Lecture #7.

HUMAN DEVELOPMENT INDEX

Human Development Index (HDI)

The HDI was created to emphasize that people and their capabilities should be the ultimate criteria
for assessing the development of a country, not economic growth alone. The HDI can also be used
to question national policy choices, asking how two countries with the same level of GNI per capita
can end up with different human development outcomes. These contrasts can stimulate debate
about government policy priorities.
The 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.
The health dimension is assessed by life expectancy at birth, the education dimension is measured by
mean of years of schooling for adults aged 25 years and more and expected years of schooling for
children of school entering age. The standard of living dimension is measured by gross national
income per capita. The HDI uses the logarithm of income, to reflect the diminishing importance of
income with increasing GNI. The scores for the three HDI dimension indices are then aggregated
into a composite index using geometric mean.
The HDI simplifies and captures only part of what human development entails. It does not reflect
on inequalities, poverty, human security, empowerment, etc. The HDRO offers the other composite
indices as broader proxy on some of the key issues of human development, inequality, gender
disparity and poverty.
A fuller picture of a country's level of human development requires analysis of other indicators and
information presented in the statistical annex of the report.

SOURCE: UNITED NATIONS DEVELOPMENT PROGRAMME (UNDP)

Lecture #8. BUSINESS CYCLE AND ECONOMIC GROWTH

Phases of Business Cycle

Any economy, whether local, national, or international, follows the four phases of a business cycle.
The phases of a business cycle include:
1. Prosperity
2. Recession
3. Depression
4. Recovery
The time frame of each phase depends on various factors that affect an economy. For instance,
insufficient supply of oil leads to increase prices and eventually may lead to a worse economic situation for
importing countries. Also, the calamities hitting many countries in the world are dragging down the economy
to depression.

Time
Figure 40. The Business Cycle

Circular flow of an Economic Activity

The economic model is a simplification of economic reality. It can be presented into the following
forms:
a. Mathematical equations
b. Set of diagrams
c. Scheme or flow charts.

Macroeconomic models provide a systematic guide that permits the complexities of the operations of
the economy as a whole for understanding and interpretation.

Macroeconomic analysis aims to diagnose the reason for failure in achieving economic goals and to
point the way toward better performance in the future.

The economic model depicting the circular flow of goods and services (output) and income is shown
in the following diagram:
 BANKS

Figure 39. Circular flow of economic activity

reflecting the outflows and inflows

We see that the consumers provide economic resources to the business firms. These economic
resources or inputs of production are utilized to produce goods and services. These will in turn be passed on
to the consumers.

The flow of physical goods is accompanied by a flow of income. The consumers deliver the
economic resources to the producers with corresponding payments. These payments are in the form of
wages and salaries, interest and rent. On the other hand, the goods and services produced by the firms will
be passed on to the consumers thru payments too, called consumption expenditures.

The incomes received by the consumers are spent for the purchase of goods and services. If there is
an equilibrium, that is the total demand of the consumers equals the amount of goods and services produced
by the business firms then everything is reverted back into the system. However, the consumers do not
always spend all the income they received. A portion of the income is saved. This amount saved is not
returned into the system. Thus, savings have the effect of decreasing the level of economic activity in the
flow. Savings constitute the first outflow from the stream.

The existence of the government in the model shows that from the income derived by the
consumers, a portion of it goes to the government in the form of taxes. Taxes lessen the disposable income
of the consumers thereby decreasing the amount for spending. Taxes therefore decrease the level of
economic activity and constitute the second outflow.

When we import foreign goods and services, such amount paid flowed out of the system. Hence,
imports lessen economic activity and constitute the third outflow.

If there is a continuous outflow in the economy, recession sets in and eventually led to depression.
Siphoning back the lost funds can offset this situation. When consumers save, normally in banks, such
amount can be reverted back to the system if the banks will invest such funds. Banks can lend the said funds
to the business sectors so that the latter will have money to produce goods and services. If investment is
equal to savings, it offsets the outflow caused by the savings of consumers.

When the government collects taxes, these are used to defray expenses such as infrastructure, social
services, education, etc. In doing so, the amounts are spent back into the system and offset the outflow in the
form of taxes.

When the Philippines imports goods, it expects that other countries reciprocate by buying our goods.
When these countries buy our goods, funds flow back into the system. Hence, export offsets import.

Equilibrium condition: Outflows = Inflows

Leakages = Injections
S + T + M = I + G + X

When the outflow equals the inflow, the level of economic activity is maintained. An excess inflow
over the outflow results to expansionary. A contracting economy follows if the outflow exceeds the inflow.
Manipulating the outflow and inflow can affect the level of economic activity. However, the outflows are
difficult to control because they are dependent on income. When income increases, savings, taxes and
imports tend to increase too. In contrast, inflows are easier to manipulate. Therefore, proper government
policy can encourage exports and investments.

In order to manipulate the inflows and outflows, various policies can be implemented. Monetary
policy can affect savings and investment. Fiscal policy can control taxes and government expenditures. While,
trade policy can affect the country’s exports and imports.

Economic Growth and Business Cycles

No economy can sustain growth and development over a long period of time. This is because every
business is affected by various factors classified as:
1. Exogenous – These are forces outside the economic system like natural calamities, political crisis,
wars or technological changes. No economy can sustain development if natural calamities, war
or any exogenous factors hit the country.
2. Endogenous – These are forces within the economic system like multiplier, accelerator,
monetary policies or innovations.
Lecture #9. EQUILIBRIUM INCOME

Consumption is the part of income spent on goods and services yielding direct satisfaction. It
occupies the biggest chunk of the expenditure on output.

Y=C+S
Where Y = Income
C = Consumption (spent portion of Y)
S = Saving (unspent portion of Y)

Factors influencing consumption include the following:

1. Distribution of national income. When income is equally distributed, then many will have
the opportunity to consume. Therefore, consumption will be high. However, if income is
unequally distributed (with the rich people getting the lion share of the income) then the
many poor are deprived to consume. Hence, consumption is low.

2. Interest rate. A high interest rate encourages people to save and consume less.

3. Desire to hold cash. For some personal or business reasons, some people desire to hold
cash, thereby decreasing consumption.

4. Price Level. During inflation when prices are high, people tend to spend more.

5. Population. A high population makes more people buy goods and services.

6. Income. High income implies more consumption.

7. Taxes. More tax on income reduces disposable income thereby decreasing consumption.

8. Attitudes and values. People’s attitudes and values over cash can influence consumption.
Those who are typically thrifty have lower consumption while those who are extravagant
naturally have higher consumption.

(Reference: Fajardo, 1990)

Consumption function is the relationship between consumption and income. All things being
equal, the amount of consumption depends on income. The higher the income, the higher also is the
consumption and vice versa.
 Table 27. Consumption schedule
Income Consumption
100 185
200 240
300 300
400 365
500 420
600 470

Changes in the income result to changes in the consumption. It can be measured by taking
the marginal propensity to consume (MPC) or the slope of the consumption function. Algebraically,
it is obtained with this formula:

C
MPC =
Y

If the consumption is equal to the income, then the MPC is equal to one. When the
consumption is less than the income, the MPC gets less than one. And when the consumption
exceeds income, the MPC is greater than one. Is it possible that the consumption gets higher than
the income? This is possible by utilizing past savings or getting into borrowing.
 Saving is the part of income that is not consumed. If the income equals the consumption,
there is no saving. When the income exceeds the consumption, the saving is positive and when the
income is less than the consumption, the saving is negative or there is a dissaving.

S=Y–C

Table 28. Consumption and savings schedule

Income (Y) Consumption Savings
100 185 -85
200 240 -40
300 300 0
400 365 35
500 420 80
600 470 130

A change in the income can affect the saving. This can be measured through the marginal
propensity to save (MPS) or the slope of the saving function. The formula is as follows:
S
MPS =
Y MPC + MPS = 1

Table 29. Marginal propensity to consume and save.

Income (Y) Consumption Savings MPC MPS
100 185 -85 - -
200 240 -40 0.55 0.45
300 300 0 0.60 0.40
400 365 35 0.65 0.35
500 420 80 0.55 0.45
600 470 130 0.50 0.50
700 550 150 0.80 0.20
800 640 160 0.90 0.10
 If the consumption function is

C = a + bY Where a = intercept or C if Y=0 or Co

b = slope or MPC
C = 20 + 0.90 Y

a = (intercept) 20 means that if income is zero, consumption is equal to 20 units.

b = (slope or the MPC) 0.90 means that for every P1.00 additional income, P0.90
is spent for consumption expenditures.

To derive the savings function from the above given consumption function, below is the procedure:

Since, Y = C + S
Substitute the value of C (given above) into Y = (a + bY) + S
Y = a + bY + S
Y - bY = a + S
1-b(Y) – a = S
Re-arranging:
S = -a + 1-b(Y)
Substituting the values given above:
S = -20 + (1-0.90)Y
S = -20 + 0.10 Y

a = (intercept) –20 means that if there is no income, saving is

-20. Notice that the result is consistent with the consumption function. If there
is no income, there is still consumption of 20 suggesting a dissaving (-20).

b= (slope or MPS) 0.10 means that if there is a P1.00 additional

income, P0.10 will be saved.

Investment and the Multiplier Effect

Investment is the expenditure on new capital goods. Capital goods are the produced goods
which are used to produce other goods.

Investment is very important in an economy because it creates employment, production and

consumption. It is one important (and most fickle) component of the country’s GNP. There are
various factors affecting investment. The Marginal Efficiency of Investment (MEI) or the Returns
on Investment (ROI) is one major determinant of investment. This is affected by factors like
population, price level, technology, peace and order, and government policies. The interest rates
affect the investment, too. A high interest rate would definitely discourage the investors and vice
versa.

When the economy is at equilibrium, the investment is equal to savings. Savings placed in
banks and other financial institutions become the funds for investments. Investment serves as an
injection to the system providing more production, income and consumption. Investment creates
more income several times. This is called the multiplier effect.

Example: Mr. Eman Wang Chu put up a noodle factory. He invested P10 M. The P10M
becomes the income of those who built the factory and those who supplied the materials needed in
the construction. But this is not the end of the flow. Those workers and construction suppliers who
initially received the P10M salary use their income to purchase their daily needs. So another group
of people would receive the same money invested by Mr. Eman Wang Chu. And the process goes
on and on. This is the multiplier effect. A single investment has created a repercussive series of
income.
(Reference: Fajardo, 1990)
 The schematic explanation of the multiplier effect is shown below:

Additional Increase
Employmen Income
Ttt

Increase
Additional Consumptio
Investment

Additional Increase
Production Demand

Figure. The Multiplier Effect

The concept of multiplier is related to accelerator effect. The effect of consumption on

investment is called the accelerator effect. More consumption encourages the businessmen to
increase production which opens the way for more employment. More employment on the other
hand stimulates more income which leads again to higher consumption. This accelerates economic
growth.

Paradox of Thrift

At equilibrium, saving equals investment. According to classical economists, economic

growth depends on capital formation. In order to accumulate capital, it is necessary for society to
save for investment funds. Hence, more savings is good because more funds will be available for
investment. However, according to John Maynard Keynes, the attempt of consumers to save more
will reduce savings. This is known as the paradox of thrift (Fajardo, 1990).

To illustrate the paradox of thrift, here is an example. Suppose everyone will not buy soft
drinks as a form of savings (being thrifty), then the soft drinks industry will eventually collapse.
Everyone employed in the industry becomes jobless. They will not have any income. Consumption
of other goods and services inevitably will decrease. Production of these goods and services will go
down and massive lay-off of workers will follow. This situation perpetuates until the economy
shrinks. When this happens, savings will contract. Evidently, what is good therefore to an
individual may be inimical to all.
Lecture #10. ECONOMIC POLICY
The economy of governments covers the systems for setting levels of taxation, government budgets,
the money supply and interest rates as well as the labor market, national ownership, and many other
areas of government interventions into the economy (Investopedia, February 2, 2022).
Economic policy is the term used to describe government actions that are intended to influence the
economy of a city, state, or nation. Some examples of these actions include setting tax rates,
setting interest rates, and government expenditures.
The Philippines has traditionally had a private enterprise economy both in policy and in practice.
The government intervened primarily through fiscal and monetary policy and in the exercise of its
regulatory authority.

What is the importance of economic policy?

To maintain a strong economy, the federal government seeks to accomplish three policy goals:
stable prices, full employment, and economic growth. In addition to these three policy goals, the
federal government has other objectives to maintain sound economic policy.

These generally include the interest rate and money supply, tax and government spending, tariffs,
exchange rates, labor market regulations, and many other aspects of government.
New Economic Policy refers to economic liberalization or relaxation in the import tariffs,
deregulation of markets or opening the markets for private and foreign players, and reduction of
taxes to expand the economic wings of the country.

The main objectives behind the launching of the New Economic policy (NEP) in 1991 by
the union Finance Minister Dr. Manmohan Singh are stated as follows:
1. The main objective was to plunge Indian Economy in to the arena of ‘Globalization and to give
it a new thrust on market orientation.
2. The NEP intended to bring down the rate of inflation
3. It intended to move towards higher economic growth rate and to build sufficient foreign
exchange reserves.
4. It wanted to achieve economic stabilization and to convert the economy into a market economy
by removing all kinds of un-necessary restrictions.
5. It wanted to permit the international flow of goods, services, capital, human resources and
technology, without many restrictions.
6. It wanted to increase the participation of private players in all sectors of the economy. That is why
the reserved numbers of sectors for government were reduced. As of now this number is just 2.
Major Economic Policies

1. Monetary Policy
Monetary policy is a set of tools used by a nation's central bank to control the overall money supply
and promote economic growth and employ strategies such as revising interest rates and changing
bank reserve requirements. In the United States, the Federal Reserve Bank implements monetary
policy through a dual mandate to achieve maximum employment while keeping inflation in check.
Fiscal policy refers to the governmental use of taxation and spending to influence the conditions of
the economy. Typically, fiscal policy comes into play during a recession or a period of inflation,
where conditions are escalating quickly enough to warrant government intervention. A good
application of fiscal policy, in theory, should be able to stabilize a teetering economy and facilitate
continued growth.

2. Fiscal Policy
The purpose of fiscal policy is to implement artificial measures to prevent an economic collapse and
to promote healthy and steady economic growth. Fiscal policies can be
either expansionary or contractionary.

Expansionary Policy
Expansionary policy, which is the more common of the two, is when the government responds to
recession by lowering taxes and increasing government spending.

The principle at play is that when taxes are lowered, consumers have more money in their pockets to
spend or invest, which increases the demand for products and securities.

Increasing demand for goods, as well as increased government spending, leads firms to hire more
employees, lowering unemployment, as well as compete for employees more fiercely, which can
increase wages.

This gives consumers yet more funds to spend, hopefully pulling the economy out of recession over
time. This is known as a virtuous cycle.

Contractionary policies are applied during a period of inflation. During this the government may
reduce spending on public projects or even reduce public-sector wages or the size of the workforce.

Contractionary policies are uncommon, though, because the preferred approach to reigning in rapid
growth is to institute a monetary policy to increase the cost of borrowing.

3. Trade Policy
Trade policy defines the laws related to the exchange of goods or services involved in trade
between different countries, including taxes, subsidies, and import/export regulations.

Trade policy. includes any policy that directly affects the flow of goods and services between
countries, including import tariffs, import quotas, voluntary export restraints, export taxes,
export subsidies, and so on.