makers.
• Another key feature is that researchers can choose a parameter α that
assigns a weight to distances between incomes in different parts of the
income distribution.
• For lower values of α, the measure is more sensitive to changes in the
lower tail of the distribution and, for higher values, it is more sensitive
to changes that affect the upper tail. The most common values for α
are 0, 1, and 2. When α=0, the index is called “Theil’s L” or the “mean
log deviation” measure. When α=1, the index is called “Theil’s T” index
or, more commonly, “Theil index”. When α=2, the index is called
“coefficient of variation”. Similarly, to the Gini coefficient, when income
redistribution happens, change in the indices depends on the level of
individual incomes involved in the redistribution and the population
size.
Palma ratio

• By José Gabriel Palma

• Index to measure income inequality
• Focused on extreme rich and poor
• They are more sensitive
• Any chnge in their income will effect country’s NI
• It is the ratio of national income shares of the top 10 per cent of
households to the bottom 40 per cent.
• empirical observation that difference in the income distribution of
different countries or over time is largely the result of changes in
the ‘tails’ of the distribution (the poorest and the richest)
• as there tends to be relative stability in the share of income that
goes to the ‘middle’.
THEORIES OF ECONOMIC GROWTH

Module II
Harrod-Domar Growth Model

• Roy Harrod in 1939s

• And Evsey Domar in 1940s
• 2 model and 2 theories, similar assumption
• They criticised keynesian model of growth in dvlpd
countries
• Both of them criticized the basic Keynesian framework of
income determination in the short run for ignoring the
role of investment to create more capacity for the
production of output.
• according to these economists, investment has a dual
role
• investment generates income
• Investment increases the productive capacity of the economy
• Harrod: keyns neglected the role of saving
• Domer: keyns neglected the role of immediate effect of
investment
• Both the economists were interested in finding out an
equilibrium growth path which would guarantee a
full employment.
• Although the two models of Harrod and Domar are similar
in many respects but they have some crucial differences as
well. Let us investigate the two models below in turns:
 HARROD’S MODEL

• 1939
• Paper- ‘Economic Journal’.
• In English

• Assumptons:
• The economy is assumed to begin with full employment
of capital.
• No gvt interference
• Closed economy
• Endogeneous variable
• No lags in adjustment
• variable like saving, investment adjust within the period. No
time lag. If investment increase the saving increases
• APS= MPS
• Capita output ratio is constant. Thus economy
operates under constant return to scale
• If plans of investment are realized then the firms
don’t change the rate of desired investment
• actual investment is more than planned then
firms increase or decrease respectively the rate of
desired investment.
• There are no lags in the adjustment between
demand and supply
• To explain this model he first asked 3 qstn:

• How the study growth can be achieved with fixed capital

output ratio
• How this achieved study growth can be maintained or
what are the conditions for maintain
• How tha natural factor put a sealing on the growth rate of
the economy
• Harrod views about economical growth:
• 3 types of growth

• Actual growth
• Warrented growth
• Natural growth
Actual growth rate

• Actual amount of saving and investment acceptable in

the economy
• Ratio of change in income to the total income in a
given period
• GA= Y/ Y
• Eg: 30/100= .3

• According to him : to achieve a study growth rate in

the economy S= I
• To get S=I…..
• GC=S
• C= marginal capital output ratio
• That is K/ Y---- K=I
• S= saving income ratio S/Y
• G= Y/ Y

• GC=S
• Y/Y * I/ Y= S/Y
• I/Y = S/Y
• (I=S)/ Y
• S=I
• Warranted growth rate

• Growth rate of economy when it is working with full

capacity with optimum use of machines and manpower
• Economy is working in full capacity
• Gw Cr= S

• Cr= required capita

• S= saving income ratio
• To get a stable economy exante investment = expost
investment
• He says that economy always will be in a position
of instability
• 2 types of instability

• G>Gw ------- inflation

• G<Gw -------- deflation

G= income growth rate

Gw= o/p growth rate
•
• Natural growth rate

• Nayural growth is determined by natural factors

like labour force, technical progress
• Y= L*(Y/L)

• L= labour
• L/Y= pdtvty of labour
• If labour growth is constant then to get growth
increase the pdtvty of labour
• In long run economy can achieve only natural
growth rate
• It set upper limit to the actual growth rate
• Relationship between G,Gw, Gn

• If G>Gw then G can continue until reach at Gn

• G=Gw=Gn called golden age
• If Gw> Gn there will be tendency toward
depression
• If Gw< Gn tendency toward inflation and
unemplyment

• Diagram:
 DOMER MODEL OF GROWTH

• Assumption:
• Economy begins with full empoyment of income
• APS= MPS
• No lags in adjustment
• No gvt
• Closed economy
• Act of investment in economy result two things:

• It increase the pdtv capacity of economy

• SS side effcet
• If pdtvy increases then goods & services increases

• Generate additional income

• Dd side effect
• If income of people increases , dd also increases
• Multipier effect
• Structure and working of the Harrod’s Model

• Harrod wanted to find out that rate of growth of

investment or output which will sustain itself
overtime.
• Used multiplier and accelerator
• Keynesian multiplier
• ∆𝑌 = ∆𝐼/𝑠…….. (1)
• Accelerator
• I= 𝐶𝑟∆Y …… (2)

• C𝑟 = ∆𝐾𝑟 /∆𝑌 ------ change in capital stock per unit increment in

output.
• DD side : SS side :

• Yd= I /  Ys= K

• Yd= level of effective dd Ys= level of o/p

• I= investment sigma = capital o/p
ra
• Alpha = MPS K = capital

• To get study growth rate the Yd= Ys

 KALDOR’S MODEL OF ECONOMIC
GROWTH
• Prof. Nicholas kaldor
• Substitution btwn labour and capital is rigid
• Growth is attained through the mutual interaction
of economic and non economic forces

• Assumptions:
• 2 factors of pdtn ( labor and capital)
• 2 types of income ( profit and wage )
• Availability of resources is the limiting factor of o/p in
growing economy
• Total saving is the sum of saving out of wage and saving
out of profit
• Constant return to scale
• Pdtn fn remain unchanged over period of time
• Capital and labor are complementary
• Income, wage, saving, investment , profit, capital
are used but expressed in constant price
• Working of model:
• Constant working pop
• Expanding pop
• Constant working population:

• Income growth rate increases per head income increased

• Explains 3 fn
• saving fn
• Investment fn
• Technical progress fn

• Saving fn :
• Rate of profit is determined by natural growth rate and saving out of
profit

• St= Pt + β (Yt-Pt)

• St= saving
• = saving out of profit or MPS of entrepreuner
• Pt= profit
• Β= saving out of wage or MPS of wage earner
• Yt-Pt=wage
1> > β> 0

Alpha always less than 1 bcz we need to consume

Beta always less than 1 bzc entrepreanurs earn more than labor
Beta might be greater or equal to 0
If beta is zero then wage earners saving zero
If beta is greater than zero, they save some thing
Investment fn
• Investment depends on previous year of o/p
plus rate of profit earn from previous year
of capital

• Kt= Yt-1 + β (Pt-1 / Kt-1) Yt-1

• Kt = stock of capital
• Yt-1 = o/p of previous year
• = coefficient of o/p of previous year
• Pt-1 = profit of previous year
• Kt-1= capital of previous year
• Pt-1/kt-1= rate of profit from previous year of capital
• Β= co efficient of rate of profit from previous year of capital
Technical progress :

• The rate of growth of income is determined

by rate of growth of capital and
technological progress

• Yt+1-Yt/Yt= ”+β’’ It/Kt

• Yt+1-Yt/Yt= growth rate in income or o/p
• ”= coefficient of technical progress
• It/Kt= rate of investment
• β“ = capital per head
• Diagram: 2.4
• X axis = propotionate growth of capital
• Y axis – propotionate growth of income
• 45 degree – study growth rate
• TT’ curve – technical progress
• When we put O1 amount of capita we are getting
G1 bcz of technical progress …….finally equals
• After this o/p will not grow. Maximum point
• Growth rate of income is more than growth rate of
capital
•
• Expanding pop

• Based on malthusian theory

• Pop growth is fn of rate of increase of subsistance
which is assumed to be equal to tha rate of increase in
total pop
• Diagram 2.5
• X axis – growth rate of Y
• Y axis - Growth rate o f pop
• M – growth rate of income
• 45 degree- study growth
• Doted curve – pop growth
• As income grows pop also growing
• After a certain point, income increases but pop
will be constant (L to λ)
• λ Lamda represent max growth rate of pop
JOAN ROBINSON GROWTH MODEL

• Book – the accumulation of capital

• 1956
• Problem of pop growth in a dvlpg economy
• Analysing the influence of pop on the role of
capital accumulation and growth of o/p
• Capital accumulation is increase in wealth
through investment and profit
• Capital is the engine of growth
Assumptions:
• Labour and capital are the only productive factors
• The economy is assumed to be
• Total wage bill is the product of real wage rate and number of
workers.
• Total income is divided between capital and labour
• The production is not affected by the technological changes i.e.,
there is no progress in technology.
• There is constancy in price level.
• Wage earners spend all of their wage income on consumption,
• while profit takers save and invest all of their profit income.
• Capital and labour are combined in a fixed proportion for a given
output.
• The national income is the sum of wage bill and total profits.
• 2 model:
• Income point of view or open model
• Expenditure point of view or closed model

Income point of view

• the conditions for the steady growth and conditions for rising rate of capital
accumulation will be discussed.
• According to him national income is the sum of the total wage bill and total
profit.
• Total wage bill is the real wage multiplied by the number of workers and
total profits are equal to profit rate multiplied by the amount of capital.

• PY = WN + πPK

• P — Price level. Y— national income.

• W — Net money wage rate. N— Amnt of labour employed.
• K— Amount of capital invested. π — Rate of profit

• Equation explains that National income dpends on wage received by labour

and profit earn by capitalist
• Capital accumulation depend of profit thus Profit
has a imp role in this model
• By increasing profit we can increase capital
accumulation
• Profit can be calculated by this equation
• equation
• 105 page no

• The above equation indicates that the profit

rate is a function of labour productivity (p)
and real wage rate (W/P) and capital labour
ratio
• Expenditure point of view :
• the concepts of Golden age and Platinum age are to
be discussed.
• Golden age is a situation of smooth steady growth with
full employment arising out of the equality of the
‘Desired’ and ‘Possible’
• if an increase in labour supply is not accompanied by
proportionate increase in the capital supply, then it will
cause unemployment in the economy.
• To achieve full employment of labour the growth rate of
population must be equal to growth rate of capital

• ∆N/N = ∆K/K N= pop K= capita

• When the rate of growth of labour and capital are

equal to each other, then there is full utilisation of
capital in the economy. That is Golden age.
• Diagram 2.7 ,, 110
• Left X axis = growth rate of capital
• Right side of x axis = capital labor ratio
• Y axis – capital o/p ratio
• OP = prdtn fn -- Each point on this curve shows the
proportion in which capital and labour are combined
to produce a particular level of output.
• NT = tangent
• NT touches the OP at A == Golden age
• At point A:
• OC = capital labour ratio,
• OD = the productivity of labour
• OW = the wage rate.
• DW = rate of return to capital.
• At point A, the growth rate of capital ∆K/K is equal to
growth rate of labour ∆N/N.
•
• State of Disequilibrium:
• when it diverges from Golden age equilibrium for
some reason.
• There are two possibilities of divergence:
(i) ∆N/N˃ ∆K/K
(ii) ∆K/K ˃ ∆K/ A
∆N/N ˃ ∆K/ K
• shows that the growth rate of population is greater than
growth rate of capital.
• occurs in underdeveloped countries.
• ‘profit wage relation’ which pushes the economy back on
the path of Golden age.
• The excess of labour supply would depress the money wage,
wages would fall. This fall in real wages would increase the
level of profit, which in turn would stimulate the growth of
capital. then the economy would be on Golden age.
• if real wages do not fall because of subsistence wage then it
would be difficult to restore the position of Golden age and it
will lead to under employment.
• ∆N/N ˂∆K/K
• the growth rate of population is less as compared
to growth rate of capital
• occurs in developed countries.
• The higher production curve will lead to higher
capital labour ratio.
• Thus, the equality between growth rate of capital
and growth rate of labour is a pre requisite for
achieving the Golden age.
• Types of golden age :
• A Limping Golden Age:
• growth rate of capital stock is less than the growth of labour
force.
• The intensity of limp depends upon fall or rise in
employability and the labour force.
• The limp is said to be severe if the actual growth of output is
less than the required rate of output per head.
• The continuous decline in the level of employment is an
indicator of severity of limp which, in turn, may lead to the
problem of inflation and unemployment.
• A Restrained Golden Age:
• situation where actual growth rate of capital is lower than
the desired growth rate.
• This is due to the operation of certain bottlenecks as of
high rate of interest and rationing of credit.
• During this period, firms cannot maintain the high rate of
growth despite the technical progress in the economy
A Bastard Golden Age:
• Prof. R.F. Kahn
• It is the age where unemployment prevails but
real wages remain rigid downwards. As a result,
the rate of accumulation cannot increase in the
absence of technical progress.
• that stock of capital equipment does not
grow faster because of inflation barrier.
• This barrier puts a limit to the growth rate of
capital accumulation which leads to
unemployment.
• Types of Platinum Age:
• the growth rate of output and employment are given
from outside and technical advance is zero.
• the development parameters are considered to be rigid.
• The steady growth cannot occur in initial stages due to
rigidity of development parameters.
• Types :
• Bastard Platinum Age:
• This is a situation when the rate of accumulation is
increasing and real wages remain constant even in the
face of technical progress.
• Therefore, acceleration of accumulation takes place
without inflation
• underdeveloped countries
• where the available capital is inadequate to provide
employment to unemployed force.
• it implies that manpower exceeds the material
power.
• Galloping Platinum Age:
• economy experiencing a rising rate of profit and rising
capital intensity of production but unemployment still
prevails.
• In this age, the rate of capital accumulation accelerates
rapidly from low level to high level.
• The rate of profit rises as the real wage rate falls.
Creeping Platinum Age:
• This age begins with full employment situation
where the rates of accumulation and profit are very
high and techniques of low capital intensity are
being installed.
• The consequent fall in the rate of profit will bring
down the desired rate of accumulation.
• As the rate of profit falls, more mechanised
techniques will be chosen at each round of
investment. This process will continue until the rate
of accumulation comes down approximately equals
the rate of growth of labour force.
 trotting platinum age:
• growth rate of capital accumulation neither
accelerates nor decelerates but it is steady.
• underdeveloped countries as their sole aim is to
attain the growth with stability.
Criticism :
• Neglects Institutional Transformation,
• Constant Price Level,
• Closed Economy,
• Unrealistic Assumptions,
• Neutrality to Policy Implications,
• Role of Human Capital ignored,
• No Role of State, and
• No Technical Progress.
• Hirofumi Uzawa
• Hirofumi Uzawa
• 1961 and 1963
• extension of Solow-Swan Neo-classical growth
model.
• Assumption:
• 2 factors of pdtn labor and capital
• Substitutable
• 2 secots industrial sector and consumer good
• Ss of labour exogenously determined
• there are two goods a consumer good say corn
denoted by c, and a capital good tractor denoted
by k.
• Both the goods are being produced under
constant returns to scale.
• Model:
• K capital
• L= labor
• I= industrial sector
• K1= capital for industrial sector
• L1= labour for industrial sector
• C = consumer good sector
• K2= capital for consumer good sector
• L2 = labor for consumer good sector
• K/L = k1+k2/L1+L2= k1/(L1+l2)+ k2/ (L1+L2)

• K= total capital in economy

• L= total labor in ec onomy
• Multiply and devide first term by L1 and second
term by L2
• k/L= k1/(L1+L2 ) *L1/L1+ k2/ (L1+L2)*L2/L2
• L1/(L1+L2) * K1/L1 + L2/L1+L2 * K2/L2
• K/L= L1/(L1+L2) (K1/L1) + (1-L1/L1+L2) K2/L2

• This equation explains that capital o/p ratio (K/L)

has been split into capital labour ratio for the
capital good sector and consumption good sector
• The wage profit ratio (W/R ) determines the
devision of labour and machines btwn the 2 sectors
• Both capital good and consumer good sectors
would make the optimal adjustment and these
would yield unit cost
• Perfevt competetion sets the price ratio P2/P1 for
the 2 commodities equal to the ratio of unit cost
• Thus W/R determine an equilibrium price ratio

• Condition for stability :

• Wage are all spent on consumer good and profit
• Given W/R and k/L and the output Y1 and Y2 equilibrium
in the commodity market requires that
WL/RK= P2Y2/P1Y1
Solow’s Growth Model

• Assumptions
• economy produces one good
• All labour is assumed to be homogeneous.
• Stock which is accumulated in the past and labour are
the factors of production in the production function
• Constant returns to scale are assumed to prevail,
• MPS is constant.
• Labour exogenously determined.
• It is a closed economy
• It is a laissez faire
• Study growth with combination of 3 factors :
• Technology
• capita;l
• Labor

• Basic pdtn fn
• Y=A (k/L)

• Y= output
• A= technology that is constant
• K= capital L= labor
• To find how labour produce, devide both side by L
• y/L = A( K/L L/L)
• Y/L= (K/L ) ignore A bcz its constant
• Y/L = output per worker
• K/L = capital per worker
• Consider Y/L = y and K/L = k
• So y=k
• To achieve study economic growth
• Sy= (n+d)k
• Required investment: is trhe amount of investment
that we need for the growth of economy
• Depends on 2 factors:
• Gowth of pop = n
• Depreciation = d
• So we required investment for 2 purpose
• To fullfill the need of growing pop
• To Replace the asset whose value had replaced

• n+d is the required investment

• (n+d)k
• K= per head capital
• For maintaining per head capital we need investment
equAal to nk and dk
• In solow model saving is a part of national income
• S=Sy
• S= saving y= income
• Fundamental equation is Sy= (n+d)k
• This equation states that saving should be equal to the required
investment …. That point is called Study state equilibrium
• Diagram 143
• F(k)= pdtn fn
• As capital per worker increases our output worker also incresing
• After a certain point (fk) starts to decline bcz of diminishing return
• Sf(K) = saving fn
• Nk= required investment
• Where saving equal to required investment --- study state growth
• Before that point saving is higher required investment , that means we
need to invest more
• After that steady state point , required investment is higher than saving,
here economy will moves to backward .
• Convergence Hypothesis
• Solow Model claims that over a long period of time,
all nations of the world would tend to converge
towards same rate of growth. It is referred to as
convergence.
• reasons are given for convergence:
• Since rate of return on capital is higher in countries where
capital is relatively scarcer, hence, capital will flow from the
developed countries to developing and under-developed
countries.
• As capital will move from developed countries to
developing and under-developed countries, the incomes of
poorer countries will also increase.
• Types of Convergence
• Absolute Convergence:
• Conditional convergence

• Absolute :
• It states that if n number of countries have access
to same technology, have same saving ratio,
same population growth rate but different capital
output ratio, then all countries would converge to
same level of equilibrium steady growth rate.
• Conditional Convergence:
• Conditional convergence states that if n number of
countries has access to same technology, same
population growth rate but different saving ratios and
capital labour ratio, then there will still be convergence at
same growth rate but equilibrium capital output may or
may not be equal.
 AK MODEL

• Endogenous Growth Theory:

• Paul Romer in 1986 and Robert Lucas in 1988.
• Internal factor like human capital and iknowledge plays a
imp role in grpwth of economy
• In jappan, natural resources are very low but they became
developed country with their innovation and new ideas
• Thus romer says that new ideas and innovation are more
imp than natural resources
• New ideas helps in 3 basis :
• New design used in intermediate good lead to a new intermediate
good
• Can produce new goods
• Increase the total stock and increase the hunman capital
• Assumptions :
• Economic growth comes from technological growth
• Mkt incentives plays imp role making technological change
• Invention of new design require specified amount human
capital
• Technology is not rival in good. That use of one firm doesn’t
prevent the use of another firm
• Increasing return to scale
•
• Pdtn function is Y=AK
• Y= aggregate o/p
• A= technical parameter
• K= capital (include human capital and physical capital
)

• According to this model capital accumulation is the

cause of growth of this economy
• To know level of capital accumulation we need to
know the change in capital stock
• Capital stock= deifference btwn investment and
appreceiation
• How do people accumulate Human Capital?
• Lucas opined that people spend on accumulating new
and scarcer skills which enhances their economic worth.
 INDIAN PLAN MODELS OF MAHALANOBIS AND
WAGE-GOODS MODEL

• Mahalanobis Growth Model:

• which provided a rationale for the heavy industry biased
development strategy.
• Mahalanobis identifies the rate of growth of investment
in the economy not with rate of growth of savings as is
usually considered by the economists but with rate of
growth of output in the capital goods sector within the
economy.
• he proves that if the proportion of total investment
allocated to the capital goods is relatively greater, the rate
of growth of output of capital goods will be greater
• To reach high standard in consumption invest in the pdtn of
capital good
• 2 nd FYP
• Dvlped 3 model for 3 sector
• Single sector
• Two sector
• Four sector
• Single sector :
• Closed to Harrod domer
• Identified 3 variable as determining the growth of
percapita income:
• : fraction of income used for investment
• Β = income investment ratio
• = rate of growth of pop

• Yt= y0 (1+β – p ) t

• β-p == the rate of growth of percapita income

• Two sector model

• In this model he focused on capital goods

industry
• Closed economy
• 2 sector .. Capital good sector and consumer
good
• Investment is determined by the SS of goods not
return of investment
• Price is constant
• No existing capital can be transferred from one
sector to another
• Total investment was devided into λK and λC

• Then λk+λc=1
• λK = proportion of investment which used to increase the pdtn
of capital goods
• λC= proportion of investment which used to increase the pdtn
of consumer goods
• Lamda = investment
• Model written as:
• Photo

• Beta= total pdtvty coefficient

• do1 = proportion of investment going to capital good sector
• do 2= proportion of investment going to consumer goods sector
• Beta1= o/p capital ratio in capital good sector
• Beta2= o/p capital ratio in consumer good sector
• Photo

• This shows that proportional change in absolute income

growth depends only on allocation investment to
capital good sector and pdtvty
• Four Sector Model:
• Mahalanobis realised that the basic heavy
industries being capital-intensive will not ensure
rapid expansion of employment opportunities
• to bring the employment aspect into sharp focus
he put forward a four sector growth model in which
he kept heavy industry sector intact but divided
the Consumption-sector into three sub-sectors:
• C1, C2, and C3
• C1 represented factory enterprises using mechanised
techniques and producing consumer goods
• C2 represented the household and small-scale
enterprises also producing consumer goods
• Sector C3 represented provision of services

• four sector model was visualised to ensure the

increased supply of consumer goods to meet their
rising demand for them and also to ensure, being
labour intensive, expansion of employment
opportunities
• Import-substituting Industrialisation:
• economy to stop imports of foreign capital
equipment and machines.
• To quote him, “The proper strategy would be to
bring about a rapid development of the industries
producing investment goods in the beginning by
increasing appreciably the proportion of
investment in the basic heavy industries.
• by using domestically produced capital goods
would also increase steadily and India would
become more and more independent
Mahalanobis Growth Model and Development
Strategy in India’s Five-Year Plans:
• Mahalanobis heavy industry first strategy of
development was put into actual practice in India’s
Five-Year Plans beginning from the Second Plan.
• Although it did not present any explicit formulation
of development strategy regarding the pattern of
investment its emphasis was on agriculture,
irrigation, power and transport aimed at creating
the base for more rapid industrialisation of the
economy in the future.
• The Wage-Goods Model and Strategy of Economic
Development
• Vakil and Brahmananda.
• This theory explains the growth of income and
employment in the context of today’s developing
countries characterised by disguised unemployment.
• work ‘Planning for an Expanding Economy’ written in
1956,
• they attribute the prevailing poverty and
unemployment to the existence of wage-goods gap.
• poverty and unemployment are the two most pressing
problems facing the under developed countries today.
• to remove this poverty it is essential to increase the
aggregate supply of wage-goods.
• Unless and until the wage-goods gap is bridged,
poverty will not be eliminated.
• Components of Wage Goods:
(1)Food grains; Cereals, Pulses, (2) Milk and Milk products, (3)
Edible oils, (4) Fish, Eggs and Meat, (5) Sugar and sugar products,
(6) Fruits and Vegetables, (7) Spices, (8) Tea, (9) Coffee, (10)
Cloth, (11) Matches, (12) Soap (13) Salt, (14) Kerosene.
Also
“drugs for common use, medical and hospital facilities, minimum
educational and library facilities, minimum utility services like
water, electricity, roads etc.,
• Now, the question arises as to why there is a
deficiency of wage goods in the economy.
• This is due to the fact that the capital stock or,
productive capacity designed and directed to produce
wage goods is deficient.
• To eliminate poverty capital stock designed for the
production of wage-goods needs to be expanded.
• if wage goods are somehow made available, they can
be used to employ labour for producing capital.
• If, the new capital is designed to manufacture wage
goods, the growth process can be started which will
become cumulative and self sustaining.
PARTIAL THEORIES OF ECONOMIC
GROWTH AND DEVELOPMENT
• Module III
• Basic Features of Underdeveloped Countries

• low real per capita income

• wide-spread poverty
• lower level of literacy
• low life expectancy
• underutilisation of resources etc.
• underdeveloped economy fails to provide
acceptable levels of living to a large fraction of its
population, thus resulting into misery and
material deprivations.
• Underdevelopment is a Relative Concept
• because it compare quality of life between the
economies that differentiates them in underdeveloped
and developed.

• Underdevelopment Sustains Absolute Poverty

• Although, concept of underdevelopment is a relative
concept but it sustains absolute poverty.
• they are a class of people who are always striving to
survive.
• Thus, underdevelopment and absolute poverty go
together or underdevelopment sustains absolute poverty.

underdevelopment is a relative concept but it

sustains absolute poverty.
Characteristics:

• Low Per Capita Income

• Slow Growth Rate of Per Capita Income
• Economic
• Low Level of Living
• Low level of capital formation
• Backward technique production
• Low productivity of labour
• .High Growth Rate of Population and Dependency Burden
• Underutilization of resources
• Large scale unemployment
• Dominance of agriculture
• Poverty
• Low foreign trade
• Infrasrtucture backwardness
Theory of Low-Level Equilibrium Trap

• by R.R. Nelson
• for underdeveloped countries.
• It states that when per capita income increases
above the minimum specific level, population
tends to increase. But when the growth rate
reaches an upper physical limit as the per capita
income increases, the growth starts declining.
• If the per capita income is increased above the
specific level through saving and investment, it
increases a growth in population.
• When level of income is low people are not able to
save and invest, this low level of saving and
investment lead to low level of growth in national
income
• According to nelson if any country want to
overcome this then growth rate of income
must be greater than growth rate of
population
• To come from this trap, the rate of increase of
growth of income must be higher than the rate of
increase in population.

• If not, higher population will push down percapita

income then economy will again stuck in low level
of equilibrium
• 3 equation:
• Income growth equation
• Population equation
• Investment equation
• A: x axis- level of per capita , Y axis - % growth
rate in pop
• Growth rate of population
• At point S population rate and growth rate of
percapita income is zero.
• S to A – as percapita starts to increase population
also starts to increase
• A to A’- after point A population rate is constant
• A’ to P – population starts to decline
• B:
• X axis – per capita income
• Y axis – per capita rate of investment
• Growth rate of investment
• X point is corresponding to S, where zero level of
saving thus investment is also zero.
• As percapita starts to increase then investment
also increases
•
• C:
• X axis – level of percapita
• Y axis – growth rate pop + growth rate of total
income
• Growth rate of pop, growth rate in income
• S is corrospondiing to S and X, where growth rate
of pop is equal to growth rate of total income
that’s why people are not able to save and
investment. And low level of investment leads to
low economic growth.
• S= low level of equilibrium trap
• To come out from this trap then growth of
income must be more than the growth of
population
• S to L growth of pop is higher than growth rate of
income, as result higher pop will push down percapita.
• Economy will stuck in S.
• We need to jump to L
• After L, income is higher than pop
• Reach at N.
• N- new stable equilibrium, good for economy
• After N, pop starts to increase
Conditions for Trapping:

• A high correlation between the level of per capita

income and rate of population growth
• A low propensity to direct additional per capita
income to increase per capita investment
• Scarcity of uncultivated arable land
• Inefficient production methods
• Cultural inertia and economic inertia.
• Factors Escaping Low Level Equilibrium Trap:

• There should be favourable socio-political environment in the country.

• Capital and income should be enhanced by obtaining funds from
abroad/international institutions.
• Improved techniques should be used to utilize existing resources.
• The requisite methods should be adopted to change distribution of
income.
• Social structure can be changed by laying stress on thrift and
entrepreneurship so that there must be ample opportunities,
incentives to limit the size of family.
• Solid investment programme should be introduced by the
Government.
• Efforts should be made to increase production with modern and latest
techniques of production.
Critical Minimum Effort Thesis

• Harvey Leibenstein
• UDCs are characterized by vicious circle of poverty (VCP)
• which keeps them around a low-income per capita
equilibrium state.
• The way out of this impasse is a certain 'Critical minimum
effort' which would raise the per capita to a level at which
sustained development could be maintained.
• UDC will have to introduce 'Stimulus
• every economy is subject to 'Shocks and Stimulants'.
• A shock has the impact of reducing the per capita income
initially
• while a stimulant tends to increase it.
• Certain countries are poor and backward because of the
reason that the magnitude of stimulant is small while that of
shocks is large.
Growth agent

• if the income increasing forces expand at a higher

rate than the income depressing forces, then the
favourable conditions for economic development
will be existing.
• In the process of development such conditions
are created by the expansion of 'Growth Agents'.
• entrepreneurs, investors, savers and the
innovators.
• two types of incentives for UDCs:
(i) Zero sum incentive :
Those incentives which do not increase national income,
but they bring a change in the distribution of income.
Eg: entrepreneurs, political parties bcz They wish to attain
monopolies; political influence; and social prestige.
(ii) Positive sum incentive:
Those incentives which result in expansion of national
income.
factors are responsible for depressing per capita
income in UDCs:
• Zero sum entrepreneurial activities.
• Conservative activities of organized and unorganized
labour.
• The resistance to new knowledge and ideas and
attachment to old ideas.
• Increase in consumption, and unproductive use of
those resources which could be used for capital
accumulation.
• Increase in population.
• High capital output ratio
• Therefore, according to Leibenstein, there is a
need to direct the zero-sum activities of the
entrepreneurs to the positive sum activities
• Ie, 'minimum effort' should be sufficiently large
to create an environment whereby the positive
sum activities could flourish.
• Figure 3.2 page no 233
• X axis – percapita income and induced income
growth
• Y axis – percapita income and induced income
decline
• 45 degree shows induced increase and decrease
in the per capital income. Ie, balance economic
growth or increase or decrease in economic
growth
• ZZ’- shocks
• XX’- stimulents
• E- initial equilibrium where socks > stimulents thus
low economic growth ,
• Oe- income level
• To attain economic growth we need minumum critical
effort, and investment
• Bcz of theses investment, employment, income, output
increaes
• So income increase from Oe to Om
• Percapita increase up to na.
• But here the income depressing forces 'fb' are greater
than income generating forces 'fa'.
• As a result, the economy will follow the downward path
'abcd'. And move back to old equilibrium E
• Why?
• Bcz if we invest in UDC which is less than
miminum required investment
• As result for short period employment, output
income increases
• But socks are greater than stimulents
• Ie, increased population , human skill, outdated
technology
• As result they cannot compete with advanced
countries and eventually they will shut down
• Again move back to trap
• Now if we invest which is equal to mimum
required investment level
• Income increase from Oe to Om
• Oercapita increase upto SG
• Socks= stimulents
• After G , shocks are less than stimulents
• So economy is growing
• Why?
• Investing infrastructure, technology, human skill
help to grow
• Criticism :
• Do no explain a specific relationship btwn pop growth and
percapita income growth (ncreasing function of growth of
per capita income in the beginning. While later on, it is a
decreasing function. )
• Closed Economy Model:
• Ignores non economic factors
• No role for gvt
• Theory of Big-Push
• P.N. Rosenstein-Rodan
• The development process by its very nature is not a
smooth and uninterrupted process.
• It involves a series of discontinuous ‘jumps’.
• The factors affecting economic growth, are marked by
a number of “discontinuities” and “hump.”
• What is needed is a “big push” to undo the initial
inertia of the stagnant economy.
• It is only then that a smooth journey of the economy
towards higher levels of productivity and income can
be ensured.
• A certain minimum of initial speed is essential if at all
the race is to be run.
• A big thrust of a certain minimum size is needed in
order to overcome the various discontinuities and
indivisibilities in the economy and offset the
diseconomies of scale that may arise once
development begins.
• According to Rosenstein-Rodan, marginal
increments in investment in unrelated individual
spots of the economy would be like sprinkling
here and there a few drops of water in a desert.
Sizable lump of investment injected all at once
can alone make a difference.
• theory is based upon the idea of ‘external economies’.
• external economies are defined as those unpaid benefits which go
to third parties.
• let us consider two industries A and B.
• If the industry A expands in order to overcome the technical
indivisibilities, it shall derive certain internal economies. This may
result in the lowering of the price for the product of the industry A.
• Now if the industry B uses A’s output as an input, the benefits of A’s
internal economies shall then be passed on to the industry B in the
form of pecuniary external economies.
• Thus, “the profits of industry B created by the lower prices of
product.
• A call for investment and expansion in industry B, one result of
which will be an increase in industry B’s demand for industry A’s
product.
• This in turn will give rise to profits and call for further investment
and expansion of industry A.”
Requirements for Big Push:
• ‘big-push’ approach lies in the reaping of external
economies But before that could become
possible, we have to overcome the economic
indivisibilities
• three kinds of indivisibilities:
(i) Indivisibilities in the production function, i.e., lumpiness
of capital, especially in the creation of social overhead
capital.
(ii) Indivisibility of demand, i.e., complementarity of
demand. (iii) Indivisibility of savings, i.e., kink in the
supply of savings.
Balanced Versus Unbalanced Growth Theories
• Both the theories are based on the theory of Big Push
• The balanced growth aims at the development of all
sectors simultaneously
• unbalanced growth recommends that the investment
should be made only in leading sectors of the economy.
• Underdeveloped countries have insufficient resources in
men, material and money for simultaneous investment in
number of complementary industries.
• The investment made in selected sectors leads to new
investment opportunities. The aim is to keep alive rather
than to eliminate the disequilibrium by maintaining
tensions and disproportions.
• Balanced growth aims at harmony, consistency and
equilibrium
• whereas unbalanced growth suggests the creation of
disharmony, inconsistency and disequilibrium.
• The implementation of balanced growth requires huge
amount of capital.
• unbalanced growth requires less amount of capital, making
investment in only leading sectors.
• Balanced growth is long term strategy because the
development of all the sectors of economy is possible only in
long run period.
• But the unbalanced growth is a short-term strategy as the
development of few leading sectors is possible in short span
of period.
Concepts of linkages.
• Hirschman
• The Strategy of Economic Development (1958)
• he proposes an unbalanced growth theory,
emphasising specific industries which have particularly
strong linkages with the rest of the economy.
• He argues that a developing country can grow from
prioritizing strategic sectors even with a relatively
small set of resources
• Hirschman uses the concepts of complementarity and
external economies to support his views on
unbalanced growth.
• Complementarity is an interdependence among
industries in the production process
• the external economy is the subsequent growth of
other industries originating from growth of a given
industry.
• The relationship among domestic industries is
known as ‘a domestic linkage’
• there are two kinds of linkages:
• backward and forward.
• a backward linkage of a given industry is strong when its growth
stimulates the production/use of other upstream industries. An
increase in these inputs is thus required to sustain the production
process.
• Eg:
• a rising demand in cars leads to an increase in the demand for
automotive parts
• Consequently, when backward linkages are strong, growth
fuels the rest of the economy.

• , forward linkage effects occur when the output of an

industry becomes the input for other industries.
• Eg: an increased amount of rubber can lead to an increase in
the production of goods that use rubber as inputs, such as
tyres and gloves.
• growth driven by linkages also hinge upon several factors such
as institutions (think of rules that encourage supply
management among firms without burdensome red tape) and
services (think of infrastructure needed to support several
stages of production).
STAGE THEORIES

Module IV
• Marxian Stage
• Karl Marx
• introduced the theory of stages of economic
development, which complemented his theory of
class struggle.
• He categorized economic evolution into five
categories
• slavery, feudalism, capitalism, socialism and
communism.
• Slavery:
• all the work is done by human labour like hunting,
preparing shelter, finding skin of animals or bark of a tree
to be used as cloths.
• This made the human labour the most important
resource which can earn income.
• Those who had maximum slaves were the most powerful
in the society.
• Feudalism:
• As the population increased, it was not possible to feed
huge population with only hunting.
• This increased the demand for land to grow food grains to
feed growing population.
• Mankind also started learning the art of sowing and
harvesting and invented tools to increase productivity.
• Shift of the economy from slavery to feudalism led to shift
of strategic resources from human labour to land.
• Those who land became most important and powerful in
the society. Fiefs held land with the permission of the king.
• Fiefs were the warlords who fought among themselves to
capture land from each other.
Capitalism:
• Industrial Revolution led to generation and spread of scientific
ideas and values among people.
• French Revolution led to realization of the need for freedom of
expression and speech.
• These developments led to many innovations and introduction of
new technology in many sectors.
• Technological improvements initially benefited agriculture resulting
in increasing the productivity.
• This led to displacement of labour from agriculture. textile and
mineral sectors
• which were able to employ labour displaced from agriculture.
• Agricultural activity was located in rural areas whereas textile and
mineral companies were located in urban areas.
• This led to shift of population from rural areas to urban areas.
• As the productivity increased in agricultural sector, lesser amount
of land was needed fa feeding population.
• This decreased the importance of land.
• Starting of ndustrial forms needed capital, which made the owners
of capital the most important and powerful section of the
population.
• Socialism and Communism:
• Maturity of capitalism will create intense class conflict
between labour class and bourgeois
• Ultimately, labour will unite together and over the state
controlled by capitalist class through a revolution.
• In a socialistic economy, labour will control the state and will
own the companies.
• Market mechanism will be substituted by planning by the
state.
• Income of the individuals will be decided by their needs and
not by market mechanism.
• Ultimately socialism will lead to communism whereby
state itself will wither away and there will be no shortage of
products.
• Rostow’s Stage Theory
• Walt W. Rostow.
• According to Rostow, the transition from
underdevelopment to development can be
described in terms of a series of steps or stages
through which all countries must proceed
• Rostow has conceived five universal stages;
• The traditional society,
• The preparation for the take-off
• The period of take
• The stage of drive to maturity
• The stage of high mass consumption.
• The Traditional Society:
• A traditional society is one of the simplest and primitive forms
of social organisation.
• Per Capita: Within a limited range of available technology
there is a low ceiling per capita output.
• Employment in Agriculture: A high proportion of workforce
(75% or more) are devoted in the production of agricultural
goods. High proportion of resources are also devoted in the
agricultural section.
• Social Mobility: A hierarchical, hereditary, status-oriented
social structure held down the mobility of society at that time.
• Political Power: The centre of gravity of political power was
localistic, region-bound and primarily based on land
ownership.
• Pre-Conditions for Take-Off:
• It is that stage of economic growth in which the progressive
elements creep into the otherwise barbaric and primitive psyches
of the members of the society.
• People try to break free from the rigidities of the traditional
society and a scientific attitude—
• Economic Progress: Economic progress became an accepted
social value. At this time the change of human mind took place
and they were able to think about their respective countries.
• New Enterprises: New types of enterprising people emerged on
the society. Their objective was to establish a firm or industry and
produce output for a long time.
• Investment: As the new enterprising persons emerged in the
society, the gross investment raised from 5% to 10%, so that the
rate of growth of output outstrips the rate of population growth.
• Infrastructure:As different industries were established in different parts
of the country, automatically transportation, more mobilised
communication, roads, railways, ports were required. So, infrastructure
was built all over the country.
• Credit Institutions: At that time necessary credit institutions were
developed in order to mobilise savings for investment.
• Mobilisation of Work Force: Due to industrialisation a large portion of
workforce was shifted from agricultural section to the manufacturing
sector. This was experienced in Great Britain in the time of
“Industrialisation (1760 onwards)”.
• Decline of Birth rate: At that time medical science was slowly
developing. The citizens understood the essence of control of birth rate
and death rates. At first the death rate was controlled and then the birth
rate was controlled. This was the second stage of Demographic Transition
experienced by the developed countries.
• Political Power: Centralised political power based on nationalism
replaced the land- based localistic or colonial power.
• The Take-Off Stage:
• The take-off stage marks the transition of the society from a
backward one to one that is on the verge of freeing itself from the
elements that retard growth.
• it is one stage in which there is a dynamic change in the society and
there is a meteoric rise in the standards set by the members of
society in all walks of life like industry, agriculture, science and
technology, medicine, etc.
• The Rate of Investment:. At the time of “Industrial Revolution” the
rate of investment was from 5% or less to over 10% of the national
income. At this time, agricultural lands were acquired for
industrialisation.
• Development of One Leading Sector: At the time of Industrial
Revolution (1760 on) we saw the development of particular
secondary section of each country in Europe.
• Eg: steel, textile
• Existence of Different Frameworks in the
Society: There was the existence of political,
social and institutional framework which exploited
impulses to expansion in the modern sector and
the potential external economies affected the
take-off and gave the process of growth a
sustained and cumulative character.
• The Drive to Maturity:
• Maturity in the context of Rostow’s theory refers to that state of
economy and the society as a whole, when winning on all fronts
becomes a habit or an addiction.
• Each and every effort to stimulate the economy meets with
success and the time period when the society tastes success is a
rather long one and the progress made on all fronts is there to stay.
• Shift in the Occupational Distribution: As due to Industrial
Revolution many industries were established in Britain and the
countries of. Western Europe, the work force was shifted from
agricultural sector to the manufacturing sector. The proportion of
the working force engaged in the agricultural sector went down to
20% or less.
• Shift in the Consumption Pattern: A new type of workforce was
created which was termed white-collar workers.
• Shift in the Consumption of Leading Sector:
The change in composition was observed to vary
from country to country. The Swedish take-off was
initiated by timber exports, wood pulp and
pasteboard products followed by the emergence
of railways, hydropower, steel, and animal
husbandry and dairy products. The Russian take-
off started with grain exports, followed by
railways, iron and steel, coal and engineering.
• The Age of High Mass Consumption:
• the stage at which durable consumer goods like radios,
TV sets, automobiles, refrigerators, etc.,
• life in the suburbs, college education for one-third to one
half the population came within reach.
• the economy, through its political process, expresses
willingness to allocate increased resources to social
welfare and security.
• Pursuit of national power and world influence,
• Welfare state redistributing income to correct the
aberrations of the market process,
• Extension of consumer demand on durable consumer
goods and high-grade foods.
• Concept of Dualism:Technological, Social,
Geographical and Financial.
• Latin duo, “two”.
• ‘dualism’ was originally coined to denote co-eternal
binary opposition, a meaning that is preserved in
metaphysical and philosophical duality discourse
but has been diluted in general usage.
• Dualism theories assume a split of economic and
social structures of different sectors so that they
differ in organization, level of development, and
goal structures.
Technological Dualism:
• Prof. B. Higgins
• the co-existence of traditional sector using
traditional technology and modern sector using
modern technology in less underdeveloped
countries.
• “a situation in which productive employment
opportunities are limited not because of lack of
demand, but because of resource and
technological restraints in two sectors.”
• The traditional rural sector has following main
features:
• It is engaged in peasant agriculture, handicrafts or very
small industries.
• Products can be produced with and wide range of
combinations of labour and capital.
• labour is relatively abundant factor and techniques are
labour intensive.
• Features of Modern Sector:
• This sector includes industries, plantation, transport and
related activities as its principal occupations.
• There is a limited scope of Technical substitutability of
factors of production.
• Compared to labour, more of capital is utilized
• Prof. Higgins explained the existence of
unemployment in underdeveloped dual
economies.
• There are two sectors of the economy:
• (a) Traditional sector (b) Modern sector
• There are two factors of production:
• (a) Capital (b) Labour
• Two Commodities are Produced
• X axis - capital (K)
• Y axis - labour (L)
• The points a, b, c denotes the fixed combinations
of factors i.e., capital and labour (K & L).
• The curve q1, is an isoquant representing a
certain level of output
• the output q1 can be produced only with the
unique combination of factors at point a.
• q1 q2q3 and q4 etc. represent different levels of
output increasing along the expansion line OE.
• The output can be increased only by increasing
the use of K and L in constant proportions given
by slope of OE.
• The dotted curves represent the case of ‘fixed
technical coefficient’.
Social Dualism:
• Prof. Boeke
• Social Dualism is the clashing of an imported social
system with an indigenous social system of another
style.
• Coexistance of capitalism and precapitalist rural
comunities
• imported social - capitalism.
• But it may be socialism or communism just as well, or
blending of them.”
• Social dualism thus is kind of social disintegration caused
by the rise of capitalism in less developed economies.
• Characteristics
• Limited Needs:
• economies is marked by limited needs in sharp contrast with
the western society.
• In western society, wants are unlimited.
• The reason of limited needs of the dualistic economy is
simple habits and simple way of thinking.
• People are therefore contented with their limited means or
money incomes.
• As soon as people earn sufficient money income to fulfil their
limited needs, people start preferring leisure to work.
• More Importance of Social Needs:
• Social perspective is of greater importance than the national
perspective.
• social value of the goods is of more important than their
economic value.

• Importance to Self Sufficiency:

• The eastern society considers ‘family’ as unit and every individual
is self-sufficient in his needs.
• People cannot easily induce to organise production or to collect
investment.
• According to Boeke “Not only do they feel strangers to basic forms
of exchange like business and profession but in so far as these are
business, they are always one-man affairs that can hardly
compete with western capitalism and are not lasting.”
• Geographical Dualism
• The thinking and knowledge of human being is always
dynamic which developed over a period of time under
the influence of society, culture, geography, climate and
peer group interaction.
• Co existance of developed and under developed
areas
• All these things can be best understood by analysing
concept of regional synthesis that sphere of geography is
not homogenous and is guided by various sister
disciplines which over period of time create dichotomy
and dualism.
• Financial Dualism
• Professor Myint
• Financial dualism means the coexistence of
organised and unorganised money market in the
LDCs.
Myrdal and Circular Causation

• Gunnar Myrdal in the year 1956.

• that a change in one form of an institution will
lead to successive changes in other institutions.
• All sectors are interdepended each other
• According to Myrdal, - “if things were left to
market forces unhampered by any policy
interferences, industrial production, commerce,
banking, insurance, etc.. Regional inequality will
increase
• In Myrdal’s analysis, the growth in advancing regions
affects the growth in depressed regions through:
• Spread effects
• Backwash effects.

• the spread effects have a positive impact on

the development of other region.
• Dvlpmnt of one region will help to dvlp other region
• Eg: Because of growth in the progressive region, on
the one hand, demand for agricultural products and
raw material from other regions in increased, and on
the other, advanced technology is made available to
lagging regions which they did not formally
processes. On account of these two factors, growth
in the other regions is promoted.
• the backwash effects are those effects
emanating from the centre of growth that
discourage growth in the other area.
• Movement of wealth from poor to rich region
• Because of their rapid growth, in contrast to the
stagnation of other regions,
• eg: the progressive regions attract net
immigration from other parts of the country.
There is a net movement of population, capital,
and goods in favour of the progressive regions
while the backward regions are continually
depressed
• the young, the educated; and the healthy that
migrate and All these factors have an adverse
effect on the growth of backward regions.
•
• A- represent dvlpd region B- under dvlpd
• X axis – labour dd and ss
• Y axis – wage rate
• Initial equilibrium in A- e, wage rate Wa
• Initial equi in B – e , wage rate – Wb
• Initial in both region the level of dvlpmnt is same bcz the
wage rate is same
• A is a dvlped region thus it will grow fast
• Investment, capita formation , dd for labour increases
• So dd for labour shift from D to D1
• New wage rate is W’a
• Wage rate in rural area is Wb
• So people start to migrate
• If more and more people migrate from B to A then
ss of labour will reduce in B
• SS of labour will shift from D to D1
• So wage will increase to Wb1
• And SS of labour increase in A so wage rate will
fall from W’a to Wa1
• New equilibrium is e1 in A and came to equal
each other
• Day by day region A getting advanced and B is
going down
• This will continue………..
• Thus Myrdal points out that the rich regions may
utilize external and internal economies of scale.
• Myrdal considers traditional mechanisms
such as mobility of capital, regional flows
and selective migration a means by which
cumulative mechanisms manifest
themselves.
• effects of individual cumulative mechanisms are
related and lead to a growth spiral to the outflow
of growth sources (capital and labour) from the
underdeveloped to more developed regions.
• Myrdal held that the If regional inequalities are
promoted through circular causation, then
doctrine of balanced regional growth is to be
advocated.
FINANCING ECONOMIC DEVELOPMENT

Module V
Domestic Resource Mobilization
• process through which countries raise and spend
their own funds to provide for their people–
• is the long-term path to sustainable development
finance.
• Domestic Resource Mobilization not only provides
governments with the funds needed to alleviate
poverty and deliver public services, but is also a
critical step on the path out of aid dependence
• Not a new tax or higher tax
• Governments often see their revenues rise
though improved audits or simplified filing
processes.
• Domestic Resource Mobilization through
Procurement Reform
• Efficient and effective procurement is fundamental
to good governance.
• Improving procurement practices can save both
governments and taxpayers money, freeing up
resources for other development spending.
• MCC promotes good governance by helping
countries establish or reform their regulatory
structures and institutions to enable open,
transparent, and accountable government
procurement.
• Domestic Resource Mobilization through Tax Reform:
• Tax reform is not simply about increasing domestic
revenue for public goods and services.
• It also includes activities that help fight corruption
through more transparent and streamlined tax
administration, which can improve a country’s
business climate as well as public perception and
confidence in government institutions.
• MCC provides partner countries with technical
assistance and guidance on institutional and policy
reforms that help them boost tax collection and
reduce opportunities for corruption.
• Prior-Savings Approach
• regards saving as a prerequisite of investment,
and stresses the need for policies to mobilise
saving voluntarily for investment and growth.
• The financial system has both the scale and
structure effect on saving and investment.
• It increases the rate of growth of saving and
investment, and makes their composition,
allocation, and utilization more optimal and
efficient.
• It activates saving or reduces idle saving
• In any economy, in a given period of time, there
are some people whose current expenditures is
less than their current incomes,
• while there are others whose current
expenditures exceed their current incomes.
• the former is called the ultimate savers or
surplus--spending-units, and the latter are called
the ultimate investors or the deficit-spending
units.
• Relationship between Financial System and
Economic Development
• helps to increase the volume and rate of saving
by supplying diversified portfolio of such financial
instruments, and by offering an array of saver.
• The growth of a banking habit helps to activise
saving and undertake fresh saving.
• A financial system helps to increase the volume
of investment also.
• It becomes possible for the deficit spending units
to undertake more investment because it would
enable them to command more capital.
• it encourages investment activity by reducing the
cost of finance and risk.
• This is done by providing insurance services and
hedging opportunities, and by making financial
services such as remittance, discounting,
acceptance and guarantees available.
• Finally, it not only encourages greater investment
but also raises the level of resource allocational
efficiency among different investment channels.
• The contribution of a financial system to growth
goes beyond increasing prior-saving-based
investment.
• There are two strands in this regard.
• According to the first one, as emphasized by
Kalecki and Schumpeter:
• financial system plays a positive and catalytic role by
creating and providing finance or credit in anticipation of
savings.
• to a certain extent, ensures the independence of
investment from saving in a given period of time.
• The investment financed through created credit generates
the appropriate level of income
• The second strand of thought propounded by
Keynes and Tobin:
• argues that investment, and not saving, is the constraint
on growth, and that investment determines saving and
not the other way round.
Financial Sector and Economic Development: A
Cautionary Approach :
• Many economists have taken a cautionary view of
the role of financial markets in development.
• The capital market enthusiasm and optimism
implicit in certain theories of finance
• Capital Asset Pricing Model and Efficient Market
Hypothesis with their multiple unrealistic,
restrictive assumptions, have been questioned in
different ways.
1. it has been argued that the financial sector can
perform the developmental role if it functions
efficiently, but in practice, it is not efficient.
Tobin’s analysis With logic and examples, he
has explained how the prices in financial markets
rarely reflect intrinsic values
2. it has been pointed out that the roles of capital
formation and finance in development have
been disproportionately stressed; that capital
shortage is not the single most important barrier
to development.
Empirically, it has been very often found that
the rate of capital formation increased without
raising the growth rate
• the above analysis are clearly expressed in the
following statements:
•  Real growth cannot be bought with money alone
(Chandler).
•  By and large, it seems to be the case that where
enterprise leads, finance follows (Joan Robinson).
Societies in which other conditions of growth were
favourable were usually capable of devising adequate
financial institutions (Habakkuk).
•  The role of finance in development is a subsidiary one
(Newlyn).
The Process of Financial Development

• It is difficult to establish precisely the sequence of

real and financial sector developments;
• the cause-and-effect relationship between them is
difficult to disentangle.
• It will be more correct to say that their growths are
intertwined, symbiotic, and mutually reinforcing.
• While financial markets accelerate
development, they, in turn, grow with
economic development.
• In the words of Schumpeter, the money market is
always the headquarters of the capitalist system
The Keynesian and Quantity Theory Approaches
to the Financing of Economic Development.
• The government normally finances its expenditure
through receipts from taxes, both direct and indirect.
• When government expenditure increases and it finds
it difficult to raise more resources from taxation, it
resorts to borrowing from the public or printing
money to finance its expenditure.
• Increase in rates of income and other tax not only
adversely affects incentives to work more, save and
invest more but also promotes tax evasion.
• there are limits to increasing revenue from taxes to
finance the increased expenditure of the
government.
• As a result, when government finds it difficult to
raise adequate resources to finance its increased
development expenditure fully through normal
taxes, it faces budget deficit
• Thus government budget constraint refers to the
limit placed on the government expenditure by the
extent it can raise resources through taxation,
borrowing from the market and using printed
money.
• The government has to make a choice between the
magnitude of borrowing from the market and the
magnitude of using printed money to finance its
budget deficit.
• Tgovernment budget equation is
• G = T + ∆B + ∆M … (1)
• G - government expenditure (including subsidies and
interest payments on past debt)
• T - tax revenue,
• ∆B - new borrowing from the market (through sale of
bonds or securities)
• ∆M - new printed money
• According to the budget constraint equation,
government expenditure in a year can be
financed by tax revenue (T), new borrowing (∆B)
by the government from the market (both within
and outside the country) through sale of its
bonds, and by creating new highpowered money
(∆M).
• The government budget constraint can be
rewritten as
• G – T = ∆B + ∆M … (2)
• G – T = fiscal deficit that must be financed by new
borrowing (∆B) and creation of new highpowered money
(∆M).
• The fiscal deficit can be financed by the government
either by printing money by the government or by
borrowing through sale of bonds to the public
• Bond
• borrowing by the government leads to the rise in
interest rate which crowds out private investment.
• if government finances its budget deficit by using
printed money, it can lead to inflation.
• Thus, due to budget constraint the government
has to make a difficult choice between
borrowing from the market and using printed
money to finance its budget deficit.
• Financing through the use of printed money is also
called money financing.
Prior Savings, Inflation and Investment:

• The prior savings approach is based on classical economics

• prior saving determines investment.
• They were against any deliberate policy of inflationary
financing through creation of new money
• there is a quantity theory approach which explains the
role of government in increasing its development
expenditure by generating inflation through creating
new money for financing its increased expenditure.

• In this quantity theory approach, through inflation,

government raising forced saving.

• Thus, financing development expenditure through printing

of new money and resultant inflation has been called
financing through inflation tax.
•
• The Keynesian Approach:
• investment that determines saving and not the
other way round.
• According to this it happens in two ways.
• 1. When resources are unemployed due to deficiency of
aggregate demand, the increase in investment through
creating new money
• will cause fuller utilisation of resources and thereby
increase in output and income.
• At higher levels of income, more will be saved.
• it is increase in investment that has generated larger
savings for its funding.
• 2. the higher investment causing larger savings
• when there prevails full employment increase in
investment causes income redistribution from the wage-
earning workers
• with lower propensity to save to the profit earners with
higher propensity to save as a result of inflation and thus
cause larger saving.

• Therefore, in the Keynesian model, investment is not

constrained by prior savings but by inflation rate
acceptable to the workers.
• Consumption is reduced through cut in real wages as
a result of income redistribution through the
medium of inflation
• How New Money is Created:
• When government’s investment expenditure
increases and it cannot be fully financed by tax
revenue, the government’s budget becomes
deficit.
• There are two possible links between budget
deficit and growth of money supply.
• First, the budgetary deficit that is financed by
borrowing by the government from the market reduces
the supply of lendable resources for the private sector
in the short run;
• this causes market interest rate to rise.
• Higher market interest leads to decline in private investment.
• In this way, budget deficit financed by borrowing crowds out
private investment.
• If the Central Bank is following the policy of targeting interest
rate, then to prevent the interest rate from rising it will
increase the money supply.
• To do so the Central Bank will buy a part of the securities or
bonds issued by the government.
• This is generally called accommodating the deficit
• The second, inancing the budget deficit through
the use of printing high powered money
• In this
Financing of Development through Money Creation:
• The government can finance its deficit and meet its
increased expenditure by printing high powered money.
• When government finances its budget deficit through
printing money, money supply in the economy increases.
• There are two views regarding the effect of increase in
money supply on inflation.
• According to the Keynesian view, when money supply is increased
in times of depression, effect of increase in money supply is to
raise output or income.
• The increase in real income, given the rate of taxation, will bring
about increase in revenue from taxation, which will tend to reduce
budget deficit in the short run
• If the government finances its deficit through money
creation, LM shift to right.
• where IS and LM curves of the economy intersect at
Point E1 and determine equilibrium income Y1 and
equilibrium interest rate r1

• Since we are assuming an economy with a

depression, when unutilised productive capacity
exists due to deficiency of aggregate demand,
• increase in demand brought about by expansion
in money supply will not cause any rise in price
level. .
2.
• if the economy is operating at or near full
employment, printing money to finance the
deficit will cause inflation.
Printed Money and the Inflation Tax:

• When government uses printed money to finance its

deficit year after year,
• it uses to pay for the goods and services it buys.
• in this process the government gets the resources to
buy goods and services and as a result, money
balances with the people increase, a part of which
they will save and the rest they will spend on goods
and services.
• However, due to inflation real value of money
balances held by the people decreases.
• Inflation Tax Revenue:
• In the Latin American countries, the governments
raised large revenues due to high inflation rates
caused by creation of large amount of printed
money due to budget deficits year after year.
• From the above equation, it is evident that
inflation tax revenue of the government depends
on the inflation revenue obtained by the
government will also be zero.
• As the inflation rate rises, the revenue obtained
by the government through inflation tax
increases.
• as the inflation rate rises, the people tend to
reduce their holdings of the real money balances
as the purchasing power of money holdings
declines.
• As a result, as the inflation rate rises the public
holds less currency and banks hold fewer excess
reserves with them.
• With this the real money balances with the public
and banks decline so much that inflation tax
revenue collected by the government declines
after a point.
• The change in the tax revenue received by the
government as the inflation rate rises is shown by AA
• Initially, in the economy there is no budget deficit
and therefore no printing of money, inflation rate is
zero,
• inflation tax revenue received by the government is
also zero
• Economy lies at the point of origin.
• As tax rate increases gvt collected revenue also
increases till a specific point
• Then decreases
Foreign Resource: Dual Gap Analysis

• Dual gap analysis which is also called two gap

analysis was made in the context of foreign aid or
foreign borrowing of capital by developing countries
required for achieving rapid economic development.
• Based on Harrod-Domar model
• which was generally used for development
planning laid stress on the saving rate and capital-
output ratio, as the two factors that determine
economic development.
• We explain below these two gaps in some detail:

• 1. Saving Gap or Saving Constraint:

• two gaps will be binding for any developing country at
any particular point of time.
• The saving gap is said to when domestic savings are
inadequate to support the desired rate of economic
growth though
• the shortage of saving can be viewed as lack of
productive resources such as manpower or other
productive resources in the economy
• In such a situation saving-gap constraint implies that the
excess foreign exchange might be used for importing
luxury consumer goods rather than capital goods and
industrial raw materials for bringing about higher
industrial growth rate.
• 2. Foreign Exchange Gap:
• the countries facing foreign exchange gap cannot
overcome it by using their excess domestic
saving.
• Therefore, foreign exchange gap is binding for
achieving a desired rate of economic growth.
• foreign capital inflows through foreign aid or
through FDI and FIIs
• so that they can import new capital and
intermediate goods including oil and petroleum
products
• 2011-12 and 2012-13 India faced large deficit on
current account of balance of payments of more
than 4% of GDP.
• If we had got adequate foreign capital inflows, it
would have been possible to fill in the foreign
exchange gap.
• national income accounting of an open economy:
• Y = C + I + X – M…........ (1)
• Y–C=I+X–M
• Y – C = national saving(S)
• Thus S = I + X – M or I – S = M – X …….…(2)

• the above equation (2) shows that

savinginvestment gap equals import-export
gap.