Edexcel IAL Economics: Measuring development and constraints on growth (YEC11) – Revision Notes

Condensed notes for specification section 4.3.6, items 1(a) to 1(c) and the first five bullets of item 2(a), of the Pearson Edexcel International Advanced Level in Economics specification (YEC11), Issue 2, June 2018. The topic belongs to Unit 4, one of the two International A2 units, so only full International A Level candidates take it. For explanations, use the study guide, then test yourself with the practice questions.

All figures are invented. Links: course hub, printable checklist, free diagnostics. Debt, credit, demographics, infrastructure, skills and non-economic constraints are on other pages.

Key definitions

Term	Meaning
Economic development	A rise in living standards, health, education and choice, wider than growth
HDI	Index from 0 to 1 combining health, education and income
Commodity price volatility	Large, frequent swings in primary product prices
Primary product dependency	Reliance on a few raw or farm exports for earnings
Prebisch-Singer hypothesis	Primary prices fall relative to manufactures over the long run
Terms of trade	100 x export prices / import prices, as index numbers
Savings gap	Investment needed for target growth minus domestic saving
Foreign currency gap	Foreign currency needed for imports minus foreign currency earned
Capital flight	Rapid outflow of residents’ money to other countries

Formulas

Item	Formula
Dimension index	(actual - minimum) / (maximum - minimum)
Income index	(ln actual - ln minimum) / (ln maximum - ln minimum)
Education index	Average of mean and expected schooling indices
HDI	Cube root of (health x education x income)
Harrod-Domar growth	g = s / k
Saving needed	s = g x k
Investment needed	g x k x GDP
Revenue	Price x quantity
Terms of trade	(Px / Pm) x 100

Method in steps: calculating an HDI

1. Index health, using the limits given.
2. Index each schooling measure, then average them.
3. Index income using natural logarithms.
4. Multiply the three indices, then take the cube root.
5. Keep four decimals until the end.

Reminder (Country K, the same illustrative limits as the guide). Life expectancy 68.0, expected schooling 11.4, mean schooling 5.7, income 3,200.

Health    = 48/65                      = 0.7385
Education = (0.6333 + 0.3800)/2        = 0.5067
Income    = ln(32)/ln(750) = 3.4657/6.6201 = 0.5235
HDI       = (0.7385 x 0.5067 x 0.5235)^(1/3) = 0.5808

The arithmetic mean is 0.5895, higher than the geometric mean.

HDI: strengths and limits

Strengths	Limits
Goes beyond income	Averages hide inequality
One figure, easy to compare	Omits environment, freedom, security, unpaid work
Log income shows diminishing returns	Equal weights are a judgement
Geometric mean limits trade-offs between components	Data quality varies, and definitions can change over time

Evaluating: the HDI adds health and education to income, yet is still an average. Judge it for the purpose given. It suits a broad ranking but not an assessment of who gains.

Other measures

Indicator	Higher level of development suggests	Typical caution
Adult male labour in agriculture	A lower share	Ignores women and farm productivity
Clean water access	Higher access	Quality and reliability
Energy per capita	Higher use	Efficiency, waste, fuel type
Internet per thousand	Higher access	Access is not use
Mobile phones per thousand	Higher access	Can exceed 1,000
Doctors per thousand	More doctors	Distribution and other staff

Reminder: a share falling from 70% to 50% of a labour force that grows from 2.0 million to 2.8 million leaves 1.4 million workers in farming, the same number as before (2.0 x 0.70 = 1.4 and 2.8 x 0.50 = 1.4). The share fell by 20 percentage points while the number stayed constant.

Commodity price volatility

Causes: price inelastic demand and supply in the short run, weather, pests, and swings in world demand. Effects: unstable farm incomes, government revenue, export earnings and exchange rates, and a risky climate for investment.

Reminder: price index 100 falls to 75 while volume rises 10%. Revenue index = 0.75 x 1.10 = 0.825, a fall of 17.5%. Higher volume does not offset a bigger price fall.

Reminder on elasticity: with demand elasticity -0.4, a supply fall of 8% raises price by about 8 / 0.4 = 20%. Revenue = 1.2 x 0.92 = 1.104, up 10.4%.

Prebisch-Singer

Chain of reasoning: low income elasticity of demand for primary goods, so demand grows slowly as world income rises. Manufactures have a higher income elasticity, so demand grows faster. Primary prices rise by less than manufactured import prices, so the terms of trade worsen, so more exports are needed to buy each import.

Reminder: export price index 108 and import price index 135 gives 108 / 135 x 100 = 80. A fall of 20%.

Reminder: income rises 2% and income elasticity of demand is 0.5 for primary goods and 1.5 for manufactures. Demand rises 1% and 3%.

Evaluation: evidence is mixed and depends on the product and period. Some commodities enjoy long booms. Diversification into manufacturing or services is the usual response, but it takes time and capital.

Harrod-Domar and the savings gap

Method:

1. Write g = s / k.
2. For a target g, saving needed is s = g x k.
3. Savings gap = needed minus actual.
4. Multiply by GDP for a money amount.

Reminder: s = 12% and k = 4.0 gives g = 3%. To reach 5%, s = 0.05 x 4.0 = 20%, so the gap is 8 percentage points. Cutting k to 3.2 means s = 16%, and the gap falls to 4 percentage points.

Ways to close the gap: higher domestic saving, foreign direct investment, aid or borrowing, and lower k through better use of capital.

Limits: k fixed, saving not always invested, ignores technology and skills, and treats every unit of capital as equally productive.

Foreign currency gap

Reminder: required imports 5.2 bn cu and foreign currency earnings 4.4 bn cu leaves a gap of 0.8 bn cu. Domestic saving cannot buy imports, so a country may have saving but lack foreign currency. If the two gaps differ, the larger gap sets the binding constraint, and a foreign inflow that closes it closes the smaller one too.

Capital flight

Causes: political instability, high inflation, expected devaluation, weak property rights, high taxes. Effects: lower investment, falling tax base, currency depreciation, a wider savings gap and foreign currency gap. Responses: stable policy and confidence, and sometimes capital controls, which treat the symptom and may deter genuine investors.

How the constraints link

A fall in commodity prices cuts export earnings. That widens the foreign currency gap, lowers tax revenue and weakens saving, so the savings gap widens too. Weak confidence can then trigger capital flight, which makes both gaps worse and pushes the exchange rate down. Dependence on one product therefore sits at the start of many chains. When a question asks for evaluation, follow a chain to its end, then ask how strong each link is, how long it lasts and what policy could break it.

Evaluation prompts

• Short run or long run: volatility bites at once, whereas Prebisch-Singer concerns decades.
• Size of the country’s dependency: a country with 80% of exports in one crop is more exposed than one with 20%.
• Availability of other finance: aid, FDI or borrowing can close a gap but may add to debt.
• Choice of indicator: judge whether the HDI or a single indicator fits the question.

Must-know distinctions

• Growth is a rise in output, whereas development covers living standards.
• Percentage and percentage-point changes differ.
• Share and number of workers differ.
• Savings gap (local resources) versus foreign currency gap (imports).
• Terms of trade, a price ratio, versus the trade balance, a money value.

Quick self-test

1. Name the three HDI components.
2. Why does the HDI use a logarithm of income?
3. Country L: life expectancy 62.0 on a 20 to 85 scale. Find the health index.
4. A price index falls from 100 to 90 and volume rises 5%. What is the revenue change?
5. Export prices rise from 100 to 104 and import prices from 100 to 130. Find the terms of trade.
6. In Harrod-Domar, what s is needed for g = 4% with k = 3.5?
7. State two limits of Harrod-Domar.
8. Required imports 6.5 bn cu, earnings 5.1 bn cu. Find the foreign currency gap.
9. Give two causes of capital flight.
10. Why can mobile subscriptions per thousand exceed 1,000?

Answers

1. Health, education and income.
2. Extra income adds less to development at higher levels.
3. (62 - 20) / 65 = 0.646.
4. 0.90 x 1.05 = 0.945, a fall of 5.5%.
5. 104 / 130 x 100 = 80.
6. 0.04 x 3.5 = 14%.
7. Any two: k fixed, saving may not become investment, ignores technology and skills.
8. 1.4 bn cu.
9. Any two: instability, inflation, expected devaluation, weak property rights.
10. People can hold several subscriptions.

Where marks are usually lost

• Naming HDI components without saying how they are measured.
• Rounding indices early.
• Confusing share with number of workers.
• Using percentage when the answer is percentage points.
• Inverting the terms of trade ratio.
• Describing Prebisch-Singer as a fact rather than a hypothesis, without evaluation.
• Giving a Harrod-Domar answer without showing s = g x k.
• Treating the two gaps as the same thing.
• Writing about capital flight without a link to investment or the exchange rate.

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Economics specification (YEC11), Issue 2, June 2018, Pearson Education Limited, Unit 4, section 4.3.6.