Management and

Business in Context 2
seminar 5.

Growth and Inequality

Thinking Problem
 Why is the average American so much
richer than the average Indian?
 International comparison of living standards
 Explaining inequality

 Why are you so much more prosperous

than your great-great-grandparents
were?
 Intertemporal comparison of living standards
 Explaining economic growth
INTERNATIONAL
COMPARISON
Compare 3 Countries (2010)

United States Peru Norway

 GDP = $14.45  GDP = 444.46  GDP = 2.57

trillion billion nuevo sols trillion kroner
 Population =  Population =  Population =
310 million 28.95 million 4.68 million
 GDP per capita  GDP per capita  GDP per capita
= $46,613 = 15,353 sols = 549,962
kroner
 The Exchange Rate Method

 Convert GDP into U.S. dollars, using

current exchange rates

 GDP in $ = ?-

$
= GDP in local currency × e−rate
local currency
 Compare by the ER Method

United States Peru Norway

 GDP per capita  GDP per capita  GDP per capita

 = 15,353 sols  = 549,962 kroner
× 0.354 $ / sol × 0.165 $ / kr.

 = $46,613  = $5,435  = $90,744

 GDP per Capita Rankings in 2010
Using the ER Method
Ranking Country GDP per Capita

1 Qatar 141,845
2 Luxembourg 108,537
3 Norway 90,744
12 United States 46,613

87 Peru 5,435

189 Dem. Rep. of Congo 189

190 Burundi 151
191 Somalia 109
© 2015 Pearson Education, Ltd.
2 Problems with the ER Method

 Prices of goods and services can vary

across economies.
 Exchange rates fluctuate throughout the
year due to reasons beyond price
changes.
 The PPP Method

 PPP: Purchasing Power Parity

 Take into consideration the difference of
price levels as well

 GDP in $ =

$
= GDP in local currency × PPP adjustment
𝒑𝒆𝒔𝒐
PPP Adjustment

 Set a representative basket of G&S

 Find the rate that makes the value of the
basket equal across the border
 E.g.: if the basket costs $10 in the USA and 17.03
sols in Peru than
10 $ $
 the PPP adjustment is = 0.587
17.03 𝑠𝑜𝑙 𝑠𝑜𝑙
 1.7 sols for $1
 $0.587 for 1 sol
 Compare by the PPP Method

United States Peru Norway

 GDP per capita  GDP per capita  GDP per capita

 = 15,353 sols  = 549,962 kr./p
× 0.587 $ / sol × 0.109 $ / kr.

 = $46,613  = $9,012  = $59,946

Exchange Rate vs. PPP Big Mac Index

Peru Norway
 PPP adjustment:  PPP adjustment:
0.587 $ / sol 0.109 $ / kr.
 Exchange rate:  Exchange rate:
0.354 $ / sol 0.165 $ / kr.
 Undervalued  Overvalued
currency currency
 Exchange rate is  Exchange rate is
„smaller” (*) than PPP „larger” (*) than PPP
(*) Be careful with the denomination!
 PPP Adjustment

 More realistic comparison of living

standards
 Raise the income levels of countries
with undervalued currencies
 Many developing countries
 Reduce the income levels of countries
with overvalued currencies
 Still very large disparities remain in
income per capita across countries
Income per Capita in 2010
(PPP-adjusted 2005 constant dollars)

Exhibit 20.1
© 2015 Pearson Education, Ltd.
Income per Capita in 2010 (PPP)

Exhibit 20.2

© 2015 Pearson Education, Ltd.

Inequality Around the World

 Income per capita measures well

differences in living standard
 It is an incomplete measure
 Well-being, environment, safety, etc.
 Does not reflect inequality within a country
HDI vs. Income per Capita in
2010 (PPP-adjusted 2005 constant $)

Exhibit 20.6
© 2015 Pearson Education, Ltd.
INTERTEMPORAL
COMPARISON
 Economic Growth

 Measurement ?
 Real vs. nominal growth
 Economic output vs. living standard

 Economic growth:
 The increase in real GDP per capita
 In ch.21: PPP adjusted 2005 constant dollars

 Exponential growth
(seminar 4.)
 Richest and Poorest Economies
Real GDP per Capita Implied
in PPP 2005 Growth (%)
1960 2010
Luxembourg 17,601 75,589 2.91
Singapore 4,383 55,862 5.22
Norway 12,524 50,488 2.79
United States 15,398 41,365 2.00
Austria 15,256 41,114 1.98
Central African Rep. 968 589 –0.99
Niger 861 522 –1.00
Burundi 344 397 0.29
Zimbabwe 285 320 0.23
Dem. Rep. of Congo 696 241 –2.10
Penn World Tables 7.1.
 Fastest- and Slowest-Growing
Economies
Real GDP per Capita Implied
in PPP 2005 Growth (%)
1960 2010
Singapore 4,383 55,862 5.22
Botswana 674 9,676 5.33
South Korea 1,656 26,609 5.71
Taiwan 1,862 32,105 5.69
Equatorial Guinea 611 13,959 6.26
Guinea 915 788 ‒0.3
Madagascar 1,052 703 ‒0.81
Central African Rep. 968 589 ‒0.99
Niger 861 522 ‒1.0
Dem. Rep. of Congo 696 241 ‒2.1
Penn World Tables 7.1.
 Average Growth Rates of GDP Per
Capita from 1960 to 2010

Exhibit 21.7
(PPP-adjusted 2005 constant dollars) © 2015 Pearson Education, Ltd.
 The Maddison Project
1820 – 1920 –
1820 1920 1970 2010
2010 2010
U.K. 2,854 6,259 14,818 32,722 1.29 1.85
U.S. 1,873 7,641 20,684 41,962 1.65 1.91
Argentina 1,374 4,780 10,049 14,115 1.23 1.20
Hong Kong 846 1,760 7,838 42,283 1.92 3.56
Chile 832 3,810 7,199 19,106 1.65 1.80
South Korea 461 839 2,983 29,864 2.22 4.05

Exhibit 21.8
© 2015 Pearson Education, Ltd.
Ch. 21.3

HISTORY OF GROWTH
 Average Global Real GDP per
capita (PPP adjusted 2005 dollars)
$10,753
(2005 dollars)
10,000
9,000
8,000
7,000
6,000
5,000
$3,001
4,000
$1,217 $2,124
3,000
$846
$642
2,000
1,000
0
1 1820 1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

Source: The Maddison Project Exhibit 21.10

© 2015 Pearson Education, Ltd.
Economic Growth

 Is a recent phenomenon
 Relevant for the last 200 yrs only
 Three distinct periods
 Pre-modern times: up to 1800
 Industrial Revolution: 1800 to 1820
 Post-Industrial Revolution: 1820 to present
 Malthusian Cycle

 Thomas Malthus (1798)

 Humankind was destined to live at the subsistence
level – the minimum that is necessary to survive.
 An increase in income per capita above the subsistence
level would lead to higher fertility rates
 The higher fertility rates would drive income per capita
back down to the subsistence level
 Because of scarcity of natural resources; e.g.: arable
land
Economic History
 Economies of pre-modern times were stuck in the
Malthusian cycle
 The Industrial Revolution
 Innovations, technological progress in production and then also in
transportation
 Demographic transition
 The movement of people from rural agriculture to urban manufacturing
led to a drop in fertility rates
 The Post Industrial Revolution period has
experienced sustained growth in income per capita
due to
 Innovations in transportation, communications, electricity, and
computers
Ch. 21.4

GROWTH AND INEQUALITY

Economic Growth

 GDP per capita does not measure the

income of all individuals in that nation
 Income inequality within a nation can
remain significant
 T. Piketty
 Inequality increases with rapid growth
Income Accruing to the Top 10%

Exhibit 21.12
© 2015 Pearson Education, Ltd.
Growth vs. Poverty

 Poverty rate
 the percentage of the population living under $1.25
per day
 There is a negative relationship
between economic growth anf growth of
poverty
 This does not prove that growth causes declining
poverty
 It shows that economic growth can provide an
effective way of reducing poverty
Growth vs. Poverty

Exhibit 21.13
© 2015 Pearson Education, Ltd.
Key Ideas

 Income per capita

 Exchange rate method
 PPP method, PPP adjustment
 Compare e-rate method with PPP
 Big Mac index
 Overvalued / undervalued currency
 Economic growth
 Exponential growth
 Malthusian cycle
 Poverty rate,, growth vs. poverty, inequality
To do for next seminar

 Read ch.21 of Acemoglu et al. (2016).

 Consider the thinking problems on
moodle