Chapter 2
Income
What Development Projects
Focus On
• Concrete outcomes related to poverty, malnutrition,
inequality, and health.
• Basic physical needs like nutrition, shelter, and clothing
• Development of the mind (and of course people’s earnings
potential), through education.
• The environment, conservation, and sustainable resource
use
• Human rights, gender and ethnic equity
• Government corruption
Income vs. Development
• In rich countries: development and income growth are
seen as similar
– E.g., think about urban development projects
• A lot of things correlate with income
– Life expectancy is higher in the US than Malawi
• But most development economists would say
development is different from income growth
– …though it’s hard to have development without
income growth
Income vs. Development (Don’t
confuse these!)
• Economic development involves many outcomes:
– Income growth (Chs 2 & 6), poverty (3),
inequality (4), human welfare (5)
• Big theme of this class:
– Income growth and development are different
things
– …but it’s hard to have development without
growth
• …so let’s start with income
Tools of the Trade:
What is Growth? Income?
• Growth: Rise in national or per-capita income and
production (Ch. 6)
• Gross Domestic Product (GDP; same as National
Income)
– Add up value of all final goods and services
produced in a country then sold
• Value at market prices
– Alternatively, add up the cost of all factor
inputs (Capital, Labor, Land), called Value
Added.
• GDP at factor cost
Per-capita Income
• Take the GDP
• Divide by the population
PCY  GDP / POP
• What everyone would have if income were
perfectly equally distributed
• One measure of welfare (and development)
Two Ways to Calculate GDP
with Input-Output Accounting
Leontief Multiplier Analysis
Income Account Agriculture Industry Services
Production Sectors
Agriculture
225
75
2
Industry
320
200
85
Services
75
150
30
Factors
Labor
100
400
275
Capital (Profits)
150
300
125
Imports
50
300
50
TOTALS
920
1425
567
1
2
3
4
The A Matrix
Production Sectors Agriculture
Agriculture
0.245
Industry
0.348
Services
0.082
The I Matrix
Production Sectors Agriculture
Agriculture
1
Industry
0
Services
0
I-A
A
B
Production Sectors Agriculture
Agriculture
0.755
Industry
-0.348
Services
-0.082
Industry
0.053
0.140
0.105
Services
0.004
0.150
0.053
Industry
Services
0
1
0
0
0
1
C
Industry
-0.053
0.860
-0.105
D
Services
-0.004
-0.150
0.947
Industry
0.086
1.223
0.143
Services
0.019
0.196
1.079
-1
Leontief Multiplier Matrix (I-A)
Production Sectors Agriculture
Agriculture
1.365
Industry
0.584
Services
0.182
• To meet a 1-unit increase in food demand in the economy, Agriculture
has to produce 1.36 more, Industry 0.58 more, and Services, 0.18
more.
Green Accounting
Income Account Agriculture
Production Sectors
Agriculture
Industry
Services
Factors
Labor
Capital (Profits)
Imports
Environment
TOTALS
Industry
Services
225
320
75
75
200
150
2
85
30
90
135
50
25
920
360
270
300
70
1425
247.5
112.5
50
40
567
Standard Accounting
Final
TOTAL
618
820
312
NA
1750
920
1425
567
697.5
517.5
400
135
697.5+517.5=
1,215(<1,350)
GNP vs. GDP
• Gross National Product: Like GDP but includes
the value the country’s citizens produce outside
the country’s borders
– Philippines: GDP is ~6% lower than GNP, because it
doesn’t count income of Philippine migrants working
abroad
– If Philippine person works in Malaysia, the value of
output she produces counts in the Philippines’ GNP but
not its GDP.
• It counts in Malaysia’s GDP but not GNP
• We often use GDP; it usually doesn’t matter much
Real vs. Nominal GDP
• Real means “adjusted for inflation”
– Very important for comparing a country’s
changes in income over time:
Year
Year 1
Year 2
% growth:
p/c GDP
1000
1200
Nominal
Real
p/c GDP
in Year-1
CPI
prices
1
1000
1.1 1090.909
20.0%
9.1%
Purchasing Power Parity (PPP)
• Adjusts exchange rates for purchasing power of
income in different countries
– Critical for comparing incomes across countries
• Mexico: Exchange Rate on 1-5-2010 was 12.8 pesos/US$
• But you get more for your money in Mexico (~44% more), so
the PPP exchange rate is around 8.9 (=12.8/1.44)
– In other words,12.8 pesos gives you not $1 but $1.44 (=12.8/8.9)
in purchasing power in Mexico if you adjust for PPP!
– 8.9 pesos give you $1 in purchasing power parity
Country
Ethiopia
Malaysia
Mexico
Japan
Ratio of PPP to
Exchange Rate
7.89
2.31
1.44
0.83
Making an Income Index
• Rank index:
F (Yi )  Ranki / N
• Income index (see index generator program):
Yi  Ymin
I Y (i ) 
Ymax  Ymin
IY ( Egypt )  (6,180  409) / (86,899  409)  0.067
Rank : 60 /167  .359
Country Typologies
• World Bank Standard:
–
–
–
–
Low Income (<US$765/capita in 2003)
Lower Middle ($765-$3,035)
Upper Middle ($3,035-$9,385)
High (>$9,385)
• Other terms:
–
–
–
–
–
Third World (Pretty much out of use)
Less Developed, Developing (Commonly heard at international forums)
Emerging (Rapidly growing: China, E. European)
Industrialized (What about post-industrial OECD?)
Transitional (E. Europe, Russia, Ukraine: Controlled market -> market
oriented economies)
– North-South (Imprecise, but still heard sometimes)
What’s NOT in GDP?
• GDP Excludes intermediate inputs (no double counting)
• Includes goods & services produced by citizens abroad
(Mexican migrant remittances add ~$25 billion/year to
Mexico’s GDP!)
• Excludes goods & services not sold
• Get divorced, hire a cook or nanny, and GDP goes
up!
• Me and Home Depot = no contractor and lower
GDP
• What about obesity? The environment?
Why Look Beyond GDP?
• Robert Kennedy explained it (a few weeks
before he was assassinated in Los Angeles):
www.youtube.com/watch?v=77IdKFqXbUY
Next Three Chapters
• In 2010, just under 1.3 billion people—22.4% of the
world’s population—lived on less than $1.25 a day (PPP
adjusted).
• The low-income countries contained 12.5% of the world’s
population but controlled less than 1% of its income, while
the high income countries had a little over 16% of its
population and 72% of its income.
• In the poorest 10% of countries, those with GDP per capita
less than $1,123, life expectancy averaged 54.4 years
(compared to 80 in the richest 10%), and years of
schooling averaged 3.2 years (compared to 10.5 years).