Absolute poverty and relative poverty

Meaning of poverty

Poverty is defined as “a state of not having enough money to take care of basic needs such as food, clothing, and shelter” according to the Encarta online dictionary. We can even go for a more complex definition such as “a situation or a state where a society or an individual found themselves in a harsh condition of lacking financial and social resources to meet the daily life human needs and to absolve shocks that may happen in a society”.

But to make it simple, poverty simply means being too poor.

Absolute poverty

Absolute poverty refers to being below a certain income threshold or the number of people living below a certain income threshold ($1 per day). In this situation, people are unable to afford certain basic goods and services. $1 per day is considered as the absolute poverty line.

Relative poverty

Relative poverty refers to those who have inadequate income compared to the general income level of the society. That means those under relative poverty are poorer than the average people. Therefore they may not be able to afford many desirable goods and services even though basic necessities are fulfilled.

Next topic: Policies to alleviate poverty

Why some countries are classified as developed and others are not

What is a developed country?

Though there may not be a standard, set definition, a developed country is a country with a relatively high economic growth and security. Some of the most common criteria for evaluating a country’s degree of development are per capita income or gross domestic product (GDP), level of industrialization, general standard of living and the amount of widespread infrastructure. Increasingly other non-economic factors are included in evaluating an economy or country’s degree of development, such as the Human Development Index (HDI) which reflects relative degrees of education, literacy and health. The outcome of the development ultimately should be the desirability or how appealing it is to live in a particular country.

Characteristics of developed and developing economies

Developed economies Less developed economies
Population low birth rate

higher life expectancy

low death rate due to better medical facilities

ageing population

 

Developing countries have higher rate of natural increase. Death rates have fallen faster than birth rates; birth rates are significantly higher than in developed countries, whereas death rates are only somewhat higher than in developed countries. Tradition, lack of contraception, poverty and lack of education are the main causes of high population growth rate.
Education High level of literary, Highly trained workforce. Workers are paid high rates of wages. Low level of literacy with low skill levels of the workforce results in low wages of the workforce. Government is the main provider of education services and have low percentage of public expenditure allocated for education.
Economic structure These economies usually have a larger tertiary sector and most of the workforce is engaged in service industries. The country produces and exports high technology products or high value added goods. Primary sector is the major contributor to the GDP of the country. Low GDP per capita is there. Usually exports agricultural goods or natural resources and imports value added goods from developed countries.

Next topic: Absolute and relative poverty

Developed and developing economies

This is the 7th Unit in Cambridge O Level Economics. In this unit, we will try to understand the characteristics of developed and developing countries. Poverty, how to alleviate poverty, growth and population are also important topics to learn in this Unit.

  1. Why some countries are classified as developed and others are not
  2. Absolute and relative poverty
  3. Policies to alleviate poverty
  4. Factors affecting population growth
  5. Consequences of population changes at different stages of development
  6. The effects of changing size and structure of population on an economy
  7. Comparing developed and developing countries and regions within a country

Upload of Tutorials Under O Level Unit 6 is complete!

Maldives Inflation
O Level Unit 6: Economic Indicators

Topics covered in this unit

1. How a consumer prices index/retail prices index is calculated
2. Inflation
3. Deflation
4. Changing patterns and levels of employment
5. Causes and consequences of unemployment
6. Gross Domestic Product(GDP)
7. Recession
8. Measures and Indicators of comparative living standards

Recession

A recession means a period of decline in economic activities which is shown by a reduction of real national output. When there is decline of output for two consecutive years, it is technically referred as a recession.

CHARACTERISTICS OF A RECESSION

  • Declining demand for output leading to higher levels of spare productive capacity
  • A sharp fall in business confidence & profits
  • A decrease in fixed capital investment spending because there is insufficient demand to justify new capital projects
  • De-stocking and heavy price discounting – this leads to lower inflation
  • Reduced inflationary pressure in the labour market as unemployment rises
  • Falling demand for imports
  • Increased government borrowing
  • Businesses will reduce production levels as they find it difficult to sell their goods and services.
  • In order to sustain growth, businesses will cut cost and will lay off employees.
  • Economy will see an increased rate of retrenchment and more money is spent by the government on unemployment benefit.
  • Government will get less revenue from income tax and VAT.
  • Stock exchanges will see reduced activity.

A recession can happen due to a reduction in aggregate demand which could be the result of the following factors:
1. Higher interest rates which reduce borrowing and investment
2. Falling real wages
3. Falling consumer confidence
4. Credit crunch which causes a decline in bank lending and therefore lower investment.
5. A period of deflation. Falling prices often encourage people to delay spending. Also deflation increases the real 6. value of debt causing debtors to be worse off.
7. Appreciation in exchange rate which makes exports expensive and reduces demand for exports.

Recession can also happen due to a reduction in the aggregate supply. It is referred as supply-side shocks.

A few examples of things which could cause a reduction in aggregate supply are:
1. Higher crude oil and gas prices – leading to increased input costs, driving inflation higher and causing a fall in real incomes for households (less consumption) and a fall in profits for businesses (less investment and possible employment cut-backs) – this is known as stagflation.
2. Higher prices for metals and other non-fuel inputs .
3. Surge in foodstuff prices which increase costs and lower profits for food manufacturers.
4. Other inflationary effects globally such as a sharp rise in inflation in the USA or China, leading to a burst of imported inflation .
5. If wages remain sticky there is a danger of a wage-price spiral emerging.

Next topic: Measures and Indicators of comparative living standards

Gross Domestic Product

Gross Domestic Product (GDP) is the market value of all officially recognized final goods and services produced within a country in a given period of time.

Economic growth is the increase in the amount of the goods and services produced by an economy over time.

Increase in GDP is the most widely used measure of economic growth.

Calculating GDP

There are three ways of calculating GDP. They are:
– The expenditure method: which calculates final spending on goods and services
– Income method: which sums the income received by all the producers within the economy
– Output method: which calculates the market value of goods and services produced within the economy.

All the methods logically bring out the same results. For the purpose of this lesson, we will look at the expenditure method in detail.

GDP is the sum of consumer spending, investment, government purchases, and net exports, as represented by the equation:

GDP = C + I + G + (X-M)

Consumer spending, C, is the sum of expenditures by households on durable goods, non-durable goods, and services. Examples include clothing, food, and health care.

Investment, I, is the sum of expenditures on capital equipment, inventories, and structures. Examples include machinery, unsold products, and housing.

Government spending, G, is the sum of expenditures by all government bodies on goods and services. Examples include naval ships and salaries to government employees.

Net exports, (X-M), equals the difference between spending on domestic goods by foreigners and spending on foreign goods by domestic residents. In other words, net exports describes the difference between exports and imports.

Next topic: Recession

Changing patterns and levels of employment

Employment is the work that people do in an economy. Over time, patterns of employment change: some industries go into decline and jobs disappear while new types of industries and jobs develop.

Employment levels too change over time due to many reasons. It could be due to the effects of business/economic cycle that every economy goes through from time to time. It could be due to the changes to the demographics of the country. It could also be due to structural changes.

If we want to look at the changes to the patterns of employment, it will be easier to understand it if we look into a particular economy. For the purpose of this topic, let us look into the economy of Maldives.

Women at work
Over the past 30 years, we have seen that more and more women choose to work and even take up careers which used to be done by only men. This could partly be due to flexibility and the rights given by the changes to the employment laws and regulations.

Other reasons for women in the skilled work force is due to increased opportunities for girls to achieve higher education. There was a time when Maldivian families used to give more importance to the education of boys rather than girls. However, this has changed due to increased awareness.

However, employment rate among men is still higher than women.

Rise of the service sector
Over the past 30 years, service sector has gained dominance in Maldives, largely due to the tourism sector. Other service industries like Banking, Insurance, Education, Private Healthcare and Consultancy has also increased in importance in the Maldivian economy.

Expatriate workers
Gone are the days when we used to see Maldivians working as waiters in the tea shops and cafeterias. Almost all the labour and odd-jobbing are now done by expatriate workers, mostly from Bangladesh. Other industries in which expatriate workers dominate are construction and agriculture. Tourism industry too has a a big percentage of expatriate workers. The reason for this could be due to the availability of workers from neighbouring countries who are willing to work at a lower wage rate than Maldivians.

More skilled workers
Over the past 40 years, skilled workers have been increasing among the Maldivian work force. This could be due to increased availability of education and training programs. Therefore more and more people are seen taking up professional careers.

Part-time workers
A huge increase in part-time staff has occurred again mainly due to more women being in the workplace and many only work part-time due to child care commitments.

The increase in students going to college and university has also resulted in a large temporary workforce available to work as receptionists, sales persons, cashiers, tutors and similar jobs.

Next topic: Causes and consequences of unemployment

Deflation

Deflation is the opposite of inflation. It refers to a general fall in the level of prices. Typically, this will occur when there is a general fall in demand for goods – for example, if people are spending less through uncertainties over rising unemployment.

Deflation is a phenomenon of persistent and continuous falling prices. In its initial and later stages it maybe respectively referred to as recession and depression

Causes of deflation

– Deflation is usually caused by falling aggregate demand, which means the total demand in the economy is not able to buy all(or enough) goods and services in the economy. When this happens, the prices will fall.

– Deflation can also happen if the productive potential of the economy increases, which leads to excess supply over demand.

– Excess use of deflationary fiscal and monetary policies also could lead to deflation. Governments often use deflationary monetary and fiscal policies to control inflation. However, when the government miscalculates and use those policies too much, deflation could happen.

Costs of deflation

1. Lower business incentive
When the prices fall, the incentive to invest and expand is less, therefore growth of business slows down, and sometimes there is negative growth if businesses start getting bankrupt. This is a very serious type of deflation.

2. Unemployment increases
When there is deflation, firms are often forced to lay-off workers in order to reduce loss. And when people become unemployed, their ability to demand for goods and services also decline.

3. Real cost of borrowing increases.
This can happen if the nominal interest rate remains the same. When deflation happens, returns to the investment declines, which could lead to difficulties in repaying the loans taken.

4. Holding back on spending
Consumers may opt to postpone demand if they expect prices to fall further in the future.

Is deflation always a problem?

Benign Deflation
If falling prices are caused by higher productivity, as happened in the late 19th century, then it can go hand in hand with robust growth. On the other hand, if deflation reflects a slump in demand and persistent excess capacity, it can be dangerous, as it was in the 1930s, triggering a downward spiral of demand and prices. If the falling prices are simply the result of improving technology or better managerial practices, that is fine.

Malign Deflation
Malign deflation occurs when prices fall because of a structural lack of demand which creates huge excess capacity in an economic system. If there is a slump in demand, companies go out of business and sack people, and hence demand falls again – the negative multiplier effect starts to have its effect.

Next topic: Changing patterns and levels of employment

How a consumer prices index/retail prices index is calculated

Retail Price Index(RPI) and Consumer Price index(CPI) are both used to measure inflation. These indices measure changes in average prices over a year. Measurements are made by recording prices of goods and services that most people will be expected to buy, or put in an imaginary shopping basket. Government statisticians decide what goods to include in this basket. This list should be updated to take account of changing spending patterns. Most governments measure prices in similar ways.

A basket of goods

The imaginary shopping basket for a typical family contains, for example, milk, bottled water, sugar, tea, meat, cooking fuel, school books and mobile phone charges. The contents included in the basket are fixed in the short term, but the prices of individual goods change.

A price index uses a single number to indicate changes in prices of a number of different goods. This is calculated by comparing the price of buying the basket of goods with a starting period, called the base year. The base year is given a figure of 100. So if the average price of goods in the basket today is 10 per cent higher than the base year, the price index will be 110. Changes in average prices (the cost of the basket of goods) can be measured on a monthly, quarterly or annual basis.

Inflation

Inflation is a persistent or sustained rise in the general level of prices over a period of time. So not every price will rise, but average prices will. The effect of this rise on ordinary people will vary, depending on what they buy.

Weighting

The weighting is a figure given to a category of goods according to the percentage of a typical household’s income that is spent on it.

Calculating average price changes

Calculating average price changes will give the rate of inflation. The calculation involves two sets of data:
• The price data (collected each month).
• The weights (representing patterns of spending, updated each year).

With this data it is possible to construct a weighted price index.
A consumer spending survey has been carried out that shows the
percentage spend of typical households in an imaginary country. The
table below shows how the percentage spend forms the basis of
the weighting given to the categories.

Category Percentage spend Weight
Food 40 4
Clothing 20 2
Transport 10 1
Other household goods 30 3
Total 100 10

The next stage is to identify price changes in each of these product categories. Let us suppose that surveys carried out in supermarkets, shops and other retail outlets across the country show the following changes since the base year:
• Food prices have increased by 20 per cent.
• Clothing has increased by 10 per cent.
• Transport has fallen by 10 per cent.
• Other household goods have increased by 30 per cent.

To find out the average change in price we need to take account of each of these price changes in terms of how much consumers spend on that item (the weight). For example, the increase in food prices of 20 per cent will have a major impact on average prices because 40 per cent of household income is spent on food. In contrast, even though transport prices have fallen by 10 per cent, this will have a smaller impact on average prices because consumers only spend a tenth of their income on transport.
To create a weighted price index we need to multiply the weight for each item by the price index for that item. This is shown in the table below.

Product Category Weight Price Index Weighted Price Index
Food 4 x 120 480
Clothing 2 x 110 220
Transport 1 x 90 90
Other Goods 3 x 130 390
Total 1180

 

Finally, divide the weighted price index by the total number of weights:
1180/10
= 118
This shows that prices have risen on average by 18 per cent (i.e. from the base year figure of 100 to 118 in the new year).

Next topic: Inflation

Economic indicators

Economic indicators are a collection of various reports and data that we can use as clues to see how well an economy is doing. These indicators are used by the government to make decisions on fiscal policy, monetary policy and supply side policies. they can also be used by private sector when making economic decisions.
1. How a consumer prices index/retail prices index is calculated
2. Inflation
3. Deflation
4. Changing patterns and levels of employment
5. Causes and consequences of unemployment
6. Gross Domestic Product(GDP)
7. Recession
8. Measures and Indicators of comparative living standards

Next Unit: Developed and Developing Economies