Lecture-1: Objectives & Functions

of Government, FD, RD, ERD, PD,

Types of Taxations
Unit-3 (A): Public Economics
NTA-UGC-NET
Economics (Paper-2)
Functions of Government

Functions of Government
Functions of Government

Functions of Government
Meaning of Government Budget
Objectives of Government Budget
 Meaning of Government Budget (Only in Class PDF)

Budget and Constitutional Provisions

• As per Article 112 of the Indian Constitution, the Union Budget of a year is termed as Annual
Financial Statement (AFS).
• It is a statement of the estimated receipts and expenditure of the Government in a financial year [01st
April of current year to 31st March of the subsequent year]
• Budget also consists of:
➢ Estimates of revenue and capital receipts,
➢ Means and ways to generate revenue,
➢ Expenditure estimates,
➢ Actual receipts and expenditure of the last financial year specifying the reasons responsible for
deficit or surplus, if any
➢ Economic policies and financial policy that will be applicable for the forthcoming year, for
example, taxation proposals, prospects of revenue, spending programme and introduction of
new schemes/projects.
 Meaning of Government Budget (Only in Class PDF)

Stages of Union Budget

An Union Budget has to pass through the following six stages:
• Presentation of Budget.
• General discussion.
• Scrutiny by Departmental Committees.
• Voting on Demands for Grants.
• Passing of Appropriation Bill.
• Passing of Finance Bill.

Budget Division of the Department of Economic Affairs in the Ministry of Finance is the nodal agency
responsible for budget preparation.

Recent Changes w.e.f. 2017

• Budget presentation to be held on February 1, which was earlier scheduled for last working day of
February month
• Clubbing of Railway Budget and the General Budget,
• Removing plan and non-plan expenditure (from the list of expenditure)
 Meaning of Government Budget (Only in Class PDF)

The Budget is presented to Lok Sabha in two parts, namely, the Railway Budget pertaining to Railway
Finance and the General Budget which gives an overall picture of the financial position of the Government
of India, excluding the Railways.
The Budget is presented to Lok Sabha on a day as the President may direct. Immediately after the
presentation of the Budget, the following three statements under the Fiscal Responsibility and Budget
Management Act, 2003 are also laid on the Table of Lok Sabha
(i) The Medium-Term Fiscal Policy Statement;
(ii) The Fiscal Policy Strategy Statement; and
(iii) The Macro Economic Framework Statement.
Simultaneously, a copy of the respective Budgets is laid on the Table of Rajya Sabha. In an election year, the
Budgets may be presented twice—first to secure a Vote on Account for a few months and later in full.
 Meaning of Government Budget (Only in Class PDF)

The Budget is presented to Lok Sabha in two parts, namely, the Railway Budget pertaining to Railway
Finance and the General Budget which gives an overall picture of the financial position of the Government
of India, excluding the Railways.
The Budget is presented to Lok Sabha on a day as the President may direct. Immediately after the
presentation of the Budget, the following three statements under the Fiscal Responsibility and Budget
Management Act, 2003 are also laid on the Table of Lok Sabha
(i) The Medium-Term Fiscal Policy Statement;
(ii) The Fiscal Policy Strategy Statement; and
(iii) The Macro Economic Framework Statement.
Simultaneously, a copy of the respective Budgets is laid on the Table of Rajya Sabha. In an election year, the
Budgets may be presented twice—first to secure a Vote on Account for a few months and later in full.
Components of Government Budget
Components of Government Budget

Components of Government Budget [Budget Receipts]

 Components of Government Budget

Non-Tax Receipts Components of Government Budget [Budget Receipts]

Components of Government Budget

Components of Government Budget [Budget Receipts]

Components of Government Budget

Components of Government Budget [Budget Expenditure]

Components of Government Budget

Components of Government Budget

Components of Government Budget

Types of Budget Deficits

 Components of Government Budget

This is only illustrative purpose and not data

For accurate and recent data, refer to Indian Economy section

Excerpt from Union Budget 2023-24

 Components of Government Budget

• Budget Estimates [Estimates of the coming financial year]

Amount of money allocated in the Budget to any ministry or scheme for the coming financial year. BE represents
the "intention to spend" of the government and are not legally binding

• Revised Estimates
Revised Estimates are mid-year review of possible expenditure, taking into account the rest of expenditure, New
Services and New instrument of Services etc. Revised Estimates are not voted by the Parliament, and hence by
itself do not provide any authority for expenditure. Any additional projections made in the Revised Estimates
need to be authorized for expenditure through the Parliament's approval. This is a mid-year estimates based on
six months actual trends and likely expenditure and receipts for the balance six months

• Actual Estimates [Estimates of expenditure and receipts of the preceding financial year]
Budget estimates as well as revised estimates are only expectations or projections. Actual estimates, as the name
suggests, is the amount actually spent by the ministry/department/scheme. Since this is derived after auditing
receipts, they are available only after the money has been spent.

• Provisional Estimates: Estimates of revenue and expenditure of the current financial year.
https://cms.pib.gov.in/WriteReadData/userfiles/Budget%20e-Book%2009%20jan.pdf
 Components of Government Budget

Figures in () indicate % of GDP

https://www.indiabudget.gov.in/doc/Budget_at_Glance/bag2.pdf
 Components of Government Budget

https://www.indiabudget.gov.in/doc/Budget_at_Glance/bag2.pdf
Components of Government Budget
Components of Government Budget
Components of Government Budget
 Components of Government Budget

Financing Sources Financing Through Deficits

Long Term Financing I) Long Term Financing
A) Financing from RBI
B) Financing other than RBI A+C=
C + D + E = Budget A + B + C + D + E =
Short Term Financing II) Short Term Financing Monetised
Deficit Gross Fiscal Deficit
C) Financing from RBI Deficit
D) Financing other than RBI
E) Drawing down of Cash

A. Net Interest Payment Deficits

B. Revenue Expenditure (except C)
minus Revenue Receipts
B+C+D+E
C. Revenue Expenditure for B+C+D= B = Effective B + C = A+ B + C + D A+ B + C + D
= Gross
Creation of Capital Assets Net Primary Revenue Revenue = Net Fiscal + E = Gross
Primary
D. Net Non-Debt Creation of Deficit Deficit Deficit Deficit Fiscal Deficit
Deficit
Capital Expenditure
E. Net Domestic Lending
 Components of Government Budget

Monetized deficit Also known as the ‘net reserve bank credit to the government’, it is that part of the government deficit
which is financed solely by borrowing from the RBI.
Since borrowings from the RBI can be both short-term and long-term, therefore, monetized deficit is the sum of the net
issuance of short-term treasury bills, dated securities (that is, long-term borrowing from the RBI) and rupee coins held
exclusively by the RBI, net of Government’s deposits with the RBI.
This is different from the Traditional Budget deficit in two ways-
1. Traditional Budget deficit includes 91-day treasury bills held by both, the RBI and non-RBI entities whereas
Monetized deficit includes 91-day Treasury Bills held only by the RBI.
2. Traditional Budget deficit includes only short-term sources of finance whereas Monetized deficit includes long-term
securities also.
Budget Deficit: From the year 1997, the government discontinued the issuance of ad-hoc and tap treasury bills. As a
result of this, now, the concept of budget deficit in the traditional sense has lost its significance in public finance and is
now not reported in the Budget documents of the Government of India.
 Components of Government Budget

Effective Revenue Deficit is the difference between revenue deficit and grants for creation of capital assets. The
concept of effective revenue deficit has been suggested by the Rangarajan Committee on Public Expenditure. It is
aimed to deduct the money used out of borrowing to finance capital expenditure. Effective Revenue Deficit was
introduced in the Budget of 2011-12 for the first time. In 2012-13, Effective Revenue Deficit was introduced as a fiscal
parameter.
The definition of the revenue expenditure is that it must not create any productive asset.
There are several grants which the Union Government gives to the state / UTs and some of which do create some assets,
which are not owned by union government but by the state government. For example, under the MGNREGA
programme, some capital assets such as roads, ponds etc. are created, thus the grants for such expenditure will not
strictly fall in the revenue expenditure.
Thus, despite being shown in the accounts as Revenue Expenditures, are involved with asset creation and cannot be
considered completely as ‘unproductive’.
 Components of Government Budget

Excerpt from
Union Budget
2023-24
Components of Government Budget
Components of Government Budget

Revenue Deficit
Components of Government Budget

Measures to Curb Revenue Deficit

Components of Government Budget

Fiscal Deficit
Components of Government Budget

How to meet Fiscal Deficit?

Components of Government Budget

Implications of Fiscal Deficit?

Components of Government Budget

Primary Deficit?
Components of Government Budget

Primary Deficit?
Questions [Dec 2010, June 2012]
 Questions

Arrange the following stages of the Budget in the

correct sequence.
A. Appropriation Bill.
B. General Discussion.
C. Finance Bill.
D. Presentation to the Legislative Assembly.
E. Voting on the Demand for Grants.
Choose the correct answer from the options given below:
A. B, C, E, A, D
B. A, B, E, C, D
In the budget at glance, which of the following items are included?
C. D, A, C, B, E A. budget estimate of the current year
D. D, B, A, C, E B. Revised estimate of the current year
C. Actuals of the current year
D. Actuals for the preceding year
E. Budget estimate for the forthcoming year.
Shift-1 Dec 2022
Choose the most appropriate answer from the options given below:
A. A and D only
B. A, B, D and E only
C. A, B and C only D.
D. C and D only
Lecture-2: Ability to Pay, Benefit
Theory, Impact, Incidence,
Elasticity, Buoyancy, Tax Shifting
Unit-3 (A): Public Economics
NTA-UGC-NET
Economics (Paper-2)
 Taxes

Tax?
• It is a compulsory levy and those who are taxed have to pay the amount of
money irrespective of corresponding return of services or goods by the
government.
• Tax-payer does not receive a definite nor any direct quid pro quo from govt.
• Direct means-> it is not like we pay for goods and services and receives and
enjoys benefits. That is, we don’t have any right to claim any benefits against
the tax paid.
• Quid Pro Quo -> means that can’t claim anything in exchange
 Taxes

Types of Tax
• On the basis of bearer & payer
➢ Direct Tax: Borne and paid by the same person. Burden can’t be shifted.
Impact & incidence of tax is on the same person.
Examples- Income Tax, Corporate Tax, Wealth Tax, Gift Tax, Other
Property Tax, Interest Tax

➢ Indirect Tax: Borne by someone (purchaser) and collected & paid by seller.
Burden can be shifted and impact & incidence of tax is on different persons.
Examples- Central Excise Duty (imposed by govt) like liquor, drugs |
Custom Duty (goods crosses political boundary), service tax, VAT
 Taxes

Types of Tax
• On the basis of tax rates
➢ Progressive Tax: Rate of tax increases with increase in income

➢ Proportional Tax: Rate of tax remains same irrespective of income

level.

➢ Regressive Tax: Rate of tax initially increases with increase in income

& thereafter, remains the same after a limit. So, higher the income,
lower is the proportion of the income that is to be paid in form of tax.

➢ Degressive Tax = Progressive + Proportional Tax

 Taxes

dt d 2t
 0 and 2
 0  Progressive tax  Tax Rates rises at rising speed with increase in Y
dY dY
dt d 2t
 0 and  0  Regressive tax  Tax Rates rises at diminshing speed with increase in Y
dY dY 2
dt d 2t
 0 and = 0  Proportional tax  Tax Rates rises at a constant speed with increase in Y
dY dY 2
 Average & Marginal Tax Rates

Average Tax Rate is the share of income that they pay in taxes. By contrast, a taxpayer’s marginal
tax rate is the tax rate imposed on their last dollar of income. While the former measures tax burden,
the latter that is marginal tax rates, on the other hand measures the impact of taxes on incentives to
earn or spend.

Let my income be Rs 10,00,000

let income tax slab be
✓ 0% upto 5 L,
✓ 10% from 5 L to 7 L and
✓ 20% for 7 L to 10 L
 Taxes

Average Tax Rate and Marginal Tax Rate

Let my income be Rs 10,00,000

let income tax slab be

✓ 0% upto 5 L,

✓ 10% from 5 L to 7 L and

✓ 20% for 7 L to 10 L

So, MRT is 10% of 2 L (7L-5L)= 20,000

Then for next slab it is 20% on 3L (i.e. 10L-7L) = 60,000

20,000 and 60000 are Marginal tax amount and 10% and 20% are MRT

While Average Tax is 80,000/10,00,000 *100 = 8%

✓ When Progressive MRT > ART

✓ Proportional MRT = ART

✓ Regressive MRT < ART

 Dalton’s Law

Dalton’s Law
• It measures the degree of progressiveness in a tax.
• P = d – (d’ + a)
✓ where p : degree of progressiveness;
✓ d : for the range of inequality of incomes before tax payment;
✓ d’ : for the range of inequality of net disposable income, after tax payment;
✓ a : value of positive constant relating to the allowance made for some increase in
inequalities on account of regressive, proportional and even regressive nature of
the tax system.

• It suggests that inequality would diminish only if P is positive as well as

greater than a.
 Impact, Incidence, Effect of Taxes
• IMPACT (initial burden): Statutory Incidence or Initial Incidence
• It denotes the immediate result of original imposition of the tax. Impact is on the
person on whom tax is imposed first.

• INCIDENCE (final burden): Economic Incidence or Final Incidence

• It refers to the location of the ultimate or the direct money burden.
• Impact is initial burden of the tax, Incidence refers to the ultimate burden of the tax.
• Impact is at the point of imposition, Incidence is at the point of settlement

• EFFECTS of Tax (final Outcome/results)

• When a tax is imposed and collected, it involves numerous responses from the tax-
payers and the economy as a whole. It can be on production, growth, saving,
investments, production technique choices, etc. Collectively, these responses are
termed as effects of tax
 Impact, Incidence, Effect of Taxes
Base, Buoyancy & Elasticity of Taxes

• BASE (kispe tax lagana hai)

• It is the legal description of the object on which tax is applied. Ex- Base of Income
Tax is income, excise duty is production or packaging, etc.
• In this, each tax payer is considered as legal entity and tax base is legally defined and
tax payable is time dimensional.
• It can be expanded or shrunk as per the government’s discretion.
 Impact, Incidence, Effect of Taxes
Buoyancy v/s Elasticity Base, Buoyancy & Elasticity of Taxes
Tax elasticity considers the
automatic response of
revenues to the change in • ELASTICITY (increase in tax revenue with rise in tax rate/ extension in coverage)
income given that tax • If tax revenue increases with an extension of tax coverage or increase in tax rates, then the
structure is unchanged. On
the other hand, tax tax is termed as elastic.
buoyancy reflects both the 𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑡𝑎𝑥 𝑟𝑒𝑣𝑒𝑛𝑢𝑒
• 𝐸𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 =
impacts of income and 𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑡𝑠 𝑐𝑜𝑣𝑒𝑟𝑎𝑔𝑒 𝑜𝑟 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒𝑠
discretionary changes on
revenue earnings. • BUOYANCY (increase in tax collection with rise in National Income w/o rise in tax rate)
•Tax buoyancy explains the
• If tax revenue increases with growth of national income, but without an extension of tax
relationship between the coverage or increase in tax rates, then the tax is termed as buoyant.
changes in government’s tax • Ex- with existing income tax rates and existing definition of taxable income, as national
revenue growth and the income rises, income tax revenues also rises, so income tax is buoyant.
changes in GDP.
•It refers to • Similarly, excise duties, if no new goods are brought into existing definition and without
the responsiveness of tax rise in tax rates, if collection of excise duties revenue increases then it is buoyant.
revenue growth to changes 𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑡𝑎𝑥 𝑟𝑒𝑣𝑒𝑛𝑢𝑒
in GDP. • 𝐵𝑢𝑜𝑦𝑎𝑛𝑡 =
𝑃𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒 𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒 𝑖𝑛 𝑛𝑎𝑡𝑖𝑜𝑛𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒
•When a tax is buoyant, its
revenue increases without
increasing the tax rate.
Tax Elasticity
•It refers to changes in tax
revenue in response to
changes in tax rate.
 Tax Shifting
Analysing Tax Shifting- Demand and Supply Theory
Tax incidence can be shifted only:
• through sale and purchase transactions
• through a revision of prices
• Price revision considers demand and supply elasticities
• Share of tax borne by seller will be greater, if demand elasticity is larger
• Share of tax borne by buyer will be greater, if supply elasticity is larger
𝐸𝑠 𝐼𝑛𝑐𝑖𝑑𝑒𝑛𝑐𝑒 𝑜𝑛 𝑏𝑢𝑦𝑒𝑟𝑠
• =
𝐸𝑑 𝐼𝑛𝑐𝑖𝑑𝑒𝑛𝑐𝑒 𝑜𝑛 𝑠𝑒𝑙𝑙𝑒𝑟𝑠
 Tax Shifting
Analysing Tax Shifting- Demand and Supply Theory
• Share of tax borne by seller will be greater, if demand elasticity is larger
• Share of tax borne by buyer will be greater, if supply elasticity is larger
𝐸𝑠 𝐼𝑛𝑐𝑖𝑑𝑒𝑛𝑐𝑒 𝑜𝑛 𝑏𝑢𝑦𝑒𝑟𝑠
• =
𝐸𝑑 𝐼𝑛𝑐𝑖𝑑𝑒𝑛𝑐𝑒 𝑜𝑛 𝑠𝑒𝑙𝑙𝑒𝑟𝑠
Impact of unit-tax is on seller. Initial demand and supply curves is DD’ and SS’.
As tax is imposed→ SS curve shifts upwards to S1S1’ and price rises to OE or P’M’.
Out of this P’M’, seller gets only AM’ & P’A goes to govt. as tax revenue.
P’M’ = P’A + AM’
(To Govt) (To Seller)
||
P’B + BA
(Incidence on Buyer) + (Incidence on Seller)
𝐸𝑠 𝐼𝑛𝑐𝑖𝑑𝑒𝑛𝑐𝑒 𝑜𝑛 𝑏𝑢𝑦𝑒𝑟𝑠 𝑃′𝐵
= =
𝐸𝑑 𝐼𝑛𝑐𝑖𝑑𝑒𝑛𝑐𝑒 𝑜𝑛 𝑠𝑒𝑙𝑙𝑒𝑟𝑠 𝐵𝐴

Impact of unit-tax is on buyer. Initial demand and supply curves is DD’ and SS’.
As tax is imposed→ DD curve shifts leftwards to D1D’1 &
𝐸𝑠 𝐼𝑛𝑐𝑖𝑑𝑒𝑛𝑐𝑒 𝑜𝑛 𝑏𝑢𝑦𝑒𝑟𝑠 𝑃′𝐵
= = = Same
𝐸𝑑 𝐼𝑛𝑐𝑖𝑑𝑒𝑛𝑐𝑒 𝑜𝑛 𝑠𝑒𝑙𝑙𝑒𝑟𝑠 𝐵𝐴
tax on inelastic demand

tax on elastic demand

 Tax Shifting

Conditions Results Conditions Results

Es = Ed • Burden of tax equally divided • Ed is Perfectly Elastic Entire burden on seller
between buyers and sellers • Es is Inelastic
• Price of good  by ½% of tax • Ed is Perfectly Inelastic Entire burden on buyer
Es > Ed • Burden of tax is more on consumer • Es is Elastic
• Price of good  by more ½% of tax • Ed is Inelastic Entire burden on buyer
Es < Ed • Burden of tax falls more on sellers • Es is Perfectly Elastic
• Price of good  by less ½% of tax • Ed is Elastic Entire burden on seller
• Es is Perfectly Inelastic
 Theories of Tax Shifting
Theories of Tax Shifting:
The earlier theories may be classified into:
(a) Concentration or Surplus theory: According to concentration theory, each tax tends to
concentrate on a particular class of people who happen to enjoy surplus from their products.

(b) Diversion or Diffusion theory: The diffusion theory states that the tax eventually got
diffused in the entire society. That is, the final placing of tax is not one but multiple. The
process of diffusion took place through shifting or through process of exchange.

Modern Theory: According to modern theory, the concentration and diffusion theories are
partially true. Actually there are both concentration and diffusion of taxes according to the
conditions present. The modern theory seeks to analyse the conditions which bring about
concentration or diffusion.
 Factors determining Tax Incidence
(a) Elasticity: While considering incidence we consider both elasticity of demand and elasticity of supply. If the demand for
the commodity taxed is elastic, the tax will tend to be shifted to the producer but in case of inelastic demand, it will be largely
borne by the consumer. In case of elastic supply, the burden will tend to be on the purchaser and in the case of inelastic
supply on the producer.
(b) Price: Since shifting of the tax burden can only take place through a change in price, price is a very important factor. If
the tax leaves the price unchanged, the tax does not shift.
(c) Time: In short run, the producer cannot make any adjustment in plant and equipment. If, therefore, demand falls on
account of price rise resulting from the tax, he may not be able to reduce supply and may have to bear the tax to some extent.
In the long run, however, full adjustment can be made and tax shifted to the consumer.
(d) Cost: Tax raises the price; rise in price reduces demand and reduced demand results in the reduction of output. A change
in the scale of production affects cost and the effect will vary according as the industry is decreasing, increasing or constant
costs industry. For instance, if the industry is subject to decreasing cost, a reduction in the scale of production will raise the
cost and hence price, shifting the burden of the tax to the consumer.
(e) Nature of tax: The incidence of taxation will definitely depend on the nature of tax. For example, an indirect tax’s
burden is fall on the consumer.
Approaches to Division of Tax Burden & Theories of Taxation
Physiocratic Theory: Advocated by Physiocrats, that only land has the capability of fetching
surplus and can add to the national wealth, so a nation should levy direct (and a single) tax on
land.
Financial Approach: Pluck the goose with as little squealing as possible
• Aims at maximum amount of revenue collection & not on proper distribution of tax
burden
• Problem- burden falls upon weaker section of society
Horizontal and Vertical Equity Theory: Equity has two aspects-
• Under like situations- those who are equally well off should pay equal tax amount
(horizontal equity)
• Under unlike situations- those who are dissimilar situations should be subject to dissimilar
treatment. People who are well-off should pay more taxes than others (vertical equity)
Cost-of Service Approach:
• Each tax payer has to pay tax = cost of service enjoyed by him
• Govt acts as a producer of good and charges tax (price) against the service rendered
• Problem- difficult to ascertain per capita cost of service (eg defence) & this is not in
accordance with the character of the tax
• This is based upon semi-commercial relationship between government and citizens.
Approaches to Division of Tax Burden & Theories of Taxation
Approaches to Division of Tax Burden & Theories of Taxation
Benefits Received Theory
• Burden of tax should be divided among people in proportion of benefits
received
• So people receiving equal (greater) benefits should pay equal (greater) tax
• It is demand sided and is based upon quid pro quo terms between
government & people

Lindahl’s solution
• A Lindahl tax is a type of taxation proposed by Swedish economist Erik
Lindahl in 1919, in which individuals pay for the provision of a public good
according to the marginal benefit they receive, to determine the efficient
level of provision for each public good.
• In the equilibrium state, all individuals consume the same quantity of public
goods but will face different prices under the Lindahl tax because some
people may value a particular good more than others.
 Lindahl’s Solution
Approaches to Division of Tax Burden & Theories of Taxation
Lindahl’s solution
• He developed a price system that leads to efficient allocation of public
goods.
• He viewed the sharing of costs by two customers of public good as supply-
demand relationship and formed a pricing rule.
• The vertical axis measures K, i.e. fraction of unit cost contributed by A.
• Given the unit cost C, so A contributes kC and her demand is Da for public
good and quantity enjoyed is S.
• Now, B’s contribution is (1 – k)C for quantity S. (both share the same
quantity)
• K + 1 – K = 1 or 100% and the equilibrium takes place at point E and
output of Public Good produced is OM.
 Ability to Pay Approach
Ability to Pay Approach
• There are two indices to ascertain paying capacity
✓ Objective Indices of Ability to Pay
➢ Property
➢ Consumption- Advocated by Kaldor and Fischer
➢ Income
✓ Subjective Indices of Ability to Pay
➢ Equal Absolute Sacrifice: tax-payers are made to sacrifice the same amount of
utility by way of taxes. [U(y) – U (y-T)]A = [U(y) – U (y-T)]B

➢ Equal proportional sacrifice: tax-payers are to sacrifice the same % of total

satisfaction which he would have derived from his income.
U(y) – U (y−T) U(y) – U (y−T)
{ }A = { }B
U(y) U(y)

➢ Equal marginal sacrifice (Least Aggregated Sacrifice): Advocated by

Edgeworth and Pigou, tax burden should be apportioned such that MU of
income left after tax with tax payer is same.
d U (y−T) 𝑑U (y−T)
{ }A = { }
d(y−T) d(y−T) B
 Ability to Pay Approach
Conditions Tax Nature Burden on High Burden on Low
Income Group Income Group
Equal Absolute • Less • Lowest • Higher
Sacrifice Progressive
Equal Proportional • More • Higher • Lower
Sacrifice Progressive
Equal Marginal • Highly • Highest • Lowest
Sacrifice Progressive
 Canons of Taxation

Principles of Taxation
A good tax system is the one which is developed and based upon certain set of
principles. Adam Smith gave 4 such principles
• Canon of Equality
• Canon of Certainty
• Canon of Convenience
• Canon of Economy
________________________
5 more added by economists over time
• Canon of Productivity
• Canon of Elasticity
• Canon of Diversity
• Canon of Simplicity
• Canon of Co-ordination
 Canons of Taxation
Principles of Taxation
A good tax system is the one which is developed and based upon certain set of principles. Adam Smith gave 4
such principles
• Canon of Equality: Related with the objective of economic justice. It states that rich people should pay more
taxes in absolute terms.
✓ Constant MU of Income: Both rich & poor will be subjected to proportional taxation with each person paying
a given % of his income as tax.
✓ Diminishing MU of Income: Richer should pay more proportion of their incomes as taxed (progressive tax)
• Canon of Certainty: It means that the tax should be certain and not arbitrary. Time of payment, manner of
payment and quantity payable should be clear.
• Canon of Convenience: Mode and timings of tax payment should be clear to the extent possible. There should
not be any unnecessary troubles
• Canon of Economy: Cost of tax collection should be minimum.
 Additional Canons of Taxation

Additional Canons
• Canon of Productivity: Taxation should have productivity in two ways.
✓ Tax yields Enough revenue: Tax collections should be enough to meet government expenses and
requirements.
✓ Diminishing MU of Income: Taxes should be levied in a manner not to discourage production.
• Canon of Buoyancy and Elasticity: It implies that the tax revenue should have a tendency to increase
along with the national income, even if the rates and tax coverage remain the same. The elasticity concept
implies that tax can be easily increased or decreased as per the government needs.
• Canon of Flexibility: Ease of possible revision in tax structure- coverage and rates.
• Canon of Simplicity: Easy to understand- computation, estimation, nature, aim, time of payment.
 Additional Canons of Taxation
Additional Canons Learners should read this
on their own
• Canon of Diversity: Government should aim at diversifying its tax base and should not aim only at a few
sources of tax. But too much taxation sources to be avoided.
• Canon of Expediency: It implies that tax should be based upon sound principles that are justified and tax
payers should have no doubt on its desirability.
• Canon of Co-ordination: Coordination among different taxes levied at local, State, Central government
levels.
 Effects of Taxation
Taxation can influence production and growth in three manner:
(i) effects on the ability to work, save and invest Learners should read this
(ii) effects on the allocation of resources on their own
(iii) effects on distribution of income

• Effects on the Ability to Work Save: Imposition of taxes results in the reduction of disposable
income. This will reduce their expenditure on necessaries which are required to be consumed to
improve efficiency. As efficiency suffers ability to work declines. This ultimately adversely
affects savings and investment of poor people. Taxation on rich persons has the least effect on
the efficiency and ability to work.

• NOT all taxes, however, have adverse effects on the ability to work. For example- tax on
cigarettes. The consumption has to be reduced to increase ability to work.

• BUT all taxes adversely affect ability to save. Since rich people save more than the poor,
progressive rate of taxation reduces savings → low level of investment. Lower rate of
investment has a dampening effect on economic growth.
 Effects of Taxation
Effects on the Ability to Work Save:
• Effects of taxes upon the willingness to work, save and invest depends on the income elasticity of
demand. Income elasticity of demand varies from person to person.

• Inelastic income demand→ A fall in income due to imposition of taxes will induce him to work
more and to save more so that the lost income is at least partially recovered.
• Elastic income demand→ Adversely affects the desire to work and save

Effects of Taxation on the Allocation of Resources:

• Taxation can affect the volume and the production quantity and can lead to diversion of resources
to the desired directions. Ex- High taxation on harmful drugs and commodities will reduce their
consumption and deviate the resources from the production of these goods.

• On the contrast, tax concessions on some products are given in a locality which is considered as
backward. In this way, taxation can promote regional balanced development by allocating
resources in the backward regions.
Learners should read this
on their own
 Effects of Taxation
Effects of Taxation on Income Distribution:
• Taxes can lead to reduction or increase in income inequality. It depends on the nature of taxes.
✓ High progressive taxation→ Reduce income inequality
✓ Regressive taxation→ Increases the inequality
✓ Taxes on luxuries and nonessential goods→ Favourable impact on income distribution.
✓ Taxes imposed on necessary articles→ Regressive effect on income distribution.

• A progressive system of taxation has favourable effect on income distribution but it has
disincentive effects on output.

• A high income tax will reduce inequalities but will lead to unfavourable effects on the ability to
work, save, investment and, finally, output.

• Thus, there is a trade off between the equitable income distribution and larger output.
Questions [Dec 2009]
Questions [J-2016 P-3]
Questions [J-2016 P-3]
Questions [J-2016 P-2]
Questions [J-2016 P-3]
Questions [Dec 2010]
Questions [Jan 2016]
 Lecture-3: Wagner's Law, Peacock-
Wiseman Hypothesis, Canons, Rahn
Curve, Armey Curve, Leviathan Model
Unit-3 (A): Public Economics
NTA-UGC-NET
Economics (Paper-2)
Homework Question: Will be solved in the next class
 Approaches to Division of Tax Burden & Theories of Taxation

Previous Class Approaches to Division of Tax Burden & Theories of Taxation

Benefits Received Theory
• Burden of tax should be divided among people in proportion of benefits
received
• So people receiving equal (greater) benefits should pay equal (greater) tax
• It is demand sided and is based upon quid pro quo terms between
government & people

Lindahl’s solution
• A Lindahl tax is a type of taxation proposed by Swedish economist Erik
Lindahl in 1919, in which individuals pay for the provision of a public good
according to the marginal benefit they receive, to determine the efficient
level of provision for each public good.
• In the equilibrium state, all individuals consume the same quantity of public
goods but will face different prices under the Lindahl tax because some
people may value a particular good more than others.
 Lindahl’s Solution
Previous Class Approaches to Division of Tax Burden & Theories of Taxation
Lindahl’s solution
• He developed a price system that leads to efficient allocation of public
goods.
• He viewed the sharing of costs by two customers of public good as supply-
demand relationship and formed a pricing rule.
• The vertical axis measures K, i.e. fraction of unit cost contributed by A.
• Given the unit cost C, so A contributes kC and her demand is Da for public
good and quantity enjoyed is S.
• Now, B’s contribution is (1 – k)C for quantity S. (both share the same
quantity)
• K + 1 – K = 1 or 100% and the equilibrium takes place at point E and
output of Public Good produced is OM.
 Ability to Pay Approach

Previous Class Ability to Pay Approach

• There are two indices to ascertain paying capacity
✓ Objective Indices of Ability to Pay
➢ Property
➢ Consumption- Advocated by Kaldor and Fischer
➢ Income
✓ Subjective Indices of Ability to Pay
➢ Equal Absolute Sacrifice: tax-payers are made to sacrifice the same amount of
utility by way of taxes. [U(y) – U (y-T)]A = [U(y) – U (y-T)]B

➢ Equal proportional sacrifice: tax-payers are to sacrifice the same % of total

satisfaction which he would have derived from his income.
U(y) – U (y−T) U(y) – U (y−T)
{ }A = { }B
U(y) U(y)

➢ Equal marginal sacrifice (Least Aggregated Sacrifice): Advocated by

Edgeworth and Pigou, tax burden should be apportioned such that MU of
income left after tax with tax payer is same.
d U (y−T) 𝑑U (y−T)
{ }A = { }
d(y−T) d(y−T) B
 Ability to Pay Approach

Previous Class Conditions Tax Nature Burden on High Burden on Low

Income Group Income Group
Equal Absolute • Less • Lowest • Higher
Sacrifice Progressive
Equal Proportional • More • Higher • Lower
Sacrifice Progressive
Equal Marginal • Highly • Highest • Lowest
Sacrifice Progressive
 Canons of Taxation

Previous Class Principles of Taxation

A good tax system is the one which is developed and based upon certain set of
principles. Adam Smith gave 4 such principles
• Canon of Equality
• Canon of Certainty
• Canon of Convenience
• Canon of Economy
________________________
5 more added by economists over time
• Canon of Productivity
• Canon of Elasticity
• Canon of Diversity
• Canon of Simplicity
• Canon of Co-ordination
 Canons of Taxation
Principles of Taxation Previous Class

A good tax system is the one which is developed and based upon certain set of principles. Adam Smith gave 4
such principles
• Canon of Equality: Related with the objective of economic justice. It states that rich people should pay more
taxes in absolute terms.
✓ Constant MU of Income: Both rich & poor will be subjected to proportional taxation with each person paying
a given % of his income as tax.
✓ Diminishing MU of Income: Richer should pay more proportion of their incomes as taxed (progressive tax)
• Canon of Certainty: It means that the tax should be certain and not arbitrary. Time of payment, manner of
payment and quantity payable should be clear.
• Canon of Convenience: Mode and timings of tax payment should be clear to the extent possible. There should
not be any unnecessary troubles
• Canon of Economy: Cost of tax collection should be minimum.
 Additional Canons of Taxation
Previous Class
Additional Canons
• Canon of Productivity: Taxation should have productivity in two ways.
✓ Tax yields Enough revenue: Tax collections should be enough to meet government expenses and
requirements.
✓ Diminishing MU of Income: Taxes should be levied in a manner not to discourage production.
• Canon of Buoyancy and Elasticity: It implies that the tax revenue should have a tendency to increase
along with the national income, even if the rates and tax coverage remain the same. The elasticity concept
implies that tax can be easily increased or decreased as per the government needs.
• Canon of Flexibility: Ease of possible revision in tax structure- coverage and rates.
• Canon of Simplicity: Easy to understand- computation, estimation, nature, aim, time of payment.
 Additional Canons of Taxation
Additional Canons Previous Class

• Canon of Diversity: Government should aim at diversifying its tax base and should not aim only at a few
sources of tax. But too much taxation sources to be avoided.
• Canon of Expediency: It implies that tax should be based upon sound principles that are justified and tax
payers should have no doubt on its desirability.
• Canon of Co-ordination: Coordination among different taxes levied at local, State, Central government
levels.
 Effects of Taxation
Previous Effects of Taxation on Income Distribution:
Class • Taxes can lead to reduction or increase in income inequality. It depends on the nature of taxes.
✓ High progressive taxation→ Reduce income inequality
✓ Regressive taxation→ Increases the inequality
✓ Taxes on luxuries and nonessential goods→ Favourable impact on income distribution.
✓ Taxes imposed on necessary articles→ Regressive effect on income distribution.

• A progressive system of taxation has favourable effect on income distribution but it has
disincentive effects on output.

• A high income tax will reduce inequalities but will lead to unfavourable effects on the ability to
work, save, investment and, finally, output.

• Thus, there is a trade off between the equitable income distribution and larger output.
 Principles for Public Expenditure: Wagner’s Law
Public Expenditure
Expenses of the public authorities or government at local, state, central for promoting economic welfare.

Principles for Public Expenditure: Wagner’s Law of Increasing State Activities

• It states that there exists a causal relationship between Govt. Expenditure and Eco Dev.
• He mentioned that during the course of eco dev, public expenditure rises more than proportionally with per
capita output. This implies income elasticity of demand for govt. exp. is more than 1.
• This is due to the rise in complexities in economic life and govt. has to incur increasing expenditure to cover
them.
• This theory is based on historical facts and is applicable to only those states which undertake expanding
public sector horizon and undertake activities related to overall benefits.
• He divided the Govt Exp. Into two categories-
✓ (1) Expenditure for Internal (due to urbanisation) and External Security
✓ (2) Expenditure for Cultural and Welfare (education, health)
 Principles for Public Expenditure: Wagner’s Law

• He divided the Govt Exp. Into two categories-

✓ (1) Expenditure for Internal (due to urbanisation) and External Security
✓ (2) Expenditure for Cultural and Welfare (education, health)
• He mentioned three types of activities lead to increase in Govt. exp.
✓ Law maintenance and enforcement internally and externally
✓ Increased participation in production of goods and services
✓ Increased provision of social services
Besides these, some additional factors too lead to rise in govt. exp.
✓ Rising Population
✓ Urbanisation (requires large civic amenities)
✓ Increasing debt servicing and repayment of loans and interest obligations
 Principles for Public Expenditure: Wiseman-Peacock
Principles for Public Expenditure: Wiseman-Peacock Hypothesis
• It states that the Govt. exp does not rises in smooth and continuous manner but in jerks and jumps ir steps like fashion.
• Whenever, some social and other disturbances take place, it creates the need for increased public expenditure. This
increased expenditure can’t met out of current public revenue. This becomes explicit to everyone in the economy.
Thereafter, finally govt. moves from older level to a newer and higher level of expenditure and taxation. This movement
is called DISPLACEMENT EFFECT.

• When the govt. moves to the newer and higher level of exp and tax, the people in the economy undertake review of the
whole process. This is called INSPECTION EFFECT.

• Gradually they all understand the motive behind the higher taxation and thereby are ready to bear the higher taxation.
They attain a new level of tolerance level. Consequently, they tolerate the greater burden of the tax and as a result, the
overall level of expenditure & revenue goes up to a new level.

• The economy gets stabilised at this higher level of tax and exp till next displacement effect.

• As with each disturbances, the central govt rises higher and concentrates on more economic activities, so it leads to
concentration effect in comparison to govt. at different levels like local and state. This is called CONCERNTRATION
EFFECT
Principles for Public Expenditure: Wiseman-Peacock
 Principles for Public Expenditure: Theory of Demand & Supply

Principles for Public Expenditure: General Theory of Demand and Supply of Govt. Services

• With the increasing economic activities and with more and more provision in private goods, there is a
corresponding demand for public goods.
• For example- education is much required today, so we have private schools along with the public schools.
• This complementarity between the private and public goods arises with the increase in per capita income.
 Canons of Public Expenditure [Findlay Shirras]
Canons of Expenditure
These principles governs the decision about public exp.

• Canon of Economy: Public Exp should only use that much resources that is required and extravagance and corruption
should be avoided. Techniques such as Zero Base budgeting and Performance Budgeting should be used to meet this
canon.

• Canon of Sanction: It implies that no pub. Exp should be incurred without the sanction of proper authority and also that
those funds should be used only for the purpose for which the fund has been approved.

• Canon of Benefits: All pub. Exp should be weighed against the expected cost and benefits derived from it. Public funds
should be spent in such a manner, the Marginal Utility from all uses should be equal.

• Canon of Surplus: It states that govt. should avoid deficit financing Govt. should always try to be prudent and every
possible attempt should be made to meet current expenditure from current revenue.

• Canon of Maximum Advantage: The objective behind this principle is that public money should be spent for general
cause and must promote social welfare. It should not be spent for the benefit of a particular group of society. Public
expenditure should result in increased production, elimination of inequality and promotion of welfare of all. It should
secure internal peace and also protection from external aggression.
 Canons of Public Expenditure [Findlay Shirras]
According to Findlay Shirras canon of economy should be observed in public expenditure. Economy does not mean
stinginess, but avoidance of waste and extravagance. Limited revenue resources should be used in a productive manner.
These principles governs the decision about public exp.
• Canon of Economy: Public Exp should only use that much resources that is required and extravagance and corruption
should be avoided. Techniques such as Zero Base budgeting and Performance Budgeting should be used to meet this
canon.
✓ Zero based Budgeting: By Peter Pyhrr in the 1970s. It is a method of budgeting in which all expenses must be
justified for each new period. The process of zero-based budgeting starts from a "zero base," and every function
within an organization is analyzed for its needs and costs. Budgets are then built around what is needed for the
upcoming period, regardless of whether each budget is higher or lower than the previous one. This budget is also
known as ‘Sun Set Budget’ which means the finance department has to present the zero-based budget before the
end of the financial year. In India, the ZBB was adopted by the department of science and technology in 1983. In
1986, the Indian government implemented ZBB as a system for determining Expenditure Budget. The government
made it compulsory for all ministries to review their activities and programmes and prepare their expenditure
estimations based on the concept of ZBB. In the seventh Five-Year Plan, the ZBB system was promoted.
 Canons of Public Expenditure [Findlay Shirras]
✓ Performance Budgeting: It is the practice of developing budgets based on the relationship between program funding
levels and expected results from that program. The performance-based budgeting process is a tool that program
administrators can use to manage more cost-efficient and effective budgeting outlays. The performance budget had
been in existence in India since 1968 when government departments started linking financial aspects with physical
results.
✓ Outcome Budget: To bring in professionalism and transparency in India, outcome budget was introduced in India as a
revision of earlier performance budgeting in 2005-06. For the first time in 2005-06, the outcome budget was presented
to the parliament covering only plan outlays. In India, development-related schemes such as MGNREGA, NRHM,
Mid Day Meal, PMGSY, Digital India, Prime Minister Skill Development Council, etc. are started every year. The
large sum of money is spent on these schemes every year. However, at present, the government doesn’t have any
parameters to measure the results of these schemes. The Government of India introduced the Outcome Budget in 2005.
 Classification of Public Expenditure

• Adam Smith classified public expenditure on the basis of functions performed by the government such as defence
expenditure, commercial expenditure and development expenditure.

• Dalton classified public expenditure into grants and purchase price. When the government transfers its resource without
any quid pro quo, it is grant. Expenditure incurred to provide services is grant. When the government transfers revenue to
individuals or community in return for specific services, it is called purchase price.

Normally, public expenditure is classified into:

1. Revenue expenditure: This means expenditure on civil administration, defence and welfare schemes, etc.
2. Capital expenditure: This is incurred once and all. It is non-recurring expenditure. Expenditure on multipurpose
projects, big factories like steel and cement, money spent on machinery, building and land are all capital expenditure.
3. Development expenditure: This is made on irrigational development, industrial development, education and health etc.
4. Non-development expenditure: This is the money spent on civil administration, police force, defence forces, judiciary,
etc.
 Size of Public Expenditure: Rahn Curve

An American economist Richard W Rahn (in 1996), a supply side supporter, set the goal of maximising
growth and held that beyond a certain level (e.g. 25 percent of GDP), public expenditure would be
counterproductive as it would compromise the level of growth. The inverted-U-shaped curve suggests that the
optimal level of government spending is 15–25% of GDP
 Economic Growth with Government: Armey Curve

The Armey curve reflects the idea that with no government, a nation’s economy will produce relatively little
output. As the size and expenditures of government increase, the economy’s output also increases, all else
equal. At a particular level of government spending, the economy’s output will be maximized, again holding all
other factors constant. Beyond that maximizing level of expenditures, the nation’s economic output will start to
decline as government begins to “crowd out” the private sector by assuming more and more of its resources and
functions.
Essentially, the relationship
depicted is one of diminishing
marginal returns to government in
the economy. Conceptually, the
Armey curve is similar to the Laffer
curve, which postulates that a tax
rate exists that maximizes the
amount of revenue the government
obtains from taxation.
 Size of Public Expenditure: Colin Clark’s Critical Limit Hypothesis

• It is concerned with the tolerance level of taxation. This theory puts forth 'Critical Limit Hypothesis', which
states that when public expenditure reaches 25% of the total economic activities, the tax payer's ability to pay
more tax is exhausted. Any further expenditure, would bring discouragement to the producers and fall in the
production due to taxation going beyond tolerable level.
• On the other hand, increase in government expenditure would constitute rising demand ultimately leading to
inflation in the economy.
• When government tax proceeds reach the threshold level of 25% ratio, incentives to earn and productivity
adversely fall.
• People become less resistant to the inflationary methods of government financing.
• If government expenditure is more than 25% then it will lead to inflation. So the limit of government
activities/share is 25%.
• If aggregate government expenditure reaches 25% then people produce less than before. This hypothesis
concern with the tolerance level of taxation
 Revenue Maximisation (Leviathan Model-1980)
by Geoffrey Brennan & James Buchanan
• This model considers State as a big monopoly. The word ‘leviathan’ means a big monster which has all the
power, here it is used for the State. Brennan and Buchanan consider State as a revenue maximising monopolist.

• It is all fine, till the point the State works for protecting the individuals welfare. But the things worsen when
State in the words of Buchanan, “who will chain the monster?”

• As per them, it is the tax-payer citizens who can chain the State through fiscal constitution. In this regard,
Wicksell argued that each expenditure proposals should be matched with the required amount of tax amount to
finance it. Indeed he suggested a balanced budget method to keep an effective check on revenue maximisng
behaviour of the state.

• Brennan and Buchanan argue that, as long as some individuals and firms are mobile, fiscal decentralization
forces governments to engage in tax competition, thereby destroying Leviathan’s monopoly on taxation and
bringing government spending closer to the preferences of citizens. Hence the empirical restriction that "total
government intrusion into the economy should be smaller, ceteris paribus, the greater the extent to which taxes
and expenditures are decentralized.
 Revenue Maximisation (Laffer Curve)
by Supply-sided Economist Arthur Laffer

• It illustrates a theoretical relationship between rates of taxation and the resulting levels of the government's tax
revenue. The Laffer curve assumes that no tax revenue is raised at the extreme tax rates of 0% and 100%, and
that there is a tax rate between 0% and 100% that maximizes government tax revenue. The shape of the curve is
a function of taxable income elasticity – i.e., taxable income changes in response to changes in the rate of
taxation.

• The Laffer curve is typically represented as a graph that starts at 0% tax with zero revenue, rises to a maximum
rate of revenue at an intermediate rate of taxation, and then falls again to zero revenue at a 100% tax rate.
However, the shape of the curve is uncertain and disputed among economists. Under the assumption that the
revenue is a continuous function of the rate of taxation, the maximum illustrated by the Laffer curve is a result of
Rolle's theorem, which is a standard result in calculus

• Paul Pecorino 1995 → 65% revenue maximizing rate

• Y. Hsing 1991 → 32.67% and 35.21% revenue maximizing rate
• Trabandt and Uhlig 2011 → 70% revenue maximizing rate
Lecture-4: Maximum Social Advantage,
Niskanen Model, Colin Clark's Limit
Hypothesis, Laffer Curve, Public Debt
Redemption
Unit-3 (A): Public Economics
NTA-UGC-NET
Economics (Paper-2)
 Size of Public Expenditure: Maximum Social Advantage

• The principle of maximum social advantage was proposed in 1920s

by H Dalton (latter by Pigou, Musgrave). It suggests that the limit of
government expenditure should be set so as to derive ‘maximum
social advantage’.
• Holding that entire expenditure is met by taxation, the limit of
taxation should coincide with that of public expenditure.
 Size of Public Expenditure: Maximum Social Advantage

• As public expenditure goes on increasing, its marginal social

advantage or benefit (MSB), keeps on decreasing; and as taxation goes
on increasing, its marginal social sacrifice (MSS), keeps on increasing.
• Net social benefit (NSB) = MSB – MSS keeps on decreasing from
high positive to high negative passing through the zero point. When
NSB = 0, MSB = MSS. Social benefit or social advantage, as Dalton
called it, is maximum when the size of public expenditure is at a level
where MSB = MSS.

• Therefore, taxation and expenditure should be carried up to this level and no further. Pigou, who was of the
view that taxes are collected and proceeds spent in the interest of the governed, called it ‘maximum aggregate
welfare’. This means, the principle of Maximum Social Advantage should be governed by two basic economic
laws: (i) decreasing marginal utility and (ii) equi-marginal utility
Size of Public Expenditure: Budget Maximisation (Niskanen Model-1971)
 Size of Public Expenditure: Budget Maximisation (Niskanen Model-1971)

• People are as rational while casting their votes like they are while choosing goods. This theory considers that
the people are motivated by self interests.

• In this theory, there are three parties- voters, legislators and executives (bureaucrats)

• According to Niskanen, rational bureaucrats will always and everywhere aim to increase the budget of their
own department, as it increases their power. They will contribute to the growth of State at the cost of society.
This is similar to Parkinson’s law, which says that ‘work expands to fill the time available for its completion’
much the same way as ‘gas expands to fit the volume’.

• A department comes into existence because there is demand for its services by the voters or electors. It offers
the services to the voters-electors. The budget of this department depends upon the quantity of services
offered by it. So, more amount of services offered, higher is the budget.

• The model assumes that the bureaucrats attempt to maximise their personal utilities by satisfying ‘self-
regarding preferences’ and that top bureaucrat decides the agenda to sell to the legislature.
 Size of Public Expenditure: Budget Maximisation (Niskanen Model-1971)

• There are two kinds of departments: 1) Earning revenue and 2) Spending revenue departments.

• The model proposes that the top bureaucrat in a spending department will try to maximise the department’s
expenditure budget, which brings prestige to the department.

• According to Niskanen, maximizing the expenditure is done by the department by equating Average Social
Benefit (ASB) with Average Social Cost (ASC) | ASB = ASC unlike Dalton’s view of MSB = MSC

Thus, department overproduces the services till the point,

Consumer Surplus is 0. However, the deadweight loss
will be equal to total surplus it could generate by equating
MSC with MSB. It can be seen that instead of attempting
to produce at Qo level it prefers to go to Q1 level. This
oversupply generates allocative inefficiency.

In India, this tendency is found to be very much present

particularly in centrally sponsored schemes which kept
proliferating. Review committees cut them down but they
again surfaced due to electoral process
 Size of Public Expenditure: Budget Maximisation (Niskanen Model-1971)
• There are five kinds of hypothesis in this model
• 1) The Overspending Hypothesis: Larger is the monopoly power of the government and the bureaus
supplying the government services, the larger will be the amount of overspending;

• (2) Production Inefficiency Hypothesis: Due to overspending, there exists inefficiency in producing a given
set of outputs and/or a higher level of some output.

• (3) The Oversupply Hypothesis: A bureau will supply more of some output valued by the legislature than
would be approved by the whole legislature;

• (4) The Overcapitalization Hypothesis: A bureau will use more capital-intensive production technology
than would a private firm producing the same service.

• (5) The Bureaucratic Structure Hypothesis: Due to consolidation of government competitive services
would increase the monopoly power of the government and lesser will be the incentives of bureaucrats from
competing on an efficiency basis to promoting the total demand for the service.
 Specific Tax Incidence and Differential Tax Incidenc

The person who originally pays the tax may not be actually bearing its money burden as such. This problem
is, therefore, to determine who bears the tax, ultimately. This is known as incidence of taxation.

The concept of “incidence” of taxation has been variously described by different economists.
Dalton, for instance, considers incidence as the direct money burden of tax on the person who ultimately
pays it. Incidence, thus, rests on the person who cannot shift the money burden of the tax to any other person.
For example, when a sales tax is imposed on a producer, but the producer recovers it from the buyers, so the
incidence of this tax lies on the buyers since they ultimately bear its money burden.

Dalton distinguishes between incidence and effects of taxation by putting that incidence are the direct money
burden of a tax while its effects are the indirect money burden.

Mrs. Ursula Hicks, on the other hand, talks of formal and effective incidence of a tax. The direct money
burden of a tax, she calls it formal incidence, while effective incidence is considered to be the economic
effects of the tax in a broader sense. To quote Mrs. Hicks: “The formal incidence means the proportion of
people’s income which does not form the incomes of those who furnish them with goods and services, but it
is paid over to governing bodies to finance collective satisfaction.”
Bridging gaps between different versions
 Specific Tax Incidence and Differential Tax Incidenc

Musgrave’s version:
• Specific tax incidence is one when the pattern of distribution changes due to the imposition of a new tax
or by changing the rates of existing taxation, keeping public expenditure and other budgetary phenomena
unchanged.

• Differential tax incidence refers to change in the distribution pattern in the economy caused by
substituting one tax for another, total tax revenue being unchanged.
 Public Debts
Public Debt
• It implies a total outstanding borrowing of the central government. All kinds
of obligations of a government including currency obligations are included in
public debt.
• Unlike an individual, government if under excessive debt, can’t be declared
insolvent.
• For individuals, when the expenditure > income, then they resort to
borrowings or debt. But for govt. it can be resort to debt, even if it does not
require funds, as it influences distribution of income, capital accumulation,
enhances employment and stability.
 Public Debts
Public Debt
• It implies a total outstanding borrowing of the central government. All kinds
of obligations of a government including currency obligations are included in
public debt.
• Unlike an individual, government if under excessive debt, can’t be declared
insolvent.
• For individuals, when the expenditure > income, then they resort to
borrowings or debt. But for govt. it can be resort to debt, even if it does not
require funds, as it influences distribution of income, capital accumulation,
enhances employment and stability.

Objectives of Public Debt

• To finance budget deficit
• To finance war and natural calamities
• To fulfil development plans
• To meet external debts and BOP deficits
 Redemption of Public Debts
Methods of Debt Redemption

• Utilisation of surplus revenue: This is an old method and badly out of tune with
the modern conditions. Budget surplus is not a common phenomenon. Even
when there is a surplus, it cannot be used for making any substantial reduction in
the public debt.

• Purchase of government bonds: The government may buy her own stocks in the
market, thus wiping off its obligation to that extent. This may be done by the
application of surplus revenues or by borrowing at low rates, if the conditions are
favourable.

• Terminable annuities: When it is intended completely to wipe off a permanent

debt, it may be arranged to pay the creditors a certain fixed amount for a number
of years. These annual payments are called ‘annuities’. It will appear that, during
the time these annuities are being paid, there will be much greater strain on the
government finances than when only interest has to be paid.
 Redemption of Public Debts
Methods of Debt Redemption

• Conversion of high-interest-rated loans to low-interest-rated loans: A

government may have borrowed when the rate of interest was high. Now, if the
rate of interest falls, it can convert a high-rated loan into a low-rated one.

• Sinking fund: This is the most important method. A fund is created for the
repayment of every loan by setting aside a certain amount every year out of the
current revenue. The sum to be set aside is so calculated that over a certain
period, the total sum accumulated, together with the interest thereon, is enough to
pay off the loan.

• Capital levy: A capital levy is just like a wealth tax in as much as it is imposed on
capital assets. Firstly, it enables a government to repay its (emergency) debt by
collecting additional tax revenues from the rich people (i.e., people who have
huge properties). This then reduces consumption spending of these people and the
severity of inflation is weakened. Secondly, progressive levy on capital helps to
reduce inequalities in income and wealth. But it has certain clear-cut
disadvantages too. Firstly, it hampers capital formation. Secondly, during normal
time this method is not suggested.
 Redemption of Public Debts
Q-11: Which one of the following is NOT the method of debt redemption?
A. Refunding
B. Repudiation
C. Sinking fund
D. Capital levy
 Redemption of Public Debts
Q-11: Which one of the following is NOT the method of debt redemption?
A. Refunding
B. Repudiation
C. Sinking fund
D. Capital levy

Answer ||| B
Solution |||
● The government can escape from the debt burden either by repudiating its debt or
repaying or redeeming them.
● Methods that can be utilized for redemption of public debt are Refunding, Conversion,
Surplus budgets, Sinking fund, Terminable annuities, Additional Taxation, Capital Levy
and Surplus Balance of Payments.
Thus, Option B is correct.
 Effects of Public Debts

• Effects on Production: Public debts are raised to finance productive enterprises of

various kinds, e.g., steel works, cement, multipurpose projects, construction of
ships, railway lines and highways, heavy electrical and engineering works, mining,
oil refining, etc.
• Effects on Consumption: When people subscribe to government loans, they
generally have to curtail consumption. Since investment of funds raised by
borrowing raises the level of employment and as a result raises the level of
consumption.
• Effects on Distribution: Public loans transfer money from rich to government.
The fiscal operations of the government are to benefit the poor primarily. The
incomes of the poor increase directly through increased employment or it benefits
them in directly through the enlargement of social services.
• Effects on the Level of Income and Employment: In modern times, public
borrowing is resorted to in order to raise funds for financing agriculture, industry,
mining, transportation, communication, etc. It increases employment
opportunities, the level of income and standard of living.
 Hicks’s Classification of Public Debts
Hicks’s Classification of Public Debts

• Deadweight Debt: It is one which is not covered by any real assets. In the words
of Hicks: “Deadweight is that which is incurred in consequences of expenditures
which in no way increase the productive power of the community, yielding neither
money revenue nor a future flow or utilities.” The loan raised during war period is
a deadweight debt because for such debts no real assets exist to balance them.

• Passive Debt: Sometimes government raises loans for spending on such projects
which neither yield money income nor help in raising the productivity of the
country. They simply provide enjoyments to the citizens such as public parks,
museums, public buildings, etc.

• Active Debt: Active debt is one which is spent on those projects that directly help
in yielding money income and increasing the productive power of the community.
 Hanson’s Classification of Public Debts
Hanson’s Classification of Public Debts

• Reproductive Debt: When a debt has assets to balance it, it is called reproductive
debt. For instance, if a state borrows money for spending it on the construction of
canals, railways, factories, etc, it is then able to repay the loan from these self-
liquidating projects.

• Deadweight Debt: A debt which is not covered by any real assets is called
deadweight debt. Debt invested on wars or prevention of war is a deadweight
debt.

• Funded Debt: Funded debts are long-term debts. The government continues
paying the annual interest on such loans but makes no promise to pay the principal
sum to the lender on any specified date. The examples of funded debts are long-
term government stocks, war loans and console.

• Floating or Unfunded Debt: Floating or unfunded debt comprises of short-term

loans. It is payable to the lender with interest on or before a fixed date.
 Hanson’s Classification of Public Debts

Dec 2013
 Hanson’s Classification of Public Debts

Dec 2009
 Hanson’s Classification of Public Debts

Dec 2011
 Hanson’s Classification of Public Debts

Jan 2012
 Hanson’s Classification of Public Debts

Sep 2013
 Hanson’s Classification of Public Debts

June 2016
NTA-UGC-NET | Classification of Public Debts
Classification of Public Debts

(a) Internal and External: When a state finds that it is not possible to obtain further
money by taxation, it resorts to borrowing from citizens and financial institutions
within the country. This is ‘internal borrowing’.
The state may accumulate funds by raising short-term loans or long-term loans or by
both. If the state is passing through a very critical period, then it can borrow all the
money which the nation saves. In that case trade and industry will suffer a lot because
no money is left to finance them. In the normal period, however, the state can borrow
only surplus funds which are left with the businessmen after meeting all the needs of
the business.

External loan is that which is raised from international money markets, foreign
governments, and from international agencies like International Monetary Fund.
When a state is in need of money, it tries to get as much loan as it can from other
states. The foreign governments do not advance loans without a limit. If the position
of the budget is sound and the taxable capacity of the nation is high, then a foreign
government may advance sizable loan to the borrowing country.
NTA-UGC-NET | Classification of Public Debts
Classification of Public Debts

(b) Productive and Unproductive: The debt that is expected to create assets which
will yield income sufficient to pay the principal amount and the interest on it, is
known as ‘productive debt’. In other words, they are expected pay their way; they are
self-liquidating. J.L. Hanson has referred such a debt as ‘reproductive debt’.

On the other hand, unproductive debt is the debt that is raised for financing
unproductive assets or heavy unproductive expenditures. Such a debt is a deadweight
debt. Debt invested on wars or prevention of war is a deadweight debt.

(c) Short-term and Long-term: The loans that are repayable within a period of one
year, they are termed as ‘short-term loans’ and if they are taken for more than one
year, they are referred to as ‘long-term loans’.
NTA-UGC-NET | Burden of Public Expenditure
Burden of Public Debts

If the debt is taken for productive purposes, for e.g., for irrigation, transportation,
railway, roads, information technology, human skill development, etc., it will not
mean any burden. Infact, they will confer a benefit. But if the debt is unproductive it
will impose both money burden and real burden on the economy.

(a) Burden of internal debt: Internal debt involves a series of transfers of wealth
within the country, i.e., from lender to government and then later on at the time of
redemption from government to lender. Money is thus transferred from one section of
the community to other sections. In this case the money burden on the economy is
zero.

But there may be real burden on the community. In order to repay the interest and the
principal amount of the debt, the government has to levy taxes. What the taxpayers
pay the lenders receive. The lenders are generally rich people and tax burden is fall
on poor especially in the case of indirect taxes. The net result may be that the wealth
is transferred from poor to rich. This is the loss of economic welfare.
NTA-UGC-NET | Burden of Public Expenditure
Burden of Public Debts

(b) Burden of external debt: External debt also involves a series of transfer of wealth
from the foreign lender to the borrowing country, and when it is repaid the transfer is
in the opposite direction. As the borrowing country paid interest to the foreign
lenders, a direct money burden is fall on the whole community.

The community is also suffered from real burden of external debts. Government has
to cover the amount of interest to be paid to the foreign lender by heavily taxing the
income of the community. As a result the production, consumption and distribution
of income is badly affected. Moreover, the foreign lender has direct involvement in
the economic activities of the country.
 NTA-UGC-NET | Burden of Public Expenditure
Public Expenditure or government spending means expenditure incurred by a government. A broad classification,
as practiced in India, is presented here.
There are two broad classification of a government’s (of any level) budget viz. economic classification and
functional classification.

Economic classification : Capital account deals with assets and liabilities while current account deals with current
revenue and current expenditure

• Revenue (or Current) Account- (i) revenue receipts and revenue expenditure
✓ (i) compensation of employees, (ii) purchase of goods and services,
✓ (iii) interest payment on debt, (iv) subsidies,
✓ (v) grants, (vi) social benefits, etc.
• Capital Account- (i) capital receipts and capital expenditure.
✓ (i) purchase of assets, (ii) building of assets,
✓ (iii) financial investment, (iv) loans, etc.

Functional classification:
(i) general public services, (ii) services related to economic affairs, (iii) social services and (iv) miscellaneous.
 NTA-UGC-NET | Burden of Public Expenditure
Alternative classification:
(i) Development expenditure: (i) agriculture, irrigation, livestock and forestry development; (ii) industry,
mineral and power development; (iii) transportation (road, railways, air and waterways); (iv) nuclear and
space programmes, communication and telecommunications, education, health and nutrition, social security,
etc. Development expenditure, therefore, covers both economic and social services

(ii) Non-development expenditure (on items like general services like legislatures, judiciary, police, etc.)
 NTA-UGC-NET | Burden of Public Expenditure
Direct Money Burden or Primary Burden of Public Debt: It is due to the money paid to the government by
the taxpayers. This represents the amount of GAS sacrificed due to the rise in taxation. If the taxpayers and the
bondholders are the same group of people, then there is no direct burden on society when government honors the
debt obligations of the bondholders. This is because in order to meet redemption of bonds, government taxes (the
same group ends up paying the taxes and they only receive the bond payments). However, if these two groups are
different, then there exists a change in income distribution (which is a real burden).

Direct Real Burden: It indicates the amount of burden or sacrifice made by the individual taxpayers to
individual bondholders. If the bondholders and the taxpayers are different, then the taxes are levied on the
taxpayers to raise amount required to meet the debt obligations owing to the bondholders. Generally, the tax
payers are the middle income class of the society, so there exists a transfer of wealth from poorer section to the
richer section of the society. This further leads to Indirect Real Burden, which is measured in terms of increased
income inequality and reduction in the incentive to work and save by the tax-payers.
Lecture-5: Capital Stock Transfer Theory,
Welfare Attitude Theory, Intergenerational
Equity, Optimal Tax Theory, Optimal
Commodity Tax, Ramsey Rule, Tiebout
Model
Unit-3 (A): Public Economics
NTA-UGC-NET
Economics (Paper-2)
 NTA-UGC-NET | Functional Finance
Functional Finance
• It is an economic theory proposed by Abba P. Lerner, based on effective demand principles and chartalism
(is a theory of money that argues that money originated with states' attempts to direct economic activity).

• It states that government should finance itself to meet explicit goals, such as controlling the business cycle,
achieving full employment, ensuring growth, and low inflation.

• It means that fiscal measures (G, T, S, PE, PD) should be judged only by their effects.
 NTA-UGC-NET | Functional Finance
Main Ideas of Functional Finance

• Governments must intervene in the national and global economy

• Main economic objective of the govt. should be to ensure a prosperous economy

• Money is a creature of the state; it has to be managed.

• Fiscal policy should be directed in light of its impact on the economy, and the budget should be managed
accordingly, that is, 'balancing revenue and spending' is not important; prosperity is important.

• The amount and pace of government spending should be set in light of the desired level of activity, and taxes
should be levied for their economic impact, rather than to raise revenue.

• Principles of 'sound finance' apply to individuals and not to the governments who is capable of issuing
money.
 NTA-UGC-NET | Functional Finance
Lerner framed Rules for Fiscal Policy

Lerner postulated that government's fiscal policy should be governed by three rules:
• The government shall always maintain a reasonable level of demand. If there is too little spending, thus,
excessive unemployment, the government shall reduce taxes or increase its own spending. If there is too
much spending, the government shall prevent inflation by reducing its own expenditures or by increasing
taxes.

• By borrowing money when it wishes to raise the rate of interest and by lending money or repaying debt
when it wishes to lower the rate of interest, the government shall maintain that rate of interest that induces
the optimum amount of investment.

• If either of the first two rules conflicts with principles of 'sound finance' or of balancing the budget, or of
limiting the national debt, so much the worse for these principles. The government press shall print any
money that may be needed to carry out rules 1 and 2.
 NTA-UGC-NET | Functional Finance
Ricardo-Pigou Thesis [Capital Stock Transfer Theory]

• This theory is coined by David Ricardo and later on developed by A.C. Pigou. According to this theory public
investment projects can be financed either through tax revenue or through borrowed capital by issuing bonds.

• As per this theory,

✓ if today government expense is financed by taxation, then the first generation transfers tax receipts to the second
generation;
✓ if today, government expense is financed by issuing bonds, then the first generation transfers bonds in form of
bequeaths to the second generation + a future tax liability levied to pay off the interest charges

• The welfare of future generation depends upon the sacrifice of present consumption without which capital cannot be
pooled to build up large productive base. However, the curtailment of current consumption depends on the reaction of
present generation to the withdrawal of real resources from the private economy, for the creation of public investment
projects.
Ricardo Thesis
 NTA-UGC-NET | Functional Finance
Ricardo-Pigou Thesis [Capital Stock Transfer Theory]

• If the government projects are financed by taxation, then the taxpayers are more likely to reduce their consumption,
because their disposable income is reduced.

• If the government projects are financed by issuing bonds, then the present generation would reduce investment and not
consumption. This is because the bonds are purchased using money out of savings and not out of consumption. Also they
can sell the bonds whenever required, so they are as liquid as money. Thus, bonds purchasing do not reduce disposable
income. So, with the bond issue option, people feel that they are richer. However, bond issue option carries future interest
earnings which will impose burden on the future generation in form of higher taxes at the time of repayment of bonds.

• Each of these methods, affects the second generation welfare differently. However, what affects the welfare of the second
generation is not whether it inherits tax receipt or government bonds, but it is the amount of real stock of capital that the
second generation inherits.

• In case of bond issues, the bond holders pays the subscription amount of bond from their savings, which they could have
utilized for other types of investments. Since they have subscribed for bond issue, so there is lesser amount left for other
investments, hence, lesser real productive capital stock, which reduces the output production capacity of the future
generation, hence, affects them badly.

• As a conclusion it can be stated that this orthodox approach ‘interprets intergenerational debt burden’ in terms of the ‘real
resources’ that are ‘available to the future generation due to debt financing by the present generation.
 NTA-UGC-NET | Functional Finance
Buchanan’s Thesis [Welfare Attitude Theory]

• James. M. Buchanan challenged the orthodox approach in 1958, in his book “Public Principles of Public
Debt”.

• He holds that the financing of a project by the government by borrowing (bond issue or debt) shift a burden
to the future generations.

• He argued that the government securities are purchased ‘voluntarily’ by the present generation who purchase
them, do not consider themselves to be undergoing a sacrifice whereas those in future generations who pay
the interest and redeem the bonds do experience a sacrifice through compulsory tax payments.

• This means that the individuals who give loans to the government voluntarily exchange excess cash for
government bonds instead of using the funds for acquiring consumption and/or investment goods. As this is
done voluntarily by the individuals, so they do not feel themselves to be any worse off.

• This argument revolves around the concept and interpretation of the term ‘burden’. Burden should be
interpreted in terms of individual attitudes & their economic well-being rather than changes in real stock or
output.
Buchanan Thesis
 NTA-UGC-NET | Functional Finance
Buchanan’s Thesis [Welfare Attitude Theory]
• For example if the required resources for funding the project is financed by tax resources, the taxpayers feel
worse off because tax is a compulsory contribution. Such compulsory payments involve an element of
sacrifice and taxpayers feel deprived of their enjoyment of income and hence this will lead to a reduction of
aggregated welfare.

• Whereas this is not the case in loan finance. Buchanan argues that during periods of borrowing and spending
activity, no burden of any kind is created. Individuals voluntarily exchange liquid funds (money) for
government bonds. This is done by diverting money from consumption purpose or for investment purpose in
private sector, output of equal value.

• No one feels himself to be any worse off, when bonds are repaid in future generation; funds are taken from
the taxpayers to pay the bond holders. In this situation, the taxpayers feel worse off, since their disposable
income is reduced.

• At the same time the bond holders do not feel themselves better off. Since they have merely exchanged
bonds for liquid cash. Since in the future generation, the bond holders are not better off, but taxpayers are
worse off, the aggregate welfare of society is reduced in the case of loan finance of public investment
project. Thus we can conclude that public debt shift the burden to future generation.
 NTA-UGC-NET | Functional Finance
Musgrave Thesis [Thesis of Intergeneration Equity]

He argues that debt finance for public investment projects necessarily spreads the burden among different
generations, whereas tax finance causes the present generation to bear the burden.

The Musgrave’s approach is based upon the ‘benefit principle’ of equity in debt burden distribution. He is of the
opinion that the cost of public investment projects should be borne by the users in proportion to the benefit they
enjoyed.

His example highlights that if a government project is financed by the bond issue, then the cost of this project can
be evenly distributed among all the generation in proportion to the benefits enjoyed by them. This is what is
termed as intergenerational equity. However, he stated that such an equity is impossible, if the project is financed
by tax.
 NTA-UGC-NET | Functional Finance
Musgrave Thesis [Thesis of Intergeneration Equity]
Example
Consider a project whose service become available in equal installments over three periods. Also suppose that the
life span of each generation covers three periods and that the population is stable. Let the repayment time limit of
loans is within the life span, i.e. 3 periods. In each period the benefit accrue to three generations:
• First period, benefits accrue to Gen 1, 2, 3,
• Second period, benefits accrue to Gen 2, 3, and 4,
• Third period, benefits accrue to Gen 3, 4, 5,

Benefits Received Cost Payable

Thus, the benefits of the projects are enjoyed by: Thus, the cost payable of the projects are :
Gen-1 and 5 for only one period Gen-1 and 5 for only one period- 1/9
Gen-2 and 4 for two periods Gen-2 and 4 for two periods- 2/9
Gen-3 for three periods Gen-3 for three periods- 3/9
 NTA-UGC-NET | Functional Finance
Musgrave Thesis [Thesis of Intergeneration Equity]
Thus, the total project cost has been divided between the five generations in accordance with the benefit received
by them. This can never be realized through tax finance.

Hence, the above example illustrated by Prof. Musgrave admits an intergeneration transfer of costs including debt
costs, among the five generations, which provides for the attainment of equality between ‘cost burden’ and
‘benefits received’ for each generation.

Thus, Richard. A. Musgrave argues that loan finance necessarily spreads the burden among different generations
while tax finance causes the present generation to bear the burden.
NTA-UGC-NET | Functional Finance
Optimal Tax Theories

Pareto efficient tax structure is one where there exists no alternative tax
structure, which can make at least one individual better off without making
anybody else worse off in the process.

There can also be many Pareto efficient tax structures depending on the initial
distribution of income or endowments.

But the optimal tax system is the one which maximises social welfare by using a
social welfare function.

This requires ranking the efficient tax structure in terms of equity criterion.

• equity and distribution of welfare

• Achieve the redistributional goals
All should be inculcated in
• minimises resource cost of the tax system Social Welfare Function
• justice and fairness
 NTA-UGC-NET | Functional Finance
Optimal Commodity Taxation
What is the best way to design taxes given equity and efficiency concerns?

This is the problem concerning Optimal Commodity Taxation. The following two factors must be balanced
when setting optimal commodity taxes:
• The elasticity rule: Tax commodities with low elasticities.
• The broad base rule: It is better to tax a wide variety of goods at a lower rate, because deadweight loss
increases with the square of the tax rate.

• Thus, the government should tax all of the commodities that it is able to, but at different rates. The tax rates
are determined by Ramsey Rule (1927). It requires that the optimal set of commodity taxes leads to an equal
percentage reduction in the compensated demands for all goods and factors. Today, an open set of tax rules
that contains Ramsey’s original tax rule and its numerous extensions, is known as Ramsey tax rules.
• Ramsey rule demands “equal-percentage change” in the quantities of each good (or factor) rather than equal
percentage change in the prices as implied by uniform taxation.
• He showed that a uniform commodity tax system, which does not change the relative prices is, in fact, rarely
optimal. It may appear that taxing goods and services at a uniform rate would be optimal, as relative prices
remain unchanged.
• Thus, imposing an uniform rate of tax on a good whose compensated demand is relatively elastic would
generate less revenue as well as greater inefficiency as demand changes relatively more.
 NTA-UGC-NET | Ramsey Rule
• The goal of the Ramsey Rule is to minimize deadweight loss of a tax system while raising a fixed amount of
revenue.
• The Inverse Elasticity Rule (IER) is often used in policy making as an approximation for equal percentage
change.
Ramsey Rule:
• It set taxes across commodities so that the ratio of the marginal
deadweight loss to marginal revenue raised is equal across Marginal Deadweight Loss MDWL
= =
commodities. Marginal Revenue MR
• As per this, the government should set taxes on each commodity 
Tax Rate =
inversely to the demand elasticity. In order to minimise Elasticity of Demand
substitution effect, less elastic items are taxed at a higher rate and
more elastic items are taxed at lower rates. This will keep
minimize the deadweight losses.
• The exemption of grocery from taxes is an example, which is
counter to the basic Ramsey rule because grocery demand is
relatively inelastic.
• It assumes that demands for different goods are unrelated, i.e., cross price elasticity of demand are zero along
with zero income effects.
In the case of linear and separable demand and supply curves (quadratic utility functions) and small taxes,
he shows that optimal taxes are inversely related to the compensated elasticity of demand and supply.
Ramsey Rule to Inverse Elasticity Rule
 NTA-UGC-NET | Functional Finance
Ramsey Rule: Derivation
• The purpose of the government is to raise a certain level of revenue & the aim is to collect this revenue most
efficiently i.e. to minimize the DWL in raising the revenue. So the problem is to min DWL subject to the
Revenue constraint:
NTA-UGC-NET | Functional Finance
Ramsey Rule: Derivation

The rule states that the proportional rate of tax on good

should be inversely related to its price elasticity of
demand. In other words, Ramsey rule recommends taxing
the various tax bases in opposite proportion to the
compensated elasticities of demand.
 NTA-UGC-NET | Functional Finance
Ramsey Rule: Limitations
While the assumption of uniform commodity taxes does not allow for distortions in the relative prices of
different goods, there are criticisms of the Ramsey model due to its underlying assumptions [such as not all
commodities are taxed and the supply curves are perfectly elastic (implicit assumption) so that consumers
bear the entire incidence of the taxes].

Ramsey formula recommends government to tax more the inelastic goods or put more tax burden on goods
where deadweight loss is low. While this will minimise efficiency costs, government might tax more the
necessities having low elasticity of demand, but taxing more of necessities will however result in lower
income consumers paying relatively more of the commodity tax than the high income consumers. This
implies that a poor, who generally consumes more of necessities, is taxed more and a rich, who consumes
necessities lesser than the poor, is taxed less. The opposite is implied for taxes on luxury goods. In this sense,
taxation is inegalitarian.

Therefore, the Ramsey solution provides an efficient way to tax commodities but not in an equitable way.
This suggests a regressive optimal tax system based on Ramsey model. Thus, while the basic Ramsey
problem of whether taxing all goods and services at a uniform rate is optimal remains (i.e. not completely
answered), Ramsey’s solution at least suggests that uniform rates do not often achieve optimality.
 NTA-UGC-NET | Functional Finance
NTA Ans- 2
Correct Ans-2
NTA-UGC-NET | Functional Finance
First Best Analysis
FBA means that the government has a set of policy options sufficient for
correcting whatever problems an economy has to restore the economy to the
bliss point on its first best utilities possibilities frontier.
Second best analysis is defined as the optimal policy of the government given
that the bliss point is unattainable.

If efficiency is the only concern, an ideal tax system is one, which is consistent
with Pareto optimality.
Imposition of lump-sum taxes, or, head tax as it is often referred to as, offers the
classical solution as this kind of tax does not affect the optimum configurations
attained by the consumers and the producers.

As, this kind of tax does not interfere with the decision making of the consumers
and producers as neither income nor prices, which determine the equilibrium
configurations, gets affected. Therefore, it would have been ideal if the
government could mobilise revenue only through this tax as the essential
properties of a Pareto optimal allocation would have remained satisfied.
 NTA-UGC-NET | Functional Finance
Tiebout Model
According to Tiebout the level and mix of local public expenditure and taxes are subjected to wide
variations among local political jurisdictions. So people will choose a particular community or
jurisdiction whose public expenditure and tax level best suits their own preferences for public goods and
services on the assumption that people can be mobile across communities. Thus, if the government
expenditure and taxation pattern is fixed, citizens will maximize their well being by choosing a
community or political jurisdiction, which Tiebout states as ‘voting on their own feet’
 NTA-UGC-NET | Functional Finance
Tiebout Model

The most important assumptions of Tiebout Model are as follows.

First, all citizens are fully mobile across local jurisdictions.

Secondly, they possess full knowledge of the government budgets in alternative political jurisdictions.

Thirdly, there are many communities that offer similar employment opportunities to their residents.

Fourthly, there are no inter-jurisdictional externalities.

The final assumption is that an optimum community size is one which corresponds to minimum cost of
the public services.
 NTA-UGC-NET | Functional Finance
First Best Analysis
But, in a real world it is not feasible.

Imposition of lumpsum tax treats all taxpayers on equal footing, which is unethical.

The government is always therefore in a Second Best environment where it levy distortionary taxes.

Also, necessary conditions for efficient outcome like perfect competition

and absence of externalities are absent.

In presence of externalities, Pigouvian taxes (or, subsidies) can correct for deviations between private
costs (or, benefits) and social costs (or, benefits) and help achieve Pareto optimal conditions.

Mostly, markets associated with externalities are ‘missing’ or non-existent. In such cases,
determining a Pigouvian tax structure to achieve optimality would not be feasible.
NTA-UGC-NET | Functional Finance
Theory of Second Best
PP' is the production possibility curve and all points on the
curve are Pareto efficient.
Lipsey and Lancaster, mentioned it is sometimes better to
move inside PP' to achieve a higher level of social welfare in
case all marginal conditions are not satisfied.

These social welfare curves represent combinations of two

products X and Y, which yield the same level of social
welfare.

Further, the higher the level of social welfare curve denotes

higher
level of welfare. It will be seen from the figure that point H at
which social welfare curve is tangent to PP' shows maximum
social welfare point satisfying all the marginal conditions of
Pareto optimality.
NTA-UGC-NET | Functional Finance
Theory of Second Best
Now, suppose due to the existence of monopoly in the
markets of the two goods, X and Y, the socially best point H
is unattainable. Further, suppose that under such
circumstances, combinations lying on the line CC' are
attainable. Suppose the economy is at present at point L on
the attainable line CC'. If Pareto optimality is to be achieved,
we can move from a point L, which is inside PP’ to point A
or B which are also on the attainable line CC'. However, as
will be seen from the figure, moving to point A or B on PP'
would put us in a lower welfare curve W1 If instead from
point L, we move the point E, which is inside PP' and is
therefore Pareto inefficient and yields a higher level of
welfare as indicated by Wz. Thus, the theory of second best
asserts that when one of the marginal conditions of Pareto
optimality is not satisfied due to some or other reasons, it
may be better to violate other marginal conditions of Pareto
optimality to achieve maximum possible social welfare.
Contestable Markets
Contestable Markets
Coase Theorem have been or will be tackled in
• Microeconomics segment [Lecture-27] &
• Environmental Economics segment [Lecture-10]
Externalities concept will be tackled in Lecture-10

Lecture-6: Types of Goods- Public, Private

and Merit Goods
Unit-3 (A): Public Economics

NTA-UGC-NET
Economics (Paper-2)
 Workshop Tomorrow at 6 p.m. only on BEP App

https://byjusexamprep.com/events/how-to-start-preparation-for-ugc-net-2023-session?utm_source=f5043540-cd33-11e8-a349-
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Public Goods and Private Goods
Public Goods & Private Goods
• Public goods cause market failure due to problem of
missing markets.
• Non-Excludability: Benefits derived from pure public
goods cannot be confined solely to those who have paid
for it. Non-payers can enjoy the benefits of consumption
at no cost to them (termed as free-riser problem)
• Non-rival Consumption: Each individual’s enjoyment
of good or service does not diminish other’s enjoyment.
MC of supplying a public good to an additional
individual is 0. If a public good is supplied to one, it is
available to all.
• Non-rejectable: The collective supply of a pure public
goods for all means that it cannot be rejected by people,
say defense
• The main reason why private sector cannot provide
public goods is the difficulty in protecting the property
rights.
• Public goods are also known as Collective Consumption
Goods
Public Goods and Private Goods
Public Goods & Private Goods
• A quasi-public good is a near public good, as it possess some of the
features of public good, like:
• Semi Non-Rival: Till a point, more people using a part, beach,
open wi-fi donot reduce the space/speed available for/to others. But
as no. of users increases, the speed reduces, space become
crowded.
• Semi Non-Excludable: Although possible but is difficult to
exclude non-paying consumers like fencing the park, charging
entrance fees to the beech, putting accessing fees to wi-fi.
Public Goods and Private Goods
Public Goods & Private Goods
• Private Goods: Refer to all those GAS consumed by private
individuals to satisfy their wants.
• These goods can be provided in competitive market

Features
• Excludable: The suppliers of private good can very exclude those
who either can’t or unwilling to pay.
• Rivalry in Consumption: One’s consumption reduces the amount
available to others.
• Revealed Preference: People reveal their preference effective
demand and market price. The revealed preferences are the signals
for the producers to produce goods that the individuals want.
 Club Goods, Common-Pool Resources & Free Goods

Club goods
Club goods, sometimes referred to as artificially scarce goods, are often excludable and non-rivalrous
public goods. This means that the item is available for the public to benefit from, and it can keep its value
no matter how many people consume it. However, the item is excludable because it allows consumers to
bar other people from gaining its benefits if they don't pay for it. These items are artificially scarce
because there is a financial gain in making them exclusive rather than the possibility of them running out.
Examples of club goods include items like: Toll roads, Private parks, Cinemas

Common-pool resource goods

A common-pool resource good is an item that's created as part of a resource system. This item can be
natural or man-made. These goods are typically public, but they can become a private or excludable good.
These goods differ from public goods because they have high consumption rates, which can impact their
value. Some examples of common-pool resource goods include: Fishing grounds, Irrigation systems, Coal
mines, Timber fields

Free goods:
Free goods are those goods that exist in such plenty that you can have as much of them as you like without
any payment, e.g., air, sunshine, etc. They are free gifts of nature. Man has not made them nor has man to
pay for them to get them.
Merit Goods

Merit Goods- R.A. Musgrave-1959

• Those goods whose consumption and use are to be

encouraged are merit goods. For ex- education
• Merit goods are rival and excludable.
• Merit goods are socially desirable goods and promote
social welfare.
• Governments provide merit goods in order to ensure
distributional justice. These are the goods which the
government feel if the people will underconsume or
produce, so these goods should be subsidized or
provided free. Ex- education, mid-day meals, essential
food articles
 Merit Goods

Merit Goods- R.A. Musgrave-1959

• Consumption of merit goods generates positive externalities- Social

Benefits from Consumption > Private Benefits
• A merit good is a product that society values and judges that people
should have regardless of their ability to pay.
• With merit good, individuals may not act in their own interest due to
imperfect information, i.e. they don’t fully understand the private
benefits of their consumption. Information failure is an important
aspect of the merit goods issue.
• Unlike pure public goods, merit goods can be rival, excludable and
rejectable.
Merit Goods v/s Public Goods

Merit Goods- R.A. Musgrave-1959

Merit Goods Public Goods
Provided by public and at times by Provided and funded by the
private sectors government
Positive MC of supplying to Collective consumption
additional users
Limited in supply due to high Largely unconstrained in supply
opportunity cost
Rival in consumption Non-rival in consumption
Excludable (like private education Non-excludable- leading the problem
and health care facilities) of free rider
Rejectable by those unwilling to pay Non-rejectable funded by the general
for GAS taxes

• Those goods who consumptions and use are to be discouraged are non-
merit goods or demerit goods eg- Alcohol.
 Mixed Goods

Mixed goods are basically those goods that are featured by the characteristics of both private and public
goods. Say, an entry in a park or club, which is dependent upon whether we pay the entry fees or not. If
we pay the entry fees, then we are allowed to enter the park but if not, then we are not allowed. So, in this
manner, entry to the park is a private good. But once we have entered, then there exists collective
consumption of park. It is non-rivalrous in nature. Different people can enjoy the beautiful scenery of the
park non-rivaloursly. Similarly, we can think of an example of the national highway, where we have to
pay the toll tax to enter but there is no maximum duration to take the exit.
 Material & Non-Material Goods, Global Public Goods

Material goods: These are items that are tangible, meaning you can touch, hold and see them within a
physical space. Consumers can move and transfer these goods from one location to another. Most goods
are material. Basic examples of material goods include items like: Cars, Food, Houses, Furniture,

Non-material goods
Non-material goods are intangible, meaning you can't touch, move or see them within a physical space.
Services, like those provided by teachers, doctors and actors, are the most common type of non-material
good. Several factors determine how much value people place on a non-material good, such as the quality
and timeliness of the service. Most non-rivalrous goods also count as non-material goods.

Global Public Goods: These are those goods whose benefits or costs are strongly universal across
countries, people and generations
 NTA-UGC-NET | Types of Voting
Voting models attempt to translate individual preferences in terms of Public Choice. When the
preferences of different individuals are expressed through points in the diagram or in written form to
derive the group choice applying voting models it is known as Spatial Voting Models.

Majority Voting
Let us assume that there are three individuals in the society X, Y and Z and there are three alternative
outcomes a, b, and c. There is pair-wise comparison of the outcomes and the transitivity rule is valid for
the individual preference as well as the group preference; i.e. if ‘a’ is preferred to ‘b’ and ‘b’ is preferred
to ‘c’ than ‘a’ is preferred to ‘c’

Let
X: a > b > c >(means preferred to)
Y: b > c > a
Z: c > b > a
For individuals X and Y, b > c for individuals Y and Z, c > a. It means the majority (two out of the three)
individuals prefer ‘b’ to ‘c’ and ‘c’ to ‘a’ therefore ‘b’ is preferred to ‘a’ due to the transitivity rule. Pair-
wise comparison of ‘b’ and ‘a’ also conforms to b>a by the majority rule. Therefore according to the
majority rule the group choice is b>c>a and it coincides with the preference pattern of individual Y. In
this case individual Y is known as the ‘Median Voter’.
NTA-UGC-NET | Types of Voting
Majority Voting
The preference patterns of X, Y and Z are given in Figure 1. Here
preferences are single peaked in the sense that they either increase or
decrease steadily (as in the case of X and Z) or have a single peak or
maximum (the case of Y). Therefore it is known as the Single Peaked
Preference Patterns and it identifies the Median Voter Y.

Let
X: a > b > c
Y: b > c > a
Z: c > b > a
According to the majority rule b >c and c > a => b > a (transitivity rule).
NTA-UGC-NET | Types of Voting
Majority Voting
The preference patterns of X, Y and Z are given in Figure 1. Here
preferences are single peaked in the sense that they either increase or
decrease steadily (as in the case of X and Z) or have a single peak or
maximum (the case of Y). Therefore it is known as the Single Peaked
Preference Patterns and it identifies the Median Voter Y.

Let
X: a > b > c
Y: b > c > a
Z: c > b > a
According to the majority rule b >c and c > a => b > a (transitivity rule).
 NTA-UGC-NET | Types of Voting
Majority Voting

X: a > b > c Let

Y: b > c > a X: a > b > c
Z: c > b > a Y: b > c > a
According to the majority rule b >c Z: c > a > b
and c > a => b > a (transitivity rule). However a > b according to the majority rule. It contradicts.
 NTA-UGC-NET | Types of Voting
Majority Voting

X: a > b > c Let

Y: b > c > a X: a > b > c
Z: c > b > a Y: b > c > a
According to the majority rule b >c Z: c > a > b
and c > a => b > a (transitivity rule). However a > b according to the majority rule. It contradicts.
NTA-UGC-NET | Types of Voting
Majority Voting

Let
X: a > b > c
Y: b > c > a
Z: c > a > b
According to the majority rule b >c and c > a => b > a (transitivity rule).
However a > b according to the majority rule. It contradicts. This is
known as ‘Cyclic Voting’ and leads to a paradox in decision-making. In
this case there is no median voter and it gives a non-single peaked
preference pattern. In Figure 2 the preference pattern of Z is not single
peaked as it forms a valley rather than a peak. The characteristic of a
single peaked preference essentially means that the middle range
alternative stands between or above the two extremes. This is true in
Figure 1 but in Figure 2, Z has no consistent pattern; he prefers either
extreme to the middle range. Hence there is no single peak, Z has double
peaked preference pattern.
NTA-UGC-NET | Types of Voting
Plurality Voting
In the case of plurality rule weightage is assigned in the ratio n: 1 for the
best preference and the least preference among n, alternative outcomes.
In between (n-1), (n-2), (n-3),……… weightage will be fixed for the rest
outcomes in descending order on the basis of order of preference
accordingly.
Suppose there are three individuals X, Y and Z and there are five
alternative outcomes such as a, b, c, d and e.
X: a > b > c > d > e
Y: a > b > c > d > e
Z: c >d > e > a > b
NTA-UGC-NET | Types of Voting
Plurality Voting
In the case of plurality rule weightage is assigned in the ratio n: 1 for the
best preference and the least preference among n, alternative outcomes.
In between (n-1), (n-2), (n-3),……… weightage will be fixed for the rest
outcomes in descending order on the basis of order of preference
accordingly.
Suppose there are three individuals X, Y and Z and there are five
alternative outcomes such as a, b, c, d and e.
X: a > b > c > d > e
Y: a > b > c > d > e
Z: c >d > e > a > b
Applying the majority rule the group choice will be a > b > c > d > e and
‘Z’ will be the minority.
In terms of plurality rule weight age will be assigned as follows
NTA-UGC-NET | Types of Voting
Plurality Voting
Group preference will be a > c > b > d > e
In comparison to majority rule outcome ‘c’ the best preference of ‘Z’
(the minority) is getting importance in the plurality rule as it is placed on
the second place in the group preference. It is on the third place in the
group preference under the majority rule. The best preference of the
majority is ‘a’ whereas the best preference of the minority is ‘c’. In the
case of comparison between ‘a’ and ‘c’, ‘b’ is considered as irrelevant.
Let us omit ‘b’.
This results as follows in terms of the preference pattern.
X: a >c >d >e
Y: a >c >d >e
Z: c >d >e >a
The group preference will be a >c > d > e according to the majority rule.

According to the plurality rule from

Table it is found that group preference
will be
c > a > d >e
NTA-UGC-NET | Types of Voting
Plurality Voting
a>c>b>d>e
In comparison to majority rule outcome ‘c’ the best preference of ‘Z’
(the minority) is getting importance in the plurality rule as it is placed on
the second place in the group preference. It is on the third place in the
group preference under the majority rule. The best preference of the
majority is ‘a’ whereas the best preference of the minority is ‘c’. In the
case of comparison between ‘a’ and ‘c’, ‘b’ is considered as irrelevant.
Let us omit ‘b’.
This results as follows in terms of the preference pattern.
X: a >c >d >e
Y: a >c >d >e
Z: c >d >e >a
The group preference will be a >c > d > e according to the majority rule.

According to the plurality rule from

Table it is found that group preference
will be
c > a > d >e
 NTA-UGC-NET | Types of Voting
Comparing Majority and the Plurality rule in this case it can be stated that the majority rule is independent of the
irrelevant alternative (i.e. ‘b’) whereas plurality rule is not.

Referring to Arrow’s “Rational Collective Choice” it is seen that plurality rule violates the axiom of ‘independence of
irrelevant alternative’. Hence plurality rule cannot be considered for the derivation of group choice. However the
supporters of plurality rule do not agree to it.
 NTA-UGC-NET | Types of Voting
Point Voting
In the case of point voting rule a fixed number of points (say, 100) is allotted to each voter. The voter castes number of
points in accordance with his intensity of preference for different alternative outcomes aggregating the number of votes
to the fixed number as allotted.
Let us assume that there are three individuals X, Y and Z and there are three alternative outcome a, b and c
X: a > b > c
Y: b > c > a
Z: c > b > a
Suppose each voter is allowed to allocate 100 votes among a, b and c in accordance with his intensity of preference.

Table explains point voting and concludes that the group choice results in b >c > a
However point voting rule gives scope for strategic voting because the casting of number of points for an outcome on
the basis of intensity of preference is not definite but subjective. Besides this, point voting might also give
indeterminate result in the group preference when alternative outcomes get equal number of votes in aggregate.
 NTA-UGC-NET | Types of Voting
Logrolling
Logrolling means vote trading. Individual X supports the preference of Y in one case provided that Y supports the
preference of X in the other case. It is illustrated in the following example.
Suppose the Government is making expenditure in the Education sector and also in the Health sector. Education is
explained by the size of school (S) and Health is explained by the size of Hospital (H).
Let H1, H2, H3 represent low size, medium size and big size of the hospital. The preference patterns of individual X, Y
and Z is given as follows:
 NTA-UGC-NET | Types of Voting
Logrolling

group choice, i.e. point M in Figure 3. Point X, Y and Z represent best position for individuals X, Y ad Z respectively on
the basis of their preferences for (H and S).
 NTA-UGC-NET | Types of Voting
Logrolling
If again there is logrolling between individual Z and Y, Z supports the preference of Y for S and in exchange Y supports the
preference of Z for H. This leads to final group choice and considered to rest on point ‘f’ in figure. Point ‘e’ and ‘f’

are different and it leads towards cyclic voting for H. Therefore in this case logrolling fails to derive the group choice. For the
success of logrolling an individual has to go for vote trading only with another individual, not with more than one individual
simultaneously.
Questions
Questions
 Lecture-7: Chelliah Committee, Jha
Committee, Narshiman Committee-I & II,
Sarkaria Committee, Gupta, Vyas and
Tarapore Committee
Unit-3 (A): Public Economics

NTA-UGC-NET
Economics (Paper-2)
 NTA-UGC-NET | Committee Special
Formation/ Report Submission
Committee Name Report on:
Date
Taxation Enquiry Committee Mathai Committee 1926
* Royal Commission on Indian Currency &
Hilton Young Commission 1931
* Indian Central Banking Enquiry Committee
Karve Committee village and small-scale industries committee 1955
Indian Tax Reforms-Report of a Survey Nicholas Kaldor 1956
R K Hazari Committee Industrial Licensing 1966
Subimal Dutt Committee Industrial Licensing Policy Inquiry Committee 1969
Wanchoo Committee Direct taxes Enquiry Committee Final Report 1970
Dandekar Committee first systematic assessment of poverty 1971
Raj Committee Taxation of Agricultural wealth & income 1972
Tandon Committee Report on Working Capital 1975
Jha Committee The Indirect Tax Enquiry Committee 1976
Ashok Mehta Committee 1978 Strengthening Panchayati Raj institutions 1977
Dantwala Committee Committee on Rural Banks 1978
Alexander Committee Review and Recommend on Import –Export Policies and Procedures 1978
Shivaraman Committee Establishment of NABARD 1979
Committee to Review Arrangements for Institutional Credit for
CRAFICARD 1981
Agriculture and Rural Development
Sarkaria Commission Centre-State Relations 1983
Kelkar Committee Working Group on Regional Rural Banks 1984
Conditions of Work and Promotion of Livelihoods in the Unorganized
Arjun Sengupta Committee 1984
Sector
 NTA-UGC-NET | Committee Special
Committee Name Report on: Formation/ Report Submision Date
Chakravarti Committee Monetary policy 1985
Vaghul Committee Money Market in India 1987
Khusro Committee Agricultural Credit Review Committee 1989
Goipuria Committee Exploring and giving recommendations for improving customer service in the banks 1990
Chelliah's Committee Tax Reforms Committee 1991
Narasimham Committee Committee on Financial System 1991
Rangarajan Committee Disinvestment of Public Sector 1993
Onkar Goswami Report of The Committee on Industrial Sickness and Corporate Restructuring 1993
reforms in the insurance sector
Malhotra Committee 1994
[Insurance Regulatory & Development Authority – a statutory body set up 2000]
Bhandari Committee Committee on Restructuring of RRBs 1994
Bagchi Committee Reform of Domestic Trade Taxes in India: Issues and Options 1994
S Padmanabhan Committee Review the System of on-site supervision over banks 1995
Misra Committee Working Group on Funds Management in RRBs 1995
Basu Committee Committee on Revamping of RRBs 1996
Tarapore Committee Capital Account Convertibility 1997
Abid Hussain Small scale industries and Trade Policy Reform 1997
Narasimham Committee-II Committee on Banking Sector Reforms 1998
R H Khan Committee Universal Banking 1998
Agrawal Committee Committee on Manpower Norms in RRBs 2000
ECRC Expert Committee on Rural Credit 2001
Rakesh Mohan Indian Railways Restructuring & Reorganisation, Departmentalisation & Infrastructure 2001
Kelkar Committee Recommendations of the Task Force on Direct & Indirect Taxes 2002
Vijay Kelkar Committee Taskforce on Direct and Indirect Taxes 2002
 NTA-UGC-NET | Committee Special
Formation/ Report Submision
Committee Name Report on:
Date
Competition Commission Established on recommendation of Raghavan Committee 2002
Advisory Committee on Flow of Credit to Agriculture and
Vyas Committee 2004
Related Activities
Tendulkar Committee Poverty Estimates 2005
Report of the Committee on
Second Tarapore Committee 2006
Fuller Capital Account Convertibility
Abhijit Sen Committee futures trading on agricultural commodity prices 2007
Saxena Committee Suitable Method for BPL Census 2009
Deepak Parekh Committee High Level Committee on Financing Infrastructure 2010
Y H Malegam Committee Microfinance 2010
Chaturvedi Committee Issues in Roads [Bucket-Basket Approach] 2010
Nair Committee Priority Sector Lending 2011
Hashim Committee Poverty Estimates 2012
Urjit Patel Committee on Monetary
2013
Policy Review and Strengthen the Monetary Policy Framework
Committee on Comprehensive Financial Services for
Nachiket Mor Committee 2013
Small Businesses and Low Income Household
M.B.Shah Committee Black Money 2014
 Indirect Taxation Enquiry Committee, 1967 [L K Jha]

Indirect Taxation Enquiry Committee, 1967 under L K Jha (former Governor of RBI) recommended:
• Rationalisation of the duty structure on final products & on raw materials.
• Introduce VAT system in Excise duty.
• Government took no initiative till 1986
• In 1986 MODVAT scheme was introduced.
• Attempt to bring Ad Valorem Duty, but lacked zeal.
• Converting specific duties into ad valorem rates, rate consolidation and input tax credit (ITC) mechanism of Value
Added Tax (VAT) at Manufacturing level (MANVAT).
• Input tax credit (ITC) is basically crediting back to the manufacturer the tax which was already paid at the time of
purchase of inputs for the production process.
• The recommendation was partially implemented in 1986 and was called MODVAT (modified VAT). Duty was
payable on value addition but was limited to select inputs and manufactured goods only and direct link between
input and manufactured good to be eligible for claiming ITC. The coverage was expanded by 1996-97.
 Recommendations of Raja Chelliah Committee [Tax Reforms Committee]

Following the Economic reforms of 1991, fiscal reforms were launched with the motive to reduce fiscal deficits,
expenditure management, resource mobilization through rationalisation of taxes and duties, widening of tax base,
modernising of tax administration, focusing attention on contingent liabilities and improving Centre-States fiscal
relations.
With this motive, the Government of India, in, 1991, set up the Tax Reforms Committee under the Chairmanship of
Raja J. Chelliah [Father of Indian tax reforms] to examine the then tax structure of the country and suggest appro-
priate changes. It submitted its report in January 1993, it has made several recommendations for reforming India’s tax
structure.
 Recommendations of Raja Chelliah Committee [Tax Reforms Committee]

Several measures recommended by Chelliah Committee:

• Reforming the personal taxation system by reducing the marginal tax rates.
• Reduction in the corporate tax rates.
• Reducing the cost of imported inputs by lowering the customs duties.
• Reduction in the number of Customs tariff rates and its rationalization.
• Simplifying the excise duties and its integration with a Value-Added Tax (VAT) system.
• Bringing the services sector in the tax net within a VAT system.
• Broadening of the tax base.
• Building a tax information and computerization.
• Improving the quality of tax administration.
 Recommendations of Raja Chelliah Committee [Tax Reforms Committee]

Recommendations : Direct Tax Reforms

1) Personal Income Tax: Recommended a reduction in top marginal rate to 40 % and adoption of a 3-tier slab system
with 20 %, 30 % and 40 %. [Implemented 20% and 30%, Initial exemption limit raised from Rs. 22,000 in 1991 to
Rs. 1,00,000 in 2007-08. The number of slabs has been reduced from 4 to 3 (10%, 20 % & 30%)]
(a) Aggregation of minor’s income, other than wage income, with the income of the parents.
(b) Abolition of tax concessions, rebates and allowances, under various incentives for saving schemes.
(2) Wealth Tax: Recommended the abolition of wealth tax on productive assets. Only unproductive assets and socially
undesirable forms of wealth were recommended to be taxed. [Implemented: Wealth tax on all assets, other than
those termed as unproductive assets, has been abolished]
(3) Capital Gains Tax: Recommended a moderate flat tax on long-term capital gains. [Implemented: capital gains of
price increases would be taxed]
(4) Corporate Income Tax: Recommended a uniform rate be applied to all domestic companies at 40 % and abolition
of surcharge on corporate tax. [Implemented 30% & to tackle zero tax companies which were having substantial
book profits, a ‘minimum alternate tax’ (MAT) was introduced in the 1996-97 budget.]
 Recommendations of Raja Chelliah Committee [Tax Reforms Committee]

Recommendations : Indirect Tax Reforms

1) Import Duties: Recommended overhauling of the system by merging of the regular and auxiliary duties;
(a) Reduction of very high rates of import duties to 15 % to 30 % for manufactures and 50 % for certain agricultural
items by 1997-98; [Implemented: The peak level of customs duty reduced to 10%]
(b) Abolition of exemptions and special treatments.

(2) Union Excise Duties: Recommended conversion of Union Excise Tax to Value Added Tax (VAT) system.
(a) For essential commodities, 10%, 15% and 20% of VAT.
(b) For non-essential commodities, 30%, 40% and 50% of VAT.

Results: VAT has been adopted by 25 states and Union Territories, uniformly across all the states at 4%, 2.5% &1 %.
The structure shifted to ad valorem rates. Import duties which were earlier 150% were reduced in a phased manner to
10% by 2007-08.
 Recommendations of Raja Chelliah Committee [Tax Reforms Committee]

Recommendations : Service Tax:

The TRC suggested that, a few selected services should be subjected to tax. It suggested that:
(i) advertising services,
(ii) services of stock Brokers,
(iii) services of automobile insurance,
(iv) services of insurance of residential property, personal effects and jewellery, and
(v) residential telephone services, be taxed.
Results:
• In 1994-95 budget, a 5 % union service tax on 3 services- namely telephone, general insurance and stock brokerage
was introduced.
• The number of services liable for taxation was raised from 3 to 6 from 1994-95 to 1996-97 and further to 100 in
2007-08.
• The service tax rate is 12 % of the value of taxable service. The service tax has been a buoyant source of revenue in
recent years, as it helped widen the tax net.
 Recommendations of Vijay Kelkar Committee

Government appointed the Vijay Kelkar Committee in 2002 which further provided direction to the tax reforms in the
country. The latest Impetus to direct tax reforms in India came with the recommendations of the Task Force on Direct &
Indirect Taxes under the chairmanship of Vijay Kelkar in 2002. The main recommendations of this task force related to
the direct taxes related to increasing the income tax exemption limit, rationalization of exemptions, abolition of long
term capital gains tax, abolition of wealth tax etc. Its key recommendations are as follows:
 Recommendations of Vijay Kelkar Committee

Government appointed the Vijay Kelkar Committee in 2002 which further provided direction to the tax reforms in the
country. Its key recommendations are as follows:
Administration of Direct Tax
• The taxpayer services should be extended both in quality and quantity and taxpayers should get easy access through
internet and email.
• PAN (Permanent Account Number) should be expanded and it should cover all citizens.
• Block assessment of search and seizure cases should be abolished.
• To clear the backlog, the department should outsource the data entry work.
• All returns and issue of refunds should be completed in a four month period. Dispatch of refunds should be
outsourced.
• Government should establish a Tax Information Network to modernize, simplify and rationalize tax collection,
particular TDS and TCS.
• Abolish the requirement of Tax Clearance Certificate on leaving the country.
• Empower CBDT with appropriate administrative and financial powers.
 Recommendations of Vijay Kelkar Committee

Personal income tax

• Increase in exemption limit to Rs.1 lakh for the general categories of taxpayers and further exemption for senior
citizens and widows.
• Rationalize income tax slabs, eliminate surcharge on personal income tax.
• Incentivise home loans by providing interest subsidy on home loans @2%.
• Increase deduction under Section 80CCC for contribution to pension funds.
• Only 2 slabs of tax rates-20 per cent upto income of Rs 4 lakhs and 30 per cent for income above 4 lakhs.
• Elimination of standard deduction and tax incentives under Sections 88, 80c and interest income under section 10.
 Recommendations of Vijay Kelkar Committee

Corporation Tax
• Reduce the Corporate tax to 30% for domestic companies and 35% for foreign companies.
• The listed companies should be exempted from tax on dividends and capital gains.
• Increase rate of depreciation for plant and machinery. Abolish Minimum Alternate Tax.
• The general rate of depreciation for plant and machinery to be reduced to 15 percent from the existing level of 25
percent.
• Income of mutual funds derived from short-term capital gains and interest to be taxed at a flat rate in the hands of
the mutual funds. Merger of tax on expenditure in hotels with service tax.

Wealth Tax
Abolition of wealth tax.
 The Narasimham committee (1991) [First NC]

• The Narasimham committee (1991) assumed that commercial banks' financial resources came from the general
public and were held in trust by the banks and that the bank funds were to be used to the greatest extent possible for
the benefit of depositors.

• This assumption implied that even the government had no business jeopardizing the solvency, health, and efficiency
of nationalized banks under the guise of using bank funds for social banking, poverty alleviation, and so on.

• As a result, the Narasimham committee set out to effect three major changes in India's banking sector:

o Assuring a certain level of operational flexibility.

o Banks have internal autonomy in their decision-making processes.

o Increased professionalism in banking operations.

 The Narasimham committee (1991) [First NC]

Recommendations
• Reduction in the SLR and CRR : The committee recommended the reduction of the higher proportion of the
Statutory Liquidity Ratio ‘SLR’ and the Cash Reserve Ratio ‘CRR’. Both of these ratios were very high at that time.
The SLR then was 38.5% and CRR was 15%. SLR was recommended to reduce from 38.5% to 25% and CRR from
15% to 3 to 5%.
• Phasing out Directed Credit Programme : In India, since nationalization, directed credit programmes were
adopted by the government. The committee recommended phasing out of this programme. This programme
compelled banks to earmark then financial resources for the needy and poor sectors at confessional rates of interest.
It was reducing the profitability of banks and thus the committee recommended the stopping of this programme.
• Interest Rate Determination : The committee felt that the interest rates in India are regulated and controlled by the
authorities. The determination of the interest rate should be on the grounds of market forces such as the demand for
and the supply of fund. Hence the committee recommended eliminating government controls on interest rate and
phasing out the concessional interest rates for the priority sector.
 The Narasimham committee (1991) [First NC]

Recommendations
• Structural Reorganizations of the Banking sector : To bring about greater efficiency in banking operations, the
Narasimham committee (1991) proposed substantial reduction in number of public sector banks through mergers
and acquisition. According to committee, the broad pattern should consist of;
➢ Three or four large banks including SBI should become international in character.
➢ Eight to ten banks should national bank with wide network of branches through out the country.
➢ The rest should remain as local banks with operations be confined to a specific region.
➢ RBI should permit the establishment of new banks in the private sector, provided they conform to the
minimum start-up capital and other requirements. The government should make declaration that no further
banks be nationalized.
➢ Foreign banks are allowed to open their branches in India either as fully owned or subsidiaries. This would
improve efficiency.
➢ Foreign banks and Indian banks are allowed to set-up joint ventures in regard to merchant and investment
banking.
 The Narasimham committee (1998) [Second NC]

In 1998 the government appointed yet another committee under the chairmanship of Mr Narsimham. It is better known
as the Banking Sector Committee. It was told to review the banking reform progress and design a programme for further
strengthening the financial system of India. The committee focused on various areas such as capital adequacy, bank
mergers, bank legislation, etc.
It submitted its report to the Government in April 1998 with the following recommendations.
• Strengthening Banks in India : The committee considered the stronger banking system in the context of the
Current Account Convertibility ‘CAC’. It recommended the merger of strong banks which will have ‘multiplier
effect’ on the industry.
• Narrow Banking : Those days many public sector banks were facing problem of the Non-performing assets (NPAs)
like as high as 20 percent of their assets. Thus for successful rehabilitation of these banks, it recommended ‘Narrow
Banking Concept’ where weak banks will be allowed to place their funds only in the short term and risk-free assets.
• Capital Adequacy Ratio : In order to improve the inherent strength of the Indian banking system the committee
recommended that the Government should raise the prescribed capital adequacy norms. This will further improve
their absorption capacity also.
 The Narasimham committee (1998) [Second NC]

Recommendations contd.
• Bank ownership : As it had earlier mentioned the freedom for banks in its working and bank autonomy, it felt that
the government control over the banks in the form of management and ownership and bank autonomy does not go
hand in hand and thus it recommended a review of functions of boards and enabled them to adopt professional
corporate strategy.
• Review of banking laws : The committee considered that there was an urgent need for reviewing and amending
main laws governing Indian Banking Industry like RBI Act, Banking Regulation Act, State Bank of India Act, Bank
Nationalisation Act, etc. This up gradation will bring them in line with the present needs of the banking sector in
India.

Apart from these major recommendations, the committee has also recommended faster computerization, technology up
gradation, training of staff, depoliticizing of banks, professionalism in banking, reviewing bank recruitment, etc.
 Tarapore Committee (1997) [First TC]

Tarapore Committee- First

• The Committee on Capital Account Convertibility (CAC) or Tarapore Committee was constituted by the Reserve
Bank of India for suggesting a roadmap on full convertibility of Rupee on Capital Account.
• The committee submitted its report in May 1997.
• The committee observed that there is no clear definition of CAC.
• The CAC as per the standards, refers to the freedom to convert the local financial assets into foreign financial assets
or vice versa at the market determined rates of exchange.
• The CAC Committee recommended the implementation of Capital Account Convertibility for a 3 year period viz.
1997-98, 1998-99 and 1999-2000.
 Tarapore Committee (1997) [First TC]

Tarapore Committee- First

• The Committee on Capital Account Convertibility (CAC) or Tarapore Committee was constituted by the Reserve
Bank of India for suggesting a roadmap on full convertibility of Rupee on Capital Account.
• The committee submitted its report in May 1997.
• The committee observed that there is no clear definition of CAC.
• The CAC as per the standards, refers to the freedom to convert the local financial assets into foreign financial assets
or vice versa at the market determined rates of exchange.
• The CAC Committee recommended the implementation of Capital Account Convertibility for a 3 year period viz.
1997-98, 1998-99 and 1999-2000.
 Tarapore Committee (1997) [First TC]

This committee had laid down some pre conditions as follows:

1. Gross fiscal deficit to GDP ratio has to come down from a budgeted 4.5 per cent in 1997-98 to 3.5% in 1999-2000.

2. A consolidated sinking fund has to be set up to meet government’s debt repayment needs; to be financed by increased in
RBI’s profit transfer to the govt. and disinvestment proceeds.

3. Inflation rate should remain between an average 3-5 per cent for the 3-year period 1997-2000.

4. Gross NPAs of the public sector banking system needs to be brought down from the present 13.7% to 5% by 2000. At the
same time, average effective CRR needs to be brought down from the current 9.3% to 3%

5. RBI should have a Monitoring Exchange Rate Band of plus minus 5% around a neutral Real Effective Exchange Rate RBI
should be transparent about the changes in REER

6. External sector policies should be designed to increase current receipts to GDP ratio and bring down the debt servicing ratio
from 25% to 20%

7. Four indicators should be used for evaluating adequacy of foreign exchange reserves to safeguard against any contingency.
Plus, a minimum net foreign asset to currency ratio of 40 per cent should be prescribed by law in the RBI Act.
 Tarapore Committee (2006) [Second TC]

Reserve Bank of India appointed the second Tarapore committee to set out the framework for fuller Capital Account
Convertibility. The committee was established by RBI in consultation with the Government to revisit the subject of fuller
capital account convertibility in the context of the progress in economic reforms, the stability of the external and financial
sectors, accelerated growth and global integration.

The report of this committee was made public by RBI on 1st September 2006. In this report, the committee suggested 3 phases
of adopting the full convertibility of rupee in capital account.

• First Phase in 2006-7

• Second phase in 2007-09

• Third Phase by 2011

 Tarapore Committee (2006) [Second TC]

Following were some important recommendations of this committee:

1. The ceiling for External Commercial Borrowings (ECB) should be raised for automatic approval.

2. NRI should be allowed to invest in capital markets

3. NRI deposits should be given tax benefits.

4. Improvement of the Banking regulation.

5. FII (Foreign Institutional Investors) should be prohibited from investing fresh money raised to participatory notes.

6. Existing PN holders (Participatory Notes) should be given an exit route to phase out completely the PN notes.

7. At present the rupee is fully convertible on the current account, but only partially convertible on the capital account.
 Vyas Committee (2003)

Vyas Committee

• The Reserve Bank of India (RBI) during 2003 constituted an advisory committee on the flow of credit to agriculture and
related activities from the banking system.

• The committee will be headed by noted economist Prof VS Vyas.

• The central bank has also outlined the role of the committee, which is asked to submit a report by April 2004.

• Report of The Expert Committee on Rural Credit

 Vyas Committee (2003)

Objectives of Vyas Committee

1. To assess the progress made in implementation of the recommendations of the Expert Committee on Rural Credit (Vyas
Committee) appointed by NABARD in August 2000.

2. To suggest measures to reduce the rate of interest on agriculture credit given by Commercial, Cooperative and Regional
Rural Banks;

3. To examine the role of NABARD as the apex institution for providing and regulating credit for the promotion and
development of agriculture and the role of Regional Rural Banks (RRBs) in purveying agricultural credit and suggest
measures for improving the same without sacrificing overall viability considerations;

4. To study the role and effectiveness of the RIDF mechanism and suggest ways to improve the same, or to suggest
alternatives, with a view to increase direct agriculture lending;

5. To identify the impediments in the flow of credit to the disadvantaged sections such as small and marginal farmers, tenant
farmers, oral lessees and landless labourers and suggest measures to be taken by banks for providing financial assistance to
them;
 Vyas Committee (2003)

[Recommendations]

• Suggested that RBI should advise banks to waive margin/security norms for agricultural loans up to Rs 50,000 and in
case of agri-business and agri-clinics, the limit can be pegged at Rs 5 lakh.

• It further urged that the stipulation of minimum acreage of 6 acre fixed by NABARD for financing purchase of tractors
may be done away with. This may be left to the commercial judgment of the banks, it said. In the absence of access to
short term loans, the productive investments are impaired.

• It is important to provide the small borrowers with a credit mechanism to fall back on for meeting their emergent and
consumption needs, it said.

• It is recommended that banks should provide a separate flexible revolving credit limit to the small borrowers of
production or investment loans for meeting their temporary shortfalls in family cash flow, it said.
 R V Gupta Committee [Agricultural Credit through Commercial Banks]

The Reserve Bank of India appointed a one-man Committee of Shri R. V. Gupta, then Dy. Governor of RBI in December
1997 with a mandate to suggest measures for the removal of the constraints faced by the Commercial Banks in increasing
flow of credit to agriculture.

Introducing new products and services and simplifying procedures and methods of working with a view to enabling rural
borrowers to access adequate and timely credit from the commercial banking system.

The Report of the Committee was submitted to Reserve Bank of India on 21 April 1998.
 R V Gupta Committee [Agricultural Credit through Commercial Banks]

• Simplification of Procedures

a. Simplify application form and documentation.

b. Delegation of powers to Branch Managers to dispose of at least 90 per cent of the applications.
c. Non-insistence of “No Dues Certificate”, i.e., the certificate from borrowers saying that they do not owe any money
to banks on previous borrowings.
d. Abolition of Stamp Duty on mortgage of agricultural land for obtaining loans from banks.
e. Non-insistence on kind component, i.e., compulsory allocation for materials other than cash.
f. Value of security should be commensurate with the size of the loan.
g. Discourage additional collateral by way of guarantors where the land has already been mortgaged.
h. Security and collateral requirements not to be prescribed by RBI or any other agency. Existing guidelines to
continue for small loans up to Rs.10, 000.
 R V Gupta Committee [Agricultural Credit through Commercial Banks]

• Appraisal of Credit Needs

a. Include under short-term credit needs, the requirements of the farm related production, post-harvest and threshold
expenses.
b. To be based on borrowers’ income stream, track record, credibility and capability.
c. Do away with scales of finance for ST loans and Unit Cost of investment credit and allow flexibility to banks in
fixing these requirements with the available expertise with them.
• Recovery of Loans

a. State Governments to set apart dedicated teams for recovery of bank loans.
b. Improving the recovery climate through rurally-oriented field publicity campaigns.
c. Tangible incentives to prompt repairs such as interest benefit or rebate besides offering a finer interest rate to those
who opt for a savings module linked to the loan product
 R V Gupta Committee [Agricultural Credit through Commercial Banks]

• Internal Control

a. Rationalize the number of returns to be compiled by banks so as to reduce paper work.

b. Periodical visits to few service area villages and convening meetings of farmer borrowers to assess their problems
and difficulties.
c. Compulsory rural posting of staff may be done away with.
d. Performance measurement to be based on number of new clients, volume of loaning and loan recovery.
e. Package of incentives like foreign exposure, training in prestigious institutions within the country, weight age in
promotion, posting to centre of choice, improvement in accommodation and education facilities and corporate
recognition for outstanding performance.
• Interest rate

Commercial Banks to be made free to fix the rates of interest for small loan amounts as has been done in the case of Co-
operative and RRBS.

• Priority Lending Target: Target of 18 per cent for agricultural loans to be done away with and instead be based on the
flow of credit through preparation of special agricultural credit plans.
 Sarkaria Commission

Background

• The agitation for State autonomy led to the creation of the Sarkaria Commission by the Central Government to
recommend changes in the Centre-State relationship. The Commission submitted its report in 1988.

• The founding fathers of the Indian Constitution were deeply concerned about ensuring the unity and integrity of the
country. They were aware of the forces of disruption and disunity working within the country. These dangers at the time
of independence could be handled only by a strong government at the Centre.

• Therefore, the framers of the Constitution assigned a predominant role to the Centre.

• At the same time, they made provisions for the establishment of cooperative federalism.

• The working of the Indian federation during the last five decades clearly shows that the relations between the Centre and
the States have not always been cordial.

• The Administrative Reforms Commission and several other Commissions were appointed by the Government of India
from time to time to regulate Centre-State relations.

• The Union Government appointed the Sarkaria Commission to suggest ways and means to improve Centre-State
relations.
 Sarkaria Commission

Major Recommendations of Sarkaria Commission

The Sarkaria Commission finally submitted its report in the year 1988. The Sarkaria Commission’s charter was to examine
the relationship and balance of power between state and central governments in the country and suggest changes within the
framework of the Constitution of India. Despite the large size of its reports – the Commission recommended, by and large,
status quo in the Centre-State relations, especially in the areas, relating to legislative matters, the role of Governors, and the
use of Article 356
 Tobin’s & Solow’s View on Phillips Curve

Tobin’s View on Phillips Curve (Kinked-Shaped Phillips Curve)

Tobin believes that there is a Phillips curve within limits. But as the economy expands and employment grows,
the curve becomes even more fragile and vanishes until it becomes vertical at some critically low rate of
unemployment.

Uc is the critical rate of unemployment at which the Phillips curve becomes vertical where there is no trade-off
between unemployment and inflation. According to Tobin, the vertical portion of the curve is not due to increase
in the demand for more wages but emerges from imperfections of the labour market
 Tobin’s & Solow’s View on Phillips Curve

Tobin’s View on Phillips Curve (Kinked-Shaped Phillips Curve)

• At the Uc level, it is impossible to provide more employment

because the job seekers have wrong skills, age, or sex or are in the
wrong place.
• Regarding the normal portion of the Phillips curve which is
negatively sloping, wages are sticky downward because labourers
resist a decline in their relative wages

• For Tobin, there is a wage-change floor in excess supply

situations. When unemployment is more than Uc level (right of
Uc), then AD and Inflation rises and involuntary unemployment
is reduced and wage-floor markets gradually diminishes.

• When all sectors of the labour market are above the wage floor,
the level of critically low rate of unemployment Uc is reached.
 Tobin’s & Solow’s View on Phillips Curve

Solow’s View on Phillips Curve (Kinked-Shaped Phillips Curve)

• Like Tobin, Solow does not believe that the Phillips curve is
vertical at all rates of inflation.
• Solow argued that Phillips curve is vertical at positive rates of
inflation and is horizontal at negative rates of inflation.
• Solow attributed this as wages are sticky downward even in the
face of heavy unemployment or deflation.
• When the demand for labour rises, wages increases with rise in
expected inflation
• As Phillips curve LPC becomes vertical at that minimum level of
unemployment, there is no trade-off between unemployment and
inflation.
 Tobin’s & Solow’s View on Phillips Curve

General Consensus on Phillips Curve

The vertical Phillips curve has been accepted by the majority of

economists. They agree that at an unemployment rate of about 4 per
cent, the Phillips curve becomes vertical and the tradeoff between
unemployment and inflation disappears. It is impossible to reduce
unemployment below this level because of market imperfections

“A little inflation will provide a boost at first—like a small dose of a drug for a new
addict—but then it takes more and more inflation to provide the boost, just it takes a
bigger and bigger dose of a drug to give a hardened addict a high.”- words of Milton
Friedman
Lecture-8: Chronology of Taxation in India,
GST in India
Unit-3 (A): Public Economics

NTA-UGC-NET
Economics (Paper-2)
 Tax Chronology in India
1773 Land Revenue Tax [Zamindari System]
1860 Income Tax
1914 Motor Vehcial Tax
1922 Entertainment Tax [first in bengal]
1926 The Indian Taxation Enquiry Committee [Chahles Todhunteb, President & John Mathai]
1940 Excess Profits Tax introduced w.e.f. 1-9-1939.
1946 Demonetisation of high denomination notes made.
Excess Profits Tax Act repealed.
1947 Business Profits Tax enacted (for the period 1-4-1946 to 31-3-1949).
1953 Estate Duty Act, 1953 came into existence w.e.f. 15-10-1953.
1954 Taxation Enquiry Commission known as John Mathai Commission set up.
Progressive tax structure.
Indirect taxes can be used as a means of progressive taxation in a limited manner
Kaldor advocated for wealth, capital gain, gift tax and personal expenditure tax (was abolished in
1956 1962)
Sales Tax introduced
Expenditure Tax, Wealth Tax, Capital Gain Tax
1957 The Wealth tax Act, 1957 introduced w.e.f. 1-4-1957.
 Tax Chronology in India
1958 The Gift-tax Act, 1958 introduced w.e.f. 1-4-1958.
Direct Taxes Administration Enquiry Committee submitted its report
1959 Direct Taxes Administration Enquiry Committee submitted its report.
Direct Taxes Advisory Committee set up - Direct Taxes Administrative Enquiry Committee constituted.
1961 Income-tax Act, 1961 came into existence w.e.f. 1-4-1962.
Corporation Tax
Central Board of Revenue bifurcated and a separate Board for Direct Taxes known as Central Board of
1963, 1964 Direct Taxes (CBDT)constituted under the Central Board of Revenue Act, 1963.
The Companies (Profits) Sur -tax Act, 1964 was introduced
1968 Bhoothalingam’s committee
1971 Report of Direct Taxes Enquiry Committee received [Wanchoo Committee]
Chokshi Committee submitted its interim report [consolidated 4 taxes together- income, wealth, gift and
1976 sur tax]
1977 Jha Committee- Indirect Tax Enquiry Committee; recommendeed MANVAT
MANVAT
1985 Interest Tax Act, 1974 discontinued w.e.f. 31.3.1985
1986 MODVAT introduced
1987 L.K. Jha Committee set up for simplification and rationalisation of tax laws.
1990 Gift tax Bill introduced on 31.5.1990.
1991 Interest Tax Act, 1974 revived.
Chelliah Committee
 Tax Chronology in India
1993 Rekhi Committee [Indirect Tax]
1994 Service Tax Introduced
2000 Interest-tax Act terminated with effect from 1-4-2000.
2001 CENVAT Introduced
Kelkar Committee Report, inter alia, recommended :-
i. Outsourcing of non-core functions of the department ;
ii. Reduction in exemptions, deductions, reliefs, rebates etc.
2002 iii. Abolishment of Wealth Tax, Mnimum Alternate Tax
Fringe Benefit Tax (FBT) was introduced as a major step towards widening of tax base and bolstering
of the Direct Tax Collection.
2004 Securities Transaction Tax (STT) was introduced.
2005 VAT
2005 Tonnage Tax was introduced for the Shipping Companies.
Banking Cash Transaction Tax (BCTT) was introduced w.e.f. 01-06-2005.
2017 GST
 Black Money Estimation in India

Black Money Estimation in India

There are two different approaches which are mostly followed in the estimation of black money.
(a) Kaldor’s approach of estimating non-salary incomes above the income tax exemption limit and
(b) Edger L. Feige’s method estimating transaction income on the basis of currency deposit ratio.

• N. Kaldor (1953-54) assessed the black money at Rs 600 crore which was about 6.0 per cent of GNP.
• Wanchoo Committee (1961-62) estimated the black money at Rs 700 crore, which was about 4.4 per cent of GNP.
This amount further raised to Rs 1,000 crore and Rs 1,400 crore in 1965-66 and 1968-69 respectively.
• Dr. D.K. Rangnekar estimated black money at Rs 1,150 crore in 1961-62, which raised to Rs 3,080 crore in 1969-70
around 8.4 per cent of GNP.
• O.P. Chopra estimated black money at Rs 916 crore (6.1. per cent of GNP) in 1961-62, which rose to Rs 8,098 crore
(10.5 per cent of GNP) in 1976-77.
• Poonam Gupta and Sanjeev Gupta ascertained the extent of black money at Rs 3,034 crore (9.5 per cent of GNP) in
1967-68 and Rs 46,487 crore (48.8 per cent of GNP) in 1978-79.
 Black Money Estimation in India

• The National Institute of Public Finance and Policy (NIPFP) had also made an estimate of black money from the
range of Rs 9,958 crore to Rs 11,870 crore (15 to 18 per cent of GNP) in 1975-76 to the range of Rs 31,584 to Rs
36,784 crore (18 to 21 per cent of GNP) in 1983-84. The estimates of black money made by NIPFP is the last official
estimate.
• A Parliamentary Standing Committee on Finance quoted unofficial estimates of black money at Rs 1,10,000 crore
in 1994-95.
• Prof. Madhu Dandavate, the then Deputy Chairman of the Planning Commission recently quoting an unofficial
estimate, disclosed that black money worth Rs 80,000 crore was in circulation in the country.
 Goods and Service Tax (GST)

It is a tax levy on the consumption, manufacture or sale of goods and services in India.

It is a system of indirect taxation that has replaced most other indirect taxes in the country.

The Indian Government had introduced this tax on 1st July 2017.

GST is levied every time there is a value addition that is made to a product or service.

The taxation also takes place at every point of sale. This is why it is termed as a destination based tax on consumption of
goods and services. It is levied at all stages right from manufacture up to final consumption with credit of taxes paid at
previous stages available as setoff. In a nutshell, only value addition will be taxed and burden of tax is to be borne by the
final consumer.

Concept of Destination Based Tax on Consumption

The tax would accrue to the taxing authority which has jurisdiction over the place of consumption which is also termed as
place of supply.
 Goods and Service Tax (GST)

Other Countries

• France was the first country to introduce GST in 1954. Currently around 160 countries have implemented the GST.

• In India the idea of GST was proposed in a meeting between former Prime Minister A B Vajpayee and his economic
advisory panel made of former RBI governors C Rangarajan, Bimal Jalan, IG Patel. A committee was formed headed
by the former Finance Minister of West Bengal, Asim Dasgupta.

• Finally GST was launched all over India on 1st July, 2017.

• The Indian GST model is based on the Canadian dual GST model.

• The dual GST model refers to the GST being levied by both Central and State governments.

• India is a federal country where both the Centre and the States have been assigned the powers to levy and collect taxes
through appropriate legislation. Both the levels of Government have distinct responsibilities to perform according to the
division of powers prescribed in the Constitution for which they need to raise resources. A dual GST will, therefore, be
in keeping with the Constitutional requirement of fiscal federalism
 What will be replaced by GST?

The GST would replace the following taxes: The GST would replace the following taxes:
(i) taxes currently levied and collected by the Centre: ii) State taxes that would be subsumed under GST are:
a. Central Excise duty a) State VAT
b. Duties of Excise (Medicinal and Toilet Preparations) b) Central Sales Tax
c. Additional Duties of Excise (Goods of Special Importance) c) Luxury Tax
d. Additional Duties of Excise (Textiles and Textile Products) d) Entry Tax (all forms)
e. Additional Duties of Customs (commonly known as CVD) e) Entertainment and Amusement Tax except when
f. Special Additional Duty of Customs (SAD) levied by the local bodies)
g. Service Tax f) Taxes on advertisements
h. Central Surcharges and Cesses so far as they relate to supply g) Purchase Tax
of goods and services h) Taxes on lotteries, betting and gambling
i) State Surcharges and Cesses so far as they relate to
supply of goods and services
 Types of GST

There are four different types of GST levied on the goods and services in India that are:

• Central Goods and Services Tax (CGST) – The Central Government of India charges the CGST on transactions
related to goods and services within a state.
✓ Imposed by central government
✓ Central Excise, Excise, Excise Duties on tax imposed by central govt.,
✓ Additional Duty of Custom Duty
✓ Service Tax and Gratuity Schemes are all under CGST

• State Goods and Service Tax (SGST) – The State Governments in India charge the SGST on transactions related to
goods and services within a state. It gets charged along with the CGST.
✓ Imposed & collected by state government
✓ State Government collected VAT,
✓ Purchase Tax, Entertainment Tax,
✓ Entry Tax, Advertisement Tax,
✓ Tax on speculation and gambling, lottery are now under SGST
 Types of GST

There are four different types of GST levied on the goods and services in India that are:

• Union Territory Goods and Service Tax (UGST) – The Union Territories in India charge the UGST on transactions
related to goods and services within their boundaries. It gets charged along with the CGST.
✓ Imposed by Uts, where there is no Legislative Assemblies such as Andaman and Nicobar, Daman and
Diu, Dadar and Nagar Haveli
✓ Taxes imposed and collected by Central government

• Integrated Goods and Service Tax (IGST) – If the transaction related to goods and services is between two states,
the government will impose the Integrated GST. It is also applicable to imports and exports. The Taxes charged under
IGST are shared both by the centre and state.
✓ Imposed & collected by central government
✓ Imposed on international goods and services
✓ The amount so collected is distributed among the states to recover for the loss of revenue generated to
the states
 Types of GST

The Centre has the powers to levy tax on the manufacture of goods (except alcoholic liquor for human consumption,
opium, narcotics etc.) while the States have the power to levy tax on the sale of goods.

In the case of inter-State sales, the Centre has the power to levy a tax (the Central Sales Tax) but, the tax is collected and
retained entirely by the States. As for services, it is the Centre alone that is empowered to levy service tax.
 Central Taxes subsumed into CGST & SGST

Central taxes subsumed under CGST

Revenue under CGST is collected by the Central Government. CGST subsumes the below given central taxations and
levies.
• Central Excise Duty Services Tax
• Central Sales Tax Excise Duty

• Additional Excise Duties Countervailing Duty (CVD)

Central taxes subsumed under SGST

Revenue under SGST is collected by the State Government. SGST subsumed the following state taxations.

• Luxury Tax State Sales Tax

• Entry tax Entertainment Tax Levies on Lottery

 Exemptions from GST

The following are the indirect taxes which are not included in GST.
1. Stamp Duty (property registration)
2. Vehicle Tax (remained under Motor Vehicle Act)
3. Liquor Excise Duty
4. Electricity Tax
5. Entertainment Tax [levied by local bodies, like in MH LBET, i.e. Local Bodies Entertainment Tax ranging from 10
to 25% on movies, cable TV and DTH services]
6. Road Tax [road tax, environment tax]
7. Basic Custom Duty
8. Toll tax
• Supplies of all goods and services are taxable except alcoholic liquor for human consumption. Supply of
petroleum crude, high speed diesel, motor spirit (commonly known as petrol), natural gas and aviation
turbine fuel shall be taxable with effect from a future date (as per July 2017, but as on today 2022 they
are outside the ambit of GST).
• Currently, petroleum products like petrol, diesel, ATF & natural gas are outside the ambit of GST and are
covered under legacy taxes like VAT, Central Sales Tax, Central Excise Duty, etc.
Source: https://www.financialexpress.com/industry/will-bringing-petroleum-products-under-gst-help-tame-
inflation/2537242/
 Composition of GST Council

In order to implement GST, Constitutional (122nd Amendment) Bill (CAB for short) was introduced in the Parliament
and passed by Rajya Sabha on 03rd August, 2016 and Lok Sabha on 08th August, 2016. As per Article 279A of the
amended Constitution, the GST Council which will be a joint forum of the Centre and the States shall consist of the
following members: –

• Union Finance Minister – Chairperson: Smt. Nirmala Sitharaman

• The Union Minister of State, in-charge of Revenue of finance – Member Shri Pankaj Chaudhary

• The 31 Minister In-charge of finance or taxation or any other Minister nominated by each State Government –
Members [28 states + 3 UT- UT of Jammu & Kashmir, Puducherry , Delhi]

GST Council is a joint forum of the Centre and the States. It makes recommendations to the Union and the States on
important issues related to GST. It is the governing body of GST having 33 members, out of which 2 members are from
the centre and 31 members are from 28 states and 3 Union territories with legislation.
 Functions of GST Council

Goods & Services Tax Council (GST Council) is a constitutional body for making recommendations to the Union and
State Government on issues related to Goods and Service Tax. As per Article 279A (4), the functions of the GST Council
include making recommendations to the Union and the States on important issues like:

• The goods and services that may be subjected or exempted from GST,
• Model GST Laws,
• Principles that govern the place of supply,
• Threshold limits,
• GST rates including the floor rates with bands,
• Special rates for raising additional resources during natural calamities/disasters,
• Special provisions for certain States, etc.
 Decision Making Process by GST Council

The Constitution (one hundred and first amendment) Act, 2016 provides that every decision of the GST Council shall be
taken at a meeting by a majority of not less than 3/4th of the weighted votes of the Members present and voting. The vote
of the Central Government shall have a weightage of 1/3rd of the votes cast and the votes of all the State Governments
taken together shall have a weightage of 2/3rd of the total votes cast in that meeting. One half of the total number of
members of the GST Council shall constitute the quorum at its meetings.
 Who all have to pay GST?

Goods and Services Tax (GST) has to be paid by persons registered under GST and required to pay tax under reverse
charge mechanism, people registered under GST and making taxable supplies under GST .You can read about the Goods
and Services Tax Act – Overview, Key Features and Criticism in the given link.
The other people who are liable to pay GST are people who are registered under GST and required to deduct Tax, E-
Commerce Operators registered under GST and required to collect tax, E-Commerce operators registered under GST and
through whom certain categories of notified supplies are made.
 Who all have to pay GST? Example

Example: Suppose rate of CGST is 10% and that of SGST is 10%.

When a wholesale dealer of steel in Uttar Pradesh supplies steel bars to a construction company which is also located
within the same State for, say Rs. 100, the dealer would charge CGST of Rs. 10 and SGST of Rs. 10 in addition to the
basic price of the goods. He would be required to deposit the CGST component into a Central Government Account while
the SGST portion into the account of the concerned State Government. Of course, he need not actually pay Rs. 20 (Rs. 10
+ Rs. 10) in cash as he would be entitled to setoff this liability against the CGST or SGST paid on his purchases (say,
inputs). But for paying CGST he would be allowed to use only the credit of CGST paid on his purchases while for SGST
he can utilize the credit of SGST alone. In other words, CGST credit cannot, in general, be used for payment of SGST.
Nor can SGST credit be used for payment of CGST
 How many rates are there in GST?

The different GST tax slabs are: 5% 12% 18% 28%

GST council has fixed over 1300 goods and 500 services under the above 4 given tax slabs. Around 81% of all goods and
services fall below or in the 18% tax slab. The primary GST slabs for any regular taxpayers are presently pegged at 0%
(nil-rated), 5%, 12%, 18% & 28%. There are a few lesser-used GST rates such as 3% and 0.25%.

GST Slab of 0%

• Kajal, Eggs, Educations Services, Health Services, Lassi & Curd*, Milk*, Children’s Drawing & Colouring Books,
Unpacked Foodgrains, Unbranded Atta, Unpacked Paneer, Unbranded Maida, Gur, Besan, Unbranded Natural Honey,
Prasad, Fresh Vegetables, Palmyra Jaggery, Salt, Phool Bhari Jhadoo.

* From 18th July 2022, 5% GST is on packaged and labelled Lassi and curd. When sold loose without label and packet, it is still 0%
 How many rates are there in GST?

GST Slab of 5%

• Goods of basic amenities are covered. Sugar, oil, spices, coffee, coal, fertilizers, tea, ayurvedic medicines, agarbatti,
sliced dry mango, cashew nuts, sweets, handmade carpets, lifeboats, fish fillet, unbranded namkeen, and life-saving
drugs.

• Services like railways, airways, takeaway food, AC and Non-AC restaurants, hotel rooms with a tariff less than ₹
7,500, and special flights for pilgrims.

GST Slab of 12%

• Goods including cell phones, sewing machine, umbrella, jewellery box, processed foods (frozen meat, fruit juices,
butter, cheese, ghee).

• Services include business class flight tickets and movie tickets below ₹ 100.
 How many rates are there in GST?

GST Slab of 18%

• Goods hair oil, safety glass, pasta, pastries, ice-cream, mineral water, hair shampoo, oil powder, water heaters,
washing machine, detergent, scent sprays, leather clothing, cookers, oil powder, cutlery, binoculars, artificial flowers,
wristwatches, suitcase, briefcase, shaving, after-shave, furniture, stationery items, mattress monitors, television screen,
lithium-ion batteries, video games are covered.

• Services include restaurants within hotels whose tariffs are above ₹ 7,500, actual hotel bill below ₹ 7,500, movie
tickets above ₹ 100.

GST Slab of 28%

• Goods More than 200 products are covered cars, cigarettes, durable consumer products, high-end motorcycles, pan
masala, weighing machine, cement are covered.

• Services include racing, betting in casinos, the actual bill of hotel stay above ₹ 7,500.

A special rate of 0.25% is levied on semi-polished and cut stones.

 Main Objectives of GST

• It helps create a common market in India with a uniform taxation system and curb tax evasion in the country. The laws
for GST are far more stringent compared to the erstwhile indirect tax laws. The aim is to have a nationwide
surveillance system under GST, making it easier to catch defaulters and tax evaders.

• It removes the cascading effect of the indirect taxes on a single transaction. It also allows the setting off for prior taxes
that are related to the same transactions in the form of the input tax credit. Under GST, the tax is applicable only on
the net value added during each stage of the supply chain.

• The government aims to reduce the need for multiple documentation under the previous taxation system by
introducing a consolidated tax like GST. The idea is to help companies with an uncomplicated tax filing procedure that
will improve their efficiency and cut down the overall costs associated with business processes.
 VAT

Every commodity passes through various stages of production and distribution till it finally reaches the consumer. And a
value addition is made to that commodity at each stage of production. So the VAT is added to that commodity for each of
those stages. It is a consumption-based tax that is ultimately borne by the consumer of that product or service. Unlike the
Goods and Service Tax (GST), the VAT is not uniform throughout the country, and it varies on a state to state basis. Each
state also had different legislations on this tax which the businesses must adhere to at all costs.
 VAT

Every commodity passes through various stages of production and distribution till it finally reaches the consumer. And a
value addition is made to that commodity at each stage of production. So the VAT is added to that commodity for each of
those stages. It is a consumption-based tax that is ultimately borne by the consumer of that product or service. Unlike the
Goods and Service Tax (GST), the VAT is not uniform throughout the country, and it varies on a state to state basis. Each
state also had different legislations on this tax which the businesses must adhere to at all costs.

Goods and Service Tax (GST)

Like VAT, it gets levied on every value addition made to a product or service in its production and distribution process.
Under the GST system, the tax on goods and services gets levied at every point of sale. If the transaction of a commodity
is between two states, the government will impose the Integrated GST. If the supply of a product is within a state, then
the tax will have two components – Central GST and State GST. If a Union territory is also involved in a transaction, the
Union Territory GST will be applicable
VAT v/s GST
 Revenue Neutral Rate

Revenue Neutral Rate is used in context of GST. It is defined as the tax rate which aims to collect the same amount of tax
revenues under GST as was before GST. Thus, the basic objective of the RNR is to prevent the GST tax structure from
having negative revenue implications.
The RNR for the CGST and the SGST is determined as:
RNR = R/B  100
Where,
RNR : Revenue Neutral Rate for the Centre or the States
R : Collection from the Central or State taxes, as the case may be, which are proposed to be subsumed in the CGST and
SGST
B : Estimated Tax base of the GST
Revenue Neutral Rate
Revenue Neutral Rate
Lecture-9: 14th & 15th Finance
Commission
Unit-3 (A): Public Economics
NTA-UGC-NET
Economics (Paper-2)
 Centre-State Financial Relations

Centre-State Financial Relations

• Indian Constitution has made elaborate provisions, relating to the distribution of the taxes as well as non-tax revenues
and the power of borrowing, supplemented by provisions for grants-in-aid by the Union to the States.
• Article 268 to 293 under Part XII deals with the provisions of financial relations between Centre and States. The
Constitution divides the taxing powers between the Centre and the states as follows:
• The Parliament has exclusive power to levy taxes on subjects enumerated in the Union List,
• The state legislature has exclusive power to levy taxes on subjects enumerated in the State List,
• Both can levy taxes on the subjects enumerated in the Concurrent List whereas residuary power of taxation lies with
Parliament only.

The Indian Constitution does not make a clear cut distribution of the financial resources and leaves much to be decided by
the Central Government from time to time. The financial resources which have been placed at the disposal of the state are
so meager that they have to look up to the Union Government for subsidies and contributions.
 7th Schedule of Indian Constitution
The 7th Schedule of Indian Constitution has three Union List (100)
lists namely, the Union list, state list, and concurrent
list that show the division of power between the Naval, military, Atomic
Arms, firearms,
and Air energy and
Union and States concerning certain subjects. Defence of India ammunition, and
Force works mineral
explosives
resources
Union List of Seventh Schedule Foreign
• As of 1st November 2021, there were 97 subjects Industries
Central Bureau of
Preventive detention Affairs:
covered in the union list (now 100 subjects) declared by for reasons connected related to
Intelligence and
Parliament by with defence or Union and
• The central government or the union government law
Investigation
Foreign Affairs any foreign
can make laws on all the subjects mentioned country
under the union list in the Indian Constitution. Citizenship,
United Nation
• All the issues or subjects related to the nation’s Organization
War and Peace Foreign jurisdiction Naturalizatio
security, the nation’s welfare, and the uniform n and Aliens
legislation throughout the country are secured by Piracy and
Pilgrimages to crime
India’s constitution and included in the union list. Extradition places outside of Railways committed
• The union list is always considered dominant to India on higher
the state list, and it is taken care of by the seas
constitution of India in case any subject overlaps Highways
Lighthouses,
with each other. The judgment made by the union declared by law Maritime shipping and
including the light RBI
made by navigation
will prevail. ships and bacon
parliament
 7th Schedule of Indian Constitution

State List (61)

State List Subjects
The state list under the 7th schedule Prisons, Pilgrimages
reformatories, and other than
originally had 66 subjects which have Public order Public health and sanitation
other institutions of those outside of
been revised to 61 subjects. the same nature India
Communication
Burials and burial through roads,
Relief of the
grounds, cremations, Libraries, museums, and bridges, ferries,
disabled and
and cremation other similar institutions and other
unemployable
grounds means of
communication
Agriculture
including Pounds and Water supplies, irrigation,
agricultural prevention of cattle canal, drainage, and Fisheries
education and trespass embankments
research
Salaries and
allowances of
Gas and Gas works Inns and innkeepers Betting and gambling members of the
Legislature of
the state
State public Duties in
services and state Public Debt of the Taxes on Agriculture respect of
public service state Income succession to
commission agricultural land
 7th Schedule of Indian Constitution

Concurrent List Subjects Concurrent List (52)

The concurrent list under the 7th Prisons, Pilgrimages
schedule originally had 47 subjects reformatories, and other than
Public order Public health and sanitation
which have been revised to 52 subjects. other institutions of those outside of
the same nature India
Communication
Burials and burial through roads,
Relief of the
grounds, cremations, Libraries, museums, and bridges, ferries,
disabled and
and cremation other similar institutions and other
unemployable
grounds means of
communication
Agriculture
including Pounds and Water supplies, irrigation,
agricultural prevention of cattle canal, drainage, and Fisheries
education and trespass embankments
research
Salaries and
allowances of
Gas and Gas works Inns and innkeepers Betting and gambling members of the
Legislature of
the state
State public Duties in
services and state Public Debt of the Taxes on Agriculture respect of
public service state Income succession to
commission agricultural land
 Grants-in-Aid

Besides sharing of taxes between the Center and the States, the Constitution provides for Grants-in-aid to the States from
the Central resources.
1. Statutory Grants: These grants are given by the Parliament out of the Consolidated Fund of India to such States which
are in need of assistance. Different States may be granted different sums. Specific grants are also given to promote the
welfare of scheduled tribes in a state or to raise the level of administration of the Scheduled areas therein (Art.275).

2. Discretionary Grants: Center provides certain grants to the states on the recommendations of the Planning Commission
which are at the discretion of the Union Government. These are given to help the state financially to fulfill plan targets
(Art.282).
3. Other grants:
o Constitution provided for a temporary grant for specific purpose. Ex: grants for the states of Assam, Bihar,
Odisha and West Bengal in lieu of export duties on jute and jute products.

o These grants were to be given for a period of 10 years from the commencement of the constitution based on
the recommendation of the Finance Commission
 Finance Commission

Although the Constitution has made an effort to allocate every possible source of revenue either to the Union or the States,
but this allocation is quite broad based. For the purpose of allocation of certain sources of revenue, between the Union and
the State Governments, the Constitution provides for the establishment of a Finance Commission under Article 280.
According to the Constitution, the President of India is authorized to set up a Finance Commission every five years to
make recommendation regarding distribution of financial resources between the Union and the States.
Article 280 in the Constitution of India 1949
280. The Finance Commission is constituted by the President under article 280 of the Constitution, mainly to give its
recommendations on distribution of tax revenues between the Union and the States and amongst the States themselves.
Article 281 in The Constitution Of India 1949
281. Recommendations of the Finance Commission The President shall cause every recommendation made by the Finance
Commission under the provisions of this Constitution together with an explanatory memorandum as to the action taken
thereon to be laid before each House of Parliament Miscellaneous Financial Provisions
 Who Appoints the Finance Commission?

The Finance Commission is appointed by the President under Article 280 of the Constitution. According to the provisions
contained in the Finance Commission [Miscellaneous Provisions] Act, 1951 and The Finance Commission (Salaries &
Allowances) Rules, 1951, the Chairman of the Commission is selected from among persons who have had experience in
public affairs, and the four other members are selected from among persons who have
• Been qualified to be appointed as Judges of a High Court; or
• Special knowledge of the finances and accounts of Government; or
• Had wide experience in financial matters and in administration; or
• Special knowledge of economics
 What is the Composition of the Finance Commission?

Finance Commission is to be constituted by the President every 5 years. The Chairman must be a person having
‘experience in public affairs’. Other four members must be appointed from amongst the following:-
1. A High Court Judge or one qualified to be appointed as High Court Judge;
2. A person having knowledge of the finances and accounts of the Government;
3. A person having work experience in financial matters and administration;
4. A person having special knowledge of economics.
 What are the Functions of the Finance Commission?
The Finance Commission is a constitutional body formed every five years to give suggestions on centre-state financial
relations. Each Finance Commission is required to make recommendations on:
(i) sharing of central taxes with states,
(ii) distribution of central grants to states,
(iii)measures to improve the finances of states to supplement the resources of panchayats and municipalities, and
(iv)any other matter referred to it.
 What are the Functions of the Finance Commission?
The Finance Commission is a constitutional body formed every five years to give suggestions on centre-state financial
relations. Each Finance Commission is required to make recommendations on:
(i) sharing of central taxes with states,
(ii) distribution of central grants to states,
(iii)measures to improve the finances of states to supplement the resources of panchayats and municipalities, and
(iv)any other matter referred to it.
The functions of Finance Commission are to make recommendations to the President on:
• The distribution between the Union and the States of the net proceeds of taxes which are to be, or maybe, divided
between them and the allocation between the States of the respective shares of such proceeds;
• The principles which should govern the grants-in-aid of the revenues of States out of the Consolidated Fund of India;
• The measures needed to augment the Consolidated Fund of a State to supplement the resources of the Panchayats in the
State on the basis of the recommendations made by the Finance Commission of the State;
• The measures needed to augment the Consolidated Fund of a State to supplement the resources of the Municipalities in
the State on the basis of the recommendations made by the Finance Commission of the State;
• Any other matter referred to Commission by President in interests of sound finance
 Who is the Chairman of the 15th Finance Commission [2021-26]?
Finance Year of
The 15th Finance Commission of India was constituted in Chairman
Commission Appointment
November 2017. The present Finance Commission’s chairman is First K.C. Neogy 1951
Nand Kishore Singh. He is a prominent Indian economist, Second K. Santhanam 1956
academician, and policymaker. Prior to this position, he presided as Third A.K. Chanda 1960

Chairman of the Fiscal Responsibility and Budget Management Fourth Dr. P.V. Rajamannar 1964
Fifth Mahavir Tyagi 1968
Review Committee (FRBM).
Sixth Brahamananda Reddy 1972
Advisory Role of Finance Commission
Seventh J.M. Shelat 1977
The recommendations made by the Finance Commission are of an
Eighth Y.B. Chavan 1982
advisory nature only and therefore, not binding upon the Ninth N.K.P. Salve 1987
government. It is up to the Government to implement its Tenth K.C. Pant 1992

recommendations on granting money to the states. Eleventh A.M. Khusro 1998

Twelfth Dr. C. Rangarajan 2002
Thirteenth Dr. Vijay Kelkar 2007
Fourteenth Dr. Y.V. Reddy 2013
Fifteenth N.K Singh 2017
 Who appoints the Finance Commissioner for a State?

Under Article 243-I of the Constitution of India, the governor of a state is required to constitute a Finance Commission
every five years.

Glimpse of Previous Finance

Commission Formula
 15th Finance Commission

November 2017, the 15th Finance Commission (Chair: Mr N. K. Singh) was constituted to give recommendations on the
transfer of resources from the centre to states for the five year period between 2020-25. However, due to pandemic, the
tenure has been segmented as 2020-21 and 2021 to 2026. Furthermore, its full-time members included Ashok Lahiri, Ajay
Narayan Jha and Anoop Singh.
The 15th Finance Commission will recommend central transfers to states, besides mandating it to:
(i) review the impact of the 14th Finance Commission recommendations on the fiscal position of the centre;
(ii) review the debt level of the centre and states, and recommend a roadmap;
(iii)study the impact of GST on the economy; and
(iv)recommend performance-based incentives for states based on their efforts to control population, promote ease of doing
business, and control expenditure on populist measures, among others.

This commission was responsible for the following five types of grants.
• Revenue Deficit grants 4. Local governments’ grants
• Disaster management grants 5. Sector-specific grants
• State-specific grants
 15th Finance Commission

Vertical Devolution (Devolution of Taxes of the Union to States):

• Recommended maintaining the vertical devolution at 41%
• Divisible pool of 42% as recommended by the 14th Finance Commission. [The divisible pool is that portion of gross tax
revenue which is distributed between the Centre and the States. The divisible pool consists of all taxes, except surcharges and
cess levied for a specific purpose, net of collection charges.]
• It has made the required adjustment of about 1% due to the changed status of the erstwhile State of Jammu and Kashmir into
the new Union Territories of Ladakh and Jammu and Kashmir.
• In XVFC’s assessment, gross tax revenues for 5-year period are expected to be 135.2 lakh crore. Out of that, the Divisible pool
(after deducting cesses and surcharges & cost of collection) is estimated to be 103 lakh crore.

• States’ share at 41 per cent of divisible pool comes to 42.2 lakh crore for 2021-26 period.

• Including total grants of Rs. 10.33 lakh crore and tax devolution of Rs. 42.2 lakh crore, aggregate transfers to States is
estimated to remain at around 50.9 per cent of the divisible pool during 2021-26 period.

• Total XVFC transfers (devolution + grants) constitutes about 34 per cent of estimated Gross Revenue Receipts of the Union
leaving adequate fiscal space for the Union to meet its resource requirements and spending obligations on national
development priorities.
 15th Finance Commission

Horizontal Devolution (Allocation Between the States): Based on principles of need, equity and performance, overall
devolution formula is as follows.
• Suggested 12.5% weightage to demographic performance, 45% to income, 15% each to population and area, 10% to
forest and ecology and 2.5% to tax and fiscal efforts.
 15th Finance Commission

Footnotes:
a. Income Distance:
i. It is the gap of the Gross State Domestic Product (GSDP) of a
particular state from the state with the highest GSDP.
ii. In order to maintain inter-state equity, the states with lower
per capita income has been given a higher weightage.

Population:
It represents direct relationship between population of a particular state and the volume of public expenditure required to cater to the public
needs.
Area: Greater the area of a state, greater the requirement for expenditure.
Forest and Ecology: This criteria considers the proportion of dense forest in a particular state.
Demographic Performance: It identifies the state’s efforts in controlling population. It considers the reciprocal of TFR of each state, scaled
by 1971 population data.
Tax Effort: It is ascertained as ratio of the average per capita own tax revenue and the average per capita GSDP during 2016-17 to 2018-
19. States with higher efficiency in tax collection are given higher share.
 15th Finance Commission

3. Revenue Deficit Grants to States:

• Revenue deficit grants emanate from the requirement to meet the fiscal needs of the States on their revenue accounts
that remain to be met, even after considering their own tax and non-tax resources and tax devolution to them.
• Revenue Deficit is defined as the difference between revenue or current expenditure and revenue receipts, that includes
tax and non-tax.
• It has recommended post-devolution revenue deficit grants amounting to about Rs. 3 trillion over the five-year
period ending FY26.
• The number of states qualifying for the revenue deficit grants decreases from 17 in FY22, the first year of the award
period to 6 in FY26, the last year.
 15th Finance Commission

4. Performance Based Incentives and Grants to States [Mainly 4 themes]

i. Social sector, focuses on health and education.
ii. Rural economy, focuses on agriculture and maintenance of rural roads.
iii. Governance and administrative reforms under which it has recommended grants for judiciary, statistics
and aspirational districts and blocks.
iv. Power sector: A performance-based incentive system for the power sector has been developed. This criteria is not
linked with the grants, but successful completion can provide the states with an additional borrowing window.

5. Fiscal Space for Centre: The aggregate 15th Finance Commission transfers (devolution + grants) accounts for 34%
of estimated Gross Revenue Receipts to the Union, leaving adequate fiscal space to meet its resource requirements and
spending obligations on national development priorities.
 15th Finance Commission

6. Grants to Local Governments:

• Along with grants for municipal services and local government bodies, it includes performance-based grants for the
incubation of new cities and health grants to local governments.
• In grants for Urban local bodies, basic grants are proposed only for cities/towns having a population of less than a
million. For Million-Plus cities, 100% of the grants are performance-linked through the Million-Plus Cities Challenge
Fund (MCF).
• MCF amount is linked to the performance of these cities in improving their air quality and meeting the service level
benchmarks for urban drinking water supply, sanitation and solid waste management.
14th v/s 15th Finance Commission
 Types of Central Government Funds

The Indian government’s funds are kept in three parts.

1) Consolidated Fund of India | Article 266(1) of the Constitution of India
a) Credited by:
i) Direct and indirect taxes
ii) Loans taken by the Indian government
iii)Returning of loans/interests of loans to the government by anyone/agency that has taken it
b) The government meets all its expenditure from this fund. Salary and Allowances of the President, Speaker / Deputy
Speaker of Lok Sabha, Chairman/ Deputy Chairman of Rajya Sabha, Salaries and Allowances of Supreme Court
judges, Pensions of Supreme Court as well as High Court Judges, Salaries and Allowances of CAG, Lok Pal are made
out of this fund.
c) The government needs parliamentary approval to withdraw money from this fund.
d) At the state level, each state can have its own Consolidated Fund of the state with similar provisions.
e) The Comptroller and Auditor General of India audits these funds and reports to the relevant legislatures on their
management.
 Types of Central Government Funds

2) Contingency Fund of India | Article 267(1) of the Constitution of India

a) Its corpus is Rs. 500 crores. It is an imprest (money maintained for a specific purpose).
b) The Secretary of Finance Ministry holds this fund on behalf of the President of India.
c) This fund is used to meet unexpected or unforeseen expenditure.
d) Each state can have its own contingency fund established under Article 267(2)
 Types of Central Government Funds

3) Public Accounts of India | Article 266(2) of the Constitution

a) All other public money (other than those covered under the Consolidated Fund of India) received by or on behalf of the
Indian Government are credited to this account/fund.
b) This is made up of:
i) Bank savings account of the various ministries/departments
ii) National small savings fund, defense fund
iii)National Investment Fund (money earned from disinvestment)
iv)National Calamity & Contingency Fund (NCCF) (for Disaster Management)
v) Provident fund, Postal insurance, etc.
vi)Similar funds
c) The government does not need permission to take advances from this account.
d) Each state can have its own similar accounts.
The audit of all the expenditure from the Public Account of India is taken up by the CAG
 FRBM Act 2003

1. The Fiscal Responsibility and Budget Management Bill was presented in the Parliament in the year 2000, which received
the assent of the President of India on 26 August 2003 and became effective from 5 July 2004.
2. The main objectives of the act were to
a) introduce transparent fiscal management systems in the country;
b) introduce a more equitable and manageable distribution of the country’s debts over the years and
c) aim for fiscal stability for India in the long run.
3. The FRBM Act proposed that the central and state fiscal deficit would each be progressively reduced to reach 3 per cent
of GDP while considering:
a) consistency with the forecast trend of household financial savings
b) the target being considered sufficient for reducing the stock of outstanding government liabilities to the level of 50
per cent of the GDP within 10 years. Even though the Constitution enables the adoption of fiscal rules through the
prescription of a ceiling on borrowing by the Union and the States, no such legislation was passed.
 Features of FRBM Act 2003

1. It was mandated by the act that the following must be placed along with the Budget documents annually in the
Parliament:
a) Macroeconomic Framework Statement
b) Medium Term Fiscal Policy Statement and
c) Fiscal Policy Strategy Statement
2. It was proposed that the four fiscal indicators i.e, revenue deficit as a percentage of GDP, fiscal deficit as a percentage of
GDP, tax revenue as a percentage of GDP, and total outstanding liabilities as a percentage of GDP be projected in the
medium-term fiscal policy statement.
 FRBM Bill Amendment [Sarma 2000]

On 17th Jan, 2000, the then Finance Minister constituted a committee under the chairmanship of Dr. E.A.S. Sarma, then
Secretary, Department of Economic Affairs. The Committee identified three categories of indicators for numerical fiscal
targets with specific time frames:
(i) revenue and fiscal deficits:
a) to discourage excessive deficit by mandating a progressive reduction in the fiscal deficit by 0.33 per cent of GDP at the
end of each financial year so as to reduce to the fiscal deficit to no more than 3 per cent of GDP in five years ending on
31 March 2006.
b) to completely eliminate the revenue deficit in five years ending on 31 March 2006 through annual reductions of 0.5 per
cent of GDP, and to build up an adequate revenue surplus thereafter. This would ensure the observance of the ‘golden
rule’, i.e., revenue surpluses would be used for the purpose of discharging liabilities in excess of assets.

(ii) total liabilities/debt: The committee also advocated a debt-GDP ratio of 50 per cent in a period of 10 years commencing
on 1 April 2001. (India’s general government debt (Centre and states) to GDP, which was 67.1% in FY14, rose sharply to
88.5% in the Covid-hit FY21, before declining to 83.1% in FY23. It has projected India’s debt to GDP to remain around
83.6% till FY28, according to IMF’s April Fiscal Monitor report.)
(iii) borrowing from the RBI.
Karnataka became the first state to enact its FRBM Act in September 2002 followed by Kerala (2003), Tamil Nadu (2003)
and Punjab (2004). West Bengal and Sikkim were the last two states to implement FRBM Act in July and September 2010
 FRBM Review Committee [NK Singh 2016]

The NK Singh Committee (FRBM Review Committee): In May 2016, Government of India constituted a five-member
committee to review the working and functioning of FRBMA. The committee made the following policy recommendations:

1. It proposed to replace the FRBM Act, 2003 with a Debt

Management and Fiscal Responsibility Bill, 2017.
2. Debt to GDP Ratio: The debt to GDP ratio should be
38.7% for the central government, 20% for the state
governments together by the FY 2022 – 23.
3. Fiscal deficit: By FY 2022 – 23, fiscal deficit to be should
be 2.5% of GDP.
4. The committee recommended achieving the above targets
by a ‘glide path’, that is, a steady progress towards them,
by achieving annual targets until 2023.
 FRBM Review Committee [NK Singh 2016]

5. Adopt a prudent medium-term ceiling for general

government debt of 60 per cent of GDP, to be achieved
by the fiscal year 2022-23.
6. Adopt a ceiling of 40 per cent for the centre, and the
balance 20 per cent for the states.
7. Adopt fiscal deficit as the key operational target consistent
with achieving the medium-term debt ceiling.
8. A path of fiscal deficit to GDP ratio of 3.0 per cent during 2017-
18 and 2019-20, 2.8 per cent in 2020-21, 2.6 per cent in 2021-22,
and 2.5 per cent in 2022-23.
9. Reduce revenue deficit to GDP ratio steadily by roughly 0.25
percentage points each year, to reach 0.8 per cent by 2022-23.
 FRBM Review Committee [NK Singh 2016]

10. The committee recommended that the government could deviate from the targets in the following scenarios:
a) National calamity, war, in considerations of national security, agricultural collapse affecting incomes and outputs.

b) Structural reforms in the economy having fiscal implications.

c) A decline in real output growth of at least 3% below the average of the previous four quarters.

11. The centre should borrow from the Reserve Bank of India only when:

a) It has to meet a temporary shortfall in receipts.

b) RBI subscribes to g-secs to fund any deviation from the prescribed targets.

c) RBI buys g-secs from the secondary market.

 FRBM w.r.t last two Financial Years

For FY 2020, the fiscal deficit limit was relaxed to 3.5% by the Central Government. As per FRBM Act, the fiscal deficit
limit should be 3% of the GDP, but there have been requests from state governments to increase the limit to either 4% or
5% due to increased borrowings, expenditures, and reduced revenue generation due to Covid-19 pandemic.
Latest Updates on FRBM w.r.t Union Budget 2021-22
• The target of Fiscal deficit at 6.8% of GDP in 2021-22.
• The budget allocation for welfare of women has seen a drop of 26 percent in comparison to revised estimates 2020-21.
• 52.7 percent increase in allocation for welfare of SCs and 50 percent for STs.
• The allocation for the North Eastern region has been increased by 32.7 percent.
Lecture-10: Functions of Environment,
Ayres-Kneese Model, Laws of
Thermodynamics, Club, Common Good
Unit-3 (B): Environment &
Demography Economics
NTA-UGC-NET
Economics (Paper-2)
NTA-UGC-NET | Economy Environment Interaction
Environment
• It is scarce in nature and has many conflicting alternative usages.
• Economics deals with the problem of choice and how to allocate scarce
resources to the areas of maximum returns.
• But if we rest upon market, then we might get inefficient results, as it would
poorly allocate environmental resources. This is because of presence of
imperfections, externalities, undefined or poorly defined property rights,
which set wrong information and signals incorrect prices.
• Consequent of the incorrect prices, the economic agents such as consumers,
producers, government tend to overexploit environment, as the market prices
fail to capture social cost and social benefits.
NTA-UGC-NET | Economy Environment Interaction
Environment
• Environment includes all life forms, energy, material resources, the
stratosphere (high atmosphere) and the troposphere (low atmosphere). These
constituent parts of environment interact with each other resulting in changes
in environment (an example is the effect of changes in biosphere on the
composition of atmosphere)
• In Economics, environment is considered as a composite asset that provides
variety of services which supports our life support through- 1) supply of raw
materials for consumption and production, 2) absorbs and transforms
economic wastes, 3) provides amenities of aesthetic value to society.
NTA-UGC-NET | Economy Environment Interaction
Circular Flow / Ayres-Kneese’s Material Balance Model- 1969
• It depicts the interlinkage between environment and economy.
• Economy consists of two sectors- consumption and production
and exchange of GAS takes place between them.
• Environmental services are rendered through 3 interlinked
circles which are contained in E4.
• Production sector extracts energy resources like coal, oil and
material resources like iron ore from the environment, which
are then transformed into GAS for consumption and production
purposes. This role of environment is termed as Supplier of
Resources.
NTA-UGC-NET | Economy Environment Interaction
Circular Flow / Ayres-Kneese’s Material Balance Model- 1969
• Additionally, there is recycling of resources within the production
as well as consumption sectors. The waste material are created at
each stage of production (say industrial effluents, air pollution,
etc.) and consumption (sewage, litter, etc.). This role of
environment is termed as Sink of Receptor for Waste Products.
• Besides human, environment too creates wastes on itself, like
shedding of old tree leaves, etc. The environment has a capability
limit to absorb the waste and convert them into useful products-
termed as Assimilative Capacity or Carrying Capacity (it is
finite and 2nd major function of environment).
NTA-UGC-NET | Economy Environment Interaction
Circular Flow / Ayres-Kneese’s Material Balance Model-
1969
• If the waste generation > carrying capacity of environment,
then it leads to pollution, which creates negative externalities
and smog.
• This smog effect on nature is related to 3rd service of
environment- i.e. providing aesthetic amenity of spiritual and
educational value to society (like mountain, wild life, sunset,
etc.)
NTA-UGC-NET | Economy Environment Interaction
Laws of Thermodynamics
• The inter-linkages in the circular diagram are governed by the physical or
natural laws termed as laws of thermodynamics. It is a branch of science that
deals with the relationships between heat and energy.

• First law of thermodynamics (law of conservation of energy or material

balance principle). It states that energy can neither be created nor destroyed,
i.e. it can only be transferred or changed from one form to another. For
instance, coal consumption must be equal to the amount of energy generated
+ wates in form of gases and solid due to combustion.
• Two implications of First Law:
✓ As more resources are extracted for the production process, more of
waste is generated. Thus, economic growth which results in increased
extraction of material resources (like coal, water, wind, etc.), for
generation of energy, is also accompanied by increased residual wastes.

✓ There are limits on the degree to which resources can be substituted for
each other in production. The degree of substitutability that can be
derived from the environment is a very important parameter referred to
in literature on economics as the ‘limits to growth’.
NTA-UGC-NET | Economy Environment Interaction
Laws of Thermodynamics
• Second law of thermodynamics (Entropy [degree of disorder] Law):
Entropy here implies that energy once generated for consumption is
unavailable for other work. Cleaning a untidy room implies that
transformation from a state of high entropy (disorder) to a state of low
entropy (order).
• Similarly, production and consumption of energy in a closed system
(environment is a closed system) which are the important inputs of
economic growth leads to use of material which further lead to flow of
energy from low entropy resource to high entropy resource [order of
environment to disorder of wastes]. It is because of the residual generated
and thrown in the economy
• This law also states that no conversion of energy from one form to another
is completely efficient and this conversion process is irreversible. For
instance, CO2 once released in environment leads to no useful substance.
Therefore, entropy creates a physical obstacle.
• Thus, if the earth is a closed system, with a limited stock of low entropy
energy resource (fossil fuel), then the system is unsustainable if the
economic activity degrades the energy resources beyond a point (referred
to as the ‘limit to growth’) where no potential for its further use remains.
 NTA-UGC-NET | Economy Environment Interaction
But earth is not a closed system, as we Laws of Thermodynamics
get unlimited supply of energy from sun. • Second law of thermodynamics (Entropy [degree of disorder] Law):
Thus, entropy law suggest that the flow Entropy here implies that energy once generated for consumption is
of solar energy establishes an upper
unavailable for other work. Cleaning a untidy room implies that
limit on the flow of energy that can be
transformation from a state of high entropy (disorder) to a state of low
sustained. And once the stock of stored
energy (fossils) gets used up, then the entropy (order).
rate of economic growth can only be • Similarly, production and consumption of energy in a closed system
determined by flow of solar energy. (environment is a closed system) which are the important inputs of
economic growth leads to use of material which further lead to flow of
energy from low entropy resource to high entropy resource [order of
environment to disorder of wastes]. It is because of the residual generated
and thrown in the economy
• This law also states that no conversion of energy from one form to another
is completely efficient and this conversion process is irreversible. For
instance, CO2 once released in environment leads to no useful substance.
Therefore, entropy creates a physical obstacle.
• Thus, if the earth is a closed system, with a limited stock of low entropy
energy resource (fossil fuel), then the system is unsustainable if the
economic activity degrades the energy resources beyond a point (referred
to as the ‘limit to growth’) where no potential for its further use remains.
 NTA-UGC-NET | Strong & Weak Sustainability
• Sustainability means meeting our own needs without compromising the ability of future generations to meet their
own needs. In addition to natural resources, we also need social and economic resources. Sustainability is not just
environmentalism. Embedded in most definitions of sustainability we also find concerns for social equity and
economic development.
• The Bruntdland Commission: In 1983, the United Nations tapped former Norwegian prime minister Gro Harlem
Brundtland to run the new World Commission on Environment and Development. After four years, the “Brundtland
Commission” released its final report, Our Common Future. It famously defines sustainable development as:
Development that meets the needs of the present without compromising the ability of future generations to meet their
own needs.
• Sustainability is a holistic approach that considers ecological, social and economic dimensions, recognizing that all
must be considered together to find lasting prosperity.
 NTA-UGC-NET | Strong & Weak Sustainability

• Though sustainable development and sustainability are closely related but they are very different.
• Weak sustainability states that 'human capital' can substitute 'natural capital'. It is based upon the work of Nobel
Laureate Robert Solow and John Hartwick.
• Contrary to weak sustainability, strong sustainability assumes that human capital and natural capital are
complementary, but not interchangeable.
• In weak sustainability concept, human (or produced) capital incorporates resources such as infrastructure, labour
and knowledge & natural capital covers the stock of environmental assets such as fossil fuels, biodiversity and other
ecosystem structures and functions relevant for ecosystem services.
• In very weak sustainability, the overall stock of man-made capital and natural capital remains constant over time. It
is important to note that, unconditional substitution between the various kinds of capital is allowed within weak
sustainability. This means that natural resources may decline as long as human capital is increased.
• Examples include the degradation of the ozone layer, tropical forests and coral reefs if accompanied by benefits to
human capital. An example of the benefit to human capital could include increased financial profits. If capital is left
constant over time intergenerational equity, and thus Sustainable Development, is achieved.
 NTA-UGC-NET | Strong & Weak Sustainability

• An example of weak sustainability could be mining coal and using it for production of electricity. The natural
resource coal, is replaced by a manufactured good which is electricity. The electricity is then in turn used to improve
domestic life quality (e.g. cooking, lighting, heating, refrigeration and operating boreholes to supply water in some
villages) and for industrial purposes (growing the economy by producing other resources using machines that are
electricity operated.)

• Strong sustainability assumes that the economic and environmental capital is complementary, but not
interchangeable. Strong sustainability accepts there are certain functions that the environment performs that cannot
be duplicated by humans or human made capital. The ozone layer is one example of an ecosystem service that is
crucial for human existence, forms part of natural capital, but is difficult for humans to duplicate.
 NTA-UGC-NET | Strong & Weak Sustainability

• Weak sustainability postulates the full substitutability of natural capital whereas the strong conception
demonstrates that this substitutability should be severely seriously limited due to the existence of critical
elements that natural capital provides for human existence and well-being.
• Weak sustainability assumes that natural capital and manufactured capital are essentially substitutable
and considers that there are no essential differences between the kinds of well-being they generate.
• Strong sustainability demonstrate that natural capital cannot be viewed as a mere stock of resources.
Rather natural capital is a set of complex systems consisting of evolving biotic and abiotic elements that
interact in ways that determine the ecosystem’s capacity to provide human society directly and/or
indirectly with a wide array of functions and services
NTA-UGC-NET | Strong & Weak Sustainability
• Weak sustainability postulates the full substitutability of natural capital
whereas the strong conception demonstrates that this substitutability
should be severely seriously limited due to the existence of critical
elements that natural capital provides for human existence and well-
being.
• Weak sustainability assumes that natural capital and manufactured
capital are essentially substitutable and considers that there are no
essential differences between the kinds of well-being they generate.
• Strong sustainability demonstrate that natural capital cannot be viewed
as a mere stock of resources. Rather natural capital is a set of
• complex systems consisting of evolving biotic and abiotic elements that
interact in ways that determine the ecosystem’s capacity to provide
human society directly and/or indirectly with a wide array of functions
and services
NTA-UGC-NET | Types of Goods
Environmental Goods
NTA-UGC-NET | Types of Goods
Environmental Goods

• Environmental goods are typically non-market goods,

including air, water, landscape, green transport
infrastructure (footpaths, cycleways, greenways, etc.),
public parks, urban parks, rivers, mountains, forests, and
beaches. Environmental goods are a sub-category of
public goods.
 Types of Efficiency

•Allocative efficiency – is about ensuring resources are allocated between alternative uses in a way that
maximises community wellbeing.
•Productive efficiency – describes the situation in which output is being produced at is lowest possible average
cost. This occurs when an organisation, industry or the economy as a whole is operating on its production
possibility frontier (i.e. producing the maximum output from a given set of inputs).
Pareto Optimality, Social Optimal, Allocative Efficiency
 Pareto Optimality, Social Optimal, Allocative Efficiency

• Pareto Optimality implies Social Optimality, which further implies Allocative Efficiency.
• Social efficiency means taking into account all of the private and social costs and benefits of a decision / policy.
Social welfare is optimised when marginal social benefit = marginal social cost.
• To find the socially optimal amount of the good we need to set the market demand curve (i.e. Price) equal to the
marginal cost curve.
• Where, demand = MSB and MC = MSC |
• MSC = MPC + MEC [MEC can be positive or negative]
• MSB = Marginal private benefit (MPB) + marginal external benefit [MEB can be positive or negative]
• This is the optimal distribution of resources in society, taking into account all external costs and benefits as well as
the internal costs and benefits. Social efficiency occurs at an output where Marginal Social Benefit (MSB) = Marginal
Social Cost (MSC)
 Market Failure
Market failures arise when free markets fail to develop, or when they fail to allocate resources efficiently. There are several
different types of market failure.
1. A complete failure: It exists when markets does not supply at all or there is a missing market. In other words, free
markets are unable to allocate scarce resources to the satisfaction of a need or want. This occurs because there are
insufficient incentives to encourage profit-seeking firms to enter a market. This is commonly the case with pure public
goods, such as street lighting, for which there is a need, but private individuals would not be prepared to pay. If no-one
is prepared to pay, no revenue can be derived, and no profit earned; hence no firm would enter the market.
 Market Failure
Market failures arise when free markets fail to develop, or when they fail to allocate resources efficiently. There are several
different types of market failure.
1. A complete failure:
2. A partial failure: It exists in the following two situations:
• When markets exist, but fails to develop or supplies the right quantity then priced it wrongly. This means that
markets form, but will fail to develop and supply sufficient quantities of a good or service. In the case of
merit goods, such as education, markets are inefficient because they under-supply these goods, and fail to
meet society’s demand.
• When markets exist, but over-supply a good or service, either because producers fail to take into account the
full costs of production to society, or because consumers fail to take into account the full costs of
consumption to themselves, or society. Externalities and demerit goods are cases of free markets over-
supplying.
Market Failure
Market Failure Happens when:
• Missing markets
• Externalities
• Public Goods
• Asymmetric Information/ Imperfections
• Moral Hazards
• Ex- Climate change is an example of market failure.
Greenhouse gases lead to externalities, which are to be
borne by the future generations.
 Non-Excludability

• Price attached to the consumption of a good or bad means that someone can be denied from the
consumption of the good, if the price is not paid.
• Normally, we expect exclusion only when the benefit of exclusion > the cost of exclusion.
• For example, consider the case of household producing garbage (it is a bad good as it needs to be
disposed of in an environmentally friendly manner) which is excludable only with the right laws on
littering and trespass.
• But urban air pollution is not excludable as everyone consumes it to the same degree.
• Therefore, “a ‘good’ is excludable if it is feasible and practical to selectively allow consumers to
consume the good.
• A ‘bad’ is excludable if it is feasible and practical to selectively allow consumers to avoid the
consumption of the bad”
 Non-Rivalry

• ‘Air pollution’ and the ‘global climate change’ are the examples of non-rival goods. As an individual
experience deterioration of health, the same is the deteriorating effect that will be experienced by all the
other people living in a region.
• Therefore, “a bad (or a good) is rival if one person’s consumption of a unit of the bad (good) diminishes
the amount of the bad (good) available for others to consume i.e. there is a negative (positive) social
opportunity cost to others associated with consumption”.
• Another feature that is applicable to common goods like a road is ‘congestion’. An undensely populated
rural highway is non-rival, as there is no opportunity cost associated with one additional person using the
road. However, once the congestion sets-in, there is opportunity cost for an additional driver with the
road no longer being nonrival.
• Roads, by their nature of indivisibility in production. Rivalry is thus important as the key is ‘efficiency’.
If there is no cost associated with the incremental use [which implies MC = 0] and the price equals
marginal cost, the incentive to invest and produce is itself eliminated.
 Externality

• Externality is said to exist, if the consumption or production activity of an individual or firm affects
another person’s utility or firm’s production for which no compensation is made (i.e. where the condition
of Pareto optimal resource allocation is violated).
• In case of presence of external costs (like presence of environmental pollution & victims are not
compensated), then the producers produce more of such goods, as they face lower private costs [actual
social costs are higher]. In this case, if the producers are exposed to social costs (say by the way of
compensating the victims), then due to higher cost of production, they would produce lesser of the goods.
• The unregulated or free market with these externalities, fail to estimate prices that do not reflect the full
social cost or benefit of their transactions. Such markets are therefore inefficient and become instances of
market failure.
 Externality

• A firm producing steel pays for the resources (inputs) used at the prevailing market price with the costs
incurred reflected in the final market price of steel.
• If the firm pollutes the environment while making steel, and is not made to pay for pollution abatement
cost, then such a cost will have to be borne by the society. Hence, the market price for steel will fail to
incorporate the full opportunity cost to society of its production.
• In this case, the market equilibrium will not be optimal. More steel will be produced than would be the
case when firms are made to pay for such damages. Consequently, the marginal social cost of the later
units produced would exceed the marginal social benefit.
• An external cost (externality) thus exist when the following two conditions prevail:
➢ (i) an activity by one agent causes a loss of welfare to another agent;
➢ (ii) the loss of welfare is uncompensated.
• If the loss of welfare is accompanied by a compensation by the agent causing the externality, the effect is
said to be internalised
 Incomplete Markets

• Market failure with environmental goods is generally linked to incomplete markets.

• Markets are incomplete because of the failure or inability of the institutions to establish well defined
property rights.
• In case of environment, lack of well defined property rights for clean air makes it difficult for the market to
be complete. Thus, people who live nearby a thermal power station suffer from the pollution effect but
cannot avoid the harm unless they have the right to claim a compensation from the thermal power station.
With incomplete market of undefined rights, the station lacks an incentive to control emission by switching
over to less polluting practices or by upgrading technology.
• This inability of the government to assign rights so that markets are complete provides the rationale for
government to intervene for the management of environmental resources. A solution to this situation,
provided by Coase (1960).
 Non-Convexities

• If markets are complete, it will send the right signal about the socially optimal level of pollution.
• But in reality, the marginal benefit and cost are not well behaved (not convex).
• This implies that Marginal cost at first increase with increased pollution, but may subsequently decrease.
• This is referred to as non-convexity implying that there may be more than one locally optimal level of
pollution.
• This is opposite to a complete market situation where the equilibrium level of pollution not only exists but
is also unique.
 Asymmetric Information

• Markets are incomplete also due to information asymmetry – a situation where full information about the
agents and their action are not completely known to all players involved in a market transaction.
• In such cases, two types of problems, Moral Hazard and Adverse Selection arise.
• Moral hazard, markets are ‘confounded’ (confused) due to the hidden actions of an agent in a manner
unobserved by the other.
• Adverse selection problem, ‘depresses’ the markets because an agent cannot again observe a ‘hidden
quality’ of goods or services.
• Both the tactics (hidden actions and hidden quality) retard the operation of market constraining the
efficient use of resources.
 Public Goods- Pure and Impure Public Goods

• A pure public good is both non-rival and nonexcludable. Example: Climate change protection, ozone layer
and biodiversity are examples of pure public good in which the benefits accrue to all those across the
globe.
• An impure public good, might be either non-excludable or non-rival, but not both. Example- Common
property and club goods like rivers, local parks, lakes are impure public goods because the benefits are
excluded from the non-members of the group who own the resource.
 NTA-UGC-NET | Externalities

Externality
• Presence of externalities prevents achievement of Pareto optimality even under PC.
• It happens when the decision-makers does not bear all of the cost or reap all the gains
from their actions.
Types of Externalities
• Negative Externality/External Cost/External Diseconomy- Pollution by a firm
during production
• Tragedy of the Commons: Over-fishing in open sea by one leads to lesser output
by other fishing companies
• Positive Externality/Beneficial Externality /External Economy- I am gardening in
front of my home benefits others.
• Network Externality- One buying smart phones for video calling, would encourage
others too buy smart phones.
• Pecuniary Externalities- These don’t affect consumption or production but affect
prices (eg- property dealer)
• Technological Externalities- They affect consumption & production costs (eg- coal)
 NTA-UGC-NET | Externalities
Basic Terminologies
1.The free-market fails when there is no allocative efficiency such that the marginal
benefit of the activity does not equal its marginal cost. The market fails to attain
private efficiency when marginal private benefit (MPB or commonly denoted as
MB when it is understood to mean marginal private benefit) does not equal marginal
private cost (MPC or just MC). The market also fails to achieve social efficiency
when there is a discrepancy between marginal social benefit (MSB) and marginal
social cost (MSC).
2.Private costs are direct costs incurred when an individual consumes a product,
and also when a product is produced. Examples: (i) The cost of production of new
bird flu vaccine. (ii) The costs (monetary, time, best alternative given up, etc.) of
buying an ice cream.
3.Private benefits are benefits received directly by the consumers or the producers
of a product. Examples: (i) The revenue from selling a new bird flu vaccine for the
producer. (ii) The satisfaction of eating a chocolate ice cream.
 NTA-UGC-NET | Externalities
Basic Terminologies
4.An externality (spill-over) is costs or benefits to third parties who are not directly involved
in the consumption or the production of a good.
a. Negative externality when costs are imposed on third parties. Examples: (i) Air
pollution due to car exhaust. (ii) Visual pollution due to an ugly air polluting factory. (ii)
Second hand tobacco smoke to non smokers.
b. Positive externality when benefits spilt-over to third parties due to consumption or
production of a good. Examples: When a lot of people are immunized against COVID19
then there will be a lower outbreak of the disease and an individual who have yet to be
immunized will also benefit from the situation.
5.Social costs are the total costs incurred by the society when a good is consumed or
produced. Social costs can be defined as private costs plus costs to third parties (i.e. private
costs + total negative externalities).
6.Social benefits is the total benefits accrued to the society from an economic activity. Social
benefits can be defined as private benefits plus benefits to third parties (i.e. private benefits
+ total positive externalities).
 NTA-UGC-NET | Externalities
Basic Terminologies
In order to decide whether or not social efficiency is achieved (i.e. highest possible social
benefits given the constraint of costs), we need to consider how marginal social benefits
compared to marginal social costs. So, CBA is also called marginal cost-benefit analysis.

Marginal cost is the additional cost of consuming or producing one more unit of a good.
Costs incurred by private individuals and society are called marginal private costs (MPC) and
marginal social costs (MSC) respectively. Marginal cost slopes upward because of
diminishing marginal returns. Marginal social benefits (MSB) and marginal private benefits
(MPB) slopes downwards like a demand curve.

Marginal benefit is the additional benefit from consuming or producing one more unit of a
good. Benefits accrued to private individuals and society are called marginal private benefits
(MPB) and marginal social benefits (MSB) respectively. The marginal benefit curve is
downward sloping because of the principle of diminishing marginal utility in the consumption
of a good.

When MSB > MPB then we have positive externality

and when MSC > MPC then we have negative externality
MPB MPC MPB MPC MPB MPC

MPB MPC
 NTA-UGC-NET | Externalities
Particulars Conditions Free Social Efficiency = Results if considers Corrective Measures
Market SMC = SMB Social Efficiency
Negative Ext SMC > PMC Lower P Higher P
Production Higher Q Lower Q
Negative Ext SMC > PMB Lower P Higher P
Consumption Higher Q Lower Q
Positive Ext SMC < PMC Higher P Lower P
Production Lower Q Higher Q
Positive Ext SMB > PMB Lower Q Higher Q
Consumption Lower P Higher Q
Lecture-11: Property Rights v/s Common
Property
Unit-3 (B): Environment &
Demography Economics

NTA-UGC-NET
Economics (Paper-2)
 NTA-UGC-NET | Property Rights v/s Common Property
A well defined property right system has thus the following 4 characteristics:
1. Comprehensive – All resources are either privately or collectively owned and all entitlements are defined,
well known and enforced.
2. Exclusive – All benefits and costs from use of a resource should accrue to the owner, and only to the
owner, either directly or by sale to others. This applies to both private and common property resources.
3. Transferable – Property rights should be transferrable from one owner to another through a voluntary
exchange. The owner thus has incentive to conserve the resources beyond the time he or she expects to
make use of it.
4. Secure – Property rights to resources should be secure from involuntary seizure or encroachment by other
people, firms, and the government. Security provides the owner with the incentives to improve and
preserve a resource while it is in his or her control rather than exploit the assets.
NTA-UGC-NET | Property Rights v/s Common Property
A common-pool resource, also called a common property resource (CPR), is a
type of good consisting of natural or human-made resource system (e.g. an
irrigation system or fishing grounds), whose size or characteristics makes it
costly (but not impossible), to exclude potential beneficiaries from its use.
Unlike pure public goods, due to rivalry, common pool resources face
problems of congestion or overuse. A common-pool resource typically consists
of a core resource (e.g. water or fish), which defines the stock variable, while
providing a limited quantity of extractable fringe units, which defines the flow
variable. While the core resource is to be protected or nurtured in order to
allow for its continuous exploitation, the fringe units can be harvested or
consumed.
Examples of common-pool resources include irrigation systems, fishing
grounds, pastures, forests, water or the atmosphere.
NTA-UGC-NET | Property Rights v/s Common Property
Unlike pure public goods, due to rivalry, common pool resources face
problems of congestion or overuse. A common-pool resource typically consists
of a core resource (e.g. water or fish), which defines the stock variable, while
providing a limited quantity of extractable fringe units, which defines the flow
variable. While the core resource is to be protected or nurtured in order to
allow for its continuous exploitation, the fringe units can be harvested or
consumed.
NTA-UGC-NET | Property Rights v/s Common Property
A pasture, for instance, allows for a certain amount of grazing to occur each
year without the core resource being harmed. In case of excessive grazing, the
pasture may become more prone to erosion and eventually yield less benefit to
its users. Because their core resources are vulnerable, common-pool resources
are generally subject to the problems of free-riding leading to congestion,
overuse, pollution, and potential destruction unless harvesting or use limits are
devised and enforced.

Free-riding can lead to what is commonly called the classic case of the
prisoner’s dilemma, also called tragedy of the commons. The dilemma exists
when people find that their individual incentives lead them to
the worst outcome possible – both for themselves and the society.
NTA-UGC-NET | Property Rights v/s Common Property
• Common property regimes (or systems of management) arise when users acting
independently threaten the total net benefit from the common-pool resource. In
order to maintain the resource system, such regimes coordinate their strategies to
keep the resource as a common property instead of dividing it up into bits of
private property.
• Common property regimes typically protect the core resource and allocate the
fringe resources through community norms of consensus decision-making.
• In the common property regimes, the resources are not public goods and access
to the resource is not free. There is relatively free but monitored access to the
resource system for community members with mechanisms in place to allow the
community to exclude outsiders from using its use. Thus, a common-pool
resource appears as a private good to an outsider and as a common good to an
insider of the community. The resource units withdrawn from the system are
typically owned individually by the appropriators. A common property good is
rivalled in consumption.
 NTA-UGC-NET | Elinor Ostrom
• Elinor Ostrom (first woman to get the noble prize in 2009) identified eight
‘principles of design’ which are prerequisites for a stable CPR arrangement.
These are:
(i) clearly defined boundaries;
(ii) congruence between appropriation & provision rules suitable to local
conditions;
(iii) collective-choice arrangements allowing for the participation of most of the
appropriators in the decision making process;
(iv) effective monitoring by monitors who are part of or accountable to the
appropriators;
(v) graduated sanctions for appropriators who do not respect community rules; (vi)
conflict-resolution mechanisms which are cheap and easy to access;
(vii) minimal recognition of rights to organize; and
(viii) in case of large CPRs allowing for formation of organisations in the
form of multiple layers of nested enterprises, with small, local CPRs as their bases
NTA-UGC-NET | Property Rights v/s Common Property
• Common property regimes typically function at a local level to prevent the over
exploitation of a resource system from which fringe units can be extracted.

• In some cases, government regulations combined with tradable environmental

allowances (TEAs) are successfully used to prevent exploitation. In other cases,
however, excessive use or pollution continue.
NTA-UGC-NET | Garrett Hardin, 1968 Tragedy of Commons
Tragedy of Commons-Garrett Hardin, 1968
[Freedom in the Commons brings Tragedy to all]
• It is a tendency for any good which is rival and non-excludable to be overused
and undermaintained.
• As common resources are not owned, so it is difficult to prevent anyone from
consuming these goods.
• People have the incentive to gather or consume more of common resource before
the others.
• Common resources like wildelife can be subjected to the tragedy of the commons.
• The resources must be carefully maintained to remain useful, but there is a little
incentive for the users to invest in maintenance.
• ToC can be regarded as type of externality where any investment in maintenance
by an individual user provides an external benefit to others.
 NTA-UGC-NET | Garrett Hardin, 1968 Tragedy of Commons

Tragedy of Commons-Garrett Hardin, 1968

• As per Hardin, environmental problems are caused by overuse of common property resources. All people
have equal rights to use these resources, as they are public goods:
• No ownership of common property say sees, mountains
• Non-exclusion, not possible to exclude others from using common property, indeed expensive to stop
others.
Solutions to the tragedy of the commons
• Rival • Social customs
• Government regulations
• Tradeable allowances
• Joint ownership is needed to control overuse
• Membership and fees should be paid to reduce usage
• Restrict number of users/members
• Fines and penalties for over-using the commons
• In 1968, Garrett Hardin postulated that humans were doomed to suboptimal outcomes, due to the tragedy of
the commons. Individuals behaving rationally would lead to overconsumption and thus, collectively
suboptimal outcomes. He, and many who came after, argued that the solutions to this tragedy were either
privatization of a resource, or alternatively government control and top-down regulation.

• But decades of research have demonstrated that local communities have demonstrated the capacity to avoid
this “tragedy” through the formation of institutions that are collectively designed, monitored, and enforced.
In Elinor Ostrom’s seminal book “Governing the Commons” she argues that by forming institutions that
follow 8 principles can allow communities to avoid the tragedy of the commons and collectively self
govern collective (or “common pool”) resources.
 Elinor Ostrom 2009 Nobel Laurette Tragedy of Commons-Garrett Hardin, 1968
Principles to Avoid Tragedy of the Commons Solutions to the tragedy of the commons
1. Boundaries of users and resource are clear 1. Social customs
2. Congruence between benefits and costs 2. Government regulations
3. Users had procedures for making own rules 3. Tradeable allowances
4. Regular monitoring of users & resource 4. Joint ownership is needed to control overuse
conditions 5. Membership and fees should be paid to reduce
5. Graduated sanctions usage
6. Conflict resolution mechanisms 6. Restrict number of users/members
7. Minimal recognition of rights by government 7. Fines and penalties for over-using the
8. Nested enterprises commons
Subsequent research has demonstrated that by improving trust through face-to-face communication, users of a resource are
more likely to be able to devise rules and creative solutions that help sustain a local resource. This research has become the
basis for extensions such as collaborative resource management, conceptions of complex socio-ecological systems and their
management, and the principles of resilience and robustness.
Lecture-12: Valuation of Environmental
Goods
Unit-3 (B): Environment &
Demography Economics
NTA-UGC-NET
Economics (Paper-2)
 NTA-UGC-NET | Valuation of Environmental Goods
Role of Environment in an Economy
• Contributes to production of output by supplying inputs such as raw materials
• Regulates climatic conditions through changes in the levels of carbon dioxide, solar energy, moisture, soil
fertility and erosion
• Provides avenues for recreational activities
• Carrier of life and provides habitat
• Absorbs wastes

Environmental degradation is of more importance, as it can adversely affect quality of human life.
 NTA-UGC-NET | Valuation of Environmental Goods
Types of Environment
• Geographical Environment : It is the terrestrial environment that is a creation of natural and environmental
conditions. It is also called a natural environment as it interacts with nature. The earth’s surface, rivers,
mountains, deserts, land, water, oceans, volcanoes, etc. come under the natural environment examples.

• Man-Made Environment: Created by man to suits its livelihood. It is also termed as social environment. It
has two types.

• The Inner Environment: It is termed as social heritage and is entirely dependent on human social influence.
It pertains to the regulations, traditions, organizations and institutions. It involves customs and folkways
which is existent in every human group.

• The Outer Environment: It is the physical environment that man has created on his own with the evolving
technology and science. It includes cities, houses, infrastructures, transport and communication, and much
more. It can be said that the outer environment changes more rapidly than the inner one because it is in the
hand of man and his evolving technology.
 NTA-UGC-NET | Valuation of Environmental Goods
Types of Capital Stocks
• Man-Made Capital (Physical capital)
• Human Capital
• Social Capital
• Natural Capital (stock of natural resources). These are converted into Man-Made by human
beings
What is the need to value environmental goods?
• When exploitation of natural resources > natural regeneration capacity
• Only private costs and benefits of the current period are considered for decision making
process, while externalities & long-run impacts are ignored
• Lack of market for environmental goods, inadequate standards of measurement techniques lead
to undervaluation of environmental goods.
• Recently, there has been general consensus, to conserve and to resort to judicious use of
environmental goods.
• Consequently, stock of natural capital and its quality is included while estimating the
Environment Adjusted GDP, i.e. EDP = GDP + Value of Environment
• In case of depletion, EDP declines.
• EDP is calculated based upon TEV total economic value of environment.
 NTA-UGC-NET | Valuation of Environmental Goods
Total Economic Value of Environment
• Non-use value-
• Option values:
• Existence Values:
• Bequest Values:

Use Value- Different uses to which the environment

is subjected to.

Non-use value is the value that people assign to

economic goods (including public goods) even if
they never have and never will use it. It is
distinguished from use value, which people derive
from direct use of the good. The concept is most
commonly applied to the value of natural and built
resources. Psychological and ethical aspects
associated with environment
 NTA-UGC-NET | Valuation of Environmental Goods

• Option value– the value placed on individual willingness to pay for maintaining an asset or resource even
if there is little or no likelihood of the individual actually ever using it, occurring because of uncertainty
about future supply (the continued existence of the asset) and potential future demand (the possibility that
it may someday be used). Additional value placed on natural resource by people who want to have the
option of using the goods & services in future. Very similar to altruistic value.

• Bequest value – values placed on individual willingness to pay for maintaining or preserving an asset or
resource that has no use now, so that it is available for future generations. Desire to preserve
environmental assets for the enjoyment of present and future generations

• Existence value – an unusual and somewhat controversial class of economic value, reflecting the benefit
people receive from knowing that a particular environmental resource, such as Antarctica. People wish to
maintain or improve environment out of sympathy for animals and nature or from moral conviction.

• Altruistic value – the value placed on individual willingness to pay for maintaining an asset or resource
that is not used by the individual, so that others may make use of it. Its value arises from others' use of the
asset or resource. It reflects individuals’ willingness to pay for environmental quality may be partly for
the benefit of other people, not just themselves.
 NTA-UGC-NET | Valuation of Environmental Goods

• Option value– the value placed on individual willingness to pay for maintaining an asset or resource even
if there is little or no likelihood of the individual actually ever using it, occurring because of uncertainty
about future supply (the continued existence of the asset) and potential future demand (the possibility that
it may someday be used). Additional value placed on natural resource by people who want to have the
option of using the goods & services in future. Very similar to altruistic value.

• Altruistic value – the value placed on individual willingness to pay for maintaining an asset or resource
that is not used by the individual, so that others may make use of it. Its value arises from others' use of the
asset or resource. It reflects individuals’ willingness to pay for environmental quality may be partly for
the benefit of other people, not just themselves.

• Vicarious use values are gained by people from the knowledge that others may be enjoying use of a
natural environment, for instance, for recreational activities, commercial activities, etc.
NTA-UGC-NET | Valuation of Environmental Goods
 NTA-UGC-NET | Valuation of Environmental Goods
Rick Freeman (1993) suggests yet another variant that he calls "pure non-use value", defined as the value that
occurs for an individual when current prices preclude use of a good, but there exists some lower price at which
the individual would use the good. The continued availability of the good provides some value to the
individual insofar as s/he may eventually be in a position to use the good.

All of these categories are offspring of the original concept of option value that was introduced into the cost
benefit analysis lexicon in 1964 by Burton Weisbrod to justify individuals' valuation of goods, assets and
resources that they do not actually use. In general, it is not possible to use market prices or other revealed
preference methods to measure non-use value. As a result, "stated preference" survey methods are generally
used, including most prominently contingent valuation methods (CVM).
NTA-UGC-NET | Valuation of Environmental Goods
 NTA-UGC-NET | Valuation of Environmental Goods

LIMITATIONS Hedonic Pricing Method

• Ignores size of houses • It is used for valuation of non-marketed goods and services.
• More subjectivity • Price of a good is decomposed into the price of its components or attirbutes.
• Huge data requirement • For example-
Rs 2,00,000 Rs 10,00,000

Location B
Location A
5 km from Railway Station
50 km from Railway Station
2 km from Hospital
20 km from Hospital
1 km from School
15 km from School

Hedonic Price : 10,00,000 – 2,00,000

= 8,00,000
 NTA-UGC-NET | Valuation of Environmental Goods
Hedonic Pricing Method
LIMITATIONS • The hedonic price method uses the value of a surrogate good or service to
• Ignores size of houses measure the implicit price of a non-market good.
• More subjectivity • For example, house prices can be used to provide a value of particular
• Huge data requirement environmental attributes.
• Individuals may be willing to pay a premium for a house located close to a
country park, while they may wish to have a discount on a house which is
located close to a open cast mining site.
House and other property prices are not simply determined by one variable as
listed above. Number of other factors including:
1. Characteristics of the property.
2. Characteristics of the location.
3. Characteristics of the environment.
The hedonic price method is used to measure the relative importance – through
use of regression analyses – of these independent ‘explanatory’ variables on
house and property prices. If, for example, through regression analyses increased
distance from an open cast mining site is found to be correlated with increased
house prices, it can be ascertained that the open cast site is having a negative
impact on house prices. It may be found that a 1km movement away from the
open cast site equates to an increase of Rs 50,00,000 on a house price.
NTA-UGC-NET | Valuation of Environmental Goods
NTA-UGC-NET | Valuation of Environmental Goods
Travel Cost Method
• It is based upon the assumption that consumers are willing to incur
substantial cost in terms of time and money to procure environmental
goods and services. used for valuation of non-marketed goods and
services.
• The value of the environmental service = Opportunity cost of time spent
and travel cost incurred by the consumer avail that service
• Has been widely used in developed countries to measure the value of
recreational facilities
 NTA-UGC-NET | Valuation of Environmental Goods
Travel Cost Method
• It is assumed that travel costs represent the price of access to a recreational site.
• Peoples’ WTP for visiting a site is estimated based on the number of trips that they make at different
travel costs. This is called a revealed preference technique, because it ‘reveals’ willingness to pay
based on consumption behaviour of visitors.
• The information is collected by conducting a survey among the visitors of a site being valued.

• The survey should include questions:

▪ on the number of visits made to the site over some period (usually during the last 12 months),
distance travelled from visitor’s home to the site,
▪ mode of travel (car, plane, bus, train, etc.),
▪ time spent travelling to the site, respondents’ income, and other socio-economic characteristics
(gender, age, degree of education, etc).
▪ The researcher uses the information on distance and mode of travel to calculate travel costs.
▪ The value of time is determined based on the income of each respondent. Time spent at the site
is for the same reason also considered as part of travel costs. For example, if respondents visit
three different sites in 10 days and spend only 1 day at the site being valued, then only fraction
of their travel costs should be assigned to this site (e.g.1/10). Depending on the fraction used,
the final benefit estimates can differ considerably.
 NTA-UGC-NET | Valuation of Environmental Goods
Travel Cost Method
TCM can be classified into three different categories:
1. The individual travel cost method (ITCM) seeks the relationship between the number of trips taken
by the same individual, and the travel costs incurred when reaching the destination.

2. Zonal travel cost method (ZTCM) analyzes the relationship between the number of trips to the site in
relation to the population of a zone and the travel costs.

3. The random utility model (RUM) combines

a TCM and a contingent valuation to determine
the number of trips to a site among a set of
possibilities.
 NTA-UGC-NET | Valuation of Environmental Goods
Travel Cost Method
The relationship between travel costs and number of trips (the higher the travel costs,
the fewer trips visitors will take) shows us the demand function for the average visitor to
the site, from which one can derive the average visitor’s willingness to pay. This
average value is then multiplied by the total relevant population in order to estimate the
total economic value of a recreational resource.
TCM is based on the behaviour of people who
actually usean environmental good and therefore
cannot measure non-use values. This method is
thus inappropriate for sites with unique
characteristics which have a large non-use
economic value component (because many people
would be willing to pay for its preservation just to
know that it exists, although they do not plan to
visit the site in the future).
NTA-UGC-NET | Valuation of Environmental Goods
 NTA-UGC-NET | Valuation of Environmental Goods
Related Goods Approach- Direct Substitute Approach
• In this case, the value of a similar good is used for valuation of natural resource.
• For example- the value of fuel wood collected by the villagers can be proximate by the equal cost of
kerosene or coal.
Contingent Market Techniques
• We construct a hypothetical market for an environment function.
• A survey is conducted, whereby interviews are conducted and respondents are asked about their willingness
to pay in monetary terms for continuation of environmental function or say for foregoing some
environmental functions and the consumers are compensated for the change in environmental service.
• But in this case, persons interviewed are hypothetical consumers, so they might not be aware of benefits of
environmental functions.
Restoration Cost
• It takes into account the cost of recreating the ecosystem.
• For example, degradation of forests results in a reduced flow of forest products and other functions. In order
to restore, government needs to intervene (in terms of policy implementation and afforestation) is required.
• According to the restoration cost method, the value of forest functions is its restoration or recreation cost.
 NTA-UGC-NET | Valuation of Environmental Goods
Contingent valuation

• Contingent valuation is a method for estimating the value of benefits that do not have an established
monetary value.

• It utilizes surveys that ask people how much they would be willing to pay for specific benefits.

• It is called "contingent" valuation, because people are asked to state their willingness to pay, contingent
on a specific hypothetical benefit.

• Contingent valuation is based on what people say they would do (stated preference), as opposed to what
people are observed to do (revealed preference).

• What people say something is worth to them may not be the same as what they would actually be
willing to pay for it. Therefore, contingent valuation is not an appropriate method if the value can be
estimated based on outside, quantifiable factors.
 NTA-UGC-NET | Valuation of Environmental Goods
Examples
•Value of traveler information: Survey travelers to determine what they would be willing to pay for a
specific, but not yet available, type of information.
•Value of highway landscaping: Survey travelers to determine what they would be willing to pay for
highway landscaping, or how they value it relative to other trip characteristics with established values,
such as travel time.
•Value of a wilderness area: Survey constituents to determine what they are willing to pay to have this
wilderness area even if they may never use it. This is sometimes referred to as the "existence value.“

Uses of Contingent Valuation

Contingent valuation is especially useful for valuing:
•Benefits that cannot be bought and sold, such as scenic views
•Things that people may never use, such as wilderness areas (often referred to as existence value)
•Things that benefit others, such as highway overpasses to preserve wildlife habitat
•Services or products that do not yet exist
 NTA-UGC-NET | Questions
Question1 Which of the following is correct about CVM used in
Question-3: Which of the following not a Environmental Economics?
part of man-made environment? a. It is used only for pollutants
a. Internal environment b. It is used only for items with positive utilities
b. External environment c. It is used for items under market failure
c. Geographical environment. d. It is used only for natural resources
d. Both a and b
Question-2: Suggest the correct choice about the nature of
Environmental Economics
a. Nature of market failure is similar to public goods
b. Willingness to pay can be negative
c. It deals for items which are not used
d. It delas for items which are used.
Select the correct answer.
i. 2 and 4
ii. 1, 2 and 3
iii. 2, 3 & 4
iv. All of these
 NTA-UGC-NET | Contingent Valuation Method

Contingent Valuation Method

• We construct a hypothetical market for an environment function.
• A survey is conducted, whereby interviews are conducted and respondents are asked about their
willingness to pay in monetary terms for continuation of environmental function or say for foregoing
some environmental functions and the consumers are compensated for the change in environmental
service.
• But in this case, persons interviewed are hypothetical consumers, so they might not be aware of
benefits of environmental functions.
 NTA-UGC-NET | Contingent Valuation Method

Contingent Valuation Method

• Contingent Valuation is a method of estimating the value that a person places on a good. The approach asks
people to directly report their willingness to pay (WTP) to obtain a specified good, or willingness to accept
(WTA) to give up a good, rather than inferring them from observed behaviours in regular market places.

• Because it creates a hypothetical marketplace in which no actual transactions are made, contingent
valuation has been successfully used for commodities that are not exchanged in regular markets, or when it
is difficult to observe market transactions under the desired conditions.

• Although it is certainly possible to employ contingent valuation for commodities available for sale in
regular marketplaces, many applications of the method deal with public goods such as improvements in
water or air quality, amenities such as national parks, and private non-market commodities such as
reductions in the risk of death, days of illness avoided or days spent hunting or fishing.

• Contingent valuation has proven particularly useful when implemented alone or jointly with other valuation
technique for non-market goods, such as the travel cost method or hedonic approaches. It remains the only
technique capable of placing a value on commodities that have a large non-use1 component of value, and
when the environmental improvements to be valued are outside of the range of available data.
 NTA-UGC-NET | Contingent Valuation Method

Contingent Valuation Method

• Much controversy surrounds the use of CV when most of the value of the good derives from passive use,
as has been typical in litigation over the damages to natural resources and amenities caused by releases of
pollutants. Critics of contingent valuation allege that the quality of stated preference data is inferior to
observing revealed preferences, consider contingent valuation a "deeply flawed method" for valuing non-
use goods and point at the possible biases affecting contingent valuation data.

Why Use the Contingent Valuation Method?

• The contingent valuation method was selected in this case because of the importance of non-use values,
and their potentially significant levels.

Alternative Approaches:
• Since non-use values are significant, and few people actually visit the site, other methods, such as the
travel cost method, will underestimate the benefits of preserving the site. In this case, contingent choice
methods might also be used, depending on the questions that must be answered, and whether contingent
choice question formats are more effective than standard contingent valuation questions. This would be
decided in the survey development stage of the application.
 NTA-UGC-NET | Contingent Valuation Method

Contingent Valuation Method- Advantages

• It can be used to estimate both use and non-use values, and it is the most widely used method for
estimating non-use values. It is also the most controversial of the non-market valuation methods.

• The contingent valuation method involves directly asking people, in a survey, how much they would be
willing to pay for specific environmental services. In some cases, people are asked for the amount of
compensation they would be willing to accept to give up specific environmental services. It is called
“contingent” valuation, because people are asked to state their willingness to pay, contingent on a specific
hypothetical scenario and description of the environmental service.

• The contingent valuation method is referred to as a “stated preference” method, because it asks people to
directly state their values, rather than inferring values from actual choices, as the “revealed preference”
methods do.

• The fact that contingent valuation is based on what people say they would do, as opposed to what people
are observed to do, is the source of its advantage + weaknesses. Contingent valuation is one of the only
ways to assign dollar values to non-use values of the environment—values that do not involve market
purchases and may not involve direct participation. These values are sometimes referred to as “passive
use” values.
 NTA-UGC-NET | Defensive Expenditures Method
Defensive Expenditures Method
•A defensive expenditure is an expenditure in response to something undesirable, such as
pollution. If smog improves (worsens) you may spend less (more) on having your windows
cleaned. The change in expenditures can be used as a measure of the change in pollution.
•There are at least five problems with this method:
1) Reduced spending on a defensive expenditure underestimates the benefits of cleaner air.
2) It assumes people adjust quickly to the new equilibrium, such as new smog levels.
3) Defensive expenditure may not remedy entire the damage.
4) Defensive expenditures may have benefits other than remedying damage, which should
be included.
5) Not all defensive expenditures are purchased in markets, for example, some people clean
their own windows; changes in these expenditures should also be included.
NTA-UGC-NET | Valuation of Environmental Goods
 NTA-UGC-NET | I = PAT
I = (PAT) is a functional form that describes the impact of human activity on the environment.

I=P×AxT
• The expression equates human impact on the environment to a function of three factors: population (P),
affluence (A) and technology (T).

• It is similar in form to the Kaya identity which applies specifically to emissions of the greenhouse gas
carbon dioxide.

• The equation was developed in 1970 during the course of a debate between Barry Commoner, Paul R.
Ehrlich and John Holdren.

• The variable "I" in the "I=PAT" equation represents environmental impact. The environment may be
viewed as a self-regenerating system that can endure a certain level of impact. The maximum endurable
impact is called the carrying capacity.

• As long as "I" is less than the carrying capacity the associated population, affluence, and technology that
make up "I" can be perpetually endured. If "I" exceeds the carrying capacity, then the system is said to be
in overshoot, which may only be a temporary state. Overshoot may degrade the ability of the environment
to endure impact, therefore reducing the carrying capacity.
 NTA-UGC-NET | I = PAT
I = (PAT) is a functional form that describes the impact of human activity on the environment.

I=P×AxT

Population
• Impact may be measured using ecological footprint analysis in units of global hectares (gha). Ecological
footprint per capita is a measure of the quantity of Earth's biologically productive surface that is needed to
regenerate the resources consumed per capita.

• Impact is modeled as the product of three terms, giving gha as a result. Population is expressed in human
numbers; therefore affluence is measured in units of gha per capita. Technology is a unitless efficiency
factor.

• Increased population increases humans' environmental impact in following ways

➢ Increased land use - Results in habitat loss for other species
➢ Increased resource use - Results in changes in land cover
➢ Increased pollution - Can cause sickness and damages ecosystems
➢ Increased climate change
➢ Increased biodiversity loss
 NTA-UGC-NET | I = PAT
I = (PAT) is a functional form that describes the impact of human activity on the environment.

I=P×AxT

Affluence
• The variable A in the I=PAT equation stands for affluence.

• It represents the average consumption of each person in the population. As the consumption of each
person increases, the total environmental impact increases as well.

• A common proxy for measuring consumption is through GDP per capita. While GDP per capita measures
production, it is often assumed that consumption increases when production increases.

• GDP per capita has been rising steadily over the last few centuries and is driving up human impact in the
I=PAT equation.
 NTA-UGC-NET | I = PAT
I = (PAT) is a functional form that describes the impact of human activity on the environment.

I=P×AxT

Technology
• The T variable in the I=PAT equation represents how resource intensive the production of affluence is;
how much environmental impact is involved in creating, transporting and disposing of the goods, services
and amenities used.

• Improvements in efficiency can reduce resource intensiveness, reducing the T multiplier.

• Since technology can affect environmental impact in many different ways, the unit for T is often tailored
for the situation to which I=PAT is being applied. For example, for a situation where the human impact on
climate change is being measured, an appropriate unit for T might be greenhouse gas emissions per unit of
GDP.
 NTA-UGC-NET | Questions
Q-1: ‘Warm glow’ refers to a situation faced while asking respondents about
their willingness to pay for an environmental service; this implies
(A) the question makes the respondent feel warm.
(B) that the respondents state high willingness to pay regardless of the impact of
such statement, just to experience the joy of being
treated as a person valuing environment.
(C) that the respondents state high willingness to pay so that others are compelled
to pay that price.
(D) that the respondents state low willingness to pay to protect themselves from
paying high prices.
 NTA-UGC-NET | Questions
Q-1: ‘Warm glow’ refers to a situation faced while asking respondents about
their willingness to pay for an environmental service; this implies
(A) the question makes the respondent feel warm.
(B) that the respondents state high willingness to pay regardless of the impact of
such statement, just to experience the joy of being
treated as a person valuing environment.
(C) that the respondents state high willingness to pay so that others are compelled
to pay that price.
(D) that the respondents state low willingness to pay to protect themselves from
paying high prices.
Ans (B)
NTA-UGC-NET | Questions
Question-2: Which of the following is correct about CVM used in
Environmental Economics?
a. It is used only for pollutants
b. It is used only for items with positive utilities
c. It is used for items under market failure
d. It is used only for natural resources
NTA-UGC-NET | Questions

Question-3: Suggest the correct choice about the nature of

Environmental Economics
a. Nature of market failure is similar to public goods
b. Willingness to pay can be negative
c. It deals for items which are not used
d. It delas for items which are used.
Select the correct answer.
i. 2 and 4
ii. 1, 2 and 3
iii. 2, 3 & 4
iv. All of these
 NTA-UGC-NET | Questions

Question-4: Which of the following not a

part of man-made environment?
a. Internal environment
b. External environment
c. Geographical environment.
d. Both a and b
 NTA-UGC-NET | Questions
Q-5: Which of the following statements is not true?
(A) Contingent valuation method is applied in a hypothetical market situation.
(B) To estimate the value of environmental quality with hedonic pricing, actual
price in which houses are sold is required.
(C) Multicollinearity may be encountered in contingent valuation method.
(D) Starting point bias is associated with contingent valuation method.
 NTA-UGC-NET | Questions
Q-5: Which of the following statements is not true?
(A) Contingent valuation method is applied in a hypothetical market situation.
(B) To estimate the value of environmental quality with hedonic pricing, actual
price in which houses are sold is required.
(C) Multicollinearity may be encountered in contingent valuation method.
(D) Starting point bias is associated with contingent valuation method.
Ans (C)
 NTA-UGC-NET | Questions
Q-6: Which of the following is not related to the Travel Cost method?
(A) Zonal approach
(B) Individual approach
(C) Utility approach
(D) Random utility approach
 NTA-UGC-NET | Questions
Q-6: Which of the following is not related to the Travel Cost method?
(A) Zonal approach
(B) Individual approach
(C) Utility approach
(D) Random utility approach

Ans (C)
 NTA-UGC-NET | Questions
Q-7: In the IPAT expression propounded by Prof. Ehrilch
(A) I ⇒ Impact, P ⇒ Population, A ⇒ Affluence, T ⇒ Technology
(B) I ⇒ Impact, P ⇒ Price, A ⇒ Affluence, T ⇒ Trade
(C) A ⇒ Annuity, P ⇒ Price, I ⇒ Investment, T ⇒ Technology
(D) A ⇒ Assets, P ⇒ Population, I ⇒ Impact, T ⇒ Trade
 NTA-UGC-NET | Questions
Q-7: In the IPAT expression propounded by Prof. Ehrilch
(A) I ⇒ Impact, P ⇒ Population, A ⇒ Affluence, T ⇒ Technology
(B) I ⇒ Impact, P ⇒ Price, A ⇒ Affluence, T ⇒ Trade
(C) A ⇒ Annuity, P ⇒ Price, I ⇒ Investment, T ⇒ Technology
(D) A ⇒ Assets, P ⇒ Population, I ⇒ Impact, T ⇒ Trade

Ans (A)
NTA-UGC-NET | Inverted U Hypothesis
Developed by Simon Kuznets in 1955
It states that the economic inequality increases with the increase in
economic growth in the initial phase of development but after the
economy reaches a particular level of development, the inequality
starts falling with the increase in level of economic growth.

According to this hypothesis, the income inequality follows an

inverted-U shape along the stages of economic development i.e. it
first rises with the growth of industrialization but declines
later due to more and more workers joining high productivity sectors
of the economy.

Changing sectoral composition of employment and income, and

changes in the level of human capital and technical progress at
different stages of development, are considered the main reasons for
this inverse-U relationship between inequality and economic growth
in the economy.
NTA-UGC-NET | Inverted U Hypothesis
As per this hypothesis, initially the inequality   Per capita
income   Movement of workers from the low productive sector
(say agriculture) to high productive sector (say industry)
and increase in physical capital.

Thus, the investment in physical capital acts as the driver of growth

and, therefore, those who save and invest realise more income.

Thus, industrialization benefits limited number of people, especially

those who possess financial endowments and entrepreneurial skills.
Technical progress is also likely to have a more uneven character at
low levels of income as it is initially biased against unskilled labour
tending to drive down their wages.

But in later stages, gains of changing composition of the economy

would spread over larger number of people as increased demand for
workers improves their wages and consequently they can invest
more in human capital. Therefore, in later stages, human capital
accumulation takes over the physical capital accumulation thereby
becoming the main engine of growth.
NTA-UGC-NET | Inverted U Hypothesis
Using the ratio of the income share of the richest 20
percent of the population to that of the poorest 60
percent of the population, Kuznets established that
between 1913 and 1948, income inequality declined
in the United States of America.
He used cross-sectional and time series data to test
income inequalities across regions/countries.

Kuznets curve is extended to study the relationship

between environmental degradation and economic
development.

The environmental Kuznets curve shows that in the

early stages of economic growth there is an increase
in environmental degradation and pollution, but
beyond some level of per capita income, the trend
reverses.
 NTA-UGC-NET | Inverted U Hypothesis
The key criticism of Arrow and colleagues and others was that the EKC model, as presented in
the World Development Report 1992 ….The assumption is that environmental damage does not reduce
economic activity sufficiently to stop the growth process and that any irreversibility is not severe
enough to reduce the level of income in the future. In other words, there is an assumption that the
economy is sustainable. However, if higher levels of economic activity are not sustainable, attempting to
grow fast during the early stages of development, when environmental degradation is rising, may prove
to be counterproductive…. David I. Stern

The early EKC studies appeared to indicate that local pollutants were more likely to display an inverted
U shape relation with income, while globalimpacts like carbon dioxide did not. This picture fits
environmental economics theory – local impacts are internalized in a single economy or region and are
likely to give rise to environmental policies to correct the externalities on pollutees before such policies
are applied to globally externalized problems.
Lecture-13: Theories of Population
Unit-3 (B): Environment &
Demography Economics

NTA-UGC-NET
Economics (Paper-2)
 NTA-UGC-NET | Population Theories
Theories of Population
• Malthusian Theory of Population (Thomas Robert Malthus) [Essay on the Principle of Population as it affects
the Future Improvement of Society]- 1798
• Logistic Curve (Pierre Francois Verhulst )- 1840s
• Marx’s Scientific Theory of Surplus Population- [Capital Vol-1]- 1867
• Optimum Theory of Population (Edwin Cannan) [Wealth]- 1924 (popularised by Robbins and Dalton)
• Theory of Demographic Transition (Frank Notestein) [Economic Problems of Population Change]- 1953

Additional Demographic Theories on

• Adolphe Landry’s
• Thompson, Bouge and Notestein- Demographic Theory
• Thomas Doubleday’s Diet Theory
• Jouse De Castro’s Protein Consumption Theory
• Corrado Gini’s theory of Biological Stages
• Herbert Spencer’s Analysis Of Fertility Function
• Social Capillarity Theory by Dumont
• Surplus Population and Social Mal Adjustment Theory of Henry
George
 NTA-UGC-NET | Population Theories
Why theories on population are required?
Population implies Human Resources that are instrumental for achieving economic development.

It supply factor services such as labour,

Development activities are linked with
capital and entrepreneurial services,
the raised living standards and superior
which determines Total Productivity and
consumption basket
Production/Output

Human Resources as Human Resources as

Factor Services Units of Consumption

Labour Force Participation Demand food stock

>
Specialisation Saving Effect
or (Burn of dependency)
Enables Technological Changes
< Investment Effect
Capital Formation (Demography Investment)

Social Overhead Requirements

 NTA-UGC-NET | Population Theories
Theories of Population
• Malthusian Theory of Population (Thomas Robert Malthus) [Essay on the Principle of Population as it affects
the Future Improvement of Society]- 1798
• Logistic Curve (Pierre Francois Verhulst )- 1840s
• Marx’s Scientific Theory of Surplus Population- [Capital Vol-1]- 1867
• Optimum Theory of Population (Edwin Cannan) [Wealth]- 1924 (popularised by Robbins and Dalton)
• Theory of Demographic Transition (Frank Notestein) [Economic Problems of Population Change]- 1953
 NTA-UGC-NET | Population Theories
Malthusian Theory of Population (Thomas Robert Malthus)- 1798
• Malthus refuted the then prevailing perception propounded by his father and Godwin
related to the notion that perfect state can be achieved if human restraints are removed.
• His idea is that due to rising pressure of increasing population on food supply would lead
the state deviate away from perfection.

Malthusian Doctrine
• He mentioned that due to the natural instincts in humans, population rises at geometrical
progression, which can double itself in 25 years, if left unchecked. The population growth
follows this trend- 1, 2, 4, 8, 16, 32, 64, 128, 256
• Growth rate in food supply follows arithmetical progression due to law of diminishing
returns, as land has inelastic supply. Thus, food supply grows at 1, 2, 3, 4, 5, 6, 7, 8 and 9.
• Consequently, after 200 years, population stands at 256, where as food supply is at 9
only. This leads to over-population and creates imbalance.
• In the figure, M is the Malthusian population curve depicting the relationship between
population growth and food supply growth.
NTA-UGC-NET | Population Theories
Malthusian Theory of Population (Thomas Robert Malthus)- 1798
Malthusian Doctrine

Arithmetical Progression
Geometrical Progression of
of Food Supply growth
Population growth rate > rate

Imbalances due to
Over Population

Corrective
Measures

Preventive Checks Positive Checks

• Late Marriage • Famines
• Moral Restraints • Floods
• Celibacy • Wars
 NTA-UGC-NET | Population Theories
Malthusian Theory of Population (Thomas Robert Malthus)- 1798
Criticisms Lack empirical results about population doubles itself in 25 years

Narrowed vision limited to England and ignored cases of Argentina and the US, where
food supply grow much faster than what Malthus stated

Ignored the technological advancements, such as Green Revolution in India

Pessimistic about younger generation as burden on food supply and ignored their future
contributions in the economic growth

Population is more related to Total Wealth and less to Food Supply (if you have wealth,
then you can import food in exchange of money or products)

Ignored the increase in population due to falling death rate

Demographists have empirically proved that population growth is a function of per capita
income. When income rises, fertility rate and population growth rate fall
NTA-UGC-NET | Population Theories
Optimum Theory of Population (Sidgwick & Edwin Cannan) 1924
• The idea was given by Prof. Sidgwick and later it was systematically provided by
Cannan.
• Contrast to Malthus, this theory links population growth rate to wealth.
• Optimum population is the ideal population which combined with the other available
resources or means of production of the country will yield the maximum returns or
income per head.
✓ Robbins → Optimum population makes the maximum returns possible
✓ Carr- Saunders → Optimum population produces maximum economic welfare
✓ Dalton → Optimum population gives maximum income per head.

Assumptions

a. The natural resources of a country are given at a point of time but they change over
time.
b. No change in techniques of production.
c. Capital stock remains constant.
d. Habits, tastes and preferences do not change.
e. Ratio of working population to total population remains constant with growing
population.
f. Working hours of labour do not change.
g. Modes of business organisation are constant.
NTA-UGC-NET | Population Theories
Optimum Theory of Population (Sidgwick & Edwin Cannan) 1924
• Based upon all these assumptions, optimum population is an ideal size of population
which leads to maximum per capita income. If there is any rise or fall in the optimum
size, then the per capita income will be reduced
The Theory
• If a country is initially under-populated (say population is OB) with low per capita
income of AB, then it should pursue increase in population till it reaches the point M,
where it attains the per capita income of MN (where its population size is ON).
• If it continues to accommodate the population rise beyond ON size, then per capita
income starts declining beyond MN.
• This is a static theory and the point of optimum population is subjective and time-
variant. That is, what is optimum today, might not be optimum tomorrow due to
growth of productive resources, so optimum point is a movable and dynamic point.
NTA-UGC-NET | Population Theories
Optimum Theory of Population (Sidgwick & Edwin Cannan) 1924
• Cannan relates the per capita income with AP of labour. He mentioned that optimum
per capita income is the highest point where AP of labour starts falling.
• To the left of OP, the country is under-populated and to the right of OP, the country is
over-populated.
• He also mentioned that point OP is dynamic and can change with technological
advancements and growth of productive resources.
• Dalton calls Mal-Adjustment (M) as a function of two variables- optimum level of
population (O) and actual level of population (A), which is algebraically denoted as:
A−O
M=
O
+ ve for overpopulated country 
 
M is −ve for underpopulated country 
0 for an optimum populated country 
 
 NTA-UGC-NET | Population Theories
Comparison between Malthusian & Optimum Theory of Population
Malthusian Optimum Theory
• It is a general study of population and is • Superior to Malthusian theory, as it links
applicable to all countries irrespective of population to per capita income, which
their economic conditions. depicts the economic conditions of nations.
• It is static concept and is applicable to a • It is dynamic as it changes over time due to
particular point of time. technological advancements
• It lacks empirical analysis and regards all • It is more practical and regards population
population growth as bad. growth rate to be desirable upto optimum
level
• It is pessimistic and regarded natural • It does not suffer from pessimism and is
calamities as positive checks to control more practical, as it relates population to per
population. capita income.
 NTA-UGC-NET | Population Theories
Theory of Demographic Transition (Frank Notestein)- 1953
Overview

• It is based upon actual population trends of developed countries.

• As per this, every country has to pass through three stages of population growth.

• First Stage: [High Birth Rate & High Death Rate]- Slow Population Growth Rate

• Second Stage: [Stable Birth Rate & Falling Death Rate]- Explosive Population Growth

• Third Stage: [Falling Birth Rate and Falling Death Rate]- Decelerating Population

• Fourth Stage: [Falling Birth Rate tends to equate to Falling Death Rate]- Stable Population
NTA-UGC-NET | Population Theories
Theory of Demographic Transition (Frank Notestein)- 1953
Stage 1: Pre-transition
• Characterised by high birth rates, and high fluctuating death rates.
• Population growth was kept low by Malthusian "preventative" (late age at
marriage) and "positive" (famine, war, pestilence) checks.
Stage 2: Early transition
• During the early stages of the transition, the death rate begins to fall. As
birth rates remain high, the population starts to grow rapidly.
Stage 3: Late transition
• Birth rates start to decline.
• The rate of population growth decelerates.
Stage 4: Post-transition
• Post-transitional societies are characterised by low birth and low death
rates.
• Population growth is negligible, or even enters a decline.
NTA-UGC-NET | Population Theories
Theory of Demographic Transition (Frank Notestein)- 1953
NTA-UGC-NET | Population Theories
Theory of Demographic Transition (Frank Notestein)- 1953
Application of Theory
• It is the most acceptable theory of population growth and is more
practical, as it is based upon the actual population growth stories of
European countries
• Besides its applicability on developed countries, LDCs are also following
the trends as mentioned by this theory.
• Thus, this theory has an universal applicability.

• This is the theory that has been adopted by United Nations

Organisation. It has shifted from classifying the growth of population in
different stages to different types of population growth, which are:
✓ High Birth & Death Rates
✓ High Birth Rate & declining fairly Death Rates
✓ High Birth Rate & fairly low Death Rates
✓ Declining Birth Rates and Low Death Rates
✓ Low or fluctuating Birth & Death Rates
NTA-UGC-NET | Population Theories
Marx’s Scientific Theory of Surplus Population (Karl Marx) Capital Vol-I
• It is in response to Malthusian theory of population.
• He argued that starvation is caused by unequal distribution of wealth and its
accumulation by the capitalists. He never separately formulated any theory of
population, but discussed it as an aspect of communism.
• He refutes the point that starvation as a cause to shortage of food supply or population
growth. He linked up starvation to inevitable features of capitalist system of
production.

• He stated that population is dependent upon economic and social organization.

• The correlation between accumulation of capital and rate of wages is nothing else than
the correlation between the unpaid labour transformed into capital, and the additional
paid labour necessary for the setting in motion of this additional capital.

• The law of capitalistic accumulation, metamorphosed by economists into pretended

law of Nature, in reality merely states that the very nature of accumulation excludes
every diminution in the degree of exploitation of labour, and every rise in the price of
labour, which could seriously imperil the continual reproduction, on an ever-enlarging
scale, of the capitalistic relation
NTA-UGC-NET | Population Theories
Marx’s Scientific Theory of Surplus Population (Karl Marx) Capital Vol-I
• Causes of Population Growth
• Marx believed that the nature of economic relations in Europe’s industrial societies
was the central problem for the world’s rapidly growing population.

• He dismissed Malthusian notion that the rising world population, rather than
capitalism, was the cause of ills.

• Marx’s argued that when society is well ordered, increases in the population should
lead to greater wealth, not hunger and misery. In contrast, he saw that the problem
was the evils of the capitalist system. Marx was of the view that this problem is only
possible in a capitalist society and not rising world population.

• He believed the system of capitalism has the capacity to produce food and other
necessities, but it was the unequal distribution of social and economic wealth that
undetermined production.

• Karl Marx completely rejected Malthusian theory as it did not fit in a socialist society.
Marxist approach in their resentment of developed nations who they claim consume
almost four-fifths of the share of the world resources.
NTA-UGC-NET | Population Theories
Logistic Curve- Pierre Francois Verhulst
• This curve was introduced by Pierre Francois Verhulst during 1840s.
• It is a model of population growth by adjusting exponential growth model.
• It is a S-shaped curve that can be used to model functions that increase gradually at
first, then more rapidly in the middle growth period and lastly slowly at the end.
• Finally the curve settles down at a maximum value after some period of time.
 NTA-UGC-NET | Population Theories
C. P. Blacker Theory of Population Growth
5 stages of population growth
▪ Stage 1: high stationary phase
▪ Stage 2: early expanding phase
▪ Stage 3: late expanding phase
▪ Stage 4: low stationary phase- low fertility balanced by equally low mortality
rates
▪ Stage 5: declining phase- low mortality, lower fertility and an excess of deaths
over births
 NTA-UGC-NET | Population Theories
This stage continued in C. P. Blacker Theory of Population Growth
Western Europe
approximately up to 1840
and in India and China till Stage 1: High stationary phase
1900 Characteristics:
• Country is backward
• Rural population engaged in agricultural activities
• high fertility and mortality rates
• few small consumer goods industries.
• tertiary sector is underdeveloped.
• low incomes and poverty of the masses
• More children considered as an insurance against old age by the parents.
• People are illiterate, ignorant, superstitious and fatalists are averse to any method
of birth control.
• Absence of proper nutrition and medical facilities
 NTA-UGC-NET | Population Theories

About 40% of the world

C. P. Blacker Theory of Population Growth
population was in this stage
up to 1930. Many countries Stage 2: Early expanding phase
of Africa are still in this
Characteristics:
stage.
• economic growth starts
• agricultural and industrial productivity increases
• Education, health and medical facilities start
improving and expanding
• Death rate lower but Birth rate still high due to
social taboo and
religious beliefs
• high fertility and high but declining mortality rates
leads to population
Explosion
 NTA-UGC-NET | Population Theories

About 20% of the world

C. P. Blacker Theory of Population Growth
population was in this stage
in 1930. Stage 3: late expanding phase
Characteristics:
• declining fertility but with more rapidly declining
mortality rates
• better medical facilities
• People are not willing to support large families.
• People adopt the use of contraceptives so as to
limit families.
• Birth rates decline a initially in urban areas
• rapidly declining death rates leads to diminishing
rate of
population growth
 NTA-UGC-NET | Population Theories

There is zero growth in

C. P. Blacker Theory of Population Growth
population during this phase
Stage 4: low stationary phase
Characteristics:
• Economic growth gains momentum- people’s
income level rises,
• output expands in various sectors through technical
transformations.
• Education and medical facilities expand further
• People discard old customs and beliefs and move to
nuclear family
• Men and women prefer to marry late
• People readily adopt family planning devices
• low fertility balanced by equally low mortality rates
 NTA-UGC-NET | Population Theories

The existence of this stage

C. P. Blacker Theory of Population Growth
in any developed country is
a matter of Stage 5: declining phase
speculation, according to
Characteristics:
Blacker.
• low mortality, lower fertility and an excess of deaths
over births
• declining stage of population.
 NTA-UGC-NET | Population Theories
Karl Sax- The Population Explosion, November 1956
• Karl Sax’s four stages of population growth, namely, Stage 1: High stationary phase
✓ High Stationary, Stage 2: Early expanding phase
Stage 3: late expanding phase
✓ Early Explosive Increase,
Stage 4: low stationary phase
✓ Late Explosive Increase, and Stage 5: declining phase
✓ Low Stationary.
• He does not explain Blacker’s Declining Stage, while his four stages almost resemble Blacker’s other stages.
• Stage I: In stage I, birth rate is accompanied by high but varying death rate. As a result, the population of a country
in this stage either remains constant or grows slowly.
• Stage II: In stage II, death rate steeply declines while birth rate remains more or less at a high level which leads to
rapid growth in population. This rapid growth in population above 1.5% per year has been called population
explosion.
• Stage III: In the third stage the birth rates start falling but the death rates level down at low level or show further
slowing down. With this the growth of population slows down.
• Stage IV: In stage IV birth rates and death rates balance at low levels with the result that population remains more or
less constant.

• It is worth noting that various stages of demographic transition are associated with the various stages of economic
growth. The first stage is regarded as a feature of agrarian underdeveloped economies, the second of the take-off
period of economic growth and third of the developed countries in their mature stage of economic growth.
 NTA-UGC-NET | Population Theories
Adolphe Landry’s
• According to Landry, a population is based on economic and demographic regimes. There are
three regimes that are based on the relationship between population and economic
development and food supply.
✓ A primitive regime: Food supply plays an important role in this stage of population change.
The rate of increase and decrease in population is based on the supply of food material.
Mortality is dependent on the availability of food.
✓ An intermediate demographic regime: In this stage, the change in population depends on
economic development of the country rather than on food supply.
✓ A modern epoch: In this stage, there is no direct relation between population and food
supply and economic development. This stage is also referred to as the Population
Revolution Stage.
 NTA-UGC-NET | Population Theories
• Thomas Doubleday’s Diet Theory:
✓ According to him, the rate of population increase will be less when the quantity of food supply is greater.

✓ It means that the increase in population and food supply are inversely related. Doubleday mentions two
states of food supply, i.e.,
✓ (i) The Plethoric state having good food supply where the fertility is low, and

✓ (ii) the Deplethoric state in which due to food shortage we find diminution of proper nourishment where
the fertility is high.

✓ Moreover, Doubleday also observes that high fertility has been found in those persons who are vegetarians,
or who eat more rice or whose staple diet is rich, whereas fertility will be low in non-vegetarian persons.
 NTA-UGC-NET | Population Theories
• Thomas Doubleday’s Diet Theory:
✓ (1) The first group includes those who are in a state of affluence and are well supplied
with luxuries. Their number is on constant decrease. While the number of those who
are engaged in mental or physical activities and are living busy life, is on the increase.

✓ (2) The second group consists of the poor people who have less supply of food. Their
number is increasing rapidly. In other words, the constant increase in population is
found in the group where people are worst supplied with food. This happens in all
societies.

✓ (3) The third group has those people who form the mean and median between two
opposite states and who fall under the average income group and those who are
tolerably well supplied with good food or who get a normal diet and do not overwork
and yet are not idle. Their number is stationary.

✓ He concludes that “it is upon the numerical proportion which these three states bear to
each other in any society that increase or decrease on the whole depends.” He also
mentioned that, “The rich produce less children as the fertility would be less amongst
them and therefore, the transfer of their wealth will be distributed among a few People.
Over a period of time, it may happen that there is no one as an heir to that property
and therefore this wealth will pass to the children of the poor. Again when the children
become rich, they will restrict their families and their wealth will be gained once again
by the poor”.
 NTA-UGC-NET | Population Theories
• Jouse De Castro’s Protein Consumption Theory:

✓ He expressed his views in his famous book The Geography of Hunger regarding the
correlation between the fertility and the consumption of protein.

✓ According to him those who are poor do not have any balanced food and they are
always short of protein in food with the result that their lever does not properly work.

✓ Under the circumstances oestrogens in women body get neutralized and increase in
their number and their fertility also increase and with that more number of children are
✓ produced.

✓ That is the reason as to why the poor produce more children.

 NTA-UGC-NET | Population Theories
• Corrado Gini’s theory of Biological Stages

✓ Corrado was an Italian sociologist and had particular interest in population problems.

✓ He believed that every country at the prime has almost the same sort of composition
and simplicity of growth.

✓ He believed that evolution of a nation and for that matter even that of a society was
very closely linked with the changes in the rates of population growth.

✓ He said that, “Evolution of a nation or any other society was closely linked to the
changes in their rates of population growth and to the varying propositions of this
growth coming from the different social classes.”

✓ According to him basic factor in population growth was always biological and not
social or economic change.

✓ He believed that different rates of increase, which were witnessed in different classes,
or sections of society were because of biological traits of the entire population.
 NTA-UGC-NET | Population Theories
• Herbert Spencer’s Analysis Of Fertility Function

✓ Spencer told about social and biological changes and proposed a natural law of
population growth in his “The Principals Of Biology”.

✓ According to him there was a natural law that absolved human beings from every
responsibility about increase in population.

✓ This is done because nature in itself weakens man’s interest in reproduction and the
interests are gradually more devoted towards personal, scientific and economic
development.

✓ According to him in nature there is antagonism between individuation and genesis.

✓ In his theory of Evolution Spencer said that those human beings, who are small, would
have more and higher fertility rate.

✓ He said that, “The minutest organisms multiply asexually in there millions”

 NTA-UGC-NET | Population Theories
• Social Capillarity Theory by Dumont

✓ According to him in a society where movement from one class to other is easy, social
capillarity is an inevitable as gravity.

✓ Social capillarity has direct relationship with social development and indirect
relationship with birth rate.

✓ He said, “What gravity is to the physical world, social capillarity is to the social order.”

✓ Dumont was the view that movement from lower class to the upper class was direct
cause of decline in the birth rate.

✓ He came to the conclusion that, “The development numbers in a nation is in inverse

ratio to the development of the individual ”

✓ According to him social capillarity is more effective in a country where movement

from class is weak and hindrances very few.

✓ As regard democratic society Dumont felt movement was rapid and birth rate should be
low, particularly in the areas, which were near the center of attraction.
 NTA-UGC-NET | Population Theories
• Surplus Population and Social Mal Adjustment Theory of Henry George

✓ His ideas are available in his book entitled ’’Progress and Poverty” in 1879.

✓ According to him, “In other words, the law of population accords with and is subordinate to the law of
intellectual developments, and any danger that human beings may be brought into a world, where they
cannot be provided for arises not from the ordinances of nature, but from the social mal-adjustments
that in the midst of wealth condemn men to want. ”
✓ Henry George highlighted the principle of basic relationship between the population and human ability
to impart subsistence to the greater number of people due to rise in population. As human population
rises, then the food production also rises, but there exists an inequality, as the former is more than the
latter. It is due to the social maladjustment, which is nothing else other than greed that there exists a
threat to existence of human and it not from the ordinances of natural law.
 NTA-UGC-NET | Population Theories
Leibenstein’s Motivational Theory of Population Growth

• It is based on his empirical evidence that the rate of population growth is a function of
the level of per capita income which, in turn, depends on the stage of economic
development.

• Leibenstein’s view is based on Dumont’s “Social-capillarity Thesis” which states that

with the increase in per capita income, the desire to have more children as productive
agents declines.

• This means that as per capita income rises with economic development, the fertility
rate declines. Similarly, the mortality rate also declines, as there is improvement in
public health measures with economic development. But the decline in the mortality
rate is fast as compared to the decline in the fertility rate. This creates a “fertility gap”
which continues to widen for quite some time.

• Leibenstein explains the fertility gap in terms of the cost-benefit analysis of bringing
up an additional child. There are three types of benefits or utilities which parents
derive from an additional child.
 NTA-UGC-NET | Population Theories
Leibenstein’s Motivational Theory of Population Growth

There are three types of benefits or utilities which parents derive from an additional child.
(a) consumption utility which they get out of love and pleasure by rearing a child;
(b) productive utility when the child starts earning from childhood and is a source of income for his parents;
and
(c) old age security utility which the child possesses when he supports his parents in old age who are unable
to earn.
• The costs of bringing up an additional child are of two types – direct and indirect. The direct costs relate to
expenditure on feeding, clothing, education, etc. These expenses are incurred by parents till the child starts
earning and become self-supporting.

• The indirect costs relate to the opportunities foregone by parents when an additional child is born. Such
opportunities foregone are earnings lost by the mother during and after the pregnancy, less social and spatial
mobility of parents due to additional responsibility in bringing up the additional child, etc.

• Lack of spatial mobility means potential loss of income. On the whole, the cost of bringing up an additional
child is less to parents with low per capita income and high with high per capita income.

• There are three types of effects which influence the utilities and costs of bringing up an additional child
during the process of economic development. They are the income, survival and occupational distribution
effects. With economic development, as per capita income increases, the chances of survival increase and
there are changes in the occupational distribution.
 NTA-UGC-NET | Population Theories
Leibenstein’s Motivational Theory of Population Growth
Per capita income of the family is shown on the horizontal axis while
utilities and costs per child are taken on the vertical axis. The
consumption utility curve is assumed as constant because it is
independent of the family per capita income. It is the pleasure and
satisfaction that the parents get in rearing a child which has nothing to
do with their per capita income. This is shown by the horizontal curve C
in the figure.
The curves S and P depict security utility and productive utility
respectively which decline as the per capita income increases. As the per
capita income increases, parents become wealthier to provide for their
own security and depend less on the child in old age.
Similarly, as the per capita income increases, there is no need for the
child in the family to earn during childhood in order to support the
family. Schooling is extended and the child is less valuable as a
productive agent. Thus the P curve also slopes downward as per capita
income increases.
 NTA-UGC-NET | Population Theories
Leibenstein’s Motivational Theory of Population Growth
The direct and indirect costs of bringing up an additional child increase
in proportion to the rise in per capita income of the family. This is
shown by the 45° straight line curve through the origin.
So far as the survival effect is concerned, the increased survival rates
raise the three utility curves. The reason is that when an additional child
is expected to survive for long years of life, there are more expected
years of satisfaction for the parents. But the survival effect reduces the
motivation to have an additional child on the part of parents.
Lastly, the occupational distribution effect adds to the direct and indirect
costs of an additional child. As per capita income increases, economic
and social mobility increases. There is spread of urbanisation and
specialisation which lead to the expansion of job opportunities. Parents
are required to provide professional and costly education to the children.
This prohibits parents to have an additional child.
 NTA-UGC-NET | Population Theories
Previous Years’ Questions- UGC NET ECONOMICS
Q-1: Who propounded the Optimum Theory of Population?

a) Robbins
b) Dalton
c) Cannan
d) Carr-Saunders

Q-2: Which is not true for the 3rd stage of the

Theory of Demographic Transitions?

a) Population growth becomes 0

b) Population growth rate approximately
stabilises in a narrow range
c) Death rate declines but slowly
d) Birth rate declines faster
 NTA-UGC-NET | Population Theories
Previous Years’ Questions- UGC NET ECONOMICS
Q-3: In the long run, which one of the following curves would
Q-5: What is meant by population aptly represent the time path of population for developing
neutralism? country?

a) Impact of population growth on a) Exponential curve

economic growth is negligible b) Logistic curve
b) Growth rate of population is hovering c) Geometric Progression curve
around stationary population d) Linear upward rising curve
c) Impact of population on food supply is
neutral
d) Change in age structure due to Q-4: Optimum Theory of Population tells about the relationship
population growth is almost neutral between:

a) Population and food supply

b) Population and overall resources
c) Dependent population and working population
d) Present population and growth rate of population
 Lecture-14: Concepts and Measures
Fertility, Mortality NFHS 2019-21 and SRS
2020
Unit-3 (B): Environment &
Demography Economics
NTA-UGC-NET
Economics (Paper-2)
 NTA-UGC-NET | Fertility Theories

• Fertility measurement is about producing rates that relate numbers of births to numbers of women.
• The most common, widely used and "accepted" measure of fertility is the Total Fertility Rate (TFR).
• Fertility is, in fact, a result of 'fecundity’. Fecundity is the physiological capacity of a man, a woman or a
couple to participate in reproduction, i.e. the capacity to produce a live child or children, on the other hand,
fertility, refers to the actual reproductive performance whether of an individual or a couple or a group.
 NTA-UGC-NET | Fertility Theories

Measuring fecundity is not possible, but fertility can be measured using the following measures.
1. Crude Birth Rate (CBR)
2. Corrected Birth Rate
3. Child/Woman Ratio (CWR)
4. General Fertility Rate (GFR)
5. Age-Specific Fertility Rates (ASFR)
6. Total Fertility Rate (TFR)
7. Children ever born (CEB)
8. Cohort Fertility (CF)
9. Parity progression ratios (PPR)
 Crude Birth Rate

• The most commonly used measure of fertility is crude birth rate (CBR), which is also the easiest to calculate and
understand.
• It requires minimum information to calculate it.
• CBR is the ratio of the total number of births during a given year to the average or mid-year population in that year.

Annual Number of live births ( in a region )

CBR= × 1000
Annual Mid-year population ( in a region )
 Crude Birth Rate

• The most commonly used measure of fertility is crude birth rate (CBR), which is also the easiest to calculate and
understand.
• It requires minimum information to calculate it.
• CBR is the ratio of the total number of births during a given year to the average or mid-year population in that year.

Annual Number of live births ( in a region )

CBR= × 1000
Annual Mid-year population ( in a region )

• It is not a rate (but a ratio) as the denominator includes children, men, older persons that are not at risk of childbearing
• The crude birth rate is defined as the number of births per 1000 population in a specific community or region. It indicates
the rate of births in a region.
 Crude Birth Rate

Example: The population on 31st March 2021 and that of on 31st March 2022 are 30000 and 50000, respectively. During the
last year, 1200 new births have been known. Find the crude birth rate.
 Crude Birth Rate

Example: The population on 31st March 2021 and that of on 31st March 2022 are 30000 and 50000, respectively. During the
last year, 1200 new births have been known. Find the crude birth rate.

1200
CBR= × 1000= 30 per 1000 person per annum
30000+50000
2
 Crude Birth Rate

Example: The population on 31st March 2021 and that of on 31st March 2022 are 30000 and 50000, respectively. During the
last year, 1200 new births have been known. Find the crude birth rate.

1200
CBR= × 1000= 30 per 1000 person per annum
30000+50000
2

Advantages
• Useful to measure approximate numbers of births in case of limited information available.
• Simple to calculate
Disadvantages
• The denominator consists of men, children, older persons that are not at a risk of childbearing (which is more significant
for women in age-group 15-49)
• It is very much affected by the age structure of the population
• It is not used as an accurate measure of fertility
 Corrected Birth Rate

• Many a time in under-developed countries and especially in rural areas, corrected birth rate is sought, which is always
greater than the crude birth rate. Corrected birth rate takes into account the registered births. The registration regarding
birth in the rural area is not done properly by the concerned officials. Often children die as soon as they are born. At that
time, the registration regarding birth and death is essential, but it remains unnoticed. At times, when the assumed
population is added to the crude birth rate, it is called corrected birth rate.
 Corrected Birth Rate

• Many a time in under-developed countries and especially in rural areas, corrected birth rate is sought, which is always
greater than the crude birth rate. Corrected birth rate takes into account the registered births. The registration regarding
birth in the rural area is not done properly by the concerned officials. Often children die as soon as they are born. At that
time, the registration regarding birth and death is essential, but it remains unnoticed. At times, when the assumed
population is added to the crude birth rate, it is called corrected birth rate. Assume that in a population of 50,000 after
700 births, there occur 50 more births, then the corrected birth rate will be in the following way:
• Corrected Birth Rate= (700+50)/50000 x 1000= 15
• Thus the crude birth rate is 14 and the corrected birth rate is 15 per 1000 people which is greater.

Registered births in one year + Possible birth

Corrected Birth Rate = 1000
Mid-year population
 Still Birth Rate

A stillbirth is the death or loss of a baby before or during delivery. Both miscarriage and stillbirth describe pregnancy loss,
but they differ according to when the loss occurs.

Stillbirth is further classified as either early, late, or term.

• An early stillbirth is a fetal death occurring between 20 and 27 completed weeks of pregnancy.

• A late stillbirth occurs between 28 and 36 completed pregnancy weeks.

• A term stillbirth occurs between 37 or more completed pregnancy weeks.

 Child/Woman Ratio (CWR)

It is defined as "the number of children of 4 years of age per 1000 women in child bearing age.

Advantages
• This ratio is useful where registration of birth is either not done or inadequate.
• Simple to calculate, but not an accurate measure of fertility
• More useful in case of small area surveys
• It is also used as a measure of youngness in a population.
• It can be constructed from census data alone, as we don’t require actual information about births. This is why CWR is
not regarded as a true fertility measure.
Disadvantages
• Children in the age group of 0 to 4 who died are not included, so the numerator is underestimated, hence, the ratio.
Usually, CWR < 1. In low fertility countries, the ratio is well below 1, while in high fertility countries, the CWR is near 1.
 General Fertility Rate (GFR)

This refers to the number of live births per 1000 women in the reproductive age group 15 to 19 years in a given year. It gives
the total number of births for all women of fertile ages.

Advantages
• Better measure of fertility than CBR and CWR.
• Simple to calculate, but not an accurate measure of fertility
• More useful in case of small area surveys
Disadvantages
• It is affected by age structure. Actually, the range of fertility age group i.e. 35 years (49-15) is quite wide and that is why
there might be significant differences in age structure between population. This is why, GFR can’t be used for
international comparisons.
• Not all females of age group 15-49 years are not exposed to the risk of child-bearing. This issue in GFR is overcome by
General Martial Fertility Rate.
 General Fertility Rate (GFR)

This refers to the number of live births per 1000 women in the reproductive age group 15 to 19 years in a given year. It gives
the total number of births for all women of fertile ages.

General Martial Fertility Rate (GMFR)

The number of live births per 1000 of married women in the reproductive age group in a given year.
 Age Specific Fertility Rate (ASFR)

It is defined as the number of live births per 1000 women in any specified age-group in a given year. These are simply
fertility rates limited to certain age-groups of women.
The groups could be of any width, or single years of age, but the convention is to form seven 5-year age groups, which cover
the range 15-49 years.
15-19 20-24 25-29 30-34 35-39 40-44 45-49
One can add an eighth group of 10-14 year old women but usually, there are very few births in this range and it adds little
advantage – but it can be done.
Sets of ASFRs and their associated graphs are commonly known as fertility schedules. These rates help us in assessing the
pattern of fertility. These rates are expressed per thousand women i.e. multiplied by 1,000; but not essentially.
 Total Fertility Rate (TFR)
• The number of children a woman would have if she lived from age 15 to age 50 and experienced the ASFRs of the
period in question.
OR
• The number of babies produced by 35 women, one of each single age 15-49, living through the single year to which the
TFR refers.
OR
• The number of children a woman would have if she experienced the age-specific fertility rates for the period in question
throughout her reproductive life.

7
Total Fertility Rate =  ASFR  5
i =1

where, i = 1 to 7 indicates seven 5 years age group

 No. of births to women aged 15-19 

7  + 2 nd + 3rd 
No. of women aged 15-19
Total Fertility Rate = 5   ASFR =   1000
i =1  No. of births to women aged 45-49 
 +4th + 5th + 6th + 
 No. of women aged 45-49 
 Total Fertility Rate (TFR)
7
If TFR < 2.1  Population  , Total Fertility Rate =  ASFR  5
If 2.1 < TFR<3.0  Pop is stationary or slow growth, i =1

If TFR > 3  Pop rapidly growing where, i = 1 to 7 indicates seven 5 years age group

• On one hand, G.F.R. reflects births per 1000 women per year, TFR reflects births per women through her life
time. The TFR gives the approximate magnitude of the completed family size.
• It is a very important measure as TFR captures all the information in the ASFRs.
• It is independent of age structure and so measures fertility in a purer & better way.
• This implies TFRs can be compared internationally without concern about age structure effects; this is why,
TFR is considered a standard way to compare fertility levels internationally.
 Total Fertility Rate (TFR)

Two terms are associated with the TFR – Tempo and Quantum – and both these are associated with the variability of
the measure. Quantum relates to the real value of the TFR – the real level of fertility over a substantial time. If TFR is
4.2 then one expects that over a reproductive lifetime 4.2 births will be produced per woman on average. 4.2 is the
quantum of fertility in that case and if fertility is truly rising (over a longish period) then one expects more than 4.2 births
to be the result.
TFR rises for a few years but then drops back the quantum of fertility may not be really changing – it is just the timing of
births that has produced an apparent and temporary change. This is a Tempo effect
 Total Martial Fertility Rate (TMFR)

This rate measures the average number of children that would be born to a married woman, if she experiences the current
fertility pattern through her reproductive life cycle. It is a better measure than TFR, as it is restricted to married woman
who are exposed to the risk of bearing children.
7
Total Martial Fertility Rate = 5   ASMFR 1000
i =1
 General Martial Fertility Rate (GMFR)

It refers to the average number of girls that would be born to a woman if she experiences the current fertility pattern
throughout her reproductive life cycle; assuming no mortality.

Bxf No. of female births to women aged x to x+5

Gross Reproduction Rate =  w 2 f =
w1
1000
Px No. of women of age x to x+5 in the mid-year population
where, w1 and w2 are lower limit and upper limit of child bearing period
* GRR is about female children and its value is 1/2 of Total Fertility Rate
 Net Reproduction Rate (NRR)

• The Net Reproduction Rate is defined as the number of daughters a newborn girl will bear during her lifetime,
assuming fixed age-specific fertility and mortality rates. The target is to attain the NRR of 1.
• Demographers agree that NRR of ideal number 1 can be achieved only if at least 60% of the eligible couples are
effectively practicing family planning.

Bxf
Net Reproduction Rate = f  1000
Px
NRR=1  Exact replacement  one woman will be replaced by another woman
NRR >1  Pop is more than replacing itself,
NRR <1 pop not replacing itself
 Net Reproduction Rate (NRR)
Bxf
Net Reproduction Rate = f  1000
Px
NRR=1  Exact replacement  one woman will be replaced by another woman
NRR >1  Pop is more than replacing itself,
NRR <1 pop not replacing itself

Bxf No. of female births to women aged x to x+5

Gross Reproduction Rate =  w 2 f =
w1
1000
Px No. of women of age x to x+5 in the mid-year population
where, w1 and w2 are lower limit and upper limit of child bearing period
* GRR is about female children and its value is 1/2 of Total Fertility Rate

* NRR is always lower than GRR

 Parity Progression Rate (PPR)

The most widely used measures of fertility are period measures - age-specific fertility rates and the total
fertility rate (TFR). These are very useful measures but they do suffer from one defect- they are not very good
at detecting real changes in fertility in the short term. That is because they are affected by the timing of births
(tempo effects).
Parity Progression Ratio (PPR), is the chance that a woman after delivering her i th child will ever proceed to
the next parity i.e. will have an additional child in future. As a useful measure of fertility the concept of PPR
was introduced by Henry (1953).
• It is a measure commonly used in demography to study fertility. The PPR is simply the proportion of
women with a certain number of children who go on to have another child. Calculating the PPR, also known
as ‘ax’ , can be achieved by using the following formula:

ax =
( women with at least x+ 1 children ever born )
women with at least x children ever born
 Mortality Rates
Mortality Rates
Mortality rate is the number of deaths due to a disease divided by the total population.
Crude Death Rate
It is defined as the number of deaths per 1000 population in a specific age group or sex group
or community or region. Annual Number of deaths ( in a region )
CDR= × 1000
Annual Mid-year population ( in a region )

Example: The population on 31st March 2021 and that of on 31st March 2022 are 30000 and 50000, respectively. During
the last year, 4800 deaths have been known. Find the crude death rate.
 Infant Mortality Rate (IMR)
It is the number of deaths of children under one year of age per 1000 live births. The infant mortality rate is defined as the
member of deaths of infants (less than one year old) per 1000 live births in a given year. IMR correlates very strongly with,
and is among the best predictors of, state failure. It is also a useful indicator of a country’s level of health or development,
and is one of the components of the physical quality of life index (PQLI). The method of calculating IMR varies between
countries, and is based on how they define a live birth and how many premature infants are born in the country. The infant
mortality rates can be calculated separately for males and females.

Annual Infant Deaths ( of males or females or total )

IMR= × 1000
Annual live births ( of males or females or total )
 Infant Mortality Rate (IMR)
Infant mortality rate comprises of two parts viz. Neo-
natal mortality rate and Post neo-natal mortality rate.
The neo-natal mortality rate also comprises of two parts
viz. Early neo-natal mortality rate and late neo-natal
mortality rate.
 Maternal Mortality Rate (MMR)
It is the annual number of female deaths per 1 lakh live births from any cause related to or aggravated by the pregnancy or
its management (excluding accidental or incidental causes).

DP
MMR = 1000
B

DP = Total number of deaths from puerperal (bacterial infection) causes occurring within 42 days of delivery among the
female population aged 15-49 in the given period in the given community
B = Total number of live births occurring in the given period in the community.
 Proportional Mortality Rate (PMR) or Specific Death Rate

It is the number of deaths from a specific cause in a specific period per 1000 deaths from all causes in the same time period.
The crude death rates for specific causes of death are calculated in a similar way by selecting deaths due to specific cause as
the numerator and mid-year population as the denominator. Thus,

Number of Deaths due to particular cause

Cause Specific Death Rate = 1000
Mid-year Population

The rates could be made specific to sex by selecting the numerator and the denominator for each sex of the population.
 Age Specific Death Rate (ASDR)

The age-specific death rates are calculated from deaths and population both specific to each age (or age group) of the
population. Thus, nDx
Age Specific Death Rate = 1000
nPx
where x indicates the age and n the class interval of age.

• The age-cause-specific death rates are obtained by selecting deaths in specific age and cause group of the population as
the numerator.
• It should be noted that the sum of the cause-specific rates over all causes equals the crude death rate. Similarly, the sum
of the age-cause-specific death rates equals the age-specific death rate at a given age.
• The ASDR is a type of central death rate, that is, a rate relating to the events in a given category during a year to the
average population of the category.
• In a high mortality situation, the death rates by age, that is, the age specific death rates, form a U-shaped curve indicating
a high mortality in early and old ages.
• At low levels of mortality, the pattern of ASDR changes to J-shaped indicating a relatively higher mortality in the very
early period of life, which drops to a low level after the hazards of early life and extends over a long period of life, and
finally it rises sharply in old ages.
 Under 5 Mortality Rate (U5MR)

U5MR is the probability per 1,000 that a newborn baby will die before reaching age five if subject to age-specific mortality
rates of the specified year.
• It is expressed as a rate per 1,000 live births.
• It is widely used to measure, assess and monitor the progress of countries with respect to child survival.
• It is related to MDG-4: Reduce child mortality, which has the target of being reduced by two-thirds, between 1990 and
2015.
 Sample registration system [SRS 2019 published in 2022]

• The Sample Registration System (SRS) is the largest demographic survey in the country mandated to provide annual
estimates of fertility as well as mortality indicators at the State and National level.
• The Office of Registrar General, India, initiated the scheme of sample registration of births and deaths in India
popularly known as Sample Registration System (SRS) in 1964-65 on a pilot basis and on full scale from 1969-70. The
SRS since then has been providing data on a regular basis.
• The present Report contains data on fertility and mortality indicators for the year 2019 for India and bigger States/UTs.
The estimates are segregated by residence and also by gender, wherever required.
Sample registration system
Sample registration system
Sample registration system
Sample registration system
Sample registration system
Sample registration system
Sample registration system
Sample registration system
 NFHS-5 [2019-21 published in 2022]

National Family Health Survey 5 [2019-21 published in 2022]

The National Family Health Survey is a survey carried out on a massive scale across the country to collect information on
many parameters which would ultimately help the Ministry of Health and Family Welfare (MOHFW) to frame policies
and programs to help in the upliftment of the vulnerable groups in India. The first round of the National Family Health
Survey was conducted in 1992-92.
 NFHS-5 [2019-21 published in 2022]

National Family Health Survey 5 [2019-21 published in 2022]

The NFHS provides estimates on key indicators related to:
• Population and household profile
• Marriage and fertility
• Family planning
• Contraception
• Maternal and child health
• Delivery care
• Vaccinations
• Treatment of childhood diseases
• Nutrition and feeding practices
• Anaemia
• Diabetes
• Hypertension and
• Cancer examination
 NFHS-5 [2019-21 published in 2022]

National Family Health Survey 5 [2019-21 published in 2022]

The scope of NFHS-5 is expanded in respect of earlier round of the survey (NFHS-4) by adding new dimensions such
as death registration, pre-school education, expanded domains of child immunization, components of micro-
nutrients to children, menstrual hygiene, frequency of alcohol and tobacco use, additional components of non-
communicable diseases (NCDs), expanded age range for measuring hypertension and diabetes among all aged 15
years and above
 NFHS-5 [2019-21 published in 2022]

National Family Health

Survey 5 [2019-21,
published in 2022]
NFHS-5 [2019-21 published in 2022]
NFHS-5 [2019-21 published in 2022]

IMR has marginally declined in

nearly all states. Assam has seen
one of the largest drops in IMR,
from 48 deaths (per 1,000 live
births) to 32 deaths. IMR remains
high in Bihar (47 deaths per 1,000
live births).
 NFHS-5 [2019-21 published in 2022]

Child nutrition indicators show a mixed pattern across

states. While the situation improved in many States and
Union Territories, there has been minor deterioration in
others.
o Malnutrition has worsened. Stunting has risen in 11
out of 18 states. Wasting was going up in 14 states.
o Stunting: 13 out of 22 states and UTs surveyed,
recorded a rise in the percentage of stunting in
children.
o Wasted: 12 out of 22 states and UTs surveyed,
recorded a rise in the percentage of children under
five years who are wasted in comparison to NFHS-
4.
o Overweight: 20 states and UTs have recorded a rise
in the percentage of children under 5 years who are
overweight.
o Diarrhoea: Children with diarrhoea in the two
weeks preceding the survey also jumped to 7.2%
from 6.6%.
 NFHS-5 [2019-21 published in 2022]

Obesity [measured by BMI] is rising for both men and women across all states in the age group
of 15-49, increased in all states (except Gujarat and Maharashtra).

In Andhra Pradesh, Goa, Karnataka, Telangana, Kerala and Himachal Pradesh, nearly one-third
of men and women are overweight or obese.
 NFHS-5 [2019-21 published in 2022]

The proportion of married women (between 18-49 years of age) who have ever faced spousal
violence has increased in 5 states.
In Karnataka, it has doubled, from 21% to 44%.
More than a third of the married women face spousal violence in Karnataka (44%), Bihar (40%),
Manipur (40%), and Telangana (37%).
 NFHS-6 [2023-24 yet to be published]

New dimensions in NFHS-6 (2023-24) – Learning from NFHS-5

In this context, NFHS-6, which is scheduled to be conducted during 2023-24, propose to cover various new
domain areas, which include:
• COVID-19 hospitalization and distress financing,
• COVID-19 vaccinations,
• Director Benefit Transfers (DBT) under various welfare schemes initiated by GoI,
• Migration,
• Utilization of health services –Health and wellness centre, health insurance/ health financing,
• Digital literacy,
• counselling on family planning after abortion and incentives under new methods of family planning,
quality of family planning programme, menstrual hygiene, marital choice, visit by community health
workers for health awareness and needs, supplementary nutrition from the Anganwadi/ ICDS center
while breastfeeding, blood transfusion (month and year), financial inclusion among women, knowledge
of anaemia, Hepatitis B &C, Syphilis etc.”
Unlike in previous rounds, NFHS-6 will adopt Urban Frame Survey (UFS, 2012-17) of NSO, MoSPI as a
sampling frame for urban area. This strategy will minimize the non-sampling errors to large extent as the
boundary identification problems using 2011 census frame will be resolved. While for rural areas, updated
list of villages from NSO will be used as a frame, which would be matched with the PCA from the Census
to get auxiliary information.
Lecture-15: Health, Morbidity, DALY, HALE,
PYLL, QALY; Migration
Unit-3 (B): Environment &
Demography Economics

NTA-UGC-NET
Economics (Paper-2)
 Migration

Population growth is determined by fertility, mortality, and migration. Population growth may be expressed as:

• Natural growth = Birth rate – Death rate

• Actual Growth = Birth rate – Death rate + Immigration – Emigration
• It should be noted that while migration is to move from one place to another as temporary measure, immigration and
emigration lead to permanent change in the status of resident. Secondly, migration can be within the country or
internationally, but emigration and immigration are only internationally with permanency.
 Migration
Migration is the movement of people which involves a
change in the place of normal residence of people
from one settlement to another. It occurs due to push
and pull factors.

✓ Push factors are those that compel humans to leave

a place of origin, for instance, war, political unrest,
poverty, natural calamity, lack of opportunity, etc.

✓ Pull factors are those that attract humans towards a

particular place. whereas some of the major pull
factors, for instance, better & more opportunity,
glamour, fertile land and soil, good means of
transport and communication, high levels of
urbanization, industrialization, etc.
 Migration

When people migrate within the same country it is called internal migration. When migration involves crossing the
boundaries of a given country, it is called international migration. Migration results in multi-dimensional changes in the
population composition - ethnic, ethnolingual, religious, demographic, cultural and economic. The structural contexts of
migrants itself has bearing in migration and what it means to be a migrant.
 Types of Migration

• Cyclic or Circulatory Migration: Movements of individuals that involve only a temporary change of residence are
generally not considered as migration. This type of movement is known as nomadism or pastoral nomadism. If this
movement of the people is along with their animal stock – sheep, goats and cattle between two fixed points it is called
transhumance. The movement of farm workers is also a kind of cyclical migration because they follow the growing
season. Tourism and commutation are not generally considered as migration. Some migrations are cyclic in nature,
which means that they are like oscillations/ circuits. People migrate between two fixed points. It is an annual cycle, to
be completed within the same year.

• Internal and External (International) Migration: When people migrate within the country of their
birth/residence/domicile, it is called internal migration. The word internal here means movement within the bounds
of the home country. When people move from one country to another, it is called international migration. Such
migrations involve crossing the borders of the countries. Sometimes the driving force is a push factor.
 Types of Migration

• Primitive or Early Migration: Distinction has often been made between Early/Primitive migration and forced/
impelled migration.

➢ Early migration, popularly during the prehistoric and early historic times were of random nature and mainly
were not planned migration. People used to migrate from one place to another in search of food, shelter and
water.

➢ Forced or Impelled Migration: When individuals or groups decide to leave their home country in order to
avoid devastation caused by drought, famine, epidemics, war, civil strife, or terrorising dictatorial regimes, it is
called forced migration. Like migration after independence 1947. Refugee Movements: Example: Bihari
Muslims who migrated to East Pakistan immediately after the partition of British India in 1947 are still living in
camps, even though fifty-seven years have passed.
 Types of Migration

• Seasonal and Periodic Migration: Migrations are sometimes seasonal or periodic. Common among the
nomadic people living on the margins of the deserts. Periodic Migration: Trewartha refers to periodic
movements, which are related to vacations, fun making or business. For e.g. travels are related to
pilgrimage to sacred places, large fairs, such as Kumbh Mela and Pushkar Mela. Millions of people in
India go on pilgrimage for a holy dip in the rivers and lakes to perform religious rites.

• Another type of periodic migration is the movement of an individual from his original place of residence
for a period of few years. He visits his home periodically. The main aim of this type of migration is to
earn more and to send remittances to the family in the native place to establish themselves after they
return to their original homes. However, initially their intentions were to remain there only temporarily’
 Migration Streams

While dealing with internal migration demographers and population scientists generally recognise four streams. The
criterion is the direction of movement of population from the places of origin to the places of destination. The migration
within the bounds of the same country generates four main streams as given below:

rural-rural migration stream; In villages where economy is based on agriculture, people migrate from one village to
another either for harvesting or sowing the crops or both. The assumption is that the native village is overcrowded and
agriculturally less productive as compared to the village of destination. In this form of migration, the migrants are mostly
males. Sometimes, women also migrate along with the male members of the family. In countries like India, young
women are married to a person living at a certain distance from their parental village. The reason is that the marriages
cannot be contracted within a radius of 4-5 miles (6-8 kms.) This no-marriage field is treated as the taboo zone. However,
this practice is a feature of North India only. There is no such practice in the south, where the girls are generally married
to their paternal or maternal cousins.
 Migration Streams

rural-urban migration stream; In the less developed countries, like India, Nepal and Bangladesh, rural to urban
migration is a common phenomenon. In regions where the rural population densities are very high and the pace of urban-
industrial development is fast, rural-urban stream is most common. These towns/cities attract the ‘surplus labour’ from
nearby or far-off villages.

• Sequential Migration is a form of migration where migrant’s decision has not been taken into consideration at
all. Most of the children of migrating families can be seen as best examples where they do not have any say in
the decision made by their elders. Another example is the wife who accompanies her husband.
 Migration Streams

urban-urban migration stream; Urban to urban migration is a common phenomenon both in the highly urbanized parts
of the world as well as in the less developed countries. People move out from one urban place to the other. The motive is
to find jobs to improve their economic status. It is a common feature that large cities attract people from small towns in
their neighbourhood. This is especially true in the case of skilled workers. This practice is known as step-wise migration.
The first step is to move out from a village to a small town; the second step is to move out rom a small town to a large
city. Urban to urban migration is due to multiple factors, economic as well as socio-cultural. It is the main channel of
labour supply to the fast growing city.

• Urban-urban migration can also be studied in the backdrop of ‘Step Migration’ as propounded by Ravenstein:

✓ Small Town→ Cities → Big Cities/Metros

✓ Darbhanga → Patna → Delhi

 Migration Streams

urban-rural migration stream: Urban to rural migration is a kind of reverse flow. This is so because large
metropolises/mega cities in developed countries attain a high degree of urbanisation, which widens the scope for
absorption of rural labour in the informal sector of economy. This also leads to the problems of housing due to over-
congestion of cities and the resultant problems of environmental pollution and poor health. This often forces the migrants
to return to their native villages. It may be noted that the rural areas in the developing countries are generally
underdeveloped. They lack infrastructure facilities to accommodate the rural poor. The story of developed countries is
entirely different. It is also termed as Counter-Urban Migration or Return Migration
 Migration Theories
Ravenstein’s original paper was based upon the British Census of 1881. Ravenstein’s laws (or
generalizations) in a condensed form can be presented as:
 Migration Theories
Ravenstein’s original paper was based upon the British Census of 1881. Ravenstein’s laws (or
generalizations) in a condensed form can be presented as:
1. Migrants move mainly over short distances; those travelling longer distances head for the great centres
of industry and commerce. [Gravity law of Migration]. This is called distance decay.
2. Most migration is from agricultural to industrial areas. [Rural-Urban Migration]
3. Large towns grow more by migration than by natural increase. [Urbanisation]
4. Migration increases with the development of industry, commerce, and transport. [Zelinsky’s (1971)
famous ‘hypothesis of the mobility transition]
5. Each migration stream produces a counter-stream. [two-way migration dynamics, net migration, and
return migration]
6. Females are more migratory than males, at least over shorter distances. Males are dominant in
international migration. [Gender element]
7. The major causes of migration are economic. [fundamental truism]
8. Migration happens in stages. Migrants do not tend to go straight to their end destinations at first.
 Migration Theories

Gravity Model by Zipf in 1946

It is based upon Newton’s law of gravitation.
 Migration Theories

Everett S. Lee has emphasized the role of pull factors or incentives associated with the destination areas, push factors or
those associated with the areas of origin, intervening obstacles such as ethnic barriers, distance, cost and the personal
factors to explain the migration of people from one area to another. The pull factor includes employment opportunities in
the cities and the push factor includes labour surplus with low productivity in the rural areas, disguised unemployment
and the exploitative relationships that exist in the villages. This theory has been utilized to explain the rural-urban
migration in India. Everett Lee has conceptualized the factors associated with the decision to migrate and the process of
migration into the following four categories:
(1) Factors associated with the area of origin; eg income, job opportunities, etc.
(2) Factors associated with the area of destination; e.g. risks, uncertainty, expectations, etc.
(3) Intervening obstacles between area of origin and destination, eg laws, distance, etc.
(4) Personal factors, eg age, sex, race, education, health, etc.
 Migration Theories

Zeros represent the indifference of the people towards migration. In between these forces are the intervening obstacles.
 Migration Theories

Labour equilibration model by W.A. Lewis (1954/58) and J.C.H. Fei (1961) and G. Ranis (1964) has also tried to
provide an explanation for migration; the model works on the assumption of a dual economy that of labour attempting to
move out from subsistence, low or zero productivity economy to the fast growth capitalist, urban sector with higher
wages. However, the critics suggest that labour productivity is not zero in the rural areas; moreover, it is the structural
factors relating to the mode of production, which lead to low production rather than little work in the villages
 Migration Theories

Harris and Todaro (1969) considered migration to be a function of labour allocation in response to the market demands,
so that the demand and supply of labour are always in equilibrium. According to this theory, labour mobility occurs in
direct response to the expected wage differential between rural and urban areas. The theory further elaborates that if wage
differential between the rural and urban sectors is in excess of equilibrium, the inter-sectoral transfer will continue until
there is equality. The theory goes on to say that given higher wages in the urban areas, people would be attracted from low-
income underdeveloped regions in numbers much larger than the available employment opportunities on the chance of
getting a job..
1. Migration is stimulated primarily by rational economic consideration of relative benefits and costs, mostly financial but
also psychological.
2. The decision to migrate depends on expected rather than actual rural real wage differentials
3. Expected differential is determined by the interaction of two variables, the actual urban-rural wage differential and the
probability of successfully obtaining employment in the urban modern sector.
4. The probability of obtaining an urban job is inversely related to the urban employment rate
5. Migration in excess of urban job opportunity growth rates are not only possible but also rational and probable in the face
of continued positive urban-rural expected income differentials.
 Migration Theories

Todaro's 2nd Model (1976)

If urban-rural wage differentials remain unchanged, then govt. attempts to reduce urban unemployment level by creation
of additional jobs in modern sector, which worsens the situation and this would further lead to rise in unemployment
rates.
• As a result migration would continue due to expected income differentials in the urban areas.
• Also, the rate of migration increases with the size of urban rural differentials.
 Migration Theories

Sameul A. Stouffer has developed the hypothesis of migration and intervening opportunities. He argued that degree of
migration would be inversely related to the distance between the two places as also the extent of intervening
opportunities but directly related to the opportunities in two places.

J. Clyde Mitchell has theorized the idea in a more comprehensive way. He has stated that a single factor explanation of
migration is totally inadequate and that listing all possible motivations is also not very useful. He has seen the need to
link together and has related the multiple causes in a logical framework and suggested a classification whose major
headings are “the nexus of a centrifugal tendencies” and “the nexus of the centripetal tendencies” sub divided by social,
psychological and economic factors
 Migration Theories

Rao (1986) has also pointed out that isolated variables cannot adequately explain the reason for migration. Hence, he has
taken the multi-dimensional approach for the analysis of migration. In this way, Rao has identified the following key
factors in the multi-dimensional approach:
• historical development of the region; wider economic and political conditions, which regulate and condition the
nature of employment opportunities;
• economic and social conditions in the place of origin; at individual level
level of skills, family circumstances, process of socialization and the personality factors; and presence of the resource
network such as social network, which acts as the most effective channel of communication that favours decision making
in migration
 Questions

Q-1. Which of the following statement is not correct?

(A) Migrants move from low opportunity areas to areas of high opportunity.
(B) Migration takes place in steps.
(C) Each rural-urban stream produces urban-rural counter stream, but the former one does not dominate the latter.
(D) The choice of destination is regulated by distance.

Kerala Set 2020

 Questions

Q-2. Natural growth of population is the outcome of the following:

I. Crude Birth Rate
II. Crude Death Rate
III. Migration
IV. Marriages
Codes:
(A) Only I
(B) Only III
(C) II & IV
(D) I & II
 Questions

Q-3. Migration of labour from rural to urban areas is classified as which type of unemployment ?
(A) Seasonal Unemployment
(B) Structural Unemployment
(C) Disguised Unemployment
(D) Open Unemployment
Questions
 Questions

Q-3. Migration of labour from rural to urban areas is classified as which type of unemployment ?
(A) Seasonal Unemployment
(B) Structural Unemployment
(C) Disguised Unemployment
(D) Open Unemployment
 Health

• 22nd July 1946 [w.e.f. 7th April 1948] Constitution of the World Health Organisation, health has been defined as ‘a
state of complete physical, mental and social wellbeing and not merely the absence of disease or infirmity.
• The enjoyment of highest attainable standard of health is the fundamental rights of every human being without
distinction of race, religion, political belief and economic or social condition.
• In economics, health is not only a state of physical and mental well being with absence of diseases but also as a
COMMODITY- a durable or capital stock which makes a person efficient and productive.
• Over time, the stock of health depreciates with age, which may be upkept with due investments in medical and
recreational ventures. Death happens when individual’s stock of health < below the critical minimum level.
• Thus, people desire good health as a commodity both for consumption and investment purposes. Good health is a
durable consumption good because it yields utility by improving the quality of life.
 Morbidity Indicators

[Morbidity means illness and is measured in two ways:]

Prevalence Rate
• It is a measure to determine the level of morbidity like to determine the likelihood of people getting a disease. A PR is
the total number of cases of a disease existing in a population divided by the total population in a particular area. Eg- If
in Delhi, say 1500 fresh cases of COVID 19 positive have been tested and already 3500 people are infected due to
COIVD 19, then PR of COVID is [3500+1500]/ total population of Delhi.
 Morbidity Indicators

Incidence Rate:
• It is a measure of disease that allows us to determine a person’s probability of being diagnosed with a disease during a
given period of time. Therefore, it is the number of newly diagnosed cases of a disease.
• An incidence rate is the number of new cases of a disease divided by the number of persons at risk for the disease. For
instance, if over the course of one month, 50,000 new people out 2lakh sample are found to be infected from COVID
19, who were not infected at the beginning of the period, then the incidence of COVID 19 is 50000/2,00,000.
• Health Status Indicator: These are the measurement of health status of a given conveyed by using various indices
including mortality and morbidity. For ex- Low Birth Weight (LBW) is an indicator defined as less than 2,500 gm of
a newly born child (weighed during the first hour of life).
 Morbidity Indicators

Burden of Disease Indicators

• At individual level, BoD refers to the overall impact of diseases and injuries. At societal level, it refers to the
economic costs of diseases.
Global Burden of Disease (GBD) is an indicator published by WB in its WDR. It measures the total loss of health
resulting from diseases and injuries. The GBD concept, first published in 1996, constituted the most comprehensive and
consistent set of estimates of mortality and morbidity yet produced (Murray & Lopez, 1996), and WHO now regularly
develops GBD estimates at regional and global level for a set of more than 135 causes of disease and injury (Mathers et
al., 2002; WHO, 2002a).
 Morbidity Indicators

• A GBD study aims to quantify the burden of premature mortality and disability for major diseases or disease groups,
and uses a summary measure of population health, the DALY, to combine estimates of the years of life lost and years
lived with disabilities. The data are also broken down by age, sex and region
• Disease burden is thus the impact of a health problem as measured by financial cost, mortality, morbidity, etc.
• It is often expressed in terms of quality adjusted life years (QALYs) or disability-adjusted life years (DALYs), both of
which quantifies the number of years lost due to disease (YLDs).
• Summary measures of population health measure the health of a population by combining data on mortality and non-
fatal health outcomes into a single number. Besides the DALY, several other such measures have been devised,
including the Quality-Adjusted Life Year (QALY), the Disability-Adjusted Life Expectancy (DALE) and the Healthy
Life Year (HeaLY)
Morbidity Indicators
 Morbidity Indicators [DALY]

• As the DALY has been the most widely-used measure. The DALY measures health gaps as opposed to health expectancies. It
measures the difference between a current situation and an ideal situation where everyone lives up to the age of the standard
life expectancy, and in perfect health. Based on life tables, the standard life expectancy at birth is set at 80 years for men and
82.5 for women.
• It is an alternative tool (emerged in the early 1990s) as a means of quantifying the burden of disease. It sums up years of life
lost (YLL) due to premature mortality and years lived in disability / disease (YLD).
• YLL is calculated as the number of deaths at each age multiplied by the standard life expectancy for each age.
• YLD represents the number of disease/disability cases in a period multiplied by the average duration of disease/disability
weighted by a disease/ disability factor.
• Conversely, DALYs measure the amount of life lost in a population as a result of premature death or disability. They can be
used to estimate the burden of disease on populations. DALYs were used in the Global Burden of Disease study to enable
mortality and morbidity comparisons to be made across countries. Weightings were applied to conditions by using the time
trade off approach, in which people were asked to consider living more years in imperfect health compared with fewer years
in perfect health. The study also placed more weight on the life of a young adult compared with a newborn.
 Morbidity Indicators [DALY]

• The DALY combines in one measure the time lived with disability and the time lost due to premature mortality:
DALY = YLL + YLD

• The YLL metric essentially corresponds to the number of deaths multiplied by the standard life expectancy at the age
at which death occurs, and it can be rated according to social preferences. The basic formula for calculating the YLL
for a given cause, age or sex, is: YLL = N x L

• To estimate YLD on a population basis, the number of disability cases is multiplied by the average duration of the
disease and a weight factor that reflects the severity of the disease on a scale from 0 (perfect health) to 1 (dead). The
basic formula (without applying social preferences) for one disabling event is: YLD = I x DW x L
 Morbidity Indicators [DALY]

• For instance, a woman with a standard life expectancy of 82.5 years, dying at age 50, would suffer 32.5 YLL. If she
additionally turned blind at aged 45, this would add 5 years spent in a disability state. If the weight factor is 0.33, then
it results in 0.33 x 5 = 1.65 YLD. In total, this would amount to 32.50 + 1.65 = 34.15 DALYs.
• For DALYs, the scale used to measure the health state is inverted to a ‘severity scale’, where ‘0’ equates perfect health
and ‘1’ equates death
 Morbidity Indicators [DALY]

DALY (Disability – Adjusted Life Years)

YLL = Years of Lost Life = no. of deaths at each age multiplied by the
Measure of overall disease burden
expected remaining years of life according to a global standard life
Developed by Harvard University for
expectancy (LE)
WHO
• Japanese LE is used as the global standard
Expressed as ‘number of years lost due
• As Japanese have the longest LE
to
YLD = Years Lost to Disability = no. of incident cases due to injury
• Ill health,
and illness is multiplied by the
• Disability or
1. Average duration of the disease and
• Early death
2. A weighting factor reflecting the severity of the disease on a scale
Used as a major measure by the ‘’Global
from 0 to 1
Burden of Disease Project’’
• Severity score = 0 =perfect health
Combines the effect of important fatal
• Severity score = 1 = death
and non-fatal disabling conditions
One DALY = one year of health life LOST
through a single measure
Calculated as:
DALY = YLL + YLD
 Morbidity Indicators [HALE]

HALE is a measure of population health that takes into account mortality and morbidity. It adjusts overall life
expectancy by the amount of time lived in less than perfect health. This is calculated by subtracting from the life
expectancy a figure which is the number of years lived with disability multiplied by a weighting to represent the
effect of the disability.
If:
A = years lived healthily
B = years lived with disability
A+B = life expectancy
A+fB = healthy life expectancy, where f is a weighting to reflect disability level.
 Morbidity Indicators [HALE]

HALE (Health – Adjusted Life Expectancy)

• Previously known as DALE (disability
adjusted life expectancy)
• Indicator used to measure healthy life
expectancy
• Based on life expectancy at birth BUT
includes an adjustment for time spent in
poor health
• Definition: equivalent number of years in
full health that a new-born can expect to
live based on current rates of ill health and
mortality
 Morbidity Indicators [QALY]

• It was invented in the 1970s and has become an

internationally recognised indicator since the mid- QALY (Quality – Adjusted Life Years)
• A measure of disease burden including both:
1990s. QALY is the arithmetic product of life
1) Quality and 2) Quantity of life lived
expectancy combined with a measure of the quality of • Used in assessing the value for money of a
life-years remaining. That is, it is the time a person is medical intervention
• Based on the number or years of life that
likely to spend in a particular state of health, weighted would be added by intervention’
by a utility score from standard valuations. • Each year in perfect health = 1.0 | Death =
0.0
• QALY of ‘1’ indicates perfect health and ‘0’ equates • 1 QALY = one year of life X one utility value
death. Certain health states are like severe disability = one year of life lived in perfect health
• Half a year lived in perfect health is
and pain, they are regarded as worse than death and
equivalent to 0.5 QALY = 1 year X 0.5 utility
are even assigned negative values. value
 Morbidity Indicators [QALY]

Sullivan’s index’ ‘Disability Free Life Expectancy’ “Active Life

Expectancy” DFLE: Disability – free life
expectancy
‘Life expectancy’ MINUS ‘duration of disability’. Health expectancy
Active life expectancy
calculated by Sullivan’s method is the number of remaining years, at a
Average number of years an
particular age, that an individual can expect to live in a healthy state. individual is expected to live
• The data for calculation is obtained from free of disability if current
pattern of mortality and
▪ population surveys and
disability continue to apply
▪ life tables
• The age-specific prevalence is directly applied to person-year of the
life table: it provides
▪ The total number of years spent with disability,
▪ The total number of years lived without disability
▪ DFLE/ Active LE/ Sullivan's index is more relevant for elderly
population
Lecture-16: Age Structure, Demographic
Dividend, Life Table
Unit-3 (B): Environment &
Demography Economics

NTA-UGC-NET
Economics (Paper-2)
 Age-Sex Structure

• Age-sex structure conveys the relative numbers of children, young and old as well as the balance of men and women at
different ages. Such information is useful for formulations of several country-specific policy-making and planning
purposes.

• The age is normally defined by a person at his/her last birthday at the time of the survey.

• The data of age-sex structure can be cross-classified by variables like educational attainment, marital status and
economic activity which alter with ages in different patterns or forms.
 Measuring Age-Sex Structure
Measuring Age-Sex Structure
The following are the three ways used for measuring Age-Sex Structure.

1. Age composition: When male and female population of a country is categorized into different age-groups such as 0-
14 years, 15-64 years and 65 years or above, then such a classification is termed as age-sex composition. It enables one
to understand the proportion of population from gender as well as from age perspective. India, as per Census 2011, has
31% of population in young age group i.e. 0-14 years, while the age-group of 15-59 years accounts for 60.5% of the
country’s population.
2. Dependency ratio: Srinivasan, 1998 defined dependency ratio as a ratio of economically active to the economically
inactive population. Dependency ratio is an age-population ratio of those who are not in the labor-force (the dependent
part) & those typically in the labour force (the productive part). The dependent part usually includes those under the
age of 15 and over the age of 64. The productive part makes up the population in between, ages 15 – 64. It is normally
expressed as a percentage.
 Measuring Age-Sex Structure
Measuring Age-Sex Structure
The following are the three ways used for measuring Age-Sex Structure.

2. Dependency ratio: Srinivasan, 1998 defined dependency ratio as a ratio of economically active to the economically
inactive population. Dependency ratio is an age-population ratio of those who are not in the labor-force (the dependent
part) & those typically in the labour force (the productive part). The dependent part usually includes those under the
age of 15 and over the age of 64. The productive part makes up the population in between, ages 15 – 64. It is normally
expressed as a percentage.
No. of Children ( 0 –14 ) + No. of Old persons ( 65 + )
Dependency Ratio =  100
No. of Adults (15 – 65)
 Measuring Age-Sex Structure
Measuring Age-Sex Structure
The following are the three ways used for measuring Age-Sex Structure.

3. Population pyramid:
• The population pyramid or age-sex pyramids show the age-sex structure of a population.

• Age-sex compositions are traditionally depicted through a diagram popularly known as population
pyramid, which is a graphical illustration that shows the distribution of various age groups in a
population (of a country or region of the world), which normally forms a pyramid.

• The age–sex structure reflects the demographic and socioeconomic history of a population over a
period of time and, even their prospects for the future. It is the result of various factors such as fertility,
mortality, and migration.
 Population Pyramid

• It typically consists of two back-to-back bar graphs, with the

population plotted on the X-axis and age on the Y-axis, one showing
the number of males and one showing females in a particular
population in five-year age groups. The Y-axis represents the age,
where the youngest at the bottom and the oldest is the pick.

• The scale can be in single or five-year age groups depending on the

precision needed.

• It must be of equal width, apart from the final open-ended age group.

• Males are conventionally shown on the left and females on the right,
and they may be measured by raw number, or as a percentage of the
total population.
 Types of Population Pyramid
i. Progressive/ Expansive pyramid
ii. Regressive/ Constrictive pyramid
iii. Stationary pyramid
iv. Intermediate pyramid
 Progressive or Expansion Population Pyramid

• A progressive age structure is one in which both birth and death

rates are high.

• This type of graph has a classic or triangular shape, with a very

wide base and pointed apex.

• It denotes larger numbers of people in the younger age categories

and is a reflection of many developing nations where birth rates
are high or stalled, and life expectancy is compact.

• Each age group presents a bar less wide than that of the age-group
before it, showing that more people are dying at the higher group.

• The large base confers to a high birth rate, which is probably due
to circumstances like a developing economy, low levels of female
education, poverty and less awareness of birth control measures.
 Progressive or Expansion Population Pyramid

• Children account for only 45-55 per cent of the total population
and the aged for only 5-10 per cent.

• It is common in developing countries where social, cultural, and

perhaps religious and economic conditions lead to high fertility,
and poor living conditions, bad diets and little medical aid lead to
high levels of mortality.

• The top of the pyramid indicates to high mortality rates, which

signifies for a low level of life expectancy at birth in the country.
This indicates existence of poor living conditions and lack of
proper medical amenities

• This type of pyramid indicate stage 2 of the demographic

transition.
 Constrictive or Regressive Population Pyramid

• A regressive age structure is one in which birth & death rates are low &
declining.

• Children account for about 30 per cent of the total population & the aged
for > 15 %.

• This pattern is common in developed countries (especially those in

Western Europe), where high living standards, education and social
awareness are accompanied by good food and medicine.
• It has lower proportion of younger age people with top bars of more
length than the bottom bars.
• Such type of pyramids is seen in the places with high life expectancy, and
healthy living conditions are significantly contributing to a higher number
of older people.
• The rising number of older people than the youth in the country places a
burden upon the working-age population to maintain a large number of
elderly dependents.
 Stationary & Intermediate Population Pyramid
A stationary age structure is one in which birth and death rates are
both low.
• Children account for about 35-40 per cent of the total population
and the aged for about 10 per cent.
• This pattern may remain the same for many years.
An intermediate age structure may vary in character.
• It is most common in countries that are passing through stages of
development.
• Such countries may once had progressive structures & in future,
have regressive structures.
 Stationary v/s Stable Population

What is difference between Stationary Population & Stable Population?

1. In a stable population we have that population growth rate equals the difference between crude birth rate
and crude death rate. But in a stationary population the growth rate is zero.
2. Stable populations with positive growth rates (r>0) grow steadily over time, negative growth rates (r<0)
imply that the population is shrinking steadily.

The special case of the stable population with zero growth (r=0) is called a stationary population
 Total Dependency Ratio
The (total) dependency ratio can be partitioned into the child dependency
ratio and the aged dependency ratio:
Number of Children ( 0 –14 )
Child Dependency Ratio =  100
Number of Adults (15 – 64 )
Number of Aged ( 65 + )
Aged Dependency Ratio =  100
Number of Adults (15 – 64 )

• Age structure directly affects the economy. The work force in

developing countries must support twice as many children as in
developed countries.
• In developed countries, on an average, the proportion of workforce is
about 65 per cent that support less than 20 per cent youthful dependants.

• Therefore, in these countries problems relate to low population growth

and old age dependency, which represent about 15 per cent of their
population
 Demographic Dividend

Demographic dividend refers to the growth in an economy that is the result of a change in the age structure of a
country’s population. The change in age structure is typically brought on by a decline in fertility and mortality rates.

• According to United Nations Population Fund (UNFPA), demographic dividend means, "the economic growth
potential that can result from shifts in a population’s age structure, mainly when the share of the working-age
population (15 to 64) is larger than the non-working-age share of the population (14 and younger, & 65 & older)".

• Demographic dividends are occurrences in a country that enjoys accelerated economic growth that stems from the
decline in fertility and mortality rates.

• A country that experiences low birth rates in conjunction with low death rates receives an economic dividend or
benefit from the increase in productivity of the working population that ensues. As fewer births are registered, the
number of young dependents grows smaller relative to the working population.
 Demographic Dividend in India
• India has one of the youngest populations in an aging world. By 2020, the median age in India will be
just 28, compared to 37 in China and the US, 45 in Western Europe, and 49 in Japan.
• Since 2018, India’s working-age population (people between 15 and 64 years of age) has grown larger
than the dependant population — children aged 14 or below as well as people above 65 years of age.
This bulge in the working-age population is going to last till 2055, or 37 years from its beginning.
• This transition happens largely because of a decrease in the total fertility rate (TFR, which is the
number of births per woman) after the increase in life expectancy gets stabilised.
• A study on demographic dividend in India by United Nations Population Fund (UNFPA) throws up two
interesting facts.
• The window of demographic dividend opportunity in India is available for five decades from 2005-
06 to 2055-56, longer than any other country in the world.
• This demographic dividend window is available at different times in different states because of
differential behaviour of the population parameters.
 Demographic Dividend in India
India enters 37-year period of demographic dividend
Read more at:
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 Demographic Dividend in India
Advantages Associated with Demographic Dividend
• Better economic growth brought about by increased economic activities due to higher working age
population and lower dependent population. It will be channelised in following ways:
✓ Increased Labour Force that enhances the productivity of the economy.
✓ Increased fiscal space by diverting resources from spending on children to investing in physical and
human infrastructure.
✓ Rise in women’s workforce that naturally accompanies a decline in fertility
✓ Increase in savings rate, as the working age also happens to be the prime period for saving.
• A massive shift towards a middle-class society, that is, the rise of aspirational class.
• Demographic dividend has historically contributed up to 15 % of the overall growth in advanced
economies.
• Rapid Industrialisation & Urbanisation
• Rise in Workforce
• Effective Policy making
 Demographic Dividend in India
Challenges Associated with Demographic Dividend
• Asymmetric demography: The growth in the working-age ratio is likely to be concentrated in some of India’s
poorest states and the demographic dividend will be fully realized only if India is able to create gainful
employment opportunities for this working-age population.
• Lack of skills: Most of the new jobs that will be created in the future will be highly skilled and lack of skill in Indian
workforce is a major challenge. India may not be able to take advantage of the opportunities, due to a low human
capital base and lack of skills.
• Low human development parameters: India ranks 130 out of 189 countries in UNDP’s Human Development Index,
which is alarming. Therefore, health and education parameters need to be improved substantially to make the
Indian workforce efficient and skilled.
• Informal nature of economy in India is another hurdle in reaping the benefits of demographic transition in India.
• Jobless growth- There is mounting concern that future growth could turn out to be jobless due to de-industrialization,
de-globalization, the fourth industrial revolution and technological progress. As per the NSSO Periodic Labour
Force Survey 2017-18, India’s labour force participation rate for the age-group 15-59 years is around 53%,
that is, around half of the working age population is jobless.
Recent News

https://www.un.org/en/desa/india-
overtake-china-world-most-populous-
country-april-2023-united-nations-
projects#:~:text=24%20April%202023%
20%2D%20China%20will,the%20popul
ation%20of%20mainland%20China.
 Population Neutralism

According to Bloom and Freeman (1986), it is a doctrine positing the absence of any significant relationship between
population growth and the rate of economic growth.

• Population neutralism was based on empirical research showing little correlation between the growth rate of income
per capita and the rate of population growth. In other words, population growth by itself has no effect on economic
performance.
• Other factors such as openness to trade, educational attainment and the quality of institutions determine whether
economic progress can keep pace with population expansion.
• Although fast-growing populations tend to experience slower economic growth, when these other factors are taken into
account, the negative impact of population expansion disappears.
 Population Ageing

• Shift in the distribution of a country's population towards older ages and is reflected by:
➢ rise in the population's mean and median ages,
➢ decline in the proportion of the population composed of children,
➢ rise in the proportion of the population composed of elderly.
• Population ageing is more popular in most highly developed countries, but now-a-days it is growing faster in less
developed regions.
• Population ageing arises due to : increasing longevity and declining fertility.
• An increase in longevity raises the average age of the population by increasing the numbers of surviving older people.
• A decline in fertility reduces the number of babies, and as the effect continues, the numbers of younger people in
general also reduce. Of the two forces, declining fertility now contributes to most of the population ageing in the
world.
• More specifically, the large decline in the overall fertility rate over the last half-century is primarily responsible for the
population ageing in the world's most developed countries. Because many developing countries are going through
faster fertility transitions, they will experience even faster population ageing than the currently-developed countries
will.
 Demographic Instability

• It is brought about by high levels of population turnover and challenges in recruiting and retaining skilled and
professional workers has been a focus of northern and remote area geography research for at least the past two
decades.
• Demographic instability is a cycle in which high population turnover leads to a sense of temporariness which
stimulates further turnover and demographic imbalances, such as an excess of working age males and a deficit of
residents post working age. These are seen as factors in discouraging women, families and seniors from moving to, or
staying in, the North.
• A lack of economic opportunities for local-born people and a pattern of migration among in-migrating early career
workers also create a volatile youth population.
 Demographic Momentum or Population Momentum

• It is the tendency for growing populations to continue growing after a fertility decline because of their young age
distribution.

• This is important because once this happens a country moves to a different stage in the demographic transition model.

• For a given population, total population momentum is the size of the hypothetical stationary population achieved by
projecting today's starting population with replacement fertility, zero net migration, and today's constant death rates,
divided by the size of the starting population today.
 Demographic Momentum or Population Momentum

• Population momentum occurs when a country's fertility rate declines to or below replacement level (2.1 children per
woman), yet the population size continues to grow due to the age structure of the population.
• It is a consequence of the demographic transition. This concept explains why a population will continue to grow even
if the fertility rate declines.
• Population momentum occurs because it is not only the number of children per woman that determine population
growth, but also the number of women in reproductive age.
• Eventually, when the fertility rate reaches the replacement rate and the population size of women in the reproductive
age bracket stabilizes, the population achieves equilibrium and population momentum comes to an end.
• Population momentum is defined as the ratio of the size of the population at that new equilibrium level to the size of
the initial population. Population momentum usually occurs in populations that are growing.
 Demographic Momentum or Population Momentum

• Nevertheless of important measures aimed at lowering reproductive rates, the population will continue to grow due to
a large proportion of its population entering its reproductive years.

• For example, when China first introduced the one-child policy, population growth continued regardless. Even though
the number of children born reduced dramatically, the sheer number of maturing youth was significant.

• In 1979 when the one-child policy entered into force, the number of people becoming adults was based on the number
of births around the 1950s, not 1979. As a result, the Chinese population maintained the same momentum of increase
as for the past 20 years.
 Young v/s Youth Population

• ‘Youth’ is often indicated as a person between the age where he/she leaves compulsory education, and the age at which
he/she finds his/ her first employment.

• Often, Youth age-group is defined differently by different countries/ agencies and by same agency in different contexts.
United Nations defines ‘youth’ as persons between 15 and 24 years of age.

• In the National Youth Policy-2003, ‘youth’ was defined a person of age between 13-35 years, but later in the National
Youth Policy 2014, the youth age-group is defined as 15-29 years.

• While there are no universally accepted definitions of adolescence and youth, the United Nations understands
adolescents to include persons aged 10-19 years and youth as those between 15- 24 years for statistical purposes
without prejudice to other definitions by Member States. Together, adolescents and youth are referred to as young
people, encompassing the ages of 10-24 years.
 Population Trap

Demographic trap is used to describe the combination of high fertility (birth rates) and declining mortality (death rates) in
developing countries, resulting in a period of high population growth rate.

High fertility combined with declining mortality happens when a developing country moves through the demographic
transition of becoming developed.

It exists during stage-2 of the demographic transition, quality of health care improves and death rates fall, but birth rates
still remain high, resulting in a period of high population growth or explosive population.

The term "demographic trap" is used by some demographers to describe a situation where stage 2 persists because "falling
living standards reinforce the prevailing high fertility, which in turn reinforces the decline in living standards."

This results in more poverty, where people rely on more children to provide them with economic security. It is regarded as
a trap, as the explosive population growth that it hampers indeed make the process of economic development impossible.
 Life Table

• Life tables have been constructed by Graunt, Reed and Merrell, Keyfitz, Greville and other demographers for
estimating population trends regarding death rates, average expectation of life, migration rates, etc. The life tables are
used to examine the mortality changes in the Social Security population over time.

• One important method of assessing the health of a population is to ask how long people can expect to live. Life
expectancy, usually reported at birth although it can be applied to other ages as well, is a commonly used summary
measure which can also be used to compare against countries. Life expectancy is calculated using life tables

• A life table is a table which shows, for a person at each age, what the probability is that they die before their next
birthday. From this starting point, a number of statistics can be derived and thus also included in the table is:

➢ the probability of surviving any particular year of age

➢ the remaining life expectancy for people at different ages

➢ the proportion of the original birth cohort still alive.

• Life tables are usually constructed separately for men and for women because of their substantially different mortality
rates.
 Life Table

Assumptions of Life Table:

1. A hypothetical cohort of life table usually comprises of 1,000 or 10,000 or 1,00,000 births.
2. The deaths are equally distributed throughout the year.
3. The cohort of people diminish gradually by death only.
4. The cohort is closed to the in-migration and out-migration.
5. The death rate is related to a pre-determined age specific death rate.
6. The cohort of persons die at a fixed age which does not change.
7. There is no change in death rates overtime.
8. The cohort of lifetables are generally constructed separately for males and females
 Method to Construct Life Table

Life tables are constructed on the basis of a single cross-sectional time data for a generation. There is also a longitudinal
life table method which takes a real cohort of persons that start life at a specific age interval and follow it throughout life
until they die. Further, a complete life table may be constructed on the basis of single years of ages. An abridged life table
can also be constructed wherein ages are grouped in 5 or 10 years of interval, taking the intial year as 0-1.
 Method to Construct Life Table

Age specific mortality rates are applied to a 1. x: Age

2. I (x): Survivorship function, i.e. the no. of person alive at the age x. It is
notional population, typically of 100,000. computed as I (x+1) = I (x) e^[-m(x)]
Starting at birth, the probability of dying in 3. d(x): No. of deaths in the interval (x, x+1) for persons alive at age x. It is
each period is applied to the number of people computed as d(x)= I(x)- I(x+1)
4. q(x): Probability of dying at age x. It is computed as q(x) = 1 -e^[-m(x)]
surviving to the beginning of the period, so
5. m(x): Mortality rate of age x. It is computed as m(x) = d(x)/L(x)
that the initial figure slowly reduces to zero.
6. L(x): total number of person-years lived by the cohort from age x to x+1. This
The different elements required for a life table is the sum of the years lived by the l(x+1) persons who survive the interval, and
the d(x) persons who die during the interval. It is computed as L(x) = l(x+1) +
include 0.5*d(x)
7. T(x): total number of person-years lived by the cohort from age x until all
members of the cohort have died. This is the sum of numbers in the L(x) column
from age x to the last row in the table. It is computed as T(x) = L(x) + L(x+1) +
L(x+2)...
8. e(x): The remaining life expectancy of persons alive at age x. It is computed as
e(x) = Tx/L(x)
Method to Construct Life Table
1. x: Age
2. I (x): Survivorship function, i.e. the no. of person alive at the age x. It is
computed as I (x+1) = I (x) e^[-m(x)]
3. d(x): No. of deaths in the interval (x, x+1) for persons alive at age x. It is
computed as d(x)= I(x)- I(x+1)
4. q(x): Probability of dying at age x. It is computed as q(x) = 1 -e^[-m(x)]
5. m(x): Mortality rate of age x. It is computed as m(x) = d(x)/L(x)
6. L(x): total number of person-years lived by the cohort from age x to x+1. This is
the sum of the years lived by the l(x+1) persons who survive the interval, and the
d(x) persons who die during the interval. It is computed as L(x) = l(x+1) + 0.5*d(x)
7. T(x): total number of person-years lived by the cohort from age x until all
members of the cohort have died. This is the sum of numbers in the L(x) column
from age x to the last row in the table. It is computed as T(x) = L(x) + L(x+1) +
L(x+2)...
8. e(x): The remaining life expectancy of persons alive at age x. It is computed as
e(x) = Tx/L(x)
 Method to Construct Life Table

There are several methods for construction of 1. x: Age

2. I (x): Survivorship function, i.e. the no. of person alive at the age x. It is
life tables. In this report, the life tables have computed as I (x+1) = I (x) e^[-m(x)]
been generated using mortality package for life 3. d(x): No. of deaths in the interval (x, x+1) for persons alive at age x. It is
table estimation (MORTPAK 4), which is a computed as d(x)= I(x)- I(x+1)
4. q(x): Probability of dying at age x. It is computed as q(x) = 1 -e^[-m(x)]
United Nation’s software package for
5. m(x): Mortality rate of age x. It is computed as m(x) = d(x)/L(x)
mortality measurements. The various columns
6. L(x): total number of person-years lived by the cohort from age x to x+1. This
given in the abridged life table are nqx, lx, nLx is the sum of the years lived by the l(x+1) persons who survive the interval, and
the d(x) persons who die during the interval. It is computed as L(x) = l(x+1) +
and ex. 0.5*d(x)
7. T(x): total number of person-years lived by the cohort from age x until all
members of the cohort have died. This is the sum of numbers in the L(x) column
from age x to the last row in the table. It is computed as T(x) = L(x) + L(x+1) +
L(x+2)...
8. e(x): The remaining life expectancy of persons alive at age x. It is computed as
e(x) = Tx/L(x)
 Method to Construct Life Table
Q-24: Which of the following items completes the life table?
A. 50.50
B. 55.00
C. 54.03
D. 51.31
1. x: Age
2. I (x): Survivorship function, i.e. the no. of person alive at the age x. It
. is computed as I (x+1) = I (x) e^[-m(x)]
3. d(x): No. of deaths in the interval (x, x+1) for persons alive at age x.
It is computed as d(x)= I(x)- I(x+1)
4. q(x): Probability of dying at age x. It is computed as q(x) = 1 -e^[-
m(x)]
5. m(x): Mortality rate of age x. It is computed as m(x) = d(x)/L(x)
6. L(x): total number of person-years lived by the cohort from age x to
x+1. This is the sum of the years lived by the l(x+1) persons who
survive the interval, and the d(x) persons who die during the interval. It
is computed as L(x) = l(x+1) + 0.5*d(x)
7. T(x): total number of person-years lived by the cohort from age x
until all members of the cohort have died. This is the sum of numbers in
the L(x) column from age x to the last row in the table. It is computed
as T(x) = L(x) + L(x+1) + L(x+2)...
8. e(x): The remaining life expectancy of persons alive at age x. It is
computed as e(x) = Tx/L(x)
 Method to Construct Life Table
Q-24: Which of the following items completes the life table?
A. 50.50
B. 55.00
C. 54.03
D. 51.31
1. x: Age
2. I (x): Survivorship function, i.e. the no. of person alive at the age x. It
Answer
.
||| C is computed as I (x+1) = I (x) e^[-m(x)]
Solution ||| 3. d(x): No. of deaths in the interval (x, x+1) for persons alive at age x.
It is computed as d(x)= I(x)- I(x+1)
exo is given by the formula: 4. q(x): Probability of dying at age x. It is computed as q(x) = 1 -e^[-
m(x)]
ex0 = Tx / Lx 5. m(x): Mortality rate of age x. It is computed as m(x) = d(x)/L(x)
6. L(x): total number of person-years lived by the cohort from age x to
= 4850000 / 89750 x+1. This is the sum of the years lived by the l(x+1) persons who
= 54.038 survive the interval, and the d(x) persons who die during the interval. It
is computed as L(x) = l(x+1) + 0.5*d(x)
Thus, Option C is correct. 7. T(x): total number of person-years lived by the cohort from age x
until all members of the cohort have died. This is the sum of numbers in
the L(x) column from age x to the last row in the table. It is computed
as T(x) = L(x) + L(x+1) + L(x+2)...
8. e(x): The remaining life expectancy of persons alive at age x. It is
computed as e(x) = Tx/L(x)
 Method to Construct Life Table
Q-25: Which of the following items completes the life table?
Age qx Ix dx Lx Tx ex
A. 72.0 B. 73.0 C. 74.0 D. 75
4 0.000194 99208 19 99199 ? ?

. 5 0.000177 99189 18 ? 7246663 73.1

1. x: Age
2. I (x): Survivorship function, i.e. the no. of person alive at the age x. It
is computed as I (x+1) = I (x) e^[-m(x)]
3. d(x): No. of deaths in the interval (x, x+1) for persons alive at age x.
It is computed as d(x)= I(x)- I(x+1)
4. q(x): Probability of dying at age x. It is computed as q(x) = 1 -e^[-
m(x)]
5. m(x): Mortality rate of age x. It is computed as m(x) = d(x)/L(x)
6. L(x): total number of person-years lived by the cohort from age x to
x+1. This is the sum of the years lived by the l(x+1) persons who
survive the interval, and the d(x) persons who die during the interval. It
is computed as L(x) = l(x+1) + 0.5*d(x)
7. T(x): total number of person-years lived by the cohort from age x
until all members of the cohort have died. This is the sum of numbers in
the L(x) column from age x to the last row in the table. It is computed
as T(x) = L(x) + L(x+1) + L(x+2)...
8. e(x): The remaining life expectancy of persons alive at age x. It is
computed as e(x) = Tx/L(x)
 Method to Construct Life Table
Q-25: Which of the following items completes the life table?
Age qx Ix dx Lx Tx ex
A. 72.0 B. 73.0 C. 74.0 D. 75
4 0.000194 99208 19 99199 ? ?

. 5 0.000177 99189 18 ? 7246663 73.1

1. x: Age
2. I (x): Survivorship function, i.e. the no. of person alive at the age x. It
is computed as I (x+1) = I (x) e^[-m(x)]
3. d(x): No. of deaths in the interval (x, x+1) for persons alive at age x.
It is computed as d(x)= I(x)- I(x+1)
4. q(x): Probability of dying at age x. It is computed as q(x) = 1 -e^[-
m(x)]
5. m(x): Mortality rate of age x. It is computed as m(x) = d(x)/L(x)
6. L(x): total number of person-years lived by the cohort from age x to
x+1. This is the sum of the years lived by the l(x+1) persons who
survive the interval, and the d(x) persons who die during the interval. It
is computed as L(x) = l(x+1) + 0.5*d(x)
7. T(x): total number of person-years lived by the cohort from age x
until all members of the cohort have died. This is the sum of numbers in
the L(x) column from age x to the last row in the table. It is computed
as T(x) = L(x) + L(x+1) + L(x+2)...
8. e(x): The remaining life expectancy of persons alive at age x. It is
computed as e(x) = Tx/L(x)
 Method to Construct Life Table

https://censusindia.gov.in/Vital_Statistics/SRS_Life_Table/SRS%2
0based%20Abridged%20Life%20Tables%202013-17.pdf
Page no. 21
 Method to Construct Life Table
Q-: In a life table, which of the following does not fit? JUNE 2014
Q-Demographic transition means: Nov 2017
a. It tells the age-specific mortality rate
a. shift from the condition of high death & low
birth rates to high death & high birth rates b. Age-specific life expectancy can be estimated
b. shift from the condition of high birth & high c. Age-specific birth rate can be derived from a life table
death rates to low borth & low death rates
c. shift from the condition of low birth rate and d. There are eight column in a life table
high death rates to high birth and high death
rates .
d. None of the above

Q-What is meant by population neutralism? Jan 2017

a. Impact of population growth on food supply is neutral
b. Due to population growth, change in age structure is almost
neutral
c. Growth rate of population is hovering around stationary
population
d. Impact of population growth on economic growth is negligible
 Projection of Population: Cohort Component Technique

The cohort component technique uses the components of demographic change to project population growth. The
technique projects the population by age groups, in addition to other demographic attributes such as sex and
ethnicity. This projection method is based on the components of demographic change including births, deaths, and
migration.

To project the total population size, and the number of males and females by 5-year age groups, find the number of
people who survive or are expected to be alive in the future. Add to the survived population number, the number of
births that take place and the number of net migrants.

Isserman (1993) offers planners an alternative way to employ this tool. Isserman's alternative method uses a different
approach to input fertility, mortality, and migration data.

Assumption
When the cohort component method is used as a projection tool, it assumes the components of demographic change,
mortality, fertility, and migration, will remain constant throughout the projection period.
 Questions

Q-1) KAR SET 2020 Q-2) KAR SET 2020

 Questions

Q-3) KAR SET 2017 P-3 Q-5) MH SET Dec 2020

Q-4) Kerala SET July 2018

 Questions

Q-6) MH SET Dec 2021

Q-7) MH SET June 2019
 Questions

Q-8) MH SET June 2019

Q-8) West Bengal SET Jan 2023