Basic (Micro and Macro)

Economic Concepts &

Theories
At
National Management College,
Lahore
By

Prof. Dr. Qais Aslam

Micro Economic Concepts & application

Concept of Consumers & Producers
Supply & Demand & its application
Macro Economic Concepts
Concept of Aggregate Demand &
Supply
GNP, GDP & its application in
Economic Governance

Micro vs. Macro Economics

Microeconomics is the study of
how households and firms make
decisions and how they interact
in specific markets
Macroeconomics is the study of
the economy as a whole or of
Aggregates
therefore
macroeconomics is a economywide
phenomena
with
Government
Interventions
&

1. Micro Economic Concepts

Wealth
Goods and services produced = Wealth
Characteristics of Wealth:
1. Scarcity:
The Diamond Water Paradox
2. Mobility:
a)
Territorial mobility
b)
Legal mobility
c) Economic mobility
and
1. Utility: Power of a thing to satisfy a human
need

Rationality
It is assumed that Buyers are rational
when they make decisions and that
their preferences of more to less at a
give price is the best judge of how
much benefits the consumers are
going to receive from the goods that
they buy in the market at a price

Rational people Think at the Marginal

Economists assume that ordinary people think
rationally in ordinary business life consumers
would demand (d) more for less money and
suppliers would supply (s) less for more money
Economists take into consideration the small
incremental changes (adjustments) for every action
and call them marginal changes
(x/ y)
Economists assume that rational people think on
the margin

Equi-marginal Principle = The rate of

change of opposing forces in
economics is equal
7

Marginal
Rational people think on the marginal = incremental

marginal
marginal
marginal
marginal

utility,
revenue,
cost,
product

People Respond to
Incentives
Because people make decisions

by
comparing costs (c) and benefits, their
behavior may change when costs or
benefits change, therefore incentives
help change behavior of people
Incentives are rewards or punishments
that induce people to change behaviors
Change in costs or benefits through
increase or decrease in Price would
change demand or supply of different
goods and services
9

Demand and Supply

Hidden hand of the force of

Demand and supply make

market economies work
and
determine
the
quantity of goods and
services produced and
the prices at which they are

Demand
Act of Buying in the market
Quantity demanded is the amount of
goods and services that buyers are
willing to buy and able to purchase
with their money (resources) and
includes:
1. need of purchaser
2. Buying power of the purchaser
3. Willingness to purchase

Negatively sloped Demand

curve
Price

Quantity demanded

Shift of the demand curve

Shift of the demand curve is due to a change in other things
Movement on the demand curve is due to change in Price

Price (P)

qd
1

qd
2

qd3

Reasons for negative relationship

between Price and Demand

1.Price Effect
2.Income Effect (Buying Power)
3.Substitution Effect (Prices of other
Commodities)
. Market Demand Curve shows the
total quantity demanded of
various goods varies as the price
of the good varies

Supply
Act of Selling
Quantity supplied is the amount of goods that
sellers (and producers) are willing and able to
sell at a Price
Determinants of Supply:
1. Price
2. Input prices
3. Technology levels
4. Expectations
5. Transport costs
6. Storage capicity

Law of supply
Other things remaining the same (ceteris
paribus or assumed to be constant)
When price of a commodity increases,
its quantity supplied (qs) also expands
and when Price of a commodity
decreases its quantity supplied (qs)
also contracts
Or
There is a Positive relationship between
Price and quantity supplied

Reason for positive relationship

between price and Supply

When Price increase Profits tend

to increase therefore suppliers
increase supply because they get
incentive to sell and when Prices
decrease Profit margins tend to
decline therefore the incentive to
sell diminishes and suppliers tend
to decrease supply

 The quantity supplied in the market

depends upon those factors that
determine quantity supplied by
individual sellers
1. prices of goods
2. Prices of inputs used
3. Availability of technology
4. Expectations
5. Transport costs
6. Storage facilities
Profit is the only motive to supply
goods and services in the market

Elasticity of demand and

supply
Elasticity measures the responsiveness of
quantity demanded and quantity supplied
to a unit change in Price
Price elasticity of demand measures how
much quantity demanded will respond to
a unit change in Price Ed = qd/P x P/q
Price elasticity of supply measures how
much quantity supplied will respond to a
unit change in Price Es = qs/P x P/q

Measurement of Elasticity
Uni-elastic or Price elasticity = 1: with a
percentage change in Price the reciprocal percentage
change in quantity is equal to the change in Price
Elastic or Price elasticity > 1: with a percentage
change in Price the reciprocal percentage change in
quantity is more than the change in Price
Inelastic or Price elasticity < 1: with a percentage
change in Price the reciprocal percentage change in
quantity is less than the change in Price
Zero Elasticity or Price elasticity = 0: with a
percentage change in Price there is no change in
quantity
Infinite elasticity or Price elasticity = : with no
change in Price there is a large change in quantity

Income and Cross elasticity of

demand
Income elasticity of demand
measures how much quantity
demanded responds to a unit change
in income of a consumer.
Ed = qd/Y x Y/q
Cross Elasticity of demand measures
how much quantity demanded of
good x responds to a percentage
change in the price of good y
Ed = qdx/Py x Py/qx

Applications of
supply, demand and elasticity
Elasticity of supply can be very high at low levels of
quantity supplied and very low at high levels of quantity
supplied and determines whether supply curve is steep
or flat.
in the short run
The demand for basic foodstuffs is usually inelastic
because they are basic goods and have few substitutes
(Demand for wheat is inelastic)
The demand for petrol is inelastic because buying habits
do not respond to immediate change in Prices of petrol
Demand for drugs is inelastic therefore drug ban usually
increases prices and also drug related crime

Normal, Inferior, Complementary,

Substitute and Giffin goods
Normal goods are goods for which, other things
being equal, an increase in income leads to an
increase in quantity demanded
Inferior goods are goods for which, other things
being equal, an increase in income leads to a
decrease in quantity demanded
complementary goods are two goods for which a
decrease in prices of one good leads to an increase
in demand for the other good and vice versa
Substitutes are two goods for which a decrease in
the prices of one good leads to decrease in in the
demand for the other good and vice versa
Giffin goods: are goods whos demand does not
change with increase in prices for very poor

Market Equilibrium and

Price
Market equilibrium is a point at which
the supply and demand curves
intersect.
The prices of the two curves cross
and therefore this is the Market
equilibrium Price for a good or
service.
Market price is only and only
determined by the equilibrium
(intersection) of the forces of market

Market Prices
Market Prices reflect both the value of a good
to the society as well as the cost to the
society of producing that good.
Bothe house holds and firms look at prices
when deciding to buy and sell
They unknowingly take into account the social
benefits and social costs of their actions , and
therefore by trying to maximize their own
welfare, they maximize the welfare of the
society
25

Market Price and equilibrium

Price (P)

Quantity Demanded (qd) and quantity

Supplied (qs)

Price increases when demand increases and

price decreases when demand decreases,
with supply remaining constant

Price (P)
P
3
P
2
P
1

D
1
Quantity Demanded (qd) and quantity
Supplied (qs)

D
2

D
3

Price increases when supply decreases and

price decreases when supply increases
decreases, with demand remaining constant

Price (P)
P
3
P
2
P
1

D
1
Quantity Demanded (qd) and quantity
Supplied (qs)

D
2

D
3

 Market equilibrium is the sum of

consumer surplus and producers
surplus as shown by the demand and
supply curves.
Market equilibrium also shows the
economic efficiency or efficiently
allocation of resources among
producers and buyers through the
price mechanism

Consumer surplus
Consumer surplus = a buyers willingness to pay
minus the amount the buyer actually pays
Consumer surplus measures the benefit to
buyers of participating in a market
When the price falls the quantity demanded rises
and the consumer surplus rises. The increase in
surplus rises, because the existing consumer now
pays less and in part because new consumer
enter the market at a lower price and vive versa
In most markets consumer surplus reflects
economic wellbeing

Producer Surplus
Producers surplus is the amount a seller is
paid for a good minus the sellers costs
When price rises, the quantity supplied
increases, the producers surplus rises. The
increase in producers surplus occurs in part
because the existing producers now receive
more and in parts because new producers
enter the market at a higher price levels
In most markets producer surplus also
reflects economic wellbeing

Increase and decrease in market

Prices
Price increases when demand is more than
supply or supply is less than demand
because buyers bid more to attain what ever
commodities are in the market and push
the price up
Price decreases when demand is less than
supply or supply is more than demand
Because the sellers try to sell off more of
their stock by lowering their supply prices
thus pushing the market price down

How Prices allocate

Resources

Market Forces harness the forces

of supply and demand to
efficiently allocate resources and
determination of Prices of goods
and services as well as Prices in
turn signal and guide the
allocation of resources efficiently
towards
production
of
commodities that are demanded
more away from commodities

Markets are usually efficient

Market economy is a system through which resources are
allocated and decisions are decentralized through many firms and
households as they interact in the market for goods and services
and factors of production (resources)
Markets work through the invisible hand of self-interest
Increase in Demand induces Price to rise while supply increase
when prices are high.
For increase in supply , production has to increase,
Increase in production in turn needs higher demand of factors of
production,
thus increasing the price of factors in the market and
forcing the movement of these factors (resources from less paid
jobs to higher paid jobs) and efficiently re-allocating resources
through the Price system of the market,
and increasing the incomes of the factors in the long run,
which in turn also influences an increase in consumptions and
saving patterns in the economy
Thus increasing the efficiency of the economy through the market
34
(Price) system

Efficiency vs. Equity

Efficiency refers to the size of the economy
that distributes scarce resources through
the Market system of demand and supply
called Price (P) Mechanism and allocates
them from areas where these resources
are less demanded to areas where they are
demanded more therefore Priced higher
Equity refers to the distribution of
economic prosperity fairly (judiciously)
among all the members of the society
through some form of Public (govt.)
intervention
35

Governments can sometimes improve

Market outcome or to ensure Equity
There are two reasons why governments
intervene in the economy
Governments intervene to improve market
efficiency :
Or

Governments intervene to promote equity

Or
Governments intervene when Markets fail
Market failure when the market fails to
allocate resources efficiently and does not
promote welfare or wellbeing of the stake holders
36

Price floor and Price ceiling

Price floor: is a legal
minimum on the price at
which goods can be sold
Price ceiling: is a legal
maximum at which goods
can be sold

How Pricing ceiling Effects Market outcomes

With a Price ceiling on a comparative market, a shortage of
the goods arises and sellers must ration the scarce goods
among the large number of potential buyers
Rationing mechanism is undesirable, because
1. Long lines of buyers waste buyers time
2. Discrimination according to sellers bias is both inefficient
and potentially unfair
3. Reduces the incentive in producers to produce and supply
4. Although government prevents prices to rise for equity
reasons and protecting the poor, but it creates shortages
and pricing policies do not create incentives to ship
supplies from other regions into the area where there is a
deficit
. Rationing mechanism in a free competitive market (without
government intervention) is both efficient and impersonal

How Pricing Floor Effects Market outcomes

Binding price floor comes as a surplus
With price floor some sellers are unable to sell and
go out of business
Sellers who appeal to personal bias of the buyers
are better able to sell
Price floor is a minimum wage and the impact of
minimum wage depends upon the skill of the
worker
Higher skilled worker are not effected by minimum
wage, but low skilled workers, women and teen
agers usually accept wages below minimum wage
in exchange for a job some economists think that
minimum wage is a poorly targeted policy

 Price control are often aimed to

help the poor
But price controls often hurt the
poor
Economists suggest rent and
wage subsidies rather than price
controls in order to help the poor
But
subsidies
increase
government
expenditures,
therefore require higher taxes

Welfare
Communitys Welfare =
Consumer surplus (increase in demand)

+
Producer surplus (increase in supply)

Governments revenue (increase in

Public revenue through income tax on
enhanced
incomes
and
GST
or
enhanced consumption as tax)
41

Externality
Externality is the effect of one persons
actions on the wellbeing of a bystander
1. Exhaust from a car is negative externality
2. Restored historic building is a positive
externality
3. Generator creates a negative externality
4. Research into new technologies create
positive externalities
5. Throwing untreated waste in rivers creates
negative externalities
6. Parks and recreational facilities creates
positive externality

A Countrys standard of Living Depends on its

ability to Produce more goods and Services
Difference of living standards around the world are
staggering and
Changes in living standards over time is also large
This is attributed to Productivity
Productivity - is the quantity of goods and services
(wealth) that can be produced (output) from each
hour of work time with different set of capital and
labor inputs (resources)
Growth rate of a countrys national productivity
determines the countrys national employment levels
(GDP) and the countrys national income levels (GDP)

43

 Productivity is the primary determinant of the

living standard of each individual and household,
and thus of the society.
Productivity comes from skill enhancement of the
individual and the capacity of the individual to
work with modern machines and technology
This capacity (skill enhancement or productivity)
is enhanced by improving the standard of
scientific and vocational education at all levels
primary to professional
To enhance standard of living, Policy makers need
to raise productivity by ensuring that workers are
well educated and have the tools (technology)
needed to produce more, better and cheaper
goods and services
44

Production Function
Production function is the relationship
between quantity of inputs used to make
a good and the quantity of output of that
good
Marginal product I the increase in output
that arises from an additional unit of input
Diminishing marginal product is the
property whereby the marginal product of
an input declines as the quantity of the
input increases

total product, marginal product and

average product
total product,
marginal product and
average product
MP = AP
Marginal product = Average
product

Cost of production

Price of factors of production is the private

Cost of Production (inputs)
1. Price of Land
= Rent
2. Price of Labor = Wages
3. Price of Capital
=Interest
4. Price of Entrepreneur (Organization) = Nominal Profits
Private Costs + Environmental Costs = Social Costs
Private Benefits + Environmental benefits = Social
Benefits

MSC = MSB
Marginal social Costs = marginal Social Benefits
47

Fixed and variable cost

Fixed Costs do no vary with the
quantity of output produced and
are usually incurred before the
production process
Variable costs vary with the
quantity of output produced and
usually are incurred with the
production process

Total costs
(TC)

Variable costs
(VC)

Fixed Costs
(FC)

 Total Costs
TC = TFC + TVC
Average Costs:
AC = TC/Q = TFC/Q + TVC /Q = AFC +
AVC
Marginal Costs: the increase in costs
that arises from an extra unit of
output produced
MC = TC / Q

Average costs
(AVC)

Average Variable
costs (AVC)

Average Fixed
costs (AFC)

Least Cost Position

MC = AC
Marginal Costs = Average
M
CostsC
AC

Q of input

Economies and Diseconomies of

scale
Efficient scale: the quantity of output that
minimizes average costs
Economies of scale is whereby the long-run
average total costs fall as the quantity of output
increases
Diseconomies of scale is whereby long-run
average total costs rises as the quantity of
output increases
Constant returns to scale is whereby the longrun average total costs stay the same as the
quantity of output changes

Economic and Accounting

Profit
Economists includes all opportunity
costs when analysing a firm
accountants measure only explicit costs
therefore economic profits are smaller
than the accountants profits
Implicit costs: external costs and
opportunity costs
explicit cost: costs of production
incurred by the producer

Revenue and Profits

A firms revenue is the amount of money
received after selling a unit of output in
the market
Firm exists in the market only for profit
motive
Revenue Costs = Profits
Or
MR = MC
Where the MC curve intersects MR from
below

Average and marginal Revenue

Average revenue (AR) = total
revenue divided by quantity
sold (TR/Q)
Marginal Revenue (MC) the
change in total revenue from an
additional unit of output sold
MR = TR/Q

Market Structure

Perfect competition.
Monopoly.
Monopolistic Competition.
Oligopoly

Perfect competition
A Market where many buyers
and sellers (small firms)
trade identical products , with
perfect
information
and
perfect mobility of factors of
production and that each
buyer and seller is a price
taker determined by the
equilibrium
of
forces
of

AC1 Loss (AC >

MR)
E

M
C

AC2 normal profit AC

=MR)

AR =
MR

AC3 super
normal Profit
(AC < MR)

Monopoly
Is a market situation where the sole seller of a
product and has no close substitutes
Monopsony is where there is a sole buyer in the
market
Natural monopoly arises because a singl firm can
supply goods or services to an entire market at a
smaller cost than two or more firms this happens
when a firms average-total-costs curve declines
over a longer period of time.
Government created monopolies arise because
government have given one firm the excusive rights
to sell some goods or services

Welfare cost of monopolies

A firm charges monopoly price which is over and above
the marginal costs and monopoly profits arise.
At monopoly price not all consumers who value the
goods at more than its costs buy it and this reduces the
consumer surplus.
The quantity produced and sold by the monopolist is
below the socially efficient levels
The deadweight loss reflects the costs of monopoly
production
Monopolies are large firms and therefore usually are
inefficient, because they are making profits due to lack of
competition and therefore do not work at their efficient
cost levels

Monopolistic Competition &

Oligopoly
Monopolistic Competition is a market structure
in which many firms sell products that are
similar but not identical
Oligopoly is a market structure in which only a
few sellers offer similar products or identical
products
Collusion is an arrangement among firms in a
market about quantities to produce or prices to
charge
Cartel is a group of firms acting in unison on
supply or price

Profits under Imperfect market

conditions
AC
MC
Demand
and
revenue
Profits

Cos
ts

AR
(D)
MR

Product differentiation and Price

discrimination
Product differentiation: Firms change the shape,
color, fragrance, brand name, shape, wrapping
of the product to charge different prices at
different markets
Price Discrimination: Firms charge different
prices for the same product in different markets
Advertisement: Advertisement and marketing
are tools of monopolistic firms to attract buyers
towards their products. Advertisements increase
revenues but increase costs also
Kinked demand curve:

Ten Principles of Economics

1.
2.
3.
4.
5.
6.
7.

People Face Tradeoffs

There are Opportunity Costs to every Decision
Rational People think on the Margin
People Respond to Incentives
Trade Increases Welfare of all
Markets are efficient
Governments
can increase efficiency of the
market
8. Production of Goods and services increases
Incomes and wealth
9. Increase in incomes increases inflation and prices
10.Short-term tradeoffs have to be made between
inflation and employment
65

2. Macro Economic Concepts

Circular Flow of income in a Two Sector

Economy
EmploymentFactors
of
of
production
Production of Goods and
Services (GDP)

House
Hold

Firms
Expenditure on Goods &
Services

Income
(Y)

67

GNP
(National Employment, Income, or
expenditure levels)
GNP is
1. The Sum Total of All the factors of Production
employed in a country in a year
2. The Sum Total of All the Incomes of Factors
of Production in a country in a year
3. The Sum Total of All the expenditures of the
house holds on their final purchase of goods
and services in a country in a year
. GDP = GNP Foreign Payments
. NNP = GNP Depression allowance
68

GDP, NNP, Yd
GDP = GNP Foreign Payments
NNP = +GNP Depreciation
Allowance
Y = national Income
Yd = Personal disposable
Income
or Y- taxes
69

Circular Flow of National Income

FACTORS OF PRODUCTION

(Y)
INCOME

FIRMS

HOUSE HOLDS
(C )
CONSUMPTION OF
GOODS & SERVICES

(S)
SAVINGS

(T)
TAXES

(I)

BANKS

INVESTMENTS
(G)

GOVERNMENT

GOVT. EXPENDITURE
70

Equilibrium of national
Income
Aggregate Supply = Aggregate Demand

C+S+T=Y=C+I
+G
S+T=I+G

Where
C = Consumption on goods & Services
S = Savings;
T = Taxes;
I = Investments
G = Government expenditure

71

E = Y =C + I + G T + Xn

E = Employment
Y = National Income (GNP)
C = Consumption
I = Investments
G = Government expenditures
T = Taxes
Xn = net exports (Exports imports)
Or

E = Y =(1/ 1 - c/Y )(a + I + G T

+ Xn)
72

Y=C+S
YC=S
C = a - bYd
a = autonomous consumption (a Y)
b = mpc (c/Y) = marginal propensity to
consume
Mps = 1- mpc or (1 - c/Y = s/Y) = marginal
propensity to save
Yd = Y-taxes
K = Investment multiplier or 1/ 1 - c/Y
Investment multiplier or 1/ 1 - c/Y
G = Government spending at 1/ 1 - c/Y
T = taxes at -mpc / 1 - mpc
73

Change in Y (National
Income)
Y = (1/1-mpc) (a + I + G + Xn bT)
Where

= Change
a = autonomous consumption or 1>a>0
mpc or (b) = marginal propensity to consume (c/ Y)
I = autonomous Investment ( I Y)
G = autonomous Government Spending ( G Y)
T = autonomous Taxes ( T Y)
Xn = Exports Imports (foreign earnings) also not a
function of domestic income
1/1-mpc = mps or marginal propensity to save (s/ Y)
Plus = increase in national income (Y)
Minus = decrease in national income (Y)
74

Income-Consumption & Income

Savings Relationship
Income (Yd) = Consumption (c ) + Savings (s)

Or

Yd = c + s

When Yd = Y - taxes
Households spend most of their income on
consumption and save after a certain level of
income
Note: 45 degree line = line of equality
dissecting 90 degrees into two equal parts.
Each point on the 45 line represents c = Yd

Consumption schedule
Consumption schedule or Consumption
function reflects the direct consumption
(disposable) income relationship of
households in the country.
In the aggregate, households increase
their spending as disposable income
increases and spend larger portion of a
smaller disposable income than a larger
part of a larger disposable income

Saving Schedule
Saving Schedule or saving function is
derived when we subtract consumption
levels from Personal disposable incomes at
each level of disposable income (s = Yd
c)
Dis-saving will occur when consumption is
more than Yd (c > yd)
Saving occurs when consumption is less
than Yd (c < Yd)
Break even is when c = Yd

Yd

Consumption-Saving graph
Yx

Yd=
c

a
Di

g
in
v
a
s-s

c
s(

>

)
Yd

0
Yx = c = no
savings

-a

>

c=

gs
n
i
v
sa

Average & Marginal

propensities
APC = average propensity to consume =
c/Yd
APS = average propensity to Save = s/Yd
MPC = marginal propensity to Consume =
change in consumption/ change in income
MPS = marginal propensity to save = change
in savings / change in income

MPC + MPS = 1

MPC = c/ yd
MPS = s/ yd or 1 mpc or 1 - c/ yd

Unemployment

Is the ratio of the

number of people
unemployed to the total
number of people in the
labor force
80

Different kinds of
Unemployment
Natural Unemployment
(a) Frictional Unemployment
(b) structural
Cyclic Unemployment
Hidden (Disguised) Unemployment
Depressed Unemployed

81

Natural Unemployment
Natural Unemployment exists at full
employment and includes: (total of 8%
permissible)
(a) Frictional Unemployment the portion of
unemployed who leave one job to look for
another both horizontally and vertically (4%)
(b) structural Unemployment are
unemployed due to changes in the structure
of the economy and introduction of new
technologies (4%)
82

Other forms of
Unemployment
Cyclic Unemployment due to the
recession and depression in the
economy
Hidden
(Disguised)
Unemployment where the MP of
labor employed is zero or near
zero
Depressed Unemployed who
have stopped looking for work
83

Inflation
Inflation is too much money chasing
too few goods in the economy
Or
The percentage change in Price
levels is Inflation rate
Philips Curve is A graph that shows
the relationship between inflation
rate and unemployment rate
84

Causes of Inflation
Printing of notes increases money supply
more than money demand and therefore
raise over all prices of goods and services
and resources in the economy ,which is

Inflation
Inflation reduces consumer surplus
Inflation increase costs of production
therefore reduces producers surplus
Therefore inflation decreases growth and
societys welfare
85

Bank borrowing
Bank
borrowing
by
the
Government increases the
cost of loans (interest rates)
for
businessmen
in
the
money market and decreases
the money supply in the
economy, thus reducing the
much needed by private
86

Taxes
Taxes increases prices and brings
down the aggregate demand
curve
thus
reducing
the
employment, income and growth
(GDP) levels,
Therefore
taxes
should
be
reduced and tax net widened for
more revenue to the Government
87

Cconsumer Price Index (CPI)

CPI is a price index computed

each month using a bundle that is
meant to represent the market
basket purchases monthly by the
typical urban consumer
The quantities of each good in the
bundle that are used for the
weightages are based upon
extensive surveys of consumers
88

GDP Deflator
GDP deflator is a price measure, measuring how
overall price level changes along with changes in
real output (GDP)
Firstly, fixed wastage procedure and 1 year as base
year is used to calculate the changes in prices in
subsequent years
Secondly, the deflator uses 1 and 2 as the base year
when computing the percentage change between
year 2 and 3 and so on
The series of changes computed in this way is taken
to be the series of percentage changes in the GDP
deflator: inflation rate of the overall price
levels
89

Difference between GDP

deflator and CPI

CPI covers only consumer

goods and services
GDP deflator covers all
goods
and
services
produced in the economy
90

Types of Inflation
Demand Pull inflation that is instigated by an
increase in aggregate demand
Cost-push Inflation (supply side inflation) which is
caused by an increase in costs of production
Stagflation Occurs when output is falling increasing
unemployment, and at the same time overall price
levels are rising
Sustained Inflation occurs when the overall price
levels continue to rise over some fairly long period of
time
Hyperinflation a 100% or more increase in prices a
year (very very bad)
91

Trade can make every one better off

Free Trade gives greater access to markets, brings in competition,
reduces costs, help increase quality of products and gives greater
choices to people
Exports help increase domestic production of comparatively
cheaper products, increases employment of efficient resources,
increases incomes, enhances domestic consumption, brings down
costs of production and equi9lizes international prices, thus help
the equilibrium in balance of payments and stabilizing the
exchange rate between nations
Imports helps put on domestic markets much needed goods,
services, raw materials and machines that are expensive to
produce at home or can not be produced with domestic factor
endowments, helps bring down domestic prices, gives a greater
spectrum of choices to consumers at home and helps increase the
quality of domestic products through international competition
Thus International trade increase consumer surplus, producers
surplus and revenue to the government = welfare and economic
growth and makes every one better off
92

Balance Of Payments
Balance of payments are a
comprehensive record of all the
transactions of the people of a
country with the rest of the world
and of all the transactions of the rest
of the world with the people of that
country
Balance of payments include
I. Current Accounts
II. Capital accounts

93

Deficit & Surplus

in Current Accounts of Balance of Payments

Deficit in Current Accounts = when

the people of the country owe more
to the world than what the world
owes the people of that country
Surplus in current Accounts = when
the world owes the people of the
country more than what the people
of that country owe to the world
94

Economic Effects of Deficit

1. Depreciation in local currency against
foreign currency
2. Exports become cheaper & imports
become expensive
3. Domestic production of exports rise
Employment increase if demand for
exports rise
4. Incomes increase
5. Consumption rises
6. Deficit in BOP tends to decrease
95

Economic effects of Surplus

1. Appreciation in local currency against
foreign currency
2. Exports become expensive & imports
become cheaper
3. Domestic production of exports fall
Employment decreases if demand for
exports falls
4. Incomes decrease
5. Consumption decrease
6. Surplus in BOP tends to decrease
96

exchange rate
exchange rate = Price of one currency in another
currency
Depreciation = when price of local currency falls
against foreign currency under free market
mechanism
Devaluation = when value of the local currency in
decreased by the government against foreign
currency under fixed exchanges system
Appreciation = when price of local currency
increases against foreign currency under free market
mechanism
Revaluation = when value of the local currency in
increased by the government against foreign
currency under fixed exchanges system
97

Goals of Macroeconomic
Policy
Low unemployment
Price Stability (low inflation)
Economic Growth (increase in
national Income)
External Balance (Stability in BOP)
Stable Exchange rates
Social Welfare
98

Policy Instruments
Fiscal Policy
Monetary Policy
Commercial (Trade) Policy

99

Fiscal Policy
Fiscal Policy is the policy of the
Federal government in order to
collect revenue and mange
government purchases and
expenditures. Fiscal policy is
expressed in the Federal Budget
Document

100

Tools of Fiscal Policy

Government Spending (G) as part of
autonomous expenditure (aggregate
Demand) of national Income (Y) is
assumed to be controlled by policy
makers and therefore is a policy
variable
Taxes (T) as part of autonomous
savings (aggregate Supply) is also
controlled by the policy makers, who
set the tax rate, and tax receipts
vary with income

101

Fiscal Stabilization Policy

Because equilibrium income is effected by
changes in government spending (G) and
taxes (T) these fiscal policy instruments
can be varied to offset the effects of
undesirable shifts in private investment
demand.
The Government can use these fiscal
policy instruments to stabilize the total of
autonomous expenditure and , therefore,
equilibrium income and employment
102

Expansionary Fiscal Policy

When the economy is working at below fullemployment levels and the employment levels
need to be risen in order to revive the economy,
then
Government expenditures (G) are increased,
therefore pushing the aggregate demand
(national income and employment levels)
upwards,
Government Spending Multiplier:
(Y/ G = 1/1-mpc)
and/or
Taxes (T) are decreased, also pushing income and
employment levels upwards
Tax Multiplier:
(Y/ T = -mpc/1-mpc)
103

Y3=C+I-T

E3

Y2=C+I+G+G2
E2
Y1=C+I+G
E1

Y1

Y2

Y3

104

Contractionary Fiscal Policy

When the economy is working at a fullemployment levels and the employment levels
need to be brought down in order to save the
economy from recession, then
Government expenditures (G) are decreased,
therefore pulling the aggregate demand (national
income and employment levels) downwards,
Government spending multiplier:
(Y/ G = 1/1-mpc)
and/or
Taxes (T) are increased, also pulling income and
employment levels downwards
Tax Multiplier:
(Y/ T = -mpc/1-mpc)

105

Ef

Y1=C+I+G

Y2=C+I-G2

E2

Y3=C+I+T
E3

Y3

Y2

Yf

106

Federal Budget & Fiscal Stabilizers

Federal budget contains Two types of

items that effect macroeconomic
goals
1. Government purchases and
expenditures (G)
2. Taxes (T)
107

Concept of Automatic Fiscal Stabilizers

As income (Y) rises net tax collection
increases and the government budget
surplus increases (or deficit declines).
Therefore at a higher levels of economic
activity, more tax revenue will be collected
at any given set of tax rates.
On the expenditure side of the budget,
government spending (G) usually do not
respond to changes in level of national
income and economic activity,
automatically. They have to be changed
108
through policy.

Consequently
The net effect of a rise in the level of
income will be to increase the federal
budget surplus or to decrease the
size of an existing deficit
Tax policy is represented by two
variables
t0 = the intercept of the tax function, and
t1 = the marginal income tax rate
109

Effect of tax change due to change in

t0
A change in the in t0 (the intercept of
the tax function) will be opposite in sign
from the effect of a change in government
spending (G),
Therefore
an increase in t0 will cause the equilibrium
income to fall
and
a decrease in t0 will cause the equilibrium
income to increase.
110

Types of Taxes
Direct Taxes
Income Tax: Highly recommended, because it is
progressive and measures the elasticity of
demand
Indirect taxes
General Sales Tax (GST): highly recommended,
because it is progressive and measures the
elasticity of demand.
GST can be levied up to 35% of the price of a
commodity sold in the market
All other Taxes except local taxes are now not
recommended under WTO regime
111

Public Choice View

Policy makers act to maximize their own
welfare or utility, rather than the social
good. Gordon Tullock If Policymakers are
ordinary men, they will make most (not all)
their decisions in terms of what benefits
them, not society as a whole* For them it
is not a question of designing policies to
stabilize the macro-economy. It is, rather,
imposing rules that eliminate the
destabilizing effects of deficit spending.
*Gordon Tullock London, 1967
112

Monetary Policy
Monetary Policy is managed and
executed by the Central Bank in
order to control money supply and
inflation in the economy
Tools of Monetary Policy
1. Open market Operations
2. Discount rate Policy
3. Required Reserve Ratio
113

Open market Operations

Government Securities constitute a major part of
the Central Banks assets
The purchase of the additional securities will
increase the government securities on the assets
side of the central banks balance Sheet. To pay
for the securities the Central Bank writes a check
drawn on itself and simply creates a new liability
against itself. The check would be deposited into
the commercial banking system, therefore
A purchase of security by the Central Bank from
the open market would increase the Commercial
banks reserve deposits by an equal amount,
Thus Increasing the money supply
A sale of security by the Central Bank into the
open market would decrease the Commercial
banks reserve deposits by an equal amount,
Thus Decreases the money supply
114

Discount Rate Policy

Discount rate is the interest rate charged by
the Central Bank on its loans to the
commercial Banks
An increase in the discount rate would
decrease the borrowing by the Commercial
Banks and
Thus decreases the Money Supply
A decrease in the discount rate would
increase the borrowing by the Commercial
Banks and
Thus Increases the Money Supply
115

Required Reserve Ratio

Required Reserve ratio is the percentage deposits
Commercial Banks must hold as money reserves.
Changes in this policy do not change the level of
total bank reserves, but by changing the required
reserve ratio, the Central Bank changes the
quantity of deposits (money supply) that can be
supported by a given level of reserves
(Usually reserve ratio is 80:20)
20% bank reserves and 80% money supply
An Increase in reserve ratio (e.g.. 75:25) would
decrease money supply in the economy
Decrease in reserve ratio (e.g.. 85:15) would
increase money supply in the economy
116

Macroeconomic problems
No one policy can be used to stabilize the
external and internal imbalances in an
economy.
External imbalances include:
1. Deficit or Surplus in Balance of Payments
2. Depreciation or Appreciation in Exchange
rate
Internal Imbalance include
3. Unemployment or Full employment
4. Inflation (Price Rise) or Deflation (Fall in
117
Prices)

Policy Mix
For Internal & External Equilibrium
IB
I.

Monetary
Policy &
Interest
Rates

II.
Inflation & surplus

Unemployment & Surplus

EB

(i)

III.
Inflation & Deficit

IV.
Unemployment & Deficit

IB = Internal Balance Policy Mix

EB = External Balance Policy Mix

Fiscal Policy & Government expenditure (G)

118

Money Supply
Money supply would include:
M1 = Currency + Demand Deposits
M2 = M1 + Time Deposits
M3 = M2 + Saving Accounts

119

The Central Bank can prevent or mitigate

the upward or downward movements of
interest rates only by changing the
monetary base and hence the money
supply
M s (money supply) = M d (money demand)
If M s > M d, or if M d < Ms,
Then interest rates fall
If M s < M d, or if M d > M s,
Then interest rates rise
120

3. Growth and Development

What is Economic Growth

Todaro Economic Growth is a
steady process by which the
productive capacity of the economy
is increased overtime by bringing
about rising levels of national output
and income
Economic Growth is increasing
national output with existing level of
technology, stock of capital and
infrastructures

Elements of Economic
Growth
1. Long-Term Growth Process
2. Rise in Real per-capita income
(Per capita income = GDP/population)
3. Rise in Productivity
4. Greater equality in income levels of
the population

Sources of Economic Growth

Supplying Factors of Production more efficiently and
productively
Demanding of more factors of Production
Using more efficiently the existing levels of technology
Improving upon the techniques, processes and
technological levels in the country
Factors of Production are:
1. Land
2. Labor
3. Capital
4. Entrepreneurs

Benefits of Economic
Growth
Help rise the standard of living of the
people
Allows the economy to have more
consumer goods, producer goods,
and intermediary goods
Increases employment opportunities
Reduces governments costs related
to social securities and uplift
schemes

Costs of economic Growth

Over use of natural resources
Increase in pollution and noise levels
Urbanization of rural areas, congestion
and traffic jams
Reduction in natural landscape and
increase in man-made structures
Decrease in bio-diversity
Increase in consumption spending on
non-necessary goods

What is Economic
Development
Mair & Baldwin Economic Development is the
process whereby an economys real national income
increases over long period of time & if the rate of
development is greater than the rate of growth of
population, then the per capita income will increase
Todoro Development must be conceived of as a
multi-dimensional process involving major changes in
social structures, popular attitudes and national
institutions as well as the acceleration of economic
growth, reduction of inequality & the eradication of
poverty. Or economic Growth + structural changes for
a better life.

Difference between Economic

Growth & Economic Development
Economic Growth is increasing output with
existing infrastructure, capital and technology
Economic Development is increasing the stock
of capital and technology in the country
Economic Growth is increase in per capita
income
Economic
Development
is
procedural,
educational,
institutional,
social,
political,
economic and technological changes in the
country and encompasses all forms of thinking,
living and working in the society

Economic Growth & Economic

Development

Good
y/
Facto
rK

Good x/ Factor L

Production Possibility Frontiers

(PPFs) of Nation A under
Economic Development and
introduction of new technologies
Quantit
y of y
product
s
produce
d

Quantity of x product produced

Objective of Economic Development

1. Provision of basic needs

2. Raising standard of living
3. Expanding of range of
economic and social
choices

Characteristics of Economic
Development
1. Changes in occupational structures
2. Changes in sectorial structures of national output
3. Changes in structures of industrial production
4. Changes in structures of foreign trade
5. Changes in technological progress
6. Changes in social attitudes
7. Institutional changes in the economy
8. Changes in thinking processes and
9. Changes in educational levels of the people
10.Changes in living standards and behaviors

Main measures of Economic

Development
1.
2.
3.
4.
5.

Increase in real GDP

Increase in real per capita income
Rise in overall wellbeing of the people
Satisfaction of basic needs of the people
Better social and economic indicators
and human development Index
6. Increase in technological development
and know how
7. Institutional development

Defining Poverty
a). Absolute Poverty
b). Relative Poverty

a). Absolute Poverty

Poverty is common to define as an insufficiency of means relative to
needs, or as a condition of MONEYLESSNESS. Poverty in the sense of
moneylessness is not having enough of the basic medium of
exchange in order to satisfy elementary human needs and to function
economically and socially. This is also called Income poverty.
According the Economic Survey of Pakistan 2000-2001, Recent
estimates suggest that poverty has further increased from 32.6% in
1998-1999 to 33.5% in 1999-2000.
Gerald Meier defines poverty as the inability to attain a minimum
standard of living.
Rowntee defines poverty, as a level of total earnings insufficient to
obtain the minimum necessities for the maintenance of merely
physical efficiency, including food, rent, and other items
Economic Survey of Pakistan, 2000-2001, Government of Pakistan, Islamabad, p xvii
Meier, G. M. & Rauch, J. E. Leading Issues in Economic Development. 7 th Edition, Oxford University Press, N.Y. 2000, p 18
. World Bank Report 2000-2001, Attacking Poverty, Oxford University Press, Washington DC, p 17

MONEYLESSNESS can be improved

by taking into account VURNABILITY.
According to the World Bank Report 2000-2001, Vulnerability is the risk that
a house hold or individual will experience an episode of income or health
poverty over time. But Vulnerability also means the probability of being
exposed to a number of other risks (violence, crime, natural disasters, being
pulled out of school). For example a person who has a job that pays him
precisely the minimum needed to function accordingly to current standards,
but who cannot be certain that he or she will have enough to get tomorrow if
his or hers income falls or his or hers needs increase is therefore is at a
highly vulnerable position. That person may become poor at any moment.
This limits his or hers range of choices and affects his or hers behavior in
life. Moneylessness is a vital aspect of powerlessness. The concept of poverty
as powerlessness underlines the importance of economic vulnerability. The
poor are separated from the non-poor not only by their current standard of
living, but also by their greater vulnerability to economic catastrophe - A
vulnerability that limits their choices and hence the freedom of the poor.
World Bank Report 2000-2001, Attacking Poverty, Oxford University Press,
Washington DC, p 19

 Poverty is also defined as POVERLESSENSS. The poor do not

differ from their fellow men or women merely in the size of their
paychecks. Many of the poor are dependent psychologically as
well as economically. Poor people have higher than average rate
of criminality, suicide, narcotic addiction, physical and mental
illnesses, alcoholism, prostitution and violence. They are more
likely to live in unhealthy surroundings and in physically unsafe
structures. Social and family disorganization is endemic to the
poor. A pathological feeling of powerlessness compounds these
problems. The poor lead lives that are, or seem to be, ordered
largely by forces outside their control by people in position of
authority or wealth, by perceived evil forces, by bad luck, or
simply as the will of God. In words of Professor Warren
Haggstrom, The poor are faced with a particular difficult variety
of situational dependency, a helplessness to effect many
important social factors in their lives, the functioning or purpose
of which they do not understand, and which are essentially
unpredicted to them.

 Poverty as powerlessness is
measured in terms of lack of power
as well as money. Powerlessness in
other words is the lack of control
over ones own destiny.
Powerlessness is a lack of
EMPOWERMENT.

 According to the World Bank Report 2000-2001,

Empowerment means enhancing the capacity of
poor people to influence the state institutions that
affect their lives, by strengthening their
participation in political processes and local
decision making. And it means removing the
barriers political, legal, and social that work
against particular groups and building the assets of
poor people to enable them to engage effectively
in markets.
World Bank Report 2000-2001, Attacking Poverty,
Oxford University Press, Washington DC, p 39

 In short moneylessness and

economic vulnerability are forms of
powerlessness, and Absolute poverty
can be defined as a state of
moneylessness and powerlessness.

Relative Poverty
family be classified as poor if its income was less than half of the medium
family income. The best way to find a relative measure of poverty is to
take into account the position of various groups on a scale of income that
must compare the income share of those at the bottom to that of those
at the top. With complete income equality, the top 20 per cent of people
would get 20 percent of the income available, and the bottom 20 per
cent would get 20 per cent also. But in reality this is hardly the case. In
Pakistan in 1996-1997 the percent share of income or consumption of the
lowest 10 percent of people was 4.1% compared to 27.8% share of
income or consumption of the highest 10 per cent of people. The percent
share of income or consumption of the lowest 20 percent of people was
9.5% compared to 41.1% share of income or consumption of the highest
20 per cent of people.
Joseph, J & Kornblum William, Social Problems, Prentice Hall Inc. New
Jersey, 1983, p 248
World Bank Report 2000-2001, Attacking Poverty, Oxford University
Press, Washington DC, p 283

Dimensions of Poverty

Economic,
Educational
Health
political,
social,
Gender
Environmental
Human.

Poverty has an Economic dimension.

In economic terms, a country, region or household
are poor when the per capita income of a country or
the income of a household is very low. When the
buying power of the economy or of the household is
below a certain minimum standards. When there are
in a nation, region or a household, low medical care
and health facilities. When the productivity of the
nation, a group or an individual in the nation is very
low. When there is illiteracy, lack of basic education,
and lack of knowledge about the peoples physical,
intellectual, spiritual, and moral environment. When
a majority or a minority of the people in a community
are hungry, venerable and powerless to make their
life better for the present or for the future.

Poverty has a Political dimension.

In political terms a country, a region or a group
of people are poor, when they do not have a
voice in the community, or are dependent on
other more powerful groups or individuals in
order to express their own rights or choices.
Political poverty is expressed in the fact that the
democratic process in a country or community is
usurped or hindered and institutions that
safeguard the basic human rights of liberty, life
and freedom of majority or minority in that
community cease to exist or do not function.

Poverty has a Social dimension.

In social terms poverty in a country, region or
household breeds all types of socially
unacceptable behaviors like drug addiction,
crime, prostitution, violence in a family or in
the community and terrorism, all of which
degrade human self respect, moral and social
values of the society as a whole, when more
and more people in the community become
intolerant of each other and are rude towards
each other in their day to day life.

Poverty has an Environmental

dimension
In its environmental terms, poverty destroys the living
environment not only of those that live in poverty but of all others
humans and non human species that depend on the same
resources and ecosystem on which those living in poverty depend
and survive upon. People living in poverty can not change their
behaviors easily, not only because of lack of resources, but also
because of lack of knowledge about their own surrounding and
survival techniques, lack of education, illiteracy and more
importantly if they do change their already marginalized living
behaviors they might die, therefore it is easy for them to survive
on what ever they have without regard to their physical and
spiritual environment, rather than take measures that might
protect their environment. Thus by destroying their own living
environment the poor in reality are destroying their own
resources on which they survive in the long run.

Poverty has a human dimension

Poverty in its human dimension is the most important of all, because poor people
live in conditions that are miserable, conditions in which they or some members
of their family die of hunger, disease, famine, or of violence. When a child is
down with a curable disease and the parents have to take a decision whether to
take the child to a doctor and buy expensive medicines for that child which would
take up a major portion of the familys income or to spend that much needed
money on the food of the other children in that family. Poverty has a human
dimension when the parent of a child sells his or her child into slavery or
prostitution because of lack of resources to feed or care for that child and its
siblings. Poverty has a human dimensions when government institutions not only
fail to protect the poor, these upholders of law, freedom and human rights
commonly abuse the poor through the very institutions that have been created in
a civic society to protect them. Poverty has a human dimension when the feudal
lord or some person with political and economic power abduct the daughter or
wife of those that serve under him or takes the poor into bonded labor and the
aggrieved are powerless to do anything. Poverty has a human dimension when
governments, institutions, groups, individuals in that society or nation have
become inhumane towards those that are more unfortunate than them women,
children, religious or political minorities, economically poor, etc.

Poverty has a human dimension

Poverty in its human dimension is the most important of all, because poor people
live in conditions that are miserable, conditions in which they or some members
of their family die of hunger, disease, famine, or of violence. When a child is
down with a curable disease and the parents have to take a decision whether to
take the child to a doctor and buy expensive medicines for that child which would
take up a major portion of the familys income or to spend that much needed
money on the food of the other children in that family. Poverty has a human
dimension when the parent of a child sells his or her child into slavery or
prostitution because of lack of resources to feed or care for that child and its
siblings. Poverty has a human dimensions when government institutions not only
fail to protect the poor, these upholders of law, freedom and human rights
commonly abuse the poor through the very institutions that have been created in
a civic society to protect them. Poverty has a human dimension when the feudal
lord or some person with political and economic power abduct the daughter or
wife of those that serve under him or takes the poor into bonded labor and the
aggrieved are powerless to do anything. Poverty has a human dimension when
governments, institutions, groups, individuals in that society or nation have
become inhumane towards those that are more unfortunate than them women,
children, religious or political minorities, economically poor, etc.

Measuring poverty

Head Count Approach

Biological Approach
Inequality Approach
Relative Deprivation
Value Judgment Approach
A Policy Definition
Poverty Line
Purchasing Power Parity (PPP)
Relative Purchasing power Parity
Lorenz Curve and Gini Coefficient
Inverted U Hypothesis of Inequality
Keynesian Minimum subsistence Levels
GDP Per capita levels

Head Count Approach

Even after the poor have been identified and specified, the concept
of poverty is concerned with the condition of the poor, there is the
problem of aggregation over the group of the poor, and this involves
moving from description of the poor to some overall measure of
poverty as such. In some traditions, this is done very simply by just
counting the number of the poor, and then expressing poverty as the
ratio of the numbers of the poor to the total number of people in the
community in question. This is called HEAD COUNT (H) measurement
of poverty. The Head count method has two serious drawbacks. First,
H takes no account of the extent of the shortfall of incomes of the
poor from the poverty line. Second, It is insensitive to the distribution
of income among the poor, because the requirement of a concept of
poverty must include, a) method of identifying a group of people as
poor (identification), and b) a method of aggregating the
characteristics of the set of poor people into an over-all image of
poverty (aggregation).

Biological Approach
Seebohm Rowntee (1901) in the Poverty in NY defined families as being in primary
poverty if their total earnings are insufficient to obtain the minimum necessities
for the maintaince of merely physical efficiency. Starvation clearly is the most
telling aspect of poverty. The criticism of the biological approach is that, first, there
are significant variations related to physical features, climatic conditions and work
habits of different regions. In fact, even for a specific group in a specific region,
nutrition requirements are difficult to define precisely. Second, the translation of
minimum nutritional requirements into minimum food requirements depends on
the choice of commodities. While it may be easy to solve the programme exercise
of a diet problem, choosing a minimum cost diet for meeting specific nutrition
requirements from food items sold at specific costs, the relevance of such a
minimum cost diet is not clear. Typically, it turns out to be very low-cost indeed, but
boring as well, and peoples food habits are not, in fact, determined by such a cost
minimizing exercise. Third, for non-food items such as minimum requirements are
not easy to specify, and the problem is usually solved by assuming that a specific
proportion of the total income will be spent on food. The minimum food-costs can
be used to calculate minimum income requirements. But then the portion on food
varies not merely with habits and culture, but also with relative prices and
availability of goods and services. Almost every procedure used under the
biological approach can be challenged but this approach does leave a basis of
minimum thought and work on poverty.

Inequality Approach
Poverty may look very like inequality between the poorest groups
and the rest of the community. Miller (1947) and Roby (1967) state,
which casting the issue of poverty in terms of stratification leads to
regarding poverty as an issue of inequality. Criticism: In this approach
our concern becomes one of narrowing the difference between those
at the bottom and the better off in each stratification dimension.
Inequality is fundamentally a different issue to poverty. Inequality
and poverty are not, of course, unrelated. But neither concept
subsumes the other. A transfer of income from a person in the top
income group to one in the middle-income range must reduce
inequality, but it may level the perception of poverty quite
unaffected. Similarly, a general decline in income that keeps the
chosen measure of inequality unchanged may, in fact, lead to sharp
increase in starvation, malnutrition and obvious hardship. Inequality
and poverty are associated with each other, and to note that a
different distribution system may cure poverty even without an
expansion of the countrys productive capabilities.

Relative Deprivation
The concept of relative deprivation has been fruitfully used in the
analysis of poverty, especially in the sociological literature. Being
poor has clearly much to do with being deprived, and it is natural,
for a social animal, the concept of deprivation will be relative one.
But within the uniformity of the term relative deprivation there
seem to exist some distinct and different notion, like feelings of
deprivation and condition of deprivation. A second contrast
concerns the choice of reference groups for comparison. Again,
one has to look at the group with which the people in question
actually compare themselves, and this can be one of the most
difficult aspects of the study of poverty based on elative
deprivation. The approach of relative deprivation even including
all its variants cannot really be the only basis of the concept of
poverty. Relative deprivation supplements rather than analysis of
poverty in terms of absolute dispossession.

Value Judgment Approach

Many authors have recently presented the view of the value judgment
approach forcefully. It seems natural to think of poverty as something
that is disapproved of, the elimination of which is regarded as morally
good. Mollie Orshansky argues, that poverty, like beauty, lies in the eyes
of the beholder. It is important to distinguish between different ways in
which the role of morals can be accommodated into the exercise of
poverty measurement. For the person studding and measuring poverty,
the conventions of society are matters of fact as contemporary
standards, and not issues of morality or of subjective search as what
should be the contemporary standards and to be the persons own value
and feeling. Adam Smith (1776) clearly stated, that by necessities I
understood not only the commodities which are indispensably necessary
for the support of life, but what ever the custom of the country renders it
indecent for credible people, even the lowest order, to be without The
poorest credible person of either sex would be ashamed to appear in
public without them. In the similar vein Karl Marx (1867) said, while
historical and moral elements enter the concept of subsistence,
nevertheless, in a given country, at a given period, the average quantity
of means of subsistence necessary for the laborer is practically known.

A Policy Definition
The measurement of poverty may be based on certain given standards,
but what kinds of these standards themselves make, there seems to exist
a certain amount of confusion on the subject too. The US presidents
Commission on Income Maintaince (1969) gave a policy definition in its
report Poverty amid Plenty. If society believes that people should not be
permitted to die of starvation or exposure, than it will define poverty as
the lack of minimum food and shelter necessary to maintain life. If the
society feels some responsibility for providing to all persons an
established measure of well-being beyond mere existence, for example
good physical health, than it will add to its list of necessities the
resources required preventing or curing sickness. There are at least two
difficulties with this policy definition. First, practical policy-making
depends on a number of influences, going beyond the prevalence notion
of what should be done. Second, even if policy is taken to stand not for
actual public policy, but for recommendations widely herald in the society
in question, there are problems. There is clearly a difference between the
notion of deprivation and the idea of what should be eliminated by policy.

Poverty Line
All the measures are judged in relation to some norms. For
example, we define life expectancy in some countries to be low in
relation to those attained by other countries at a given date. The
choice of the norm is particularly important in the case of the
consumption-based measures of poverty. A consumption based
poverty line can be thought of as comprising two elements: the
expenditure necessary to buy a minimum standard of nutrition
and other basic necessities and a further amount that varies from
country to country, reflecting the cost of participating in the
everyday life of society.
As a rule of thumb, poverty line regardless of the family size, the
age of its members, or their place of residence is a fixed poverty
line of a minimum where total income equals total consumption
expenditure or where total income is less than total consumption
expenditure.

Purchasing Power Parity (PPP)

The Summer and Hanston (1988) recalculation of income per capita
approach based on purchasing power parity (PPP) shows that the
income figures must be treated with a good deal of circumspection.
The adjustment for PPP is only one of the many problems associated
with comparing incomes across countries, but making just this one
change can have very substantial effects. Changes at the bottom end
are particularly dramatic. China, India and Pakistan are all ranked
fairly closely under conventional national income measures, where as
in the Summers and Henston data the per capita income of Pakistan
is more than 50 per cent above that of India and the per capita
income of China is more than twice of that of Pakistan. Than there is
much more to standard of living than income. The great variety of
conditions in developing countries is further illustrated in some of the
other dimensions. Further, the variations in other indicators are far
from perfectly correlated with income per capita whether measured
in the standard or PPP manner.

Relative Purchasing power Parity

In country comparisons of levels of income are often misleading
when they are made by converting the income of various
countries into common currencies (US$) through the use of official
exchange rates. These nominal exchange rates do not reflect the
relative purchasing power of different currencies, and thus errors
are introduced into the comparison. The depression of per capita
income is exaggerated by systematically understating those poor
countries. PPP, rather than exchange rates are the correct
converter for translating GDP from national currencies to dollars.
In recognition of comparative national price levels, studies by
Irving Kravis and his associates have therefore attempted to
adjust international comparisons for the real purchasing power
parities of national currencies. Nominally the purchasing power of
the currencies of a less developed country (LDC) tends to be
greater than is suggested by official exchange rates.

Lorenz Curve and Gini Coefficient

The Gini Coefficient is a single measure of relative poverty and the most frequently
measured encountered in studies of income distribution. It is based on a curve
fitted to percentile shares, which was developed by Lorenz. Gini coefficient flows
from the Lorenz curve.
The vertical axis measures the percentage of income recipients, who are arrayed in
percentile on the horizontal axis. Income recipients are ordered from poorest to the
richest, moving from left to right. Thus OX percent of population is the poorest
group which receives a percent of income and so on, giving the Lorenz curve L.
Complete equality would occur only if a percent of the population receives a
percent of the income. As indicated by the curve of complete equality E. The curve
of perfect inequality is OGH with a right angle G. This curve represents the case
where one person has 100 per cent of the income. Area A enclosed by the
theoretical line of equality E, and the observed Lorenz curve L is known as the
concentration area or the area of inequality. The Gini coefficient is the ratio of area
A to the total area under the line of equality A/A+B. The simplest computation of
the Gini coefficient records by taking the sum of the area under all the trapezoids
such as WXYZ, and subtracting this from the area under E to give the concentrated
area. The required ratio than follows as a measure of the inequality. Thus 0
represents perfect equality and 1 represents perfect inequality.

Inverted U Hypothesis of Inequality

Much attention has been given to how the distribution of
income changes in the course of development in
particular, to Simon Kuznets inverted U Hypothesis. Kuznet
advocated his hypothesis that the secular behavior of
inequality follows are inverted U-shaped pattern with
relative income inequality first increasing and than
decreasing in the course of development.
The inverted U results have been seriously questioned by A.
Anand and Kanbur in the Journal of Development Economics
(Feb 1993). Their study shows that the results are very
sensitive to the measure of inequality and the choice of
data set. By making different choices one can get U
relationship, inverted U relationship, or no relationship at
all.

Thank You
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Meier, Gerald M. 1995, Leading Issues in
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University Press New York, Oxford

161

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