Measure of Economic Welfare (MEW)

Economic Development – Measure of Economic Welfare (MEW)

0. Where MEW Fits in the A‑Level Syllabus

• Topic 11.3 – Economic Development (Cambridge International AS & A Level Economics 9708) ends with the sub‑section Measure of Economic Welfare (MEW).
• MEW follows:
  1. Classification of economies (development level + national‑income level)
  2. Monetary indicators of development
• Why it matters for the exam:
  • Allows comparison of living standards over time and between countries.
  • Provides the basis for evaluating distribution, gender gaps and environmental sustainability.
  • Shows the limits of relying on a single figure such as GDP.

1. Classification of Economies

Cambridge distinguishes economies on two dimensions. Understanding both is essential because welfare measures often aim to capture the shortcomings of a purely income‑based classification.

Development Level	Typical Characteristics
Low‑income (developing)	High poverty, low life expectancy, large informal sector, limited industrial base.
Middle‑income (emerging)	Rapid structural change, improving health & education, expanding services sector.
High‑income (developed)	High per‑capita income, advanced technology, ageing population, service‑led economy.

National‑income levels (PPP‑adjusted) are expressed in GNI per capita:

• Low‑income: < US$ 1 000
• Middle‑income: US$ 1 000 – 12 000
• High‑income: > US$ 12 000

Link to MEW: The same country can be “high‑income” but still have poor welfare if, for example, inequality or environmental degradation is severe. Hence, MEW indicators complement the classification.

Exam‑tip

When a question asks you to “classify a country”, state both its development level (based on social characteristics) and its income level** (using the PPP‑adjusted GNI thresholds).

2. Monetary Indicators of Development

2.1 Gross Domestic Product (GDP)

Market value of all final goods and services produced within a country’s borders in a given period.

Expenditure approach:

\[ \text{GDP}=C+I+G+(X-M) \]

• C – Consumption
• I – Investment
• G – Government spending
• X‑M – Net exports

2.2 Gross National Income (GNI) / Gross National Product (GNP)

GNI = GDP + Net primary income earned abroad (remittances, profits, interest). GNP is the same concept; the World Bank now prefers the term GNI.

2.3 Net National Income (NNI)

NNI = GNI – Depreciation (consumption of fixed capital). It shows the amount of income that can be used without reducing the economy’s productive capacity.

2.4 Real vs. Nominal Measures

• Nominal – measured at current market prices.
• Real – adjusted for inflation using a price index (usually CPI or a chain‑type index).

2.5 Per‑Capita and PPP‑Adjusted Measures

• GDP per capita = GDP ÷ Population. Allows size‑adjusted comparisons.
• PPP‑adjusted GNI (or GDP) corrects for differences in price levels, giving a better indication of the quantity of goods and services that can be purchased.

\[ \text{GDP (PPP)} = \text{GDP (current US\$)} \times \frac{\text{PPP conversion factor}}{\text{Official exchange rate}} \]

2.6 Growth Rates

Annual growth is expressed as the percentage change in real per‑capita GDP (or GNI) from one year to the next.

\[ \text{Growth Rate}_{t}= \frac{\text{Real GDP per capita}_{t}-\text{Real GDP per capita}_{t-1}}{\text{Real GDP per capita}_{t-1}}\times 100 \]

2.7 Summary of Monetary Indicators

Indicator	What it measures	Key advantage	Key limitation (exam focus)
GDP (real, per‑capita)	Market output produced domestically	Widely available; clear link to material living standards	Ignores distribution, non‑market activity, environment; informal sector often omitted
GNI (PPP‑adjusted)	Total income accruing to residents, adjusted for price differences	Useful for economies with large overseas earnings; enables cross‑country comparison	Same as GDP plus reliance on accurate cross‑border income data; no info on inequality
NNI	GNI after deducting depreciation	Shows sustainable income that can be consumed or saved	Depreciation estimates are imprecise, especially in developing economies

3. Non‑Monetary Indicators & the Kuznets Curve

3.1 Human Development Index (HDI)

Combines three dimensions: health, education and standard of living.

• Life Expectancy Index (LEI) = (LE – 20)/(85 – 20)
• Education Index (EI) = (Mean Years of Schooling Index + Expected Years of Schooling Index)/2
• Income Index (II) = \(\dfrac{\ln(\text{GNI per capita})-\ln(100)}{\ln(75\,000)-\ln(100)}\)

Geometric mean (reduces substitutability):

\[ \text{HDI}= \bigl(\text{LEI}\times \text{EI}\times \text{II}\bigr)^{1/3} \]

3.2 Gender Development Index (GDI)

Ratio of female HDI to male HDI. Values < 1 indicate a gender disadvantage.

3.3 Multidimensional Poverty Index (MPI)

Assesses acute poverty using ten indicators grouped into three dimensions.

Dimension	Indicators (equal weight)
Health	Nutrition, Child mortality
Education	Years of schooling, School attendance
Living standards	Cooking fuel, Sanitation, Water, Electricity, Housing, Assets

A household is “multidimensionally poor” if deprived in at least one‑third of the weighted indicators.

3.4 Gini Coefficient

Measures income (or consumption) inequality on a scale from 0 (perfect equality) to 1 (perfect inequality).

\[ G = \frac{\displaystyle\sum_{i=1}^{n}\sum_{j=1}^{n} |y_i - y_j|}{2n^{2}\mu} \]

• \(y_i, y_j\) = individual incomes
• \(n\) = number of individuals
• \(\mu\) = mean income

3.5 Kuznets Curve

Hypothesised inverted‑U relationship between economic growth and inequality:

• Early development – growth → rising inequality (labour moves to higher‑skill industry).
• Later stages – further growth → falling inequality (redistribution, education, safety nets).

Useful for evaluating whether policies that boost growth automatically improve welfare.

3.6 Genuine Progress Indicator (GPI)

Starts with personal consumption (similar to GDP) and makes the following adjustments:

• Positive additions: value of household work, volunteer work, net capital formation.
• Negative subtractions: environmental degradation, loss of leisure, crime costs, depletion of natural resources, and a distributional adjustment for inequality.

Result: a “net social welfare” figure that can rise or fall even when GDP is growing.

4. Detailed Review of Each Measure

4.1 Gross Domestic Product (GDP)

• Derivation: Sum of market‑price values of all final goods and services produced domestically.
• Interpretation: Size of economic activity; a rising real GDP per capita usually signals higher material living standards.
• Policy use: Governments set GDP‑growth targets; central banks monitor it to guide monetary policy.
• Limitations (exam focus):
  • Excludes income distribution.
  • Omits non‑market activities (housework, volunteering).
  • Ignores environmental damage and resource depletion.
  • Quality of growth hidden – growth from harmful industries may not improve welfare.
  • Data problems in the informal/underground economy.

4.2 Gross National Income (GNI) / Gross National Product (GNP)

• Derivation: GDP + net primary income earned abroad.
• Interpretation: Total income accruing to residents; important for economies with large overseas earnings (e.g., oil exporters, remittance‑dependent states).
• Policy use: Basis for World Bank income‑group classifications and eligibility for development assistance.
• Limitations: Same as GDP plus reliance on accurate cross‑border income data; still silent on inequality.

4.3 Net National Income (NNI)

• Derivation: GNI – depreciation of the capital stock.
• Interpretation: Income that can be consumed or saved without reducing the economy’s productive capacity.
• Policy use: Used in long‑run growth models (e.g., Solow) to assess sustainable income.
• Limitations: Depreciation estimates are often rough, especially in developing economies; non‑market factors remain omitted.

4.4 Human Development Index (HDI)

• Derivation: Geometric mean of the three dimension indices (health, education, income).
• Interpretation: Provides a broader picture of welfare than income alone – higher HDI = longer life, better education, higher living standards.
• Policy use: Highlights which dimension is lagging, guiding targeted investment (e.g., schooling programmes).
• Limitations (exam focus):
  • Only three dimensions – ignores political freedom, environmental quality, and intra‑country inequality.
  • Equal weighting is arbitrary; geometric mean reduces but does not eliminate substitutability.
  • Data lag – health and education statistics may be a few years old.
  • Aggregates hide regional or gender disparities.

4.5 Gender Development Index (GDI)

• Derivation: Ratio of female HDI to male HDI.
• Interpretation: Values < 1 indicate a gender gap; the closer to 1, the more gender‑equal the outcomes.
• Policy use: Guides gender‑sensitive policies (e.g., scholarships for girls, maternal‑health programmes).
• Limitations: Relies on the same three HDI dimensions and suffers from data scarcity on gender‑disaggregated health and education.

4.6 Multidimensional Poverty Index (MPI)

• Derivation: Weighted count of deprivations across ten indicators; a household is counted as poor if deprived in ≥ 33 % of the weighted indicators.
• Interpretation: Highlights specific deprivations (e.g., lack of safe water) rather than income alone.
• Policy use: Enables targeted interventions – e.g., prioritising rural electrification if “no electricity” is a major deprivation.
• Limitations (exam focus):
  • Indicator selection and thresholds are partly subjective.
  • Data‑intensive; many low‑income countries lack up‑to‑date household surveys.
  • Does not capture temporary poverty or short‑term shocks.

4.7 Gini Coefficient

• Derivation: Numerical summary of the Lorenz curve (formula shown above).
• Interpretation: Higher values = greater inequality; useful for tracking the impact of redistributive policies.
• Policy use: Governments may set targets (e.g., “reduce Gini by 0.05 over five years”).
• Limitations (exam focus):
  • Ignores overall welfare – a low‑income country can have a low Gini but still very poor.
  • More sensitive to changes in the middle of the distribution than to extremes.
  • Requires reliable household income/consumption data, often missing in low‑income economies.

4.8 Kuznets Curve

• Derivation: Empirical observation that inequality first rises and then falls as per‑capita income increases.
• Interpretation: Suggests that early growth may exacerbate inequality, but later stages can reduce it through education, technology diffusion and redistribution.
• Policy relevance: Encourages students to question the assumption “growth = welfare”.
• Limitations: The relationship is not universal; some countries experience persistent inequality despite high income.

4.9 Genuine Progress Indicator (GPI)

• Derivation: Starts with personal consumption (GDP) and adds positive non‑market contributions while subtracting environmental and social costs, plus a distributional adjustment.
• Interpretation: Positive GPI growth indicates net improvement in social welfare after accounting for externalities; a decline signals unsustainable growth.
• Policy use: Adopted by some local authorities to assess the net benefit of large projects or to design “green” fiscal policies.
• Limitations (exam focus):
  • Highly data‑intensive – requires valuation of non‑market goods (clean air, leisure).
  • Methodological disagreements on weighting and aggregation.
  • Not widely published, limiting international comparison.

5. Comparative Summary of Key Measures

Measure	Focus	Strengths (exam‑friendly)	Weaknesses (exam‑friendly)
GDP (real, per‑capita)	Aggregate market output	Widely available; clear link to material living standards; easy to calculate growth rates.	Ignores distribution, non‑market activity, environment; informal sector often missed.
GNI (PPP‑adjusted)	Total resident income, price‑level adjusted	Allows cross‑country comparison; captures overseas earnings.	Same as GDP plus reliance on accurate cross‑border income data; no inequality info.
NNI	Sustainable income after depreciation	Shows income that can be used without eroding capital stock.	Depreciation estimates are imprecise; still omits non‑market factors.
HDI	Health, education, income	Broadens welfare beyond income; easy to interpret.	Only three dimensions; equal weighting arbitrary; data lag; masks internal disparities.
GDI	Gender gap in HDI dimensions	Highlights gender inequality; simple ratio.	Depends on same limited HDI data; gender‑disaggregated data scarce.
MPI	Multidimensional acute poverty	Identifies specific deprivations; useful for targeted policy.	Indicator selection subjective; data‑intensive; no short‑term shock capture.
Gini Coefficient	Income/consumption inequality	Clear numerical measure; tracks impact of redistributive policies.	Ignores overall welfare level; less sensitive to extremes; data gaps.
Kuznets Curve	Relationship between growth & inequality	Helps evaluate “growth = welfare” assumption.	Empirical relationship not universal; may not hold for all countries.
GPI	Net social welfare (includes environmental & social factors)	Captures externalities; indicates sustainability of growth.	Data‑intensive; weighting disputes; limited international use.

6. Using MEW Measures in Exam Answers

1. Identify the question’s focus. Is it asking you to compare living standards, evaluate a policy, or discuss the limitations of a single indicator?
2. Select the most appropriate measure(s). For material standards – real GDP per capita; for broader welfare – HDI or GPI; for inequality – Gini or Kuznets.
3. State the formula or definition briefly. (e.g., “Real GDP = Nominal GDP ÷ CPI × 100”).
4. Explain what the figure tells you** about welfare**. Link the number to health, education, environment, or distribution as relevant.
5. Discuss at least two limitations. Show depth of understanding and earn higher marks.
6. Conclude with a balanced judgement. Weigh the strengths against the weaknesses and, if required, recommend a policy or further data needed.

Exam‑tip Box

When a question asks you to “evaluate the usefulness of GDP as a measure of welfare”, structure your answer as:

• Definition & formula of GDP (real, per‑capita).
• Two‑to‑three advantages (e.g., data availability, link to material living standards).
• Two‑to‑three limitations (distribution, non‑market activity, environment).
• Brief mention of an alternative (e.g., HDI or GPI) that addresses one of the limitations.
• Balanced conclusion.