UNIT ONE

OVERVIEW OF ECONOMIC
GROWTH &
DEVELOPMENT
1.0. Introduction
• In this dichotomized world as “Developed” and “Developing” and “poor” and
“rich”, people lead their livelihood in different style.
• People in developed world live in the comfortable home with many rooms,
have more than enough to eat, well clothed and healthy
• Others (people in LDC’s), the majority of the earth’s around 6.4 Billion
people are much less fortunate. They may have little or no shelter and
adequate food supply, poor health, unable to read and write etc.
Example
A) People in Europe and North America (have nuclear family of four, an annual income of $
50,000, live in comfortable sub-urban houses with a small garden and 2 cars and life
expectancy of 78 years)
B) People in Asia, Latin America & Africa (Have extended family with 8 or more, per
capita income of $250-$300, live in poorly constructed (1 or 2 room) houses,
Few adult can read or write, only one meal a day, the houses has no electricity,
no sanitation, or safe water supply etc.
1.1. Overview of Economic Growth
1.1.1. What is Economic Growth ?
• Economic growth is the process whereby the country’s real national
and per capita income increases over a long period of time.
• Economic Growth implies a process of increase in National Income
and Per-Capita Income and not just the increase in money income or
the nominal national income.
• Economic growth refers an increase in income should be based on
Increase in Productive Capacity.
• Even though economic growth and development are sometimes used
synonymously in economic discourse
• Economic growth refers to a rise in per-capita GDP. Whereas,
economic development is more than economic growth which
includes (in addition to the rise in per capita income) implies
fundamental change in the structure of the economy
1.1.2. What is Economic development ?
• Economic development is defined as a sustained improvement in
material well being of society.
• Economic development is a wider concept than economic growth.
Apart from growth of national income, it includes changes – social,
cultural, political as well as economic to material progress.
• Economic development contains changes in resource supplies, rate of
capital formation, size and composition of population, technology,
skills and efficiency, institutional and organizational set-up.
• In short, economic development is a process consisting of a long
chain of interrelated changes in fundamental factors of supply and
structure of demand, leading to a rise in the net national product of a
country in the long run.
• Economic growth is a narrow term which involves an increase in
output in quantitative terms but economic development is changes
in qualitative terms such as social attitudes and customs with
quantitative growth of output or national income
Comparison of Economic growth and economic development
1.2. Goals of development
• According to professor Goulet (1972) development has three core
values:
A) Life sustenance;- is the ability to meet the basic needs. It is
concerned with the provision of basic human needs including food,
shelter, health, minimal education and protection sometimes it is
called “Basic need approach” to development which is indicated by
the World Bank.
B) Self-esteem;- is also called “to be a person” this is concerned with
the feeling of self-respect and independence or not being used as a
tool by others for their own need.
C) Freedom;- is freedom from servitude sometimes called “to be able
to choose”. This refers to freedom from ignorance and squalor-
poverty so that People are able to determine their own destiny. Thus,
the advantage of economic development is that it expands range of
human choice open to individual societies at large.
1.3. Measurement of Economic Growth and Development
• One reason why the concepts of growth and development are too
often confused is there is lack of proper indicators to measure them.
• Often the same measures are used for calculating both growth and
development processes. The problems are serious in the measurement
of development than quantifying economic measurement of
development than quantifying economic growth.
• By economic growth we generally mean the rate at which the national
income is growing over a period of time. This definition implies that
economic growth can be measured in terms of changes in the national
income of a country.
• The growth rate could be computed as:

Where, g = is growth rate, Yt = is national income year t and Yt-1 = is

the national income in year t-1
• Different methods of measuring development and making international
comparisons have so far been devised.
• Among these Income Measures, Physical Quality of Life Index,
Human Development Index and Human Poverty Index are the
widely employed indicators.
o Conventional Measures of Development: The dominant conventional
measures of growth and development are the Gross National Product
(GNP) or Gross Domestic Product (GDP) and their corresponding per
capital values.
A) Gross Domestic product (GDP): refers to total goods and service
produced within the economy before allowing for capital depreciation.
• GDP measures the values of all goods and services produced within a
particular country. It does not matter whether the individuals or
companies profiting from this production are national or foreign.
• GDP per capita measures the average values of all goods and services
produced within a particular country. It is calculated dividing the total
value of GDP by the population size of a given country.
 GDP per capita =
The following are the points to be remembered about GDP:
A) It measures current production only. We take newly produced final
goods and services only and any output produced last year will not
be counted. Ex;- a chair produced last year and resold this year will
not be counted as part of this year’s total output of Ethiopia.
B) It takes final goods and services only.
C) We take end products of production processes.
D) It takes final goods and services only.
E) We take end products of production processes. Since intermediate
goods are not included in the calculation because they are
completely used up in the production of another goods in the same
period.
• The final product will be counted irrespective of who owns that
output. i.e nationality of the producer is not its concern. It is owned by
foreigners but it will be counted as part of the GDP of Ethiopia
• GDP can be categorized as Nominal and real GDP;-
A) Nominal GDP;- is the monetary value of currently produced goods
and services measured at current price is not used to compare a
country’s economic performance.
GDP = Q x P current
B) Real GDP;– is measured of real production measured by removing
the effects of price change on the GDP measurement.
GDP= Q x P Constant
• Real GDP per capita (PPP$) to GDP per capita converted in to US
dollars on the basis of the purchasing power parity of a country’s
currency, which is the number of units of that currency required to
purchase the same representative basket of goods and services that a
US Dollar would buy in the united states (or a similar basket of goods
and services).
B) Gross National Product (GNP): measures the value of all goods and
services claimed by residents of a particular country regardless of where
the production took place. For example, Some of the Ethiopian labor is
used in Saudi Arabia, Beirut, US etc.
• Therefore, GDP plus the income accruing from abroad (such as
repatriation of profit) minus the income claimed by people oversea.
• GNP is an indicator of key activities – provision of goods and services
– an increase of which is a necessary condition for development.
• In short, GNP measures the total output or income generated by
domestic resident’s factors of production irrespective of where
these resources are used.
 GNP = GDP + NFI
• Net Factor Income (NFI) is factor income received by citizens from abroad
minus factor income received by foreigners from the domestic economy.
• Note that NFI can be positive, negative or zero
 When NFI > 0, then GNP > GDP
 When NFI < 0, then GNP< GDP
 When NFI=0, then GNP = GDP if the economy is a closed economy
• Basically there are three methods in measuring GDP and GNP.
1. Product Approach;– is adding the market value of goods and services
currently produced by each sector of the economy.
GDP (as per output method) = Real GDP (GDP at constant prices) – Taxes
+ Subsidies.
2. Income Approach: is adding all incomes from domestic factors of
production earn for their contribution in the current production of final
goods and services in the country
GDP = GDP at factor cost + Taxes – Subsidies
3. Expenditure Approach;– conducted by putting together all expenses
incurred by the various sectors in the purchase of raw materials,
intermediate goods, the services of factors and goods and services as
finished products.
• This approach takes in to account personal consumption
expenditures (PCE), gross domestic private investment
expenditures (GDPI), government spending on goods and services
(GS) and Net exports.
GDP = C + I + G + (X-IM)
C: Consumption expenditure,
I: Investment expenditure,
G: Government spending and
(X-IM): Exports minus imports, that is, net exports.
• National income (GNP/GDP) measures are used for the measurement
of economic development in several ways like;-
1. For a given country over two or more years, the absolute value
of national income or per capita income is compared for
different years
2. The difference between the values for various years then reflects the
growth rate over the period.
3. The level of per capita income is taken as a measure of the
average standard of living of the population, while the growth
rate measures improvements in the standard of living.
4. Income measure of development is also used to compare the
economic performance of different countries.

5. The level of national income or per capita income and their

growth rates can be compared internationally.
Limitations of conventional income (GDP & GNP) measures
1. GNP/GDP measure excludes non-market activities, transactions and
subsistence production. Ex;- Transfer Payments, Private and the public
social security and Welfare payments
2. National income accounting is subject to statistical problems like risk
of double counting of intermediate inputs, underestimation and exclusion
of unrecorded transactions, the statistical problems arising from the non-
quantifiability of important economic variables and activities.
3. It is very difficult to measure non-marketed outputs: There are
some goods and services for which either there is no price or
produced and consumed in the house without payment. E.g. public
goods like roads, education and defense, goods and home activities like
cooking, washing, child rearing etc. But difficult to count it since
the service has no market price.
4. Another difficulty arises as a result of differences in the rate of
inflation among countries such that those with high rates of inflation
can post very high levels of national income. National income
deflators can moderate this problem if appropriately applied.
5. The other problem in international comparison relates to the problem
of conversion of national incomes measured in national currencies
into the US dollar at the official exchange rate. The concern is the
underestimation of the living standard of developing countries. If
the US dollar is used as a unit of account, the national per capita
income of a given country in US dollar is given by GNP/Population
X (multiply) exchange rate.

6. It is very difficult to measure outputs produced in the informal

sector. It consists of activities of outputs that are never reported to
the tax and other government authorities which includes both legal
and illegal activities.
7. Distribution of income across households is not included in GDP.
i.e. GDP does not tell us how income is distributed equally.

8. Cost of environmental damage (externalities) is not counted in

GDP. For e.g. Environmental degradation, air pollution, polluted water,
etc, reduce the quality of life.

Alternative Development Indicators

• Attempts to construct alternative indicators like modification of
GNP/GDP based on glaring omissions, e.g. environmental impact,
health conditions, activities in the non-monetized sector, etc.

• Among the developed alternative indicators of GDP/GNP measures,

the major are the Physical Quality of Life Index (PQLI), Human
Development Index (HDI) and Human Poverty Index (HPI).
A. Physical Quality of Life Index (PQLI) = developed by Morris
(1979)
• It is a composite index of three simple indicators: Infant mortality, life
expectancy and literacy. For each indicator, the performances of
individual countries are rated on a scale of 1 to 100(1 for worst and
100 for best performance).
• Life expectancy the upper limit of 100 was assigned to 77 years
(achieved by Sweden in 1973) and the lower limit of 1 was assigned
to 28 years (the life expectancy of Guinea Bissau in 1950).
• Infant mortality, the upper limit was set at 9 per 1,000 (achieved by
Sweden in 1973) and the lower limit at 229 per 1000 (Gabon 1950).
• Literacy rates measured as percentages from 0 to 100 provide their
own direct scale. The PQLI of each country is given by the following
formula.
PQLI = Life expectancy index + infant mortality index + literacy index
3
• PQLI indirectly reflects the effects on human development of
investment in health service, water and sewage systems, quality of
food and nutrition, education, housing, and changes in income
distribution. One positive aspect of the PQLI is it helped redirecting
attention away from growth, toward a broader concept of human
development.
 However, the PQLI has been criticized as;-
1. It is an indicator of social development in relation to both choice of
indicators as well as weight assigned to the different indicators.
2. It is handicapped by the limited data availability
3. It gives disproportionate weight to longevity as two of the three
indicators, infant mortality and life expectancy.
4. It gives equal weight to each indicator arbitrarily without obvious
rationale
5. It treats economic and social indictors separately, instead of
combining them in a composite index.
B. Human Development Index (HDI)
• HDI is ranking various countries according to the relative success
they have had with the human development of their population.
• UNDP is offering the HDI as an alternative to the GNP for measuring
relative socio-economic progress of nations.
• HDI has also attempted to take account of some of the limitations of
the PQLI.
• HDI is based on three variables:-
 Longevity:- as measured by life expectancy at birth
 Educational attainment:- as measured by a condition of adult
literacy (two third weight) and a combined primary, secondary, and
tertiary school enrollment ratios (one third weight).
 Standard of living;- measured by real per capita income at PPP. The
marginal value of money income above the world average threshold
of $5120 real GDP per capita is assumed to be rapidly diminishing
• To construct the index fixed minimum and maximum values are taken
for each of the variables. For life expectancy at birth the range is 25-
85 years. For adult literacy, the range is 0 – 100 percent. For real per
capita income the range is $100 – 40,000.
• Hence, the general formula is:

• The index range from 0 to 1.

• If the actual value of the variable is equal to minimum value, the
index is Zero.
• If the actual value of the variable is equal to maximum value, then the
index is one.
Calculating life expectancy
• It measures the relative achievement of a country in life expectancy
at birth.
Life Expectancy Index = – 25
Calculating the Education Index
• It measures the country’s relative achievement in both adult
literacy and combined primary, secondary and tertiary gross
enrollment.
Education Index (EI) = 2/3 x Adult Literacy Index + 1/3 x Gross enrollment Index
First, an index for adult literacy and one combined gross enrollment
are calculated.
Then these two indices are combined to create education index with
2/3 weight given to adult literacy and 1/3 weight given to combined
gross enrollment.
• Adult Literacy Index (ALI) =
• Gross Enrollment Index (GEI) =
• Education Index(EI) = 2/3 x ALI + 1/3 x GEI
Calculating the GDP Index
• is using adjusted GDP per capita (PPP US$).
• Income is adjusted because achieving respectable level of human
development does not require ultimate income.
• Accordingly, the logarithm of income is used.
GDP Index =
• Once the dimension indices have been calculated, determining the
HDI is straight forward.
• It is the simple average of the three dimension indices;-
• Finally, once the dimension indices have been calculated, determining
the HDI is straightforward. It is a simple average of the three
dimension indices.
HDI = 1/3 (life expectancy index) + 1/3 (education index) + 1/3 (GDP
index)
The index thus ranges from 0 to 1. The HDI ranks countries into three
groups: Low human development (0.0 to 0.49), medium human
development (0.50 to 0.79) and high human development (0.80 to 1.00).
Exercise;-
Consider a country where;-
A) Adult literacy rate = 65%
B) Gross enrollment rate = 75%
C) Combined gross enrollment ratio = 60%
D) Life expectancy = 46 years
E) GDP per capita = 300 birr
Based on the above data, calculate the Human Development Index (HID)
of the country ?
• By combining social and economic data, HDI allows nations to take a
broader measure of their development performance, both relatively
and absolutely and thus to focus their social and economic policies
more directly on those areas in need of improvement.
• Nevertheless, HDI has been criticized on grounds such as:
1. It does not include non-quantitative elements of human
development such as human freedom, the existence of civil liberties
and the degree of political participation
2. It is biased in the choice of indications
3. Its assumption of the rapidly diminishing marginal value of money
income above the world average threshold of $ 5120 real GDP per
capita distorts some HDI estimates and limits its applicability.
4. Its statistical methodology may also be compromised by insufficient
or inaccurate data.
C. Human Poverty Index (HPI)
• While the HDI measures average achievement, Human Poverty Index
(HPI) is focuses on the proportion of people below a threshold level
or deprivation in basic dimensions of human development captured in
the HDI.
• Calculating the HPI is more straightforward than calculating the HDI.
• The indicators used to measure the deprivations are already
normalized between 0 and 100 (because they are expressed as
percentages), so there is no need to create dimension indices as for the
HDI.
• Human poverty index for developing countries (HPI-1) uses different
variables than the index for high-income OECD countries (HPI-2).
A) Human poverty index for developing countries (HPI-1) 
• The HPI-1 measures deprivations in the three basic dimensions of
human development captured in the HDI in developing countries.
This includes:
A) A long and healthy life;- vulnerability to death at a relatively early
age, as measured by the probability at birth of not surviving to age 40.
B) Knowledge;- exclusion from the world of reading and
communications, as measured by the adult illiteracy rate.
C) A decent standard of living;- lack of access to overall economic
provisioning, as measured by the unweighted average of two indicators,
the percentage of the population without sustainable access to an
improved water source and the percentage of children under weight for
age.
Calculating the HPI-1
Measuring deprivation in a decent standard of living
• An Unweighted average of two indicators is used to measure
deprivation in decent standard of living.
• Unweighted average = ½(population without sustainable access to
an improved water source) + ½(children under weight for age).
Example; according to WB (2008) report Cambodia had population
without sustainable access to an improved water source of 70%,
Children under weight for age of 45%.
Calculate
a) Unweighted average = ½(70) + ½(45)
Calculating the HPI- 1
• The formula for calculating the HPI – 1 is :
HPI – 1 = [1/3(P1α + P2 α + P3 α )]1/3
Where:
P1 = probability at birth of not surviving to age 40 (times 100)
P2 = Adult literacy rate
P3 = Unweighted average of population without sustainable access to an
improved water source and children under weight for age.
α= 3
Example
• A sample calculation: Cambodia
P1 = 24.0%
P2 = 30.6%
P3 = 57.5%
HPI – 1 = [1/3(24.03 + 30.63 + 57.53) 1/3 = 42.6
B) Human poverty index for selected OECD countries (HPI-2)
• HPI-2 measures deprivations in the same dimensions as the HPI-1 and
also captures social exclusion. Thus it reflects deprivations in four
dimensions:
A) A long and healthy life;- vulnerability to death at a relatively early
age, as measured by the probability at birth of not surviving to age 60.
B) Knowledge;- exclusion from the world of reading and
communications, as measured by the percentage of adults (aged 16–65)
lacking functional literacy skills.
C) A decent standard of living;- as measured by the percentage of
people living below the income poverty line (50% of the median
adjusted household disposable income).
D) Social exclusion;- as measured by the rate of long-term
unemployment (12 months or more).
Formula:
HPI – 2 = [1/4(P1 α + P2 α + P3 α + P4 α )1/3
P1 = probability at birth of not surviving to age 60 (times 100)
P2 = Adult lacking functional literacy skill
P3= Population below income poverty line (50% of household disposable
income
P4= rate of long term unemployment (lasting 12 month or above)
α =3
A sample calculated for Canada
P1 = 8.7%
P2 = 16.6.6%
P3 = 12.8%
P4 = 0.7%
HPI – 2 = [1/4(8.73 + 16.63 + 12.83 +0.73) 1/3
= 12.2
• Why α=3 in calculating the HPI -1 and HPI - 2
• The value of α has an important impact on the value of the HPI.
• If α = 1 the HPI is the average of its dimensions. As α rises, greater
weight is given to the dimension in which there is the most
deprivation.
• Thus as α increases towards infinity, the HPI will tend towards the
value of the dimension in which deprivation is greater.
1.4. Objectives of Development
• An economic development should serve four interrelated grand
objectives;
a) Livelihood Security: refers to assuring access to resources, food and
income, and basic services like adequate stocks and flows of food,
income to meet basic needs and to support well-being.
b) Capabilities: refer to what people are capable of doing and being.
• They are a means to livelihood and fulfillment, and their enlargement
through learning; practicing, training and education is the core to
better living and to well-being.
c) Equity: Suggests that the poor, the weak, the vulnerable, and the
exploited should come first.
• Equity includes human rights, intergenerational and gender equity,
and the reversals of “putting the last first and the first last”, to be
considered in all contexts.
d) Sustainability: is long-term perspectives should apply to all policies
and actions as objectives for present and future generations.
1.5. Obstacles to Economic Development
• There are factors have the mutual causative relationships that are
bottlenecks for economic development. It includes:
1) Vicious Circle of Poverty: Vicious circle of poverty implies a circular
association of forces tending to act and react up on one another in such
away as to keep a poor country in state of poverty.
A) Demand Side vicious circle:
• Low level of income leads to a low level of demand
• Low level of income leads to a low level of demand
• Low level of demand leads to a low level of investment
• Hence back to deficiency of capital and low productivity
B) Supply side vicious circle:
• Low level of real income means a low rate of saving.
• Low level of saving leads to a low rate of investment
• This in turn to deficiency of capital and low productivity
Demand Side vicious circle

Low
Productivity

Capital Low
deficiency
Income
 
 

Low Low
Investment Demand
 
 
Supply Side vicious circle

Low
Productivity

Capital
Low
deficiency
Income
   

Low
Low
Investment Saving
   
2) Low rate of Capital Formation
• Shortage of capital is the second obstacle to economic development.
• Poverty is both a cause and consequence of a country’s low rate of
capital formation.
• Most of the LDCs people are illiterates and unskilled. They use
outmoded
• capital equipment and methods of production and their marginal
productivity, also extremely low.
• According to the vicious circle of poverty, low productivity leads to
low real income, low saving, low investment and to a low rate of
capital formation.
• The consumption level is already low in that, it is difficult to restrict
further to increase the capital stock.
• The savings of the few rich do not flow into productive channels but
into durable consumer goods and conspicuous consumption.
3) Socio-Cultural obstacles
• Economic Development has much to do with human endowments,
social attitudes, political conditions and historical accidents.
• Capital is a necessary but not a sufficient condition of progress.
• Broadly speaking, LDCs possess social institutions and display such
attitudes as are not conducive to economic development.
• According to the UN Report on Processes and problems of
Industrialization in LDCs, their elements of social resistance to
economic change in LDCs which include institutional factors such as:
 Rigid stratification of occupations rein forced by traditional beliefs
and values;
 Attitudes involving inferior valuation attached to business roles,
 Backward social attitudes.
 Unfavorable political conditions and historical accidents ( class ,
religion, ethnic)
4) Repercussions of International Forces
• The issues that can cause under development may include:
 Unbalancing or disequalizing forces in the world economy as a result
of that the gains from trade have pone mainly to the DCs.
 Historical influence (e.g. Colonialism, Neo-colonialism).
 Adverse effects of foreign investment.
1.6. Basic requirement for Economic Development
• There are crucial and major requirement for economic development
and conditions that is essential to remove obstacles for achieving
economic development. These include the following ;
1. An Indigenous Base: This implies internal motivation for the growth
process must be confidently decomposed within the domestic economy
2. Removing market Imperfections: The market imperfections lead to
factor immobility and inhibit sectoral expansion and development.
Under this:
 The existing socio-economic institutions must be removed and
improved in order to replace them by better ones.
 Capital and money markets should be expanded.
 Cheap (low interest rate) and larger credit facilities should be made
available to the cultivators, small traders and business men and
 Radical changes must be brought in order to push the production
frontier beyond the production possibility curve.
3. Structural Changes
• Structural changes implies the transition from a traditional
agricultural society to modern society or industrial economy
involving a radical transformation of existing institutions, social
attitudes & motivations, structural change leads to increasing
employment opportunities, higher labor leads to increasing
employment opportunities, higher labor productivity and stock of
capital, exploitation of new resources and improvement in technology.
• Furthermore, structural changes transfer population from primary to
secondary and tertiary sectors
4. Capital formation
• Capital formation involves three interdependent stages
 An increase in the volume of savings:
 The existence of credit and financial institutions to mobilize and canalize
these savings for converting them into investable funds, and funds, and
 The use of these saving for purposes of investment in capital goods.
5. A suitable Investment criterion
• Having a suitable investment criterion is inevitable to assist a faster
economic development. It may include:
a) Social marginal productivity;- Investment should be directed towards the
most productive uses so that the ration of current output to investment is
maximized or conversely the capital output ratio (K/O) is minimized.
b) Balanced growth:- Investment should be based on the principle of
balanced growth. The doctrine of balanced growth implies an all round and
simultaneous development of sectors, of the economy.
• This is because the various sectors of an economy should grow in a
harmonious way so that no section lags behind or moves fast a head of
others.
6. Social and Economic Overheads: Investment should aim at
developing the growing points in the economy. In the beginning
particular growing points should be developed which, in turn, will set
chain reactions and influence the entire economy E.g. Infrastructures.
• Choice of Technique;- Choice of Techniques influences the amount
and pattern of investment in an underdeveloped amount and pattern of
investment in an underdeveloped (developing) economy.
• Capital Output ration(K/O):- While making a choice among
investment project and in determining priorities, k/o ratios of different
projects should be compared
• Investment should be confined to those projects that lower the k/O
ratio
7. Socio- Cultural Requirements: These requirements include changing
people’s attitudes selectively by stages through persuasion and not
coercion.
• For example, people attitudes toward work, domestic products etc. In
this regard, Education is a means of enlightenment
7. Administrative: The existence of strong competent and incorrupt
administration is crucial for economic development.
• Government must be strong one, capable of maintaining law & order
and defending the country against external aggression.
• This is due to that in the absence of stable government and peace
public policies are likely to change very frequently.
1.7. Actors in economic Development
1. Individual
• Depending on income, class, gender, ethnicity, age and other social
variables can have a great deal of choice and influence, or be left with
very little agency
2. Household
• Group of people who live together and share expenses; not always
members of the same family; can operate as a unit to ensure that all
household members have their basic needs met
3. Community
• Group of people with shared interests in some senses; usually based
on shared residential location, e.g. a village or urban district, but can
also refer to a community based on shared social identity
4. Government
• Operates at a range of scales from local and municipal government to
national government; important in setting economic framework; can
be interventionist, or can play a regulatory role in development.
 1.8. Inequality, Poverty & Development
• Many developing countries that had experienced relatively high rates of
economic growth by historical standards discovered that such growth
often brought little in the way of significant benefits to their poor.
• Because the elimination of widespread poverty and high and even
growing income inequality are at the core of all development problems
• Income and economic growth, conventionally understood—although
discussions of inequality are usually left out in conventional accounts
• The conventional measures of World Bank, measures not only growth but
the levels and changes in average age of death, infant mortality,
population per physician, secondary education, and use of electricity.
• Other conventional estimates such as the HDI measures development in
terms of life expectancy at birth, knowledge and income sufficiency.
• In this regard also the gap between rich and poor countries actually
widened over time
1.8.1. Measurement of Income inequality
Income inequality;- refers to the disproportionate distribution of total
national income among households.
• There are two principal measures of income distribution for both
analytical and quantitative purposes:
a) Personal or size distribution of income and
b) Functional or distributive factor share distribution of income.

a) Personal or size distributions of income

• It refers to the distribution of income according to size class of
persons—for example, the share of total income accruing to the
poorest specific percentage or the richest specific percentage of a
population—without regard to the sources of that income.
• This simply deals with individual persons or households and the total
incomes they receive. The way in which that income was received is
not considered
• What matters is how much each earns irrespective of whether the
income was derived solely from employment or came also from other
sources such as interest, profits, rents, gifts or inheritance.
• Moreover, the locational (urban or rural) and occupational sources of
the income (e.g. agriculture manufacturing, commerce, services) are
neglected.
• Economists therefore arrange all individuals by ascending personal
incomes and then divide the total population into distinct groups, or
sizes.
• A common method is to divide the population into successive
quintiles (fifths) or deciles (tenths) according to ascending income
levels and then determine what proportion of the total national income
is received by each income group.
• Quintile is a 20% proportion of any numerical quantity. A population
divided into quintiles would be divided into five groups of equal size.
• Decile is a 10% portion of any numerical quantity; a population
divided into deciles would be divided into ten equal numerical groups.
• Example in Table 1 consider the following hypothetical data.
• In this data, 20 individuals (households) representing the entire
population of a given developing country are arranged in order of
ascending annual personal income, ranging from the individual with
the lowest income (0.8 units) to the one with the highest (15.0 units).
Table 1; Typical size distribution of personal income in developing countries by income
share – Quintiles and deciles
• The total income of all individuals amounts to 100 units and is the
sum of all entries in column 2. In the third column, the population is
grouped into quintiles of four individuals each.
• The first quintile (4 out of 20) represents the bottom 20% of the
population on the income scale which receives only 5% (a total of 5
money units) of the total income. The second quintile receives 9% of
the total income. Alternatively, the bottom 40% of the population
(quantities 1 plus 2) is receiving only 14% of the income while the top
20% (the fifth quintile) of the population receives 51% of the total
incomes.
• A common measure of income inequality that can be derived from
column 3 is the ratio of incomes received by the bottom 40% and top
20% of the population. This ratio is often used as a measure of the
degree of inequality between the two extremes; this inequality ratio is
equal to 14 divided by 51, or approximately 0.28.
• Alternatively, income inequality that can be derived from column 3 is
the ratio of the incomes received by the top 20% and bottom 40% of
the population. This ratio has often been used as a measure of the
degree of inequality between high- and low-income groups in a
country. In our example, this inequality ratio is equal to 51 divided by
14, or approximately 3.64.

• To provide a more detailed breakdown of the size distribution of

income, decile (10%) shares are listed in column 4. We see, for
example, that the bottom 10% of the population (the two poorest
individuals) is receiving only 1.8% of the total income, while the top
10% (the two richest individuals) receives 28.5%.
• Finally, if we want to know what the top 5% receives, you would
divide the total population into 20 equal groups of individuals (i.e
each of the 20 individuals) and calculate the percentage of total
income received by the top group. i.e. The top 5% or the 20th
individual receives 15% of the total income, a higher share than the
combined shares of the lowest 40% individuals (i.e only14 %).
• Another common way to analyze personal income statistics is to
construct what is known as a Lorenz curve.
• Lorenz curve shows the actual quantitative relationship between the
percentage of income recipients and the percentage of the total
income received during a given period.
• It is a graph depicts the variance of the size distribution of income
from perfect equality.
• To construct a Lorenz curve, we plot the number of income recipients
in cumulative percentage on the horizontal axis and the share of
income received by each group (% ) on the vertical axis.
• Figure 1 shows how Lorenz curve works. For example, at point 20,
we have the lowest (poorest) 20% of the population, at point 60 we
have the bottom 60%, and at the end of the axis all 100% of the
population has been accounted for(see next slide)
• Similarly, the vertical axis shows the share of total income received
by each percentage of the population. It also is cumulative up to
100%, meaning that both axes are equally long. So, the entire figure is
enclosed in a square, and a diagonal line is drawn from the lower left
corner (the origin) of the square to the upper right corner.
Figure 1; Lorenz Curve
• At every point on that diagonal, the percentage of income received is
exactly equal to the percentage of income recipients. Fore example,
• The point the halfway along the length of the diagonal represents 50%
of the income being distributed to exactly 50% of the population.
• At the three-quarts point our diagonal, 75% of the income would be
distributed to 75% of the population. In other words, the diagonal line is
representative of “perfect equality” in distribution of income. i.e. Each
group of income recipients is receives that same percentage of the total
income. The bottom 40% of receives 40% of the income, while the top
5% receives 5% of the total income.
• In the above figure, we have plotted this Lorenz curve using the decile
data in table 1. In other words, we have divided both the horizontal and
vertical axes into 10 equal segments corresponding to each of the 10
deciles groups.
• Point A shows that the bottom 10% of the population receives only 1.8%
of the total income,
• Point B shows that the bottom 20% is receiving 5% of the total income,
and so on for each of the other eight cumulative decile groups.
• Note that at the half way point, 50% of the population is in fact
receiving only 19.8% of the total income. The more the Lorenz line
curves away from the diagonal (perfect equality), the greater the
degree of inequality represented.
• The extreme case of perfect inequality (i.e. A situation in which one
person receives all of the national income while everybody else
receives nothing) would be represented by the congruence of the
Lorenz curve nothing) would be represented by the congruence of the
Lorenz curve with the bottom horizontal and right-hand vertical axes.
• Because no country exhibits either perfect equality or perfect
inequality in its distribution of income. The Lorenz curves for
different countries will lie somewhere to the right of the diagonal
Figure 2; The greater the curvature of Lorenz line, the greater the relative degree of inequality
• The figures 2(a) compares tow representative distribution one for a
relatively equal distribution and the other for a more unequal
distribution.

• Figure 2(b) represents more unequal distribution of income. The

further the Lorenz curve is away from the main diagonal, the higher
the degree of inequality it represents. If the Lorenz curve of a
distribution lies at every point to the right of the right of the Lorenz
curve of some other distribution the former should be judged as more
unequal than the latter.

• Gin Coefficient: A very convenient shorthand summary measure of

the relative degree of income inequality in a country can be obtained
by calculating the ratio of the area between the diagonal and the
Lorenz curve divided by the total area of the half square in which the
curve lies.
Figure 2: Estimating Gini coefficient
• Gini-coefficient;– is a number that summarizes inequality among
individuals. Referring the above figure, it is the ratio of the shaded
area A to the total area of the triangle BCD.
• Gini- coefficients are aggregate inequality measures and can vary any
where from 0 (perfect equality) to 1 (perfect inequality). The higher
the value of Gini-coefficient, the higher the inequality.
• If Gini-coefficient is 0-the Lorenz curve coincides with the main
diagonal and implies perfect equality. If Gini-coefficient is 1, it shows
perfect inequality when all income is owned by one person.
• For example- If there are two countries A and B with Gini-coefficient
0.28 and 0.60, respectively, it implies that Country B is characterized
by more unequal distribution of income than A.
• For example as of WB report of 2021, Ethiopian Gin coefficient
index is .35 which is relatively low. Of the 172 ranked by WB,
Ethiopia ranked for 106th (https://
worldpopulationreview.com/country-rankings/gini-coefficient-by-cou
ntry
)
b) Functional distribution
• The second common measure of income distribution used by
economists, the functional or factor share distribution of income,
attempts to explain the share of total national income that each of the
factors of production (land, labor, and capital) receives.
• In income is distribution by function-laborers are paid wages, owners of
land receive rents, and capitalists obtain profits. It is a neat and logical
theory in that each and every factor gets paid only in accordance with
what it contributes to national output, no more and no less.
• Instead of looking at individuals as separate entities, the theory of
functional income distribution inquires into the percentage that labor
receives as a whole and compares this with the percentages of total
income distributed in the form of rent, interest, and profit (i.e., the
returns to land and financial and physical capital).
• Although specific individuals may receive income from all these
sources, that is not a matter of concern for the functional approach.
• It attempts to explain the income of a factor of production by the
contribution that this factor makes to production
• Supply and demand curves are assumed to determine the unit prices of
each productive factor.
• When these unit prices are multiplied by quantities employed on the
assumption of efficient (minimum-cost) factor utilization, we get a
measure of the total payment to each factor.
• For example, the supply of and demand for labor are assumed to
determine its market wage.
• When this wage is then multiplied by the total level of employment, we
get a measure of total wage payments, also sometimes called the total
wage bill.
• Figure 4 provides a simple diagrammatic illustration of the traditional
theory of functional income distribution. We assume that there are only
two factors of production: capital, which is a fixed (given) factor , and
labor, which is the only variable factor.
• Under competitive market assumptions, the demand for labor will be
determined by labor’s marginal product (i.e., additional workers will be
hired up to the point where the value of their marginal product equals
their real wage)
• But in accordance with the principle of diminishing marginal
products, this demand for labor will be a declining function of the
numbers employed. Such a negatively sloped labor demand curve is
shown by line DL in Figure 3.
Figure 3: Functional Income Distribution in a market Economy
Kuznets’s Inverted - U Hypothesis: inequality Vs Eco growth
• An Economist called Simon Kuznets suggested that in the early
stages of economic growth, the distribution of income will tend to
worsen, while at the better stage it will improve. His observation can
be characterized by the inverted “U” Kuznets curve.
• Kuznets curve is a graph reflecting the relationship between a
country’s income per capita and its equality of income distribution.
Figure 4: The Inverted ”U” Kuznets's Curve
• Explanations as to why inequality might worsen during the early
stages of economic growth before eventually improving are
numerous. They almost always relate to the nature of structural
change.
• Kuznets curve could be generated by a steady process of modern-
sector enlargement growth as a country develops from a traditional to
a modern economy.
• Alternatively, returns to education may first rise as the emerging
modern sector demands skills and then fall as the supply of educated
workers increases and the supply of unskilled workers falls.
• The Kuznets inverted-U hypothesis could in principle be consistent
with a sequential process of economic development.
• Few development economists would argue that the Kuznets sequence
of increasing and then declining inequality is inevitable.
• But inequality can be gradually reduced through well-implemented
policies to promote pro-poor growth over time.
1.8.2. Poverty and economic growth
What is poverty ??GAD PPT\Economic developement
note\Faces of poverty.pptx
• Poverty is a clear indicator of underdevelopment & most people might
say reduction of poverty is fundamental way of economic development.
• We do have a number of approaches to assess the well being of
individuals.
• According to WB, poverty has many dimensions such as lack of
opportunity, low capability, vulnerability and empowerment
 The first dimension is material deprivation (lack of opportunity),
which is measured by an appropriate concept of income or
consumption.
 The second dimension is low achievement in education, health, etc
 The third dimension of poverty is Vulnerability (exposure to risk or
low level of security)
 The fourth dimension of poverty is Voicelessness.
Facts about poverty
About 46 percent of the world’s population lives on less than $2 per
day according to 2020 WB estimate.
Roughly one in seven people—just under a billion—subsist (manage to
survive) on less than $2 per day.
GDP of the poorest 48 nations (i.e. a quarter of the world’s countries)
is less than the wealth of the world’s three richest people combined
Nearly a billion people entered the 21st century unable to read a book
or sign their names
According to UNICEF, 30,000 children die each day due to poverty.
4.4 Billion People live in developing Countries.
Of these ;-
Three-fifths lack basic sanitation
Almost one third have no access to clean water
A quarter do not have adequate housing
A fifth have no access to modern health services
• On average American enjoys an income 20 times greater than the
average sub- Saharan African.
• In many countries, poverty has disappeared only from view,
concentrated in disadvantaged regions or neighborhoods or households
• The number of people in developing countries who live in absolute
poverty(less than $1 a day) dropped from 40 percent of the
population in 1981 to 18 percent in 2004 (Ferreira and Ravallion
2008).

• The largest reductions have been in China and India, countries with
high growth rates; the smallest in the countries of Sub- Saharan
Africa.

• But inequality has been on the rise world wide. Clearly, the benefits of
development have not yet reached the neediest.
Etymology
• Poverty-Latin word – “Pauper” = poor via Anglo- Norman povert.
What is Poverty?
⇒ Poverty is hunger.
⇒ Poverty is lack of shelter.
⇒ Poverty is being sick and not being able to see a doctor.
⇒ Poverty is not having access to school and not knowing how to
read.
⇒ Poverty is not having a job, is fear for the future, living one day at
a time.
⇒ Poverty is losing a child to illness brought about by unclean water.
⇒ Poverty is powerlessness, lack of representation and freedom.
Types of poverty
A) Absolute Poverty;- is based on a measurement of the absolute
minimum a person requires for biological survival like food, Water,
shelter & Clothing.
B) Relative poverty;- is when people are compared to those around
them, reasonably be expected to afford. It include lack of educational
opportunity, material possessions, health care, good quality housing,
civil rights and social opportunity
C) Subjective Poverty;- is based on the notion of “felt poverty”. People
feel poor if those around them have more than they do. The people
against whom one measures oneself are known as “reference group”.
• Amartya Sen, has described four dimensions of poverty that
interfere with functioning in society:
1. Lack of opportunity
2. Capability,
3. Security, and
4. Empowerment
Approaches to Measure Poverty
a) Income poverty: is a measure of poverty using income or
consumption as a measure of income.
• Absolute poverty;- can be defined by the number of people living
below a specified minimum level of income, an imaginary
international poverty line.
• Poverty line;- is the cost of bundles of goods deemed sufficient for a
basic need i.e. able to buy sufficient food and essential non-food items
• Headcount index: The proportion of a country’s population living
below the poverty line (Headcount index = H/N), where; H, those
whose incomes fall below the absolute poverty line, and, N; total
population.
• A person is considered as an absolute poor if he earns less than the
poverty line. i.e. the widely accepted international poverty line is 1
dollar a day , of a person earns less than 1 dollar per day, he is
considered as an absolute poor
• So, by taking the proportion of people whose income is below the
poverty line, we can say how much of the total population line under
absolute poverty.
• For example, if the poverty line in U.S. is $360 per year. It makes a
big difference whether most of the absolute poor earn $ 350 or $200
per year. In both cases, they are below the poverty line. But, $350 is
much closer to the line than $200. So, this can be captured by the
concept of poverty gap.
• Poverty gap;- measures the total amount of income necessary to raise
everyone who is below the poverty line up to that line or measures
how far an individual is below the poverty line.
• Total poverty gap (TPG): The sum of the difference between the
poverty line and actual income levels of all people living below that
line. It is the extent to which the incomes of the poor lie below the
poverty line—is found by adding up the amounts by which each poor
person’s income, Yi, falls below the absolute poverty line as follows;-
• Figure 5 below illustrates how we could measure the total poverty gap
as the shaded area between poverty line, PV, and the annual income
profile of t
Figure 5; Measuring Total Poverty Gap
b) Low capability:
• Low capability is low achievement in education and health. Income is
not the only component of poverty.
• Different scholars use education and health as an indicator of poverty
• Education is an input in to the material well being: it helps people to
earn more income.
• It also allows individuals to participate in decision-making that
determines the well-being of the society .
• Hence, literacy enrolment ratios are taken as indicator of well- being.
Net enrollment ratio
Net Primary enrollment Ratio (NPER) =

• So, countries with a higher enrollment ratio are considered to be in a

better position than countries with lower enrollment ratio even if they
have a greater level of per capita income
• Health status of a household can be taken as an indicator of well-being.
The health status of individual can be assessed by infant mortality,
under five mortality rate and life expectancy. Or the nutritional status of
the society can be considered.
• In a country where there is a high infant mortality rate, lower life
expectancy or poor nutrition and higher disease prevalence, it may be
concluded that the extent of poverty is higher.
c) Vulnerability
• Vulnerability is the probability of an individual being exposed to
various shocks (heath or income) that makes him/her to be poor.
• At micro level, the most important Vulnerability (risk) that affect the
poor are the risk of illness, death, injury, disability, harvest failure and
unemployment.
• At macro level, flood, drought, inflation, balance of payment deficient
could be some of the risks. Vulnerability can reduce the livelihood of a
household’s capacity to get out of poverty. While the micro level risks
can be of set by actions at household level, the macro level risks require
public actions.
d) Voicelessness
• Voicelessness is the lack of voice, power independence, humiliation,
exploitation by institutions of the state and society.
• Absence of rule of law, lack of protection against violence, lack of
civility and unpredictability of public officials are some of the
indicators of voicelessness.
• Voicelessness in general means being prevented from involvement in
decision making that affects society’s life .
• The solution for voicelessness is empowering people. Empowerment
is an active process which occurs at different levels.
• At community (regional & national levels), empowerment means
equality in access to resources, and social interactions that affects
gender inequality empowerment also includes representativeness in
decision making bodies at local, regional and national levels of
governments.
Thank you for your attention !!!