Price Elasticity of Demand: how sensitive is the demand for a product to a change in the products own price.

Defining elasticity of demand: Ped measures the responsiveness of demand for a product following a change in its own price.
the co-efficient of elasticity of demand = Percentage change in quantity demanded the percentage change in price

Understanding values for price elasticity of demand If Ped = 0 then demand is said to be perfectly inelastic. This means that demand does not change at all when the price changes the demand curve will be vertical If Ped is between 0 and 1 (i.e. the percentage change in demand from A to B is smaller than the percentage change in price), then demand is inelastic. Producers know that the change in demand will be proportionately smaller than the percentage change in price If Ped = 1 (i.e. the percentage change in demand is exactly the same as the percentage change in price), then demand is said to unit elastic. A 15% rise in price would lead to a 15% contraction in demand leaving total spending by the same at each price level. If Ped > 1, then demand responds more than proportionately to a change in price i.e. demand is elastic. For example a 20% increase in the price of a good might lead to a 30% drop in demand. The price elasticity of demand for this price change is 1.5

We shall concentrate on the growth of gross domestic product at factor cost valued at 1993-94 prices. We shall consider the growth of per capita national income, also valued at 199394 prices, which can be taken as the simplest indicator of the level of living or development. In an earlier chapter, one of the notions of development was posed in terms of structural change along with growth. What do we mean by structure? Most people mean by it production structure, that is, composition of output produced by the economy. Some would like to find out how and where our labour is absorbed. Other factors such as land and capital are not given equal importance. Some would also like to find out how the production of output is divided between rural and urban areas of the country or between public and private sectors of the economy or between organised and unorganised sectors. We shall discuss all of them. But we can appreciate developments since Independence better once we have a little hint about the scene on the eve of Independence.

Economy on the eve of Independence

We had inherited an economy, which was basically geared to the interest of our colonial masters. The rate of growth of per capita income during the hundredyear period before Independence, from whatever scanty information is available, was just 0.5 per cent per annum. It has further been noted that there were long spells when the economy actually stagnated or declined. In the past, we were known for producing fine cotton fabric, handicrafts and other merchandise. Even during the early British Raj, that is, before the onset of industrial revolution in Britain, our economy was an industrial economy by the standards of those days whereas the European economies had yet to usher in modern civilisation. Yet, by the time we got Independence, our economy was primarily reduced to an agricultural economy and we used to export mainly raw materials and minerals for the British industries and even foodgrains while we might have been hungry ourselves. In 1950-51, our per capita income was no more than Rs 3,700 at 1993-94 prices (while in 1999-2000, it is a little more than Rs 10,000). The contribution of agriculture sector (including animal husbandry and livestock) to the GDP was around 54 per cent by current prices and 50 per cent by constant prices of 1993- 94. If we include forestry and logging and fishing in this sector, then the contribution turns out to be 57-58 per cent. And, if we add mining and quarrying and call the combined sector as primary sector, the contribution of primary sector is found to be about 60 per cent. Manufacturing contributed only around 10 per cent. Contribution of the service sector was thus around 30 per cent. Most of the people were engaged in agricultureas cultivators on their own tiny holdings or as wage labourers on others fields.

Growth of GDP since 1950-51

Growth of an economy is reckoned with growth in its GDP at constant prices. We have now a complete series of gross domestic product at 1993-94 prices from 1950-51 onwards but we give here the GDP series at five yearly interval (see above table). However, in order to give you a feel about the general tendency of rise and occasional decline in a few years in comparison to their respective preceding years, we give here a graphical presentation of the whole series. We notice from the graph that there were occasional drops in the GDP which we do not notice in the abridged Table presented here. But, generally it has been rising. Over the period of last fifty years, it has increased more than eight times. But we are and should be more interested to know whether growth rate itself has risen over time. We can also calculate rates of growth for different plan-periods or different decades or for periods divided by significant events. All such breakups have been used by scholars. We shall calculate growth rate per annum by decades only. We shall use two popular methods ofcalculation of annual rate of growth for long periods, viz. average annual growth and compound annual growth rate.

Growth of Per Capita Income

Per capita income is the ratio of net national product to the (mid-year) size of population. Net national product is likely to follow the pattern of gross domestic product, as the component of net factor income from abroad is small in comparison to the total. Population has been secularly rising in the last fifty years though, of late, the rate of growth of population has started declining. We can remember that, in the case of population, we have only decennial figures and, therefore, can calculate only a single rate of growth of population. Using this technique, population size for each mid-year is interpolated. Dividing net national product by the size of population, per capita income is calculated. Annual per capita income has risen a little less than three times from a little less than Rs 3,700 in 1950-51 to over Rs10,000 in 2000-01, at constant prices of 1993-94. In none of the years shown here, there is a decline over the year in the previous row. But, one can notice that there is hardly any rise in 1965-66 over 1960-61, that is, after a gap of five years. Generally, there is some rise in normal years. It means that 1965-66 was a particularly bad year. In fact, 1965-66 and 1966-67 were years of severe drought, though they gave us green revolution. However, with a view to giving you an idea about the wider fluctuations in case of per capita income, we give here the graphical presentation.

Changes in Production Structure of the Economy

As an economy grows, its production structure changes. It moves from agriculture towards manufacturing and structure changes. It moves from agriculture towards manufacturing and services. It is understandable. You might have noticed that relatively well-off families spend proportionately less on food items and more on manufactured items. You may also note in your family that, as income increases, expenditure on items other than food increases more than proportionately. But, you should note that normally absolute amount of expenditure does not, broadly speaking, decline; in fact, increases but less than proportionately. It implies that production structure should shift away from agriculture. Moreover, many agricultural products, which used to directly reach the households, will now reach after some processing and through long channel of distribution. Bread, noodles, sauces and juices are good examples. It means activities of manufacturing and trade will increase. So, let us see how the production structure has changed. We know that hundreds of thousands of activities are always in operation in any modern economy. Many activities emerge and some of them die down; some of them even re-emerge, may be, in a modified form. But, it is difficult to discuss in terms of each single item. We often aggregate them on the basis of similarity of products or nature of activities. Our Central Statistical Organisation uses nine broad categories, called sectors. Six of them are further subdivided in two/three/four subcategories. Industry as a sector does not occur in it; industry is accommodated in mining (and quarrying), manufac-turing and electricity. In total, there are 18 categories, sectors and sub-sectors, in which total economic activity of the country is presented in the National Accounts Statistics. There are, however, two three-fold classifications in which economists discuss changes in production structure. One is agriculture, manufacturing/ industry, and services and the other is primary, secondary and tertiary. Besides cultivation of crops, agriculture includes livestock and animal husbandry. But forestry and logging and fishing are clubbed with agriculture to make a broad sector of agriculture, forestry and fishing. If we add the sector of mining and quarrying to this sector, we can call it primary sector as these activities are associated with nature. The manufacturing sector is further subdivided into registered and unregistered manufacturing, depending upon whether manufacturing units are registered under Factories Act 1948. Industry may include manufacturing and mining and quarrying. On the other hand, if we club the sectors of electricity, gas and water supply and construction with manufacturing, we can call it secondary sector. This is just a matter of convention. There may be differences between countries and within a country changes in classification may occur over time. We did not have exactly the same classification always. While new products gain entry with each major revision of national accounts, some swapping of activities is possible. For example, earlier LPG gas was included in

the sector of electricity, gas and water supply, now it is part of manufacturing. While we shall highlight some salient features of production structure or composition of output, it would be interesting for you to do your own exercises and develop your own views on contributions of different sectors.

Absolute Contribution of Different Sectors

It is easy to see that agriculture production has been continuously on increase and has increased about fourfold. Since our Table does not include all the years, we do not find any drop in agricultural production. There are many periods when agricultural production actually fell. Whenever we notice a fall in the gross domestic product, a major reason is likely to be a fall in agricultural production as its contribution to GDP had been substantial. We were most severely hit in agriculture in the consecutive years of 1965-66 and 1966-67. These years, however, gave us green revolution. We are now quite comfortable with the overall performance of agriculture. Yet, we had had two-three years of setback in each of the decade. We should remember that agriculture gives us food, milk and meat and gives to industry the raw material needed particularly for consumer goods industries. Compared to agriculture, other sectors included in primary sectors are small; the contribution of primary sector is found to have risen only four times. Manufacturing which contributed about Rs 12,500 crore in 1950-51, contributed to the tune of Rs. 2,00,000 crore in 1999-2000, almost sixteen-fold increase over the period. Annual construction activity also rose ten times. Construction does not mean only houses but also roads and railway lines, dams, and canals, bridges and flyovers, etc. and also huts. Electricity, gas and water supply were in nascent stage in the wee hours of Independence, contributing less than Rs 500 crore at 1993-94 prices. Its contribution rose 60 times in 50 years. Overall contribution of the secondary sector rose fifteen-fold. Trade along with hotel and restaurant business rose fourteen-fold over the period while transport along with storage and communication rose eighteen-fold. Financial and business services including insurance and real estate also rose fifteen times while community, social and personal services, including public administration and defence rose only eleven-fold. Thus, in the second half of the twentieth century while the contribution of primary sector to GDP rose to four fold that of secondary and tertiary sectors rose by fifteen fold each.

Indicators of Development

Per Capita Income

Gross domestic product is supposed to measure the level of output produced by the economy during an accounting period. However, the command of people over goods is somewhat different than GDP. We have our property outside our own national economy and some of our nationals work in other countries. As a result, we earn wage income or property income outside the country. Similarly, foreigners have property in our economy and some foreigners do work here. Adjusting for these incomes, we get gross national product (GNP). In the case of large countries and countries having little interaction with other countries for factors of production, GDP and GNP are not very different. But, there are economies where GNP and GDP are quite different. In our case, GNP is somewhat less than GDP. It may be noted that GNP better represents the entitlement of the nationals of a country (individuals and their collectivities) while GDP actually shows the output of the activities carried out within the economic boundaries of the country. Still further, we should take account of consumption of fixed capital in the process of production. We should ensure that the capital stock is kept intact during the year; otherwise, we shall, one day, eat away the whole of our fixed capital. So, we should subtract that amount of capital, which we think has been consumed in the process of production. Then, what we shall get is known as Net National Product (NNP). Net national product is also known as the national income. We shall use a particular version of net national product known as net national product at factor cost and designate as NNPFC. Now, if we want to compare the welfare of people at two points of time or of two economies at the same point of time, it becomes necessary to find out the size of population. From the view point of welfare or well-being of the people, for which development is pursued, it is suggested that the NNPFC, valued at constant prices, should be divided by the size of the population. NNPFC divided by population is popularly known as per capita income. It helps us to compare the level of development of the country in 2001 when we are 100 crore with that in 1961 when we were 43 crore only. In order to render international comparisons meaningful, national incomes should be divided by sizes of their respective populations. Otherwise a country like Canada, which by all standards, is considered a rich country, could be found to be poorer than India. The population of India may be 30 times that of Canada. Such a division (deflation/normalisation) is needed even to assess the progress over time. For example, our NNPFC has grown a little more than eight fold over the last fifty years but the population has also almost trebled during this period. As a result, per capita income has grown less than three times. Our living conditions can be expected to have become better by a factor of three rather than by a factor eight. With this in view, per capita national income has come to be increasingly used. In short, it helps us to compare the development of India with that of the USA or with that of Pakistan for any given year as also our own development over time. We may further note that it is this indicator, which is often used to categorise countries as developed/ underdeveloped countries or high/ middle/low income countries. In the case of international comparison, per capita incomes of different countries have to be brought to a common currency. However, it is very often pointed out that its scope is quite limited. Most of the limitations arise from the numerator whatever it may be, namely, GDP, GNP or NNP. These concepts do not account for the economic activities performed inside the household, which are non-marketed. Bulk of womens household work gets ignored, while it is equally important from the point of view of well-being and welfare of people. It does not adequately capture activities performed even outside household. As production is valued in terms of market prices, activities for which there does not exist market do not adequately get accounted for. It is also pointed out that economic welfare, which it can measure, even though imperfectly, is not the total welfare that the people look for.

Distribution of national income over individuals is an important dimension, which cannot be ignored. National income and its distribution, both, have to be considered together. It has been argued that the welfare of a society depends on what is the size of the cake and how it is distributed over people. Over time, people have come to enjoy more leisure, which, according to many, may be the ultimate aim of all activities. It has, therefore, been argued that its value needs to be added to the national income in order to make it yield a better measure of welfare. A suggestion was also made to deduct the social cost of harmful effects in terms of variety of pollutions that many economic activities entail.

Evolution of Alternative Measures

These corrections, however, did not leave many people satisfied and national income or its per capita variant as indicators of welfare have been in use for long though with reservations. However, in the last few decades, some attempts have been made to develop some alternative indicators of economic welfare and of social development. Search for better indicators of social development has continued. We often read in the newspaper that Sri Lanka has a fairly high life expectancy, low infant mortality and good literacy levels. The levels in Sri Lanka are comparable to their counterparts in developed countries. Our own state Kerala has done wonders on literacy front as well as on demography front. Tamil Nadu is also faring well. Therefore, it was natural for researchers to try to develop such indices as would capture these social dimensions. There is an UN institution called United Nations Research Institute for Social Development (UNRISD). In this institute, people tried to develop such indices as would encompass social, political and economic variables (indicators) impinging upon industrialisation, urbanisation and modernisation. They went on enlisting indicators, which they thought, reflected some or the other dimension of development. At one stage, they listed as many as 73 indicators though, finally, they selected only 16 as it was found that many of the indicators were reflected through others. hospital beds and number of doctors per lakh of population. They also included enrolment rates, electricity consumption and steel consumption per head. Length of metalled roads, number of villages electrified and availability of post offices also got their way into it. So did the character of agricultural organisation. These are important indicators and are considered by many as the ends in themselves. A question was, however, raised: whether inputs can be taken as development indicators. While enrolment rate indicates an input, literacy rate shows the output. While hospital facilities indicate inputs, life expectancy shows the output. If you have better sanitation, you have better health and you require less of hospital facilities. Even income is in a way an input. Researchers and policy-makers were not very happy with such alternatives to national income as welfare measures as they did not find the approach suitable to produce a meaningful social indicator. Attempts were, then, made to develop composite index of development, purportedly based on aims and objectives of development or outcomes of the development process rather on the means thereof.

Quality of Life Indices

We may recall the constituents of quality of life in the previous chapter. They were generally indicated as health, freedom, education, environment, etc., the things that you directly enjoy. Based on these parameters, attempts have been made in the recent past to construct indices, which may, broadly, be called indices of quality of life. In fact, longevity and Foreign trade per capita, 1960 US $ Percentage of salaried and wage earners to total economically active population While at your level, it is not necessary to go into the nitty-gritty of the ways the indices were developed, an idea of the variables that were included in such attempts could be of some interest. The variables included are per capita income, literacy have undisputedly been accepted as parameters of quality of life. We shall be studying two popular indices, viz., Physical Quality of Life Index (PQLI) and Human Development Index (HDI), which have both used longevity and literacy as basic constituents. There is, indeed, an attempt to measure quality of life and we will make reference to it towards the end. It is important to remind at this stage that these indices were developed in the international context and were used for ranking different countries according to numerical value of achievement in descending order. The indices are simple arithmetic averages of normalised aggregates for society/groups. Physical Quality of Life Index Towards the end of the seventies of the past century, Morris David Morris perused the variables adopted by several UN Committees, the UNRISD, and the OECD development economists. He found that most of the indicators were inputs to development process rather than result of the development process. These indicators reflected the belief that there exists only one course of development. It implied that economically less developed countries are simply underdeveloped versions of industrialised countries. This view has certain biases and value-bias of Europe. It overlooks the diversity among the underdeveloped countries and the differences in social organisation in different economies. Moreover, such efforts seem to measure development as an activity rather than as an end. He, therefore, proposed a set of criteria for developing a composite index of development. He further proposed that indicators chosen should reflect results and social distribution of results and should not reflect values of specific (Euro-American) societies. Composite index should be simple to construct and easy to comprehend and should lead itself to international comparison.