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Economic Development Module

BSA (Bulacan State University)

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BULACAN STATE UNIVERSITY

College of Business Administration
City of Malolos, Bulacan

Course Title : Economic Development

Course Code :
Course Credit : 3 Units

LEARNING MODULE FOR THE

SUBJECT ECONOMIC DEVELOPMENT

Within this Module will be discussed the study of the economics of

development which focuses on promoting and maintaining accelerated economic
growth in the country and in the lives of the people, especially in low developed
countries. This course or subject deals primarily with the overall performance of
the economy that leads to the development of the people. Topics tackled include
gross domestic product, inflation, price level, unemployment, economic growth,
fiscal policy, and sustainable development.

Learning Objectives:

After successful completion of this Module, the student should be able to:
1. Differentiate economic growth from economic development.
2. Identify the main theoretical approaches in analyzing development.
3. Compare and contrast different theoretical approached for several specific
topics in economic development.
4. Write technical essays with the use of data, figures, models and graphs.

Learning Output:
The student is expected to engage in lifelong learning and being aware of the need
of studying economics and to keep up with the development of their specific field by
utilizing the learning’s in economic development.

Units for Discussion are:

1. Development and Growth
2. Distribution and Human Resources
3. Macroeconomic Policies for Development
4. Agriculture, Trade, and Sustainability

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UNIT 1: DEVELOPMENT AND GROWTH

CHAPTER 1: PATTERNS OF DEVELOPMENT

As people throughout the world awake each morning to face a new day, they do so under
very different circumstances. Some live in comfortable homes with many rooms, some have more
than enough to eat, are well clothed, healthy, and financially secured. While majority of the
earth’s people are much less fortunate. They may have inadequate food, shelter, unemployed,
may not know how to read and write, and their prospects for a better life are uncertain.

Three Vignettes

1. Malaysia
2. Ethiopia
3. Ukraine

✔ Globalization – is the set of processes by which more people become connected in more
and different ways across ever greater distances. For the Economist, globalization
increases free trade, build global economic organizations, and eliminate or reduce
barriers to trade like tariffs.

The Nature of Development Economics

❖ Relative Poverty – is the condition in which people lack the minimum amount of income
in order to maintain the average standard of living in the society in which they live.
❖ Absolute Poverty – refers to a condition where a person does not have the minimum
amount of income needed to meet the minimum requirements for one or more basic
living needs over an extended period of time.

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❖ Development – the process of improving the quality of all human lives and capabilities by
raising people’s levels of living, self-esteem, and freedom.
❖ Economic Development – the study of how economies are transformed from stagnation
to growth and from low-income to high-income status, and overcome problems of
absolute poverty.
❖ Economic Growth – refers to a rise in national or per capital income.
❖ Traditional Economics – an approach to economics that emphasized utility, profit-
maximization, market efficiency, and determination of equilibrium.
❖ Political Economy – the attempt to merge economic analysis with practical politics – to
view economic activity in its political context.

Rich and Poor Countries

❖ Global North – defined as the developed and industrialized countries.

❖ Global South – the less socio-economically developed global regions. Countries known as
“third world” or “developing countries”.
❖ Most Developed Countries (MDCs) – the richest of the industrialized and democratic
nations of the world.
❖ Less Developed Countries (LDCs) – countries with little development, little wealth, and
high population growth.
❖ Least Developed Countries (LLDCs) – countries with very low per capital income, low
literacy rates, and very little in the way of manufacturing industries.

Three Core Values of Development

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1. Sustenance – the basic goods and services, such as food, clothing, and shelter that are
necessary to sustain an average human being at the bare minimum level of living.
2. Self-esteem – the feeling of worthiness that a society enjoys when it’s social, political,
and economic systems and institutions promote human values such as respect,
dignity, integrity, and self-determination.
3. Freedom – a situation in which a society has at its disposal a variety of alternatives
from which to satisfy its wants and individuals enjoy real choices according to their
preferences.

Sustainable Development Goals – a set of 17 goals for the world’s future through 2030.
It is backed up by a set of 169 detailed targets and was agreed to by nearly all the world’s nations
on September 25, 2015.

✔ Universality – first, and most important, these goals apply to every nation and every
sector. Cities, businesses, schools, organizations, all are challenged to act.
✔ Integration – second, it is recognized that the goals are inter-connected in as system.
✔ Transformation – and finally, it is widely recognized that achieving these goals involves
making very big fundamental changes in how we live on Earth.

CHAPTER 2: MEASURING ECONOMIC GROWTH AND DEVELOPMENT

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Economic Growth – is the period of steady growth in output along with an improvement in
living standards. Economic growth is measured by GDP/Real DGP.

GDP (Gross Domestic Product) – is the market value of all final goods and services produce within
a nation in a given time.
a. Nominal GDP – measure of output based on current prices
b. Real GDP – measure of output based on changes in inflation

GDP Calculations:
a. Expenditure Approach – GDP is based from the spending by households, businesses
and the government in a given period.
b. Income Approach – GDP is based from the earnings of the households, businesses,
and the government in a given period.
c. Flow of product approach – GDP is the sum of the amount of final goods and services
produced and multiplied by their respective prices in a given period.
d. Gross Value Added (GVA) Approach – GDP is the sum of the output (GVA) of the major
industries of the economy for a given period.

Notes on GDP Calculations:

a. Only final goods are included in the calculation
b. Secondary sale of a good is not included
c. Only final goods for the period considered are included in the calculation

Limitations of GDP:
a. Does not include non-market activities that could be considered part of economic
activity
b. Does not include the informal sector
c. Does not include externalities

Other measures of Economic Growth:

a. GNP (Gross National Product) – market value of all final goods and services produced
by nationals of a country for a given period.

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b. NI (National Income) – total income received by the most basic factors of production
of a country.
c. DI (Disposable Income) – income received by an individual net of taxes. Take-home
pay.

Economic Development – according to Sen, it is about expanding the capabilities of people

lives. It is the same with Economic Growth but with significant participation of people in
producing wealth. Economic development requires alleviating the sources of “capability
deprivation” that prevent people from having the freedom to live the lives they desire.

✔ State of Health well-being

✔ Environmental adversity
✔ Social Climate: crime, violence, security
✔ Relative Deprivation and Inequality

Human Development Index (HDI) – is a summary measure of average achievement in key

dimensions of human development: a long and healthy life, being knowledgeable and have a
decent standard of living. The HDI is the geometric mean of normalized indices for each of the
three dimensions.

Is Economic Growth Desirable?

● Easterlin Paradox – states that at a point in time

happiness varies directly with income both among and
within nations, but over time happiness does not trend
upward as income continues to grow.

CHAPTER 3: THEORIES OF ECONOMIC GROWTH

AND DEVELOPMENT

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1. Rostow’s Stages of Growth – according to the American economic historian Walt T.

Rostow, the transition from underdevelopment to development can be described in
terms of a series of steps or stages through which all countries must proceed.

2. Harrod-Domar Growth Model – a functional economic relationship in which the growth

rate of gross domestic product depends directly on the national net savings rate and
inversely on the national capital output ratio.
▪ Net savings ratio – savings expressed as a proportion of disposable income
over some period of time.
▪ Capital output ratio – a ratio that shows the units of capital required to
produce a unit of output over a given period of time.

3. Lewis two-sector Model – a theory of development in which surplus labor from the
traditional agricultural sector is transferred to the modern industrial sector, the growth

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of which absorbs the surplus labor, promotes industrialization, and stimulates sustained
development.
4. Solow Growth Model – is an exogenous model of economic growth that analyzes changes
in the level of output in an economy over time as a result of changes in the population
growth rate, the savings rate, and the rate of technological progress.

Characteristics of Rapidly Growing Countries

1. Macroeconomic and Political Stability – economic and political instability undermine

investment and growth and are especially hard on the poor, who are least able to protect
themselves against volatility.
2. Investment and Health Education – a longer life expectancy indicates general
improvements in the health of a population, which in turn means a healthier and more
productive labor force.
3. Effective Governance and Institutions – stronger governance and institutions help
improve the environment for investment by reducing risk and increasing profitability.
4. Favorable Environment for Private Enterprise – sustained economic growth requires
millions of private individuals to make decisions every day regarding saving, investment,
education, and job opportunities.
5. Trade, Openness, and Growth – most economists agree that international trade plays an
important role in economic growth.
6. Favorable Geography

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CHAPTER 4:
STATES AND
MARKETS

MARKETS AND MARKET FAILURES

❖ Market Economy – an economic system in which economic decisions and the pricing of
goods and services are guided by the interactions of a country’s individual citizen and
businesses.
❖ Markets under certain conditions provide the “invisible hand” to
the economy.
o Invisible Hand – the unobservable market force that helps
the demand and supply of goods in a free market to reach
equilibrium automatically.
❖ The power of markets in organizing national economies has been
proved in successful markets.

CHARACTERISTICS OF MARKETS

1. Allocate resources efficiently.

2. Market system is more flexible and able to adjust to business cycles than government
control.
3. Market promotes competition.
4. Reliance in markets disperses economic and political power and therefore consistent with
democracy.

AREAS OF MARKET FAILURE

1. Monopoly or Oligopoly control

a. Monopoly – refers to when a company and its product offerings dominate a sector
or industry.
b. Oligopoly – is a market structure with a small number of firms, none of which can
keep the others from having significant influence.

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2. Presence of Externalities
a. Positive Externalities – is a benefit that is enjoyed by a third-party as a result of an
economic transaction.
b. Negative Externalities – is a cost that is suffered by a third party as a consequence
of an economic transaction.
3. Markets may not facilitate change in economic structure
a. Infant Industry – is a term used in economics to describe an industry that is in its
early stages of development.
4. Missing or underdeveloped institutions rules/laws
5. Macroeconomic Imbalances

Market Pessimists vs. Market Optimists

Stabilization of the Macro-economy

❖ Stabilization – refers to correcting imbalances in budgets and money supply aimed at

controlling inflation. It also means the need to devalue the currency or exchange rate to
avoid currency controls.

A. International Monetary Fund Stabilization Programs

1. Reducing government budget deficit via higher taxes, reduce spending, and financing
by borrowing which crowds out private investment.
2. Restrictions on central credit-control of money supply.
3. Adjust exchange rate via devaluation to stimulate exports.
4. Remove price controls on consumer goods including food prices.
5. Restrain wage increases.

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B. World Bank Structural Adjustment Program

1. Trade reform
a. Faster Reform
b. Graduate Reform
2. Adjusting prices
3. Promoting market competition
4. Fostering privatization
5. Creating market support institutions

The Washington Consensus – economist Williamson labelling of growing agreement

among Washington Institutions (US Government, World Bank, IMF).

Ten Components of the Washington Consensus:

1. Fiscal Discipline
2. Reordering public expenditure and priorities
3. Tax Reform
4. Liberalize interest rates
5. Promote competitive exchange rates
6. Trade Liberalization
7. Liberalization of Foreign Direct Investment (FDI)
8. Privatization
9. Deregulation
10. Secure Property Rights in the private sector

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UNIT 2: DISTRIBUTION AND HUMAN RESOURCES

CHAPTER 5: POVERTY AND INEQUALITY

Measuring Inequality

In this section, we define the dimensions of the income distribution and poverty problems
and identify some similar elements that characterize the problem in many developing countries.

❖ Inequality – occurs when individuals do not possess the same level of material wealth or
overall living economic conditions.
❖ Income inequality – the disproportionate distribution of total national income among
households.
❖ Personal or Size distribution of income – the distribution of income according to size class
of persons – for example, the share of total income accruing to the poorest specific
percentage of a population without regard to the sources of that income.
o Quintile – a 20% proportion of any numerical quantity. A population divided into
quintiles would be divided into five groups of equal size.
o Decile – a 10% portion of any numerical quantity. A population divided into deciles
would be divided into ten equal numerical groups.

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❖ Lorenz Curve – graphical representation in income inequality or wealth inequality

developed by American economist Max Lorenz in 1905.

*the greater the curvature of the Lorenz Curve, the greater the inequality

❖ Gini Coefficient – an aggregate numerical measure of income inequality ranging from 0

(perfect equality) to 1 (perfect inequality). It is measured graphically by dividing the area
between the perfect equality line and the Lorenz curve by the total area lying to the
right of the equality line a Lorenz diagram.

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*the higher the value of the coefficient is, the higher the inequality of income
distribution; the lower it is, the more equal the distribution of income

⮚ The Gini Coefficient has some nice properties which is why it is most commonly used to
measure income inequality in development economics:
a. Anonymity – Gini coefficient does not depend on who is who (just their income
level)
b. Scale Independence – if income is measured in different units, Gini coefficient
remains the same.
c. Population Size Independence – Gini coefficient is units-free, if a person is clone
into 2, each with the same income as the original person, Gini coefficient
remains the same.
d. Transfer Principle – holding all else constant, if income is transferred from a
richer person to a poorer person, Gini coefficient declines.

❖ Functional distribution of income – the distribution of income to factors of production

without regard to the ownership of the factors.
o Factors of Production – resources or
inputs required to produce a good or a
service, such as land, labor, and capital.

Measuring Absolute Poverty

❖ Headcount Index – the proportion of a country’s population living below the poverty line.
❖ Total Poverty Gap – the sum of the difference between the poverty line and actual
income levels of all people living below that line.
❖ Human Poverty Index – poverty is measured in terms of life expectancy, basic education,
and overall economic conditions of people.
❖ Multidimensional Poverty Index (MPI) – a poverty measure that identifies the poor using
dual cut-offs for levels and numbers of deprivations, and then multiplies the percentage
of people living in poverty times the percent of weighted indicators for which poor
households are deprived on average.

Poverty, Inequality, and Welfare

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1. Economic efficiency: income inequality can lead to inefficiencies

2. Political and Social Stability
3. Moral and Fairness Objections to Inequality

Who are the poor?

1. Rural – poor are disproportionately located in rural areas.

2. Women – women who are paid less for same tasks and have less access to education,
employment, and social security.
3. Ethnic Minorities
4. People in poor countries

Policies for Poverty Alleviation and Reducing Inequality

1. Dollar and Kraay Policy Variables

2. Human Capital
3. Increase school enrolment for girls
4. Rural Development

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CHAPTER 6: POPULATION AND DEVELOPMENT

Brief History of World Population

⮚ Rapid Population Growth is a recent phenomenon in human history. It took more than
10,000 years for the world to reach one billion in 1804, and it took only 125 years to add
the next billion or double the population to two billion.
⮚ Annual population was 0.08% from 1AD to 1800.
⮚ Population explosion occurred in the 1960s and 70s.
⮚ World population reached five billion in 1987 and six billion in 1999. Between 1945- 2004,
population growth reaches an average of 1.6% per year, with no historical precedence.

❖ Demographic Transition – when population starts with low growth rates due to high
birth rates and high death rates, moves through rapid growth stage with high birth
rates and low death rates and later become stable with low-growth rate where both
birth and deaths are low.

❖ Stages of Population Growth:

o Stage 1: low growth due to high death rates and high birth rates
o Stage 2: high growth rates driven by high birth rates and low death rates
o Stage 3: stable or falling growth rate due to low birth rates and low death rates

The Causes of Population Growth

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❖ Thomas Malthus was population “Pessimist” – he argued that population growth because
of “passion between sexes” that leads to rapid population growth.
❖ He also argued that population growth geometrically and food production grows
arithmetically at best, leading to famines and starvation.
❖ Yet, birth rate decline in spite of Malthus pessimism because all societies control their
birth rates thru a natural process and by viewing children as an economic decision for
they impose cost and incur benefits.

The Economics of Childbearing

1. Fertility should be higher when children earn income and

contribute to the household.
2. Reducing infant deaths should lower fertility.
3. Institutionalized social security and pension will lower the
need for parents to depend on their children so fewer
children are desired by parents.
4. Fertility should be lower if there is more opportunity for
employment for couples, especially for women.
5. Fertility may be higher with higher income.

❖ Gary Becker Theory of Household Economics – analyzed whether children are

“normal” or “inferior” goods. He argued couples maximize joint total Utility Function
from having children which is a function of the following factors: number of children,
child quality (associated with health and education), goods and services, time,
income, and cultural constraints.

QDC = F (N, Q, P, I, C)

Where:
QDC = demand for children
N = number of children
Q = quality of children
P = prices or costs of other goods and services
I = income
C = cultural factors like religion
*how do changes in the right hand side variables affect the demand for children

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Population Growth and Economic Development

Is population an obstacle or helpful to development?

1. Population and Productivity – rapid population growth may retard labor productivity in
the short run.
2. Population and Accumulation – Demographers A. Coale and E. Hoover are population
pessimists arguing population growth retards economic development by reducing income
per capita in three ways:
a. Capital per worker for growing number of workers or capital widening decreases
and permits more investment to be used increase per capital per worker or capital
deepening.
b. Lower fertility investment will be diverted from education and health to physical
capital investment.
c. Higher population growth will increase dependency ratio.
o Dependency Ratio – ratio of non-working population (0-14 & 65
and over) divided by total working population.
3. Population and Market Failures – assumes that market failures where costs and benefits
of a reproductive behavior are not fully borne by them. There is a negative externality
from population growth resulting resource depletion, congestion, natural resources and
environmental decay.
o Tragedy of the commons scenario.

Population Growth and Economic Development

1. According to UN World Population (1974), the biggest reducer of population is

economic development – “take care of the people, population will reduce itself”.
2. Chinese one child policy campaign in 1979 – difficult to implement in Africa and other
societies.
3. Family Planning Programs – use of persuasion and education to influence couples to
have fewer children.

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CHAPTER 7: EDUCATION AND DEVELOPMENT

Belief in the importance of education for economic development is not a new idea. As according
to the Chinese Philosopher Guan Zhong, “if you plan for a year, plant a seed. If for ten years,
plants a tree. If for hundred years, teach the people. When you sow a seed once, you will reap a
single harvest. When you teach people, you will reap a hundred harvests.”

❖ Education is a form of Human Capital.

❖ Education is a “public good” with positive externalities.
❖ Economist Theodore Schultz underscored the critical role of human capital
investment in the form of education for development.
❖ Stocks – refer to the amount of schooling embodied in a population.
❖ Flows – net change in those stocks as the result of school enrollment patterns.
❖ Net enrollment rates – refer to enrollments of only those of the relevant age group.
❖ Grade survival rates – estimate how many children actually complete a certain grade
level.

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Schooling vs. Education

⮚ Years of schooling and gender

distribution of that schooling are two
ways of charting the accumulation of
human capital. But schooling is only a
means to an end; the real goal is
education – that is, the skills
individuals acquire from time spent
studying and learning.
⮚ Students can sit through many years
of schooling and learn very little, while education is measuring the learning outcomes.
⮚ Unfortunately, there is a gap between rich and poor nations in educational quality.

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CHAPTER 8: HEALTH AND DEVELOPMENT

❖ Better health is central to human happiness and well-being.

❖ It makes an important contribution to economic progress, as healthy populations live
longer, are more productive, and save more.
❖ Many factors influence health status and a country’s ability to provide a quality health
services for its people. Ministries of health are important actors, but so are other
government departments, donor organizations, civil society groups and communities
themselves.

⮚ Health – the World Health Organization (WHO) defines health as a state of complete
mental, physical, and social well-being and not merely the absence of disease.
⮚ Mortality – measured death in population
⮚ Morbidity – measures rates of disease and illness.
⮚ Health-adjusted life expectancy (HALE) – reduces life expectancy by years spent with
disabilities, and disabilities are weighted according to their level of severity and duration.
The balance remaining is the expected number of years of healthy life.
⮚ Epidemiologic Transition – shift in disease pattern. One early characterization of the
epidemiologic transition identified three main stages: the age of pestilence and famine,
the age of receding pandemics, and the age of degenerative and human-made diseases.

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WHO’s on Health and Development

❖ It is concerned with the impact of better health on development and poverty reduction,
with the impact of development policies on the achievement of health goals.
❖ It aims to build support across government for higher levels of investment in health, and
to ensure that health is prioritized within overall economic and development plans.
❖ WHO also works with donors to ensure that aid for health is adequate, effective and
targeted at priority health problems.

Income and Health

As income increase, individuals, households, and societies at large are able to increase spending
on a range of goods and services that directly or indirectly improve health.

❖ Preston Curve – the relationship between income levels and life expectancy.

*in this bubble graph, each bubble is proportional to the population of the country represented,
life expectancy climbs rapidly at lower levels of per capita income and then levels off at higher
incomes.

❖ Health and Productivity – health can improve a worker’s activity by improving their
physical capacity.
❖ Health and Investment – by committing to health and strengthening primary health care,
leaders can protect their countries against the health challenges of the future, build
strong economies and promote thriving communities.

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UNIT 3: MACROECONOMIC POLICIES FOR DEVELOPMENT

CHAPTER 9: INVESTMENT AND SAVINGS

Investment and Savings around the World

In many Low Countries, there appear to be abundant opportunities for increased

investment that could have significant economic and social benefits, but these investments do
not happen. Roads are absent or of poor quality, electricity and telecommunications facilities are
in short supply and unreliable, and there seem to be many workers with few factories to employ
them.

❖ Capital Fundamentalism – the notion that physical capital accumulation is the primary
determinant of economic growth – has been often ascribed to Harrod-Domar proposition
that the rate of growth is the product of the saving rate and of the output-capital ratio.
❖ Cost-Benefit Analysis – this tool is applicable to both private and public investment and
to investment made by foreign firms as well.
o Net Cash Flow – measuring the difference between the cash revenues from the
sale of the product and the cash outlays on investment, material inputs, salaries
and wage, purchased services, and other items.
o Discounting – process of reducing the value of future flows.
o Opportunity costs
o Shadow prices – the opportunity costs of goods and services for the economy as
a whole.

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❖ Foreign Direct Investment (FDI) – is defined as a long-term investment in which a non-

resident entity exerts significant management control over an enterprise in the host
country.
❖ Portfolio Equity – an investor takes a smaller stake in an enterprise, either through a
direct purchase or through a stock exchange.
❖ Foreign Savings – foreign aid that is transferred to low income countries and either
invested or consumed.
❖ Domestic Savings – is made up of household, Domestic Corporation, and government
savings.

Household Saving and Consumption

Two main reasons of savings by households:

1. To generate future income
2. To protect against unexpected fall in income – “Precautionary motive”

Theories on Household Saving Behavior

1. Life Cycle Hypothesis

2. Keynesian Absolute-Income Hypothesis
3. Dusenberry Hypothesis
4. Permanent Income Hypothesis

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❖ Dependency Ratio – is the measure of the number of dependents ages zero to 14 and
over the age of 65, compared with the total population aged 15 to 64.

*what is the impact of dependency ratio on savings and investment?

CHAPTER 10: FISCAL POLICY

When a government raises its expenditures or cutes taxes on individuals and corporations so that
they can raise their expenditures, these actions are referred to as Fiscal Policy. When
government efforts instead rely on the central bank to adjust money supply and interest rates to
raise or lower individual and corporate expenditures, this is referred to as the exercise of
Monetary Policy.

⮚ The first function of fiscal policy is to manage government expenditures used to fund
whatever activities government policy makers and the people they represent think the
government should support.
⮚ The next closely related function of fiscal policy is to find a way of financing those
government expenditure, either through the collection of taxes, issuance of government
bonds, or in more desperate cases by printing money.

Government Expenditures

❖ Public Good – refers to a good or service that exhibits two traits:

o Non-rival Consumption – one person’s use of a good does not reduce the
benefits available to others.

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o Non-excludability – means that it is either impossible or prohibitively

expensive to exclude anyone from the benefits once the good is available.
❖ Development Expenditures – or public investment expenditures are those that, like
investment in general, generate a stream of income or services into the future. For
example, highways, buildings, infrastructures, health, education, and etc.
❖ Recurrent Expenditures – are those expenditures that a government must make year
after year. This includes the salaried of government employees, the purchase of office
equipment, and annual payments to families living in poverty and for pensions for
retirees.

Taxation

❖ Taxes – enforced proportional contributions from persons and property levied by the
law-making body of the state by virtue of its sovereignty for the support of the
government and all public needs.

“Taxes are the price we pay for a civilized society”

- Oliver Wendell Holmes, Jr.

❖ Neutral Tax – is one that does not lead to a material change in the structure of private
incentives that would prevail in the absence of tax. A neutral tax system, then, is one
that relies, to the extent possible, on uniform rates: a tax on all income at a flat rate or a
sales tax with the same rate applied to all goods and services.
❖ Efficient Tax – involves a minimum amount of excess burden for raising a required
amount of revenue.

❖ Taxes are used by the government to:

1. To raise revenue for the government to cover its own expenditure on the provision of
social services such as education, health, public infrastructures, etc.

❖ Classifications of Taxes
A. As to subject matter or object:

1. Personal, poll, or capitation – taxes of a fixed amount imposed on persons residing

within a specified territory.
2. Property – tax imposed on property, whether real or personal, in proportion either
to its value, or in accordance with some other reasonable methods of appointment.

B. As to who bears the burden:

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3. Direct taxes – are taxes levied by government on the income and wealth received by
households and businesses in order to raise government revenues.
4. Indirect taxes – are taxes levied by government on goods and services in order to
raise revenues.

C. As to determination of amount:

5. Specific – tax of a fixed amount imposed by the head or number, or by classification

of the objects to be taxed.
6. Ad valorem – the phrase “ad valorem” means “according to value”. Tax of a fixed
proportion of the value of the property with respect to which the tax is assessed.

D. As to purpose:

7. General, fiscal, or revenue – tax imposed for the general purposed of the
government.
8. Special or regulatory – tax imposed for a special purpose to achieve some social or
economic ends irrespective of whether revenue is raised or not.

E. As to scope (or authority imposing the tax)

9. National –tax imposed by the national government.

10. Municipal or local – tax imposed by municipal corporations or local government
units.

F. As to graduation or rate:

11. Proportional – are taxes that place an equal burden on the rich, the middle class,
and the poor.
12. Progressive – are taxes that place a greater burden on those best able to pay and
little or no burden on the poor.
13. Regressive – are taxes that fall heavily on the poor than on the rich.

❖ TYPES OF TAXES

1. Capital Gains Tax is a tax imposed on the gains presumed to have been realized by the
seller from the sale, exchange, or other disposition of capital assets located in the
Philippines, including pacto de retro sales and other forms of conditional sale.

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2. Documentary Stamp Tax is a tax on documents, instruments, loan agreements and

papers evidencing the acceptance, assignment, sale or transfer of an obligation, rights,
or property incident thereto.

3. Donor's Tax is a tax on a donation or gift, and is imposed on the gratuitous transfer of
property between two or more persons who are living at the time of the transfer.

4. Inheritance Tax is a tax on the right of the deceased person to transmit his/her estate to
his/her lawful heirs and beneficiaries at the time of death and on certain transfers which
are made by law as equivalent to testamentary disposition.

5. Income Tax is a tax on all yearly profits arising from property, profession, trades or
offices or as a tax on a person’s income, emoluments, profits and the like.

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CHAPTER 11: FINANCIAL DEVELOPMENT AND INFLATION

A country’s Financial System consists of a variety of interconnected financial institutions, both

formal and informal. A central bank lies at the core of the organized financial system and is
responsible for the control of the money supply and the general supervision of organized financial
activity. Virtually everywhere, and particularly in developing countries, the commercial banking
system is the most visible and vital component of the formal financial system, as acceptor of
deposits and grantor of short-term credit. Other elements of the formal financial system include

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savings banks; insurance companies; and in a growing number of middle-income countries,

pension funds and investment banks specializing in long-term credit as well as emerging stock
exchanges.
❖ Financial Policy – embraces all measures intended to affect the growth, utilization,
efficiency, and diversification of the financial system.
❖ Micro-credit Institutions – designed to reach left-out individuals.

Functions of Financial System

The financial system provides four basic services essential for the smooth functioning of an
economy:
1. It provides a medium of exchange and a store of value, called money, which also
serves as a unit of account to measure the value of the transactions.
2. It provides channels for mobilizing savings from numerous sources and channeling
them to investors, a process called Financial Intermediation.
3. It provides a means of transferring and distributing risk across the economy.
4. It provides a set of policy instruments for the stabilization of economic activity.

Money and the Money Supply

❖ Money – anything that serves a commonly accepted medium of exchange to facilitate

trade smoothly.
❖ Kinds of Money:
a. Commodity Money – money with intrinsic value
b. Fiat Money – money with no intrinsic value
❖ Functions of Money:
1. Medium of exchange
2. Unit of account
3. Store of value
❖ Demand for Money:
1. Transactions demand for money
2. Asset demand for money
❖ Price of Money
● Interest rate – amount paid for the use of a certain amount of money per unit of
time, expressed as a percentage of the amount used/borrowed.
● Nominal interest rate (i) – yields in units of money per year and per amount of
money invested.
● Real interest rate (r) – nominal interest rate corrected for inflation.
❖ Components of Money Supply

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1. Narrow Money (M1) – money used for transactions.

2. Broad Money or Near Money (M2) – includes M1 plus savings accounts and
demand deposits.
3. M3 – M2 plus investments in stocks and bonds. Money that needs to be converted
to casg before they can be used for transactions.

Flow of Funds through the Financial System

❖ Financial Intermediary – an entity that acts as the middleman between two parties in a
financial transaction, such as a commercial bank, investment bank, mutual fund, or
pension fund.
❖ Indirect Finance – borrowers borrow money from financial market through any kind of
third part intermediary.
❖ Direct Finance – borrowers borrow funds from financial market without any connection
of the third party institutions.

Inflation

From the 1980s to the present Price Inflation, defined as a sustained increase in the overall price
level, generally was regarded as a malady that in its milder forms was annoying but tolerable and
in its moderate from corrosive but not fatal. Run-away inflation, also known as Hyperinflation,

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however, always has been recognized as severely destructive of economic processes, with few
offsetting benefits.

❖ Inflation Episodes
o Chronic Inflation – prices rising 20 to 50 percent per year for three years or more.
o Acute Inflation – prices rising between 50 and 200 percent for three or more
consecutive years.
o Runaway (Hyper) Inflation – inflation rates in excess of 200 percent per year.

Controlling Inflation through Monetary Policy

❖ Monetary Policy – government’s management of the money, credit, and banking system
of the economy through a monetary authority/central bank.
❖ Reserve Requirements – are the amount of funds that a bank holds in reserve to ensure
that it is able to meet liabilities in case of sudden withdrawals. Reserve requirements are
a tool used by the central bank to increase or decrease money supply in the economy and
influence interest rates.
❖ Credit Ceilings – maximum amount that a person, company or entity can borrow.

The array of available instruments for anti-inflationary monetary policy in developed countries
includes:

1. Open-market operations – in which the central bank can directly contract bank reserves
by sales of government securities.
2. Increase in legal reserve requirements of banks – so that a given volume of reserves
support a lower stock of money.
3. Increases in rediscount rates – so that commercial bank borrowing from the central bank
becomes less attractive.

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4. Moral Suasion – which the exhortations of monetary authorities are expected to leas to
restraint in bank lending policies.

Financial Development

❖ Financial Deepening – refers to the increased provision of financial services with a wider
choice of services geared to all levels of society.
❖ Shallow Finance – means that the range of financial assets for that country is narrow.
❖ Deep Finance Strategy
o Mobilizing a larger volume of savings from the domestic economy – that is,
increasing the ratio of national savings to the GDP.
o Enhancing the accessibility of savings for all types of domestic investors.
o Securing a more efficient allocation of investment throughout the economy.
o Permitting the financial process to mobilize and allocate savings to reduce reliance
on the fiscal process, foreign aid, and inflation.
❖ Informal Credit Markets – financed by the savings of relatively wealthy individuals, such
as local landowners, trades, family members, and the pooled efforts of cooperative
societies.

UNIT 4: AGRICULTURE, TRADE, AND SUSTAINABILITY

CHAPTER 12: AGRICULTURE AND DEVELOPMENT

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When food prices rise dramatically, what does this imply for developing countries and the welfare
of the poor? If many of the poor are farmers, do they benefit from the kinds of food price
increases that have occurred in recent years? Some may benefit, if they produce and sell food in
sufficient quantities; yet, most poor household are net consumers of food. Similarly, most poor
countries are net importers of food. Hereby, increases in world food prices may be quite harmful.

Agricultural Systems

❖ Traditional Agriculture – where traditional farms tend to be small in area, typically less
than three hectares but intensively cultivates. Also traditional agriculture uses traditional
technologies, which typically rely on fewer purchased inputs (such as fertilizer,
insecticides, and pesticides), grow locally indigenous crop varieties, and operate, at low
levels of productivity.
❖ Farming systems, characterized by technology, mix of crops and livestock, and the
physical environment, vary widely across the developing world. The major types of
farming systems are:
o Shifting Cultivation – describes a system in which producers cultivate one area
until its fertility is exhausted and then migrate to another plot of land.
o Pastoral Nomadism – describes a farming system in which producers travel more
or less continuously. This mobility requires that their production system be based
on livestock, which the nomads shepherd across grazing areas.
o Settled Agriculture – includes a variety of systems, which as a group represent the
best potential for productivity growth. Some settled agricultural systems are the
following:

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▪ Intensive Annual Crops – the most dominant system in terms of total

cultivated area, typically concentrating in production of staple cereal crops
(wheat, rice, and corn).
▪ Mixed Farming – which builds on the interactions of crops and livestock
production to manage risk and maintain soil fertility.
▪ Perennial Crops – generally tree crops such as bananas, coffee, cocoa,
along with sugarcane, that produce for a period of years.
▪ Livestock Systems – producing dairy and meat products, either through
grain feeding (intensive production) or exclusively by grazing (extensive
production).

Unique Characteristics of Agricultural Sector

Economists Peter Timmer, Walter Falcon, and Scott Pearson identified five characteristics of the
agriculture sector that distinguish it from other sectors of most developing economies.
1. The agricultural sector’s share of GDP
2. The agricultural sector’s share of the labor force
3. Special characteristics of the agricultural production function
4. That much of the agricultural sector’s output is directly consumed by its producers
5. Agriculture’s role as a resource reservoir

Agriculture is a dominant sector in many of the world’s poorest countries. It plays an important
role in generating national income, it is also clear that the magnitude of that role has trended
downward over time. Nonetheless, the challenge of accelerating economic growth becomes
much more difficult if a large sector such as agriculture is left to lag behind the rest of the
economy.
❖ Structural Transformation – refers to the systematic changes in sector proportions as
economies grow.
o This process of structural transformation is driven by Engel’s Law, the observation
by nineteenth-century statistician Ernst Engel that the proportion of income spent
on food declines as income rises. This implied that income grows faster than the
demand for food, resulting in the decline of agriculture as a share of national
income.

Two-Sector Models of Development

1. The Labor Surplus Model – the best known of the early models appeared in David
Ricardo’s The Principle of Political Economy and Taxation, published in 1817. In his

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model, Ricardo included two basic assumptions that have played an important role in
the agricultural sector.
a. He assumed that agricultural production was subject to diminishing returns
because crops require land and the supply of arable land is limited. To increase
production, farmers would have to move onto poorer and poorer land, and
therefore each new acre of land matched with the same amount of labor would
produce less grain.
b. Ricardo formulated a concept that today is called labor surplus. It is believed
that the industrial sector could draw away surplus labor from the farms without
reducing total agricultural production or causing a rise in wages in either urban
or rural areas.

2. The Neoclassical Two-Sector Model – formalized by Harvard economist Dale Jorgenson,

differs from the labor surplus in two key ways:
a. The additional labor in agriculture is never zero.
b. There is no institutionally fixed minimum wage.

Agriculture and Economic Growth

⮚ The evolution of thought regarding the role of agriculture in economic growth is best
understood in terms of intersectoral linkages.
o Intersectoral Linkages – actions involving two or more sectors.
⮚ Agricultural productivity is not growth automatic. It requires substantial investment in
research and development, systems to extend new techniques to farmers, and
functioning input and output markets with appropriate incentives.

Agriculture and Poverty Alleviation

⮚ Agriculture provides a potent vehicle for addressing poverty, much of which is

concentrated in rural population. These contributions are direct and indirect and include
both those employed in agriculture and net food consumers for whom agricultural
growth reduces the price of food, often the major share of the household expenditures.

CHAPTER 13: TRADE AND DEVELOPMENT

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Trade provides low- and middle- income nations with significant opportunities to improve
welfare and accelerate growth and development. With more open trade, families and businesses
have more and better choices in price, quality, and array of products than if they buy only from
domestic firms. Producers have much large markets to which they can sell. If successful,
exporting firms can generate rapid job growth for large numbers of low-skilled workers, which
can have a strong impact on poverty reduction. Trade also invites investment and creates the
possibility for the transfer of new technologies from rich to poor countries, which can raise
productivity and incomes.

Trade Trends and Patterns

⮚ Trade patterns are also influenced by a country’s geographical characteristics, including

its access to shipping routes – especially whether it is landlocked – and its location
relative to major markets.

Who Trades?

The extent to which a country trades with the rest of the world depends on many factors. Small
countries, measured in this instance by population size, tend to trade more than larger ones, as
they cannot efficiently produce the full range of consumer goods, intermediate products, and
capital equipment demanded by consumers and businesses.

❖ Import Substitution – is the production of goods and services that replace (or substitute
for) imports.
❖ Outward Orientation – shifts the focus to producing for export for global markets.
❖ Comparative Advantage – describes trade patterns under assumptions of static
conditions that hold the factors of production in fixed supply and unable to cross borders.

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Comparative advantage has rich implications about the gains from trade. Among the most
powerful results are the following:
o A country can increase its welfare by trading because the world market provides
an opportunity to buy and sell goods at different prices than those that otherwise
would be available to a nation that closed its economy to the rest of the world.
o The smaller the country, the greater is this potential gain from trade.
o A country often gains most by exporting commodities that it produces using its
abundant factors of production most intensively, while importing goods whose
production requires relatively more of scarcer factors of production.
❖ Absolute Advantage – is the ability of an individual, company, region, or country to
produce a greater quantity of good or service with the same quantity of inputs per unit
of time, or to produce the same quantity of a good or service per unit of time using a
lesser quantity of inputs, than another entity that produces the same good or service.

The Benefits of Trade

The core of comparative advantage is that both countries gain from trade whenever the relative
prices of commodities in each country differ in the absence of trade. Once the two countries
begin to trade, the relative prices of commodities begin to shift until they are the same in two
countries. This is because the model assumes no tariffs, quotas, or other barriers to free trade
and it assumes that transport costs are negligible.

❖ International Terms of Trade – the ratio of the prices a nation receives for the goods it
exports relative to the prices it receives for the goods it imports. It is an important
determinant of the gains from trade.
❖ Gains from Trade – the extra production and consumption benefits that countries can
achieve through international trade.
❖ Gains from Exchange – refers to the net benefits to agents from voluntary trading with
each other.
❖ Gains from Specialization – when nations specialize, this exchange creates gains from
trade. The benefits of specialization include a larger quantity of goods and services that
can be produced, improve productivity, production beyond a nation’s production
possibility curve, and finally, resources that can be used more efficiently.

CHAPTER 14: SUSTAINABLE DEVELOPMENT

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Will economic growth save or destroy the environment?

1st decade of the 21st century Challenges:

1. Collapsing Financial Markets

2. Rising Unemployment Rate

3. Shrinking Middle Class

4. Deeper Inequalities

5. Extreme Indebtedness

6. Inability of Governments to force through reforms

7. Climate Change Problems

8. Scarcity

❖ Risk Society – the main reason for the current problems has been the inability of
modern societies to produce enough stability and sustainability.
❖ Stability – according to IMF (2012), is avoiding large swings in economic activity, high
inflation, and excessive volatility in exchange rates and financial markets.

“Economy is Stable”

❖ Sustainability – is the development that meets the needs of the present without
compromising the ability of future generations to meet their own needs (World
Commission on Environment and Development, 1987).

“Tragedy of the Commons” – Garret Hardin

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❖ Escape from Sustainability Dilemma:

a. Technology
b. Human Capital
c. Education

❖ Problem:

o Market Assumption – like a rocking horse, no matter the reason, a horse with
blinkers will move in an expected way.

❖ Approaches to Growth

o The Roll-over effect – domination of GDP index in measurements of

performance of national economies.

o More Growth – the more goods produced the better for economies.

o Amended Growth – GDP is just one important index. There are many more
indexes such as HDI (Human Development Index).

o End of Growth – “there are no ‘low hanging fruits’ anymore” – Tyler Cowen.
Slower pace of innovation.

References:

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Todaro, M. & Smith, S. (2015). Economic development 12th edition. Pearson. The
George Washington University.
Perkins, D., Radelet, S., Lindauer, D., & Block, S. (2013). Economics of
development 7th edition. W.W. Norton & Company.
Fajardo, F. (1995). Economics 3rd edition, Manila: Rex Bookstore, Inc.

Mc Graw-Hill, I. (2006). Macroeconomics 6th edition, New York: Mc Graw Hill

Companies Inc.

Prepared and submitted by:

John Pius Mailes D.C. Donado

Faculty

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