Debre Tabor University

College of Business and Economics

Department of Economics

Development Planning and Project Analysis I

Course Code: Econ4131

Target Group 4th Year Economics Students

1
 Chapter Four
Quantitative Development Planning Techniques

• Characteristics of Development Planning Techniques

4.1

• Aggregated Consistency Planning Models

• The Harrod-Domar growth model
4.2 • Two-Gap Model

• Disaggregated Consistency Development Planning Models

• Input-Output Planning Models
4.3 • Social Accounting Matrix (SAM)
• Linear Programming Model

2
 Introduction
 Quantitative development planning technique involves:
 The use of data,
 Statistical analysis, and
 Mathematical models to inform and guide the
planning process.
 These techniques are used to:
 Analyze current conditions,
 Forecast future trends, and
 Evaluate the potential impacts of different
development strategies.
3
 Basic Data in Planning
 In the realm of planning, several types of basic data play
pivotal roles in guiding decisions and strategies.
 Collecting and analyzing these various types of basic data
is fundamental for effective planning.
 It enables planners:
 To gain a comprehensive understanding about the current
situation,
 Identify key needs and priorities,
 Develop informed strategies and policies
 To identify and evaluate alternative policies and courses
of action
 To provide feedback about the impact of these courses of
actions during or after their implementation.

4
 Types of data required for planning
 Distribution Data: Provides information about the
distribution of resources, populations, or other relevant
factors across a region.
 This helps in identifying disparities and targeting
interventions effectively.
 Interrelationship Data: Describes the relationships between
different factors that are linked to planning objectives.
 This includes data on how various factors influence each
other and how changes in one factor can affect others.
 Development Indicators: These are data points that indicate
the level of development in a particular area.
 These indicators help in assessing progress towards
development goals and identifying areas for improvement.
5
 Determination of Growth rate and Plan targets
 Determining the growth rate and setting plan targets involves
a systematic approach that considers various factors and data
sources.
 Objectives Setting: Define clear and specific development
objectives, considering economic, social, and environmental
dimensions.
 Ensure objectives are SMART (Specific, Measurable,
Achievable, Relevant, Time-bound).
 Plan Targets: Set quantitative and qualitative targets aligned
with the objectives.
 Targets should be realistic, based on data and analysis, and
address key development challenges.
6
 Cont……
 Determination of Growth Rate: Analyze historical data and
use forecasting techniques to estimate future growth rates.
 Consider factors such as population growth, productivity
improvements, and external factors like global economic
trends.
 Sectoral Projections: Analyze each sector's current
performance and potential for growth.
 Develop sector-specific projections based on trends, policies,
and external factors affecting each sector.
 Project Appraisal: Evaluate proposed projects based on their
alignment with objectives and targets.
 Assess the economic, social, and environmental impacts of
projects.
7
 Cont……..
 Social Cost-Benefit Analysis (CBA): Conduct a CBA for
projects to quantify and compare their social costs and
benefits.
 Consider both tangible (e.g., economic gains, improved
infrastructure) and intangible (e.g., social welfare,
environmental benefits) factors.
 Integration and Alignment: Ensure that objectives, targets,
growth rates, sectoral projections, and project appraisals are
integrated and aligned with each other.
 Adjust projections and targets based on the results of the
appraisal and CBA.
 Monitoring and Evaluation: Establish mechanisms for
monitoring progress towards targets and objectives.
 Conduct regular evaluations to assess the effectiveness of the
plan and make adjustments as needed.
8
 Characteristics of Development Planning Techniques
 Development planning techniques possess several key
characteristics that distinguish them from other planning
approaches.
 Purpose-Driven: Development planning techniques are
purposeful, aiming to achieve specific goals such as economic
growth, poverty reduction, and environmental sustainability.
 Holistic Approach: These techniques consider a wide range
of factors, including economic, social, environmental, and
political aspects, for comprehensive planning.
 Data-Intensive: Development planning relies heavily on data
analysis to understand current situations, predict future trends,
and make informed decisions.
9
 Cont……
 Future-Focused: These techniques take a long-term view,
looking ahead to ensure sustainable development over time.
 Inclusive and Engaging: Development planning involves
stakeholders from various sectors to ensure plans reflect the
needs and aspirations of all involved.
 Flexible and Adaptive: Plans are designed to be flexible,
allowing for adjustments based on new information and
changing circumstances.
 Policy Integration: Development planning techniques are
closely aligned with policy formulation and implementation,
translating policy goals into actionable plans.

10
 Cont……
 Interdisciplinary Nature: Drawing from multiple
disciplines, development planning tackles complex challenges
from diverse perspectives.
 Resource Optimization: These techniques aim to make
efficient use of resources, considering constraints and seeking
optimal outcomes.
 Continuous Improvement: Monitoring and evaluation
mechanisms are integrated to assess progress and refine
strategies for better results.
 Overall development planning techniques are dynamic and
multifaceted, blending data, stakeholder engagement, and
long-term vision to achieve sustainable development
outcomes.
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 Why Models are Important for Planning?
 Planning involves a set of social and economic variables.
 These variables are assumed to be interrelated and the
relationship can be very complex.
 Therefore, in order to understand the complex relationship
between these variables, we need analytical tools or models.
 Models are used to analyze the complex relationships
between different variables; however, some of the variables
may be unrelated.
 One of the advantages of models is that they are essential
aids for clear understanding or different relationships
between variables.

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Advantages
 Deductive values: Models, therefore, are
simplification of the complex reality or simplified
version of a reality.
 It can also communicative: Different organizations or
individuals want to communicate each other the complex
nature of the economy. Planners want to communicate with
politicians.
 Models attempt to establish a relationship between the
goals of the society and the instruments to achieve these
goals.
 Then, planners do quantify the goals in terms of target.
 Models enable to give alternatives in terms of resource
constraints or capacity to achieve the goals.
 Models provide a frame work with different agents to
carry out meaningful dialogue.
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Limitations of Analytical Tools
 Models may not necessarily provide the intended
solutions. i.e. models do not provide the solution for
every thing. They only help to find the solutions or
provide the frame work for solution.
 Models can’t replace the value judgment that is required
through experience. That is why we say models don’t
provide the solutions but the way to approach for
solutions.
 Furthermore, no single model is the best model as
remedy. Depending on the situation, different models can
be used for different problems.

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 Characteristics of Models
 Models have some common characteristics.
 Using these characteristics we can distinguish between
different types of models or plans.
 The most common characteristics include:-
 Coverage: - this shows scope, whether it is
national /overall model or Sectoral or project
analysis.
 On the basis of coverage, we can classify models into
 Overall (national) models aggregated/integrated

 Sectoral (regional) models

 Project Models
15
 dis aggregated sectoral model

Cont……..
 Based on Degree of Aggregation
I. Aggregated models:- may forecast aggregate variables it
treats the whole economy as one producing sector.
II. Main sector models:- dividing the economy or region in
to major sectors. For example
lehulet kefele
 Lewis model dichotomizing the economy into agriculture and
non agriculture sectors.
 Mahalonobis model divides the economy in to
consumption and capital goods producing sector.
III. Multi sector models:- the economy or the region is
divided into large number of sectors which are interrelated.
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 Cont………
 Based on Time Dimension (capacity and treatment)
I. Based on the capacity to predict the future
development, it can be Long-term models,
Medium-term models and Short-term models.
II. Based on time treatment with in the models it can be
Static models that compare future development with
present development but don’t necessarily consider the
path of development and Dynamic models that
provide the path of future development.
 Based on Behavioral Relationships: model can be
Stochastic and Deterministic
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 Cont…..
 Based on Degree of Closure:
I. Open models:-if the variables (unknown) are not
explained with in the system. As an example open input
out put models (when the final demand is assumed to be
given, and not some thing that is solved within the model).
II. Fully closed models:- if the variables can be calculated
within the system itself.
III. Partially closed models:- if more than one value of the
variables is possible to calculate with in the system. In
optimization (maximization of benefits or minimizing of
costs) given certain constraints in linear programming.

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Cont……….
 Based on Accounting Frame work:- if models
have an explicit or implicit relationship accounting
framework.
I. Consistency models:- when models
provide a consistency relationship between
the identity of variables
II. Programming models;- when models proved
inequality relationship between the identity of
variables.

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 Generally
 Models are idealized representative of real world situation.
 Modeling and forecasting occupy an important place in
the planning process.
 Forecasting is usually done using a model.
 Model may be used not only to forecast but also to test the
implications of different policies , programs and projects .
 The classification of models based on their characteristics is
not necessarily mutual exclusive.
 No single characteristic of the model can be considered as
the best
 Some of the models may overlap because the output of one
model may serve as input for the other.
 Hence, it may be important to consider the planning models
in stages. It is a process rather than a static, i.e. it may
involve several stages [ex Harrod-Domar model]
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 Aggregated Consistency Planning Models
 Aggregate consistency planning models are frameworks used
in development planning to ensure that plans and policies are
internally consistent and aligned with overarching
development goals.
 These models aim to reconcile various sectoral plans and
objectives to achieve a coherent and integrated development
strategy.
 The Harrod-Domar and Two gap models exemplify
aggregate consistency planning by integrating various factors.
 They provide frameworks for policymakers and planners to
align sectoral plans and policies with overarching
development goals.
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 The Harrod-Domar growth model
 The Harrod-Domar growth model, developed independently
by Roy Harrod and Evsey Domar in the 1930s and 1940s.
 It is a simple framework used to understand the relationship
between economic growth, savings, and investment.
 It is based on the idea that the level of investment in an
economy determines its growth rate.
 The Harrod-Domar growth model is closely linked to
development planning, particularly in the context of
identifying targets for investment and savings to achieve
desired levels of economic growth.
 However, it oversimplifies complexities of economic growth
and does not consider technology, population and structural
change in the economy.
22
 Key features of the Harrod-Domar growth model
 Basic Equation: The model starts with the basic identity that
states that national income (Y) is equal to consumption (C)
plus savings (S), i.e., Y = C + S.
 Savings-Investment Relationship: The model assumes that
savings are a fixed proportion of national income, denoted by
the savings ratio (s). Therefore, S = sY.
 In a simple form, the model could be set out as follows:
St = It=sY, It= Kt+1 – K1, St= sYt-1 and Kt = vYt-1
 Where S is savings, I is investment, K is capital stock, Y
is income, v is the capital-output ratio or capital coefficient
and s is the propensity to save.
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Cont………
 Saving leads to investment S= I
 Investment leads to change in capital I= K
 Constant capital output ratio K  K  k Capital-output ratio (v)
Y Y

 Investment Requirement: The model posits that

investment (I) is required to maintain a constant capital-
output ratio (k), which represents the amount of capital
needed to produce one unit of output.
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 Cont…….
 Therefore, I = ΔK, where ΔK represents the change in capital
stock required to maintain the capital-output ratio.
 Growth Rate: The growth rate of the economy (g) is determined
by the ratio of investment to capital stock (I/K).
 Therefore, g = ΔK / K. or g=s/​k s= saving rate, k capital-output ratio
 Stability Condition: For the economy to be in a stable
equilibrium, the savings ratio must be equal to the capital-output
ratio. This is expressed as s = K/Y.
 Implications: The model suggests that to achieve a higher growth
rate, either the savings rate must increase or the capital-output
ratio must decrease.
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 How it connects to development planning?
 Setting Investment Targets: Development planners can use
the Harrod-Domar model to calculate the level of investment
needed to achieve a specific growth target.
 By determining the desired growth rate (g) and the capital-
output ratio (K/Y), planners can calculate the required
investment (I) using the formula g = ΔK / K.
 Promoting Savings: The model highlights the importance of
savings in financing investment and stimulating economic
growth.
 Planners can use this insight to design policies that encourage
higher levels of saving, such as tax incentives for saving or
the establishment of savings mobilization programs.
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 Cont………
 Setting Growth Targets: Policymakers can use the model to
set realistic economic growth targets based on current savings
rates and capital-output ratios.
 For example, if a country wants to achieve a 6% growth rate
and has a capital-output ratio of 3, it needs a savings rate of
18% of GDP.
 Focus on Key Sectors: Prioritize investments in sectors with
high potential for productivity gains and economic growth,
such as manufacturing, technology, and infrastructure.
 Addressing Structural Issues: Tackle structural issues that
affect savings and investment, such as financial market
development, governance, and macroeconomic stability.
27
 Cont……..
 Infrastructure Development: The model emphasizes the
role of investment in infrastructure development for economic
growth.
 Planners can prioritize infrastructure projects that have high
economic returns and contribute to increasing the capital
stock.
 Foreign Aid and Investment: For developing countries
facing a savings constraint, the model suggests that foreign
aid or investment can help bridge the savings-investment gap.
 Planners can use this insight to attract foreign investment or
negotiate aid packages to finance development projects.

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 Case Study: South Korea's Economic Development
 South Korea's rapid economic growth from the 1960s onwards
is a practical example of the Harrod-Domar Model in action:
 High Savings Rates: South Korea implemented policies to
encourage household savings and reinvested these savings into
the economy.
 Savings rates increased significantly, providing the necessary
capital for investment.
 Efficient Investment: The government focused on improving
the efficiency of investment by targeting key industries and
adopting advanced technologies.
 Investments were directed towards sectors that could yield
high returns, such as electronics, shipbuilding, and
automobiles.
29
 Cont……….
 Export-Oriented Growth: South Korea adopted an export-
oriented growth strategy, which helped to improve the
efficiency of capital use and generated foreign exchange.
 This approach led to substantial gains in productivity and
economic growth.
 Government Role: The South Korean government played a
crucial role in coordinating investments, providing
infrastructure, and creating a conducive environment for
growth.
 Policies such as the establishment of special economic zones
and support for education and R&D contributed to sustained
economic growth.
30
 Cont……
 Economic Transformation: South Korea transformed from a low-
income agricultural economy to a high-income industrialized nation
within a few decades.
 The country achieved average annual GDP growth rates of over 8%
during its high-growth period.
 Increased Living Standards: Rapid economic growth led to
significant improvements in living standards, reductions in poverty,
and increases in per capita income.
 The Harrod-Domar Growth Model provides a valuable framework for
understanding the dynamics of economic growth, particularly in
developing countries.
 By focusing on increasing savings and improving investment
efficiency, countries can achieve sustained economic growth.
 South Korea’s successful implementation of this model underscores
its practical relevance and potential for driving economic
development.
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Two-Gap Model and Its Application in Development Planning

 The Two-Gap Model, formulated by Hollis B. Chenery and

Alan M. Strout in the 1960s, is a cornerstone framework in
development economics.

 It highlights two primary constraints the savings-investment

gap and the foreign exchange gap that impede economic
growth in developing countries.

 Understanding and addressing these gaps are essential for

effective development planning.
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 Savings-Investment Gap
 This gap occurs when domestic savings fall short of the
investment needed to drive economic growth.
 Causes: Low income levels often lead to low savings rates.
 Consequences: Limited funds for investment in critical
sectors such as infrastructure, industry, and education.
 Strategies to Bridge the Savings-Investment Gap:
 Increase Domestic Savings:
 Implement tax incentives to encourage saving.
 Strengthen financial institutions to facilitate savings.
 Promote microfinance and other community-based savings
programs.
33
Cont….
 Attract Foreign Investment:
 Create a favorable business climate through regulatory
reforms.
 Develop infrastructure to attract foreign direct
investment (FDI).
 Seek External Financing:
 Secure international aid and loans to supplement domestic
resources.

34
 Foreign Exchange Gap
 This gap arises when a country's foreign exchange earnings (from
exports) are insufficient to cover the cost of necessary imports.
 Causes: Over-reliance on a limited range of exports and low
export competitiveness.
 Consequences: Inability to import essential goods and technology,
hampering growth.
 Strategies to Bridge the Foreign Exchange Gap:
 Boost Export Performance: Enhance the competitiveness of
domestic industries and diversify export products and explore new
markets.
 Promote Tourism: Develop and market the country as a tourist
destination to generate foreign currency.
 Seek External Assistance: Obtain foreign aid or loans aimed
specifically at bridging the foreign exchange gap.
35
 Cont…..
 The two-gap approach introduces the assumptions that an
imported commodity not produced domestically is
essential for the production of investment goods.
 If the availability of foreign exchange to purchase these
imported capital goods constrains the growth of the
economy, the growth would be Exogenous.
 Since it depends on foreign investment goods and
technology.
 Foreign capital can be introduced in the form of official
flows, or foreign direct investment (FDI).

36
 Cont………
 If the above assumption does not hold, the economy can
domestically produce investment goods, then a shortage
of domestic savings can be essential constraint on
growth.
 If the economy produces only enough consumption
goods to maintain the current production level, it doesn’t
save or grow.
 If the availability of domestic saving constrains the
growth of the economy, we may call the growth
Endogenous, since the economy has own technology
and human resources.
37
 Cont……..
 Most of the successful economic growth in the Asian
countries during the 1990s initially took an exogenous.
 Latter, the foreign exchange earned by strong exports
increased their domestic saving and changed their
development pattern to fit in the endogenous growth
path.
 Therefore, it was argued that the impacts of the foreign
assistance be studied carefully.
 Development assistance is capital and technology
transfers provided by industrialized countries for the
purpose of improving the welfare of the poor.
38
 Cont………
 Different models have been designed to explain how these
transfers would affect economies of the recipient
countries.
 One of the various theories of development assistance and
foreign capital inflows is reviewed by two or three gap
models.
 The gap model has three basic steps, it begins with the
general macro economic identity then calculates the gap
using some formula and finally identifies targets for that
gap.

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 Application in Development Planning
 The Two-Gap Model provides a robust framework for
designing and implementing development policies.
 Identify Constraints: Determine whether the primary
constraint on growth is the savings-investment gap, the
foreign exchange gap, or both. Use this analysis to tailor
policy interventions.
 Formulate Targeted Policies:
 Savings-Investment Gap: Increase domestic savings and
attract foreign investment. Utilize external financing
judiciously.
 Foreign Exchange Gap: Enhance export performance and
promote tourism. Secure foreign aid and loans for critical
imports.
40
 Cont……
 Integrate Development Strategies:
 Address both gaps simultaneously for a holistic approach to
development.
 Ensure policies complement each other; for instance,
improved export performance can support increased
investment without causing a foreign exchange crisis.
 Monitor and Evaluate:
 Regularly assess the status of both gaps.
 Adjust policies based on effectiveness and changing
economic conditions.

41
 Case Study: Ethiopia
 Ethiopia provides a practical example of the Two-Gap Model
in action:
 Addressing the Savings-Investment Gap: Financial sector
reforms to boost domestic savings.
 Attracting FDI through infrastructure improvements and
regulatory ease.
 Tackling the Foreign Exchange Gap: Diversifying exports
beyond traditional agriculture to textiles and manufactured
goods.
 Promoting Ethiopia as a tourist destination to earn foreign
currency.
 Securing international aid and loans to support critical
imports.
42
 Cont………
 The Two-Gap Model is a vital tool for understanding and
overcoming the economic constraints faced by developing
countries.
 By identifying and addressing the savings-investment and
foreign exchange gaps, policymakers can design effective
strategies for sustainable development.
 Ethiopia’s application of this model underscores its practical
relevance and potential for driving economic growth.

43
Mahalanobis Model and Its Application in Development Planning
 Mahalanobis's was an Indian economist who contributed
a lot in the 2nd five year plan of India .
 The Mahalanobis Model, named after the Indian
statistician Prasanta Chandra Mahalanobis, played a
crucial role in shaping India’s Second Five-Year Plan
(1956-1961).
 This model emphasizes heavy industrialization and the
strategic allocation of resources to achieve long-term
economic growth.
 It is particularly notable for its use of mathematical and
statistical techniques to inform economic planning.
44
 Key Features of the Mahalanobis Model
 Focus on Heavy Industry: Prioritizes the development
of capital goods industries (like steel, machinery, and
infrastructure) over consumer goods industries.
 The rationale is that a strong heavy industry base will
stimulate overall economic growth and enable self-
sustained development.
 Emphasis on Domestic Production: Encourages self-
reliance by reducing dependence on foreign imports.
 Promotes the development of indigenous industries to
meet domestic demand.

45
Cont……….
 Investment Planning: Utilizes mathematical models
to optimize the allocation of resources.
 Focuses on maximizing the growth rate of the
economy through strategic investment in key sectors.
 Five-Year Plans: The model was implemented
through India’s Five-Year Plans, which provided a
structured approach to economic development.
 These plans set specific targets for growth,
investment, and sectoral development.

46
 Mathematical procedures of Mahalanobis Model
 In 1953, Mahalanobis developed a two sector model where
the entire net output of the economy was supposed to be
produced in only two sectors.
 These are the capital goods sector and the consumer goods
sector.
 Assumptions
 The economy consists of two sectors
 Closed economy where there is no foreign trade
 There is full capacity production
 Investment is determined by the supply of capital goods.
 There are no changes in prices
 Non – shiftability of capital equipment once installed

47
 Con….

48
 The income identity equation for the entire economy is
Y = C+ I
 When national income (Y) changes, investment (I) and
consumption ( C) also change.
 The change in investment depends upon previous year’s
investment and so does consumption on previous year’s
consumption.
 So the increase in investment in period t, is and the increase
in consumption is.
 The increase in the two sectors is related to the linking up of
productive capacity of investment and the output capital ratio.
 The investment growth path is determined by the productive
capacity of investment in the capital goods sector and its
output – capital ratio
49
Cont………

50
Cont………

51
Cont….

52
 Cont……..
 In 1955 he developed the four –sector model.
 The Mahalanobis model is not a growth model in the real
sense, rather it is an allocation model.
 The Mahalanobis model takes a four – sector economy
consisting of:
 The investment goods sector (k)
 The factory produced consumer goods sector (C1)
 The small household produced ( including agricultural
products) consumer goods sector (C2) and,
 Services (health, education , etc) producing sector (C3)

53
Cont…….

54
.

55
 Illustration
 Suppose the planning commission in Ethiopia has planned a 5% increase
in national income. The maximum available fund or net investment for
the coming 5 years is approximated to be Birr 5,600 million and the
objective in this 5 years period is to create an additional employment of
11 million.
 In addition, with the current technological conditions output- capital ratio
for investment goods sector (K), factory produced consumer goods ( C1) ,
small household industries (C2) and services (C3) are 0.20, 0.35, 1.25 and
0.45 respectively. Capital – labor ratios for the same sectors are 2000,
875, 250 and 375 respectively
 Further, the experts in the planning commission have decided the
proportion of investment allocated to each sector to be 33% for
investment goods, 17% for factory produced consumer goods, 21% for
small household industries and 29% for services.
 Given the above data, calculate the amount of investment, the increase in
income, the increase in employment in each sector of the economy as a
result of the investment.

56
Application of the Mahalanobis Model in Development Planning
 Strategic Resource Allocation: The model employs
input-output analysis to determine the optimal allocation
of resources across different sectors.
 This helps in identifying the sectors that will drive
economic growth and ensures that resources are
channeled accordingly.
 Industrial Policy: The Mahalanobis Model guided
industrial policy by emphasizing the development of
heavy industries.
 Policies were formulated to support the growth of capital
goods industries through subsidies, protective tariffs, and
investment incentives.
57
Cont………..
 Long-Term Growth Focus: The model’s emphasis
on heavy industry is aimed at achieving long-term
economic growth rather than short-term gains.
 By building a robust industrial base, the economy can
achieve sustainable growth and reduce vulnerabilities.
 Self-Reliance: Encourages the development of
domestic industries to reduce reliance on imports.
 This self-reliance approach is aimed at strengthening
the economy’s resilience to external shocks.

58
 Case Study: India’s Second Five-Year Plan
 Heavy Industry Focus: Significant investments were made
in steel plants, heavy machinery, and infrastructure projects.
 This laid the foundation for India’s industrial capabilities and
long-term economic growth.
 Investment in Key Sectors: The plan allocated substantial
resources to sectors like energy, transport, and
communications.
 These investments were aimed at supporting the heavy
industry and improving overall economic productivity.
 Growth Outcomes: The emphasis on heavy industry led to
substantial growth in the production of capital goods.
 While the model faced criticism for neglecting agriculture and
consumer goods, it established a strong industrial base that
contributed to India’s future growth.
59
Cont…….
 The Mahalanobis Model is a landmark in development
planning, particularly for countries aiming to build a
strong industrial base.
 By prioritizing heavy industry and strategic resource
allocation, the model seeks to achieve sustainable long-
term economic growth.
 India’s application of this model during its Second Five-
Year Plan provides valuable lessons for other developing
nations aiming to transform their economies.

60
Disaggregated Consistency Development Planning Models
 In many Less Developing Countries, relevant data for the
entire economy may not be available although enough
information could be obtained for a single project.
 In such cases Sectoral models are developed and different
Sectoral plans are combined together to form an overall
Sectoral-project.
 The main defect of the Sectoral plans lies in the lack of
co-ordination among them.
 Thus the heterogeneous collection of plans for different
projects may neither be consistent with each other nor
feasible when they are taken together.
61
Input-Output Analysis and Its Application in Planning
 Input-Output Analysis, developed by economist Wassily
Leontief, is a quantitative economic technique that represents
the interdependencies between different sectors of an
economy.
 It provides a detailed framework for understanding how
changes in one sector can impact others, making it a valuable
tool for development planning.
 Each industry requires certain inputs from other sectors in
order to produce its own out put.
 Similarly, each industry sells some of its gross out put to
other industries so that they too can satisfy their intermediate
material needs.
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 Key Features of Input-Output Analysis
 Inter-sectoral Relationships: The analysis captures the flow
of goods and services between industries within an economy.
 It uses an input-output table to map these interdependencies,
showing how the output of one sector is the input for another.
 Input-Output Table:
 Rows: Represent the output of each sector and where it is
used.
 Columns: Represent the inputs required by each sector to
produce its output.
 The table helps to identify key sectors and their contributions
to the overall economy.

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 Cont…….
 Leontief Matrix:
 A mathematical representation derived from the input-output
table.
 It is used to analyze the impact of changes in final demand on
the total output of the economy.
 Multipliers:
 Input-output analysis calculates multipliers that measure the
ripple effects of changes in demand or supply in one sector on
other sectors.
 These multipliers are crucial for assessing the broader
economic impact of policy decisions.

64
Cont……
 The input output analysis of an economy, which is in
equilibrium, the model assumes that whatever is produced it
used as either intermediate input or final demand including
exports.
 The model deals, what can be produced and how much
quantity of raw materials should be utilized in the production
process.
 The model is based on empirical investigation. The analysis
seeks to determine what can be produced, and quantity of each
intermediate product.
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 The assumptions of Input-output analysis includes:
 An economy is decomposed in to n sector (industries) and
each of these produces only one i.e. no two products are
produced jointly.
 The total out put of any industry used as inputs by other
industry.
 There are constant returns to scale. i.e. increase in inputs
in the same proportion with the level of out put.
 Prices, consumer demands and factor supplies are given.
 There are no external economics and diseconomies of
production.
 All transactions may be considered in terms of money value
since money is a suitable common unit for aggregating inputs
and outputs of industries
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 Transactions Matrix (X matrix)
 This matrix contains data on the flow of goods and services in
the economy.
 It shows how the total output of the ith industry or sector of
the economy ( i.e , Xi) is distributed to all other sectors as
input.
 where, i= 1, 2…n, and j= 1, 2, …n, with n number of non-final
demand sectors in the economy) and to the final demand
sector (Di).
 The assumption of fixed proportion of factor inputs enables us
to calculate the input requirements of various output levels
from the transaction matrix.

67
 The Technical coefficient matrix (Direct requirements matrix)
 The transactions matrix is transformed into a table of direct
requirement coefficients or called the technical coefficients
matrix ( A-Matrix).
 The A-matrix shows the distribution of inputs (xij) per unit of
output E(xij).
 Each coefficient (aij) represents the amount one industry
purchases directly from another industry per dollars worth of
output.
 The inverse of Leontief matrix [I-A] represents total
multiplier.
 Each coefficient in the inverse of [I-A] matrix, {mij}, reveals
the linkage between industries in the economy.
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 Cont…….
 Each {mij} reveals by what factor row industry i sells goods
and services to column industry j because of a change in final
demands forward linkage; {mij} also reveals by what factor
column industry j purchases goods and services from row
industry i because of changes in final demands backward
linkage.
 Leontief Inverse tell us how $1 dollar spent by an industry
impacts other industries in the economy.
 Multipliers determine by how much the economy will increase
or decrease because of a change in final demands.
 Multipliers are simply the sum of direct effects, indirect
effects and induced effects.
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 Cont………
 Direct effects: These may be thought of as the revenues, jobs,
and wages that a new business or expanding business brings
into the local economy or removes from the economy as the
case might be.
 Indirect effects: Any business expansion or new entry into a
market will lead that business to make purchases from and/or
sales to local firms.
 Because of new demand, local firms are likely to create some
number of new jobs, increase wages and revenues.
 Induced effects: are specific to the behavior of the labor
force.
 Employees of the new business and the related businesses will
spend their earnings in the local economy to purchase items.
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 Illustration1
 A system is composed of three industries with the following inputs:
 To produce one birr worth of output, industry A requires 0.10 birr
of its own product, 0.15 birr worth of industry B and 0.25 birr of
industry C product and 0.2 birr of imported goods.
 To produce one birr worth of output, industry B requires none of
its own product, 0.45 birr of industry A and 0.05 birr of industry C
product and 0.25 birr of labor.
 To produce one birr worth of output, industry C requires 0.05 birr
of its own product, none of industry A's product and 0.35 birr of
industry B product and 0.05 birr of imported product.
 The outside sector consumes 20 birr worth of industry A product,
30 birr worth of industry B product and 25 birr worth of industry C
product.
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 Cont……
 Formulate direct requirement matrix?
 Formulate total requirement matrix (inverse of Leontief
matrix)?
 Drive the total multiplier of each sector?
 Find the total output of each sector to meet the total demand
as planned?
 Find the total spending for intermediate input in each sector?
 Find the total spending for employment creation after the plan
implementation?
 Find the total spending for imported imputes to implement the
plan?
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 Illustration 2
Sector Agri Industry Service Final demand Total
Agri 100 60 20 180 360
Industry 40 40 30 260 370
Service 60 20 10 350 440
Primary (VA) 160 250 380 ---------- 790
Total 360 370 440 790 ----------

 Formulate the direct requirement matrix

 Formulate the total requirement matrix
 Total multiplier for each of the three producing sectors
 If the final demand in industry sector change amounts 10,000
what will be the impact on economy?

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 Application of Input-Output Analysis in Planning
 Economic Impact Assessment: Governments and
planners use input-output analysis to assess the potential
economic impact of investments, policies, and external
shocks.
 For example, understanding how an increase in
infrastructure spending can stimulate growth in related
sectors like construction, manufacturing, and services.
 Sectoral Analysis: Identifies key sectors that drive
economic growth and those that are most interconnected.
 Helps in prioritizing sectors for investment and
development.
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 Cont……..
 Resource Allocation: Provides a framework for efficient
resource allocation by highlighting the most productive
linkages in the economy.
 Ensures that resources are directed towards sectors with the
highest multiplier effects.
 Policy Simulation: Allows policymakers to simulate the
effects of various policy scenarios on the economy.
 For example, assessing the impact of tax changes, subsidies,
or trade policies on different sectors and the overall economy.
 Regional Planning: Input-output analysis can be tailored to
specific regions, helping regional planners understand local
economic structures and interdependencies.
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 Cont…..
 To forecast the Sectoral output needed .
 To forecast the primary factor or resource required to produce the
given level of Sectoral output.
 To Forecast capacity expansion (investment requirements).
 To forecast import requirements and the BOP.
 Problems
 I-O is based on the assumption of constant returns to scale and
constant technique of production in technology. However, these
may not remain constant when growth is taking place..
 The I-o analysis assumes that each industry has only one way of
producing a given product. But there could be more than one
process or activity.

76
 Social Accounting Matrix (SAM)
 A Social Accounting Matrix (SAM) is a comprehensive,
economy-wide data framework that captures the transactions
and transfers between different sectors, institutions, and
agents within an economy.
 It is an extension of input-output tables, incorporating more
detailed information on the distribution of income and
expenditure across households, firms, government, and the
rest of the world.
 SAMs are used to analyze the structure of an economy and
the linkages between different sectors, providing valuable
insights for economic planning and policy analysis.

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 Structure of a Social Accounting Matrix (SAM)
 A typical SAM consists of a square matrix where:
 Rows represent receipts or incomes.
 Columns represent expenditures or payments.
 The main components of a SAM include:
 Production Activities: Representing the output of various sectors.
 Commodities: Representing the goods and services produced and
consumed.
 Factors of Production: Including labor and capital.
 Households: Capturing the distribution of income among different
household groups.
 Firms: Representing business enterprises.
 Government: Reflecting public sector income and expenditure.
 Rest of the World: Capturing international trade and financial flows.
 Capital Account: Representing savings and investment.
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 I-O table
Intermediate demand Final Demand

Sectors Agri Industry Service Total HHcon Govcon Invt Export

Agri 50 60 40 1350 60 68 27 80

Industry 50 30 60 1350 48 60 50 45

Service 30 30 45 1050 75 60 32 75

Labor 70 40 35

Raw mat 60 65 55

Tax 50 35 35
Fixed
capital 40 45 32

imported 35 38 45
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 SAM
Activity Commodities Factors Agents
Agri Ind Ser Agri Ind Ser Lab RM HH Govt ROW Invt Total
Agri 305 80 385
Acti Ind 298 45 343
vity Ser 272 75 347
Agri 50 60 40 60 68 27 305
Com
modi Ind 50 30 60 48 60 50 298
ties Ser 30 30 45 75 60 32 272
Fact Lab 70 40 35 145
ors RM 60 65 55 180
HH 145 180 325
Govt 50 35 35 120
ROW 40 45 32 117
Agen
ts Invt 35 38 45 142 -68 -83 109
Total
385 343 347 305 298 272 145 180 325 120 117 109
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 Applications of SAM in Planning
 SAMs are powerful tools for economic planning and policy
analysis. Their applications include:
 Economic Structure Analysis: SAMs provide a detailed
picture of the economic structure, showing how different
sectors and institutions are interconnected.
 This helps planners understand the flow of goods and services
and the distribution of income.
 Impact Analysis: SAMs can be used to simulate the impact
of policy changes or external shocks on the economy.
 For example, changes in tax policy, government spending, or
external trade conditions can be analyzed to see their effects
on different sectors and households.
81
 Cont…….
 Income Distribution: SAMs allow for the analysis of income
distribution among various household groups.
 This helps in designing policies aimed at reducing poverty
and inequality.
 Sectoral Linkages: By examining the interdependencies
between sectors, SAMs help identify key sectors that can
drive economic growth and development.
 This information is crucial for prioritizing investments and
policy interventions.
 Multiplier Analysis: SAMs are used to calculate multipliers
that measure the ripple effects of changes in one part of the
economy on the rest.
 For instance, an increase in government spending can have a
multiplier effect, leading to increased production, income, and
consumption in other sectors.
82
 Cont………
 Regional and Sectoral Planning: SAMs can be
disaggregated to analyze specific regions or sectors within a
country.
 This is useful for regional planning and for developing sector-
specific policies.
 Poverty and Inequality Analysis: By incorporating detailed
household data, SAMs help in analyzing the effects of
different policies on poverty and inequality, aiding in the
design of inclusive development strategies.
 Environmental and Social Accounting: SAMs can be
extended to include environmental and social accounts,
providing a comprehensive framework for sustainable
development planning.
 This helps in assessing the trade-offs between economic
growth, environmental sustainability, and social equity.
83
Linear Programming Technique and Its Application in Planning
 Linear Programming (LP) is a mathematical optimization
technique used to achieve the best outcome in a mathematical
model whose requirements are represented by linear
relationships.
 It is particularly useful in resource allocation, production
scheduling, and various planning problems in economics,
engineering, and management.
 Therefore Lp is a mathematical technique for the analysis of
optimum decisions, subject to certain constraints in the form
of linear inequities.
 It applies to those problems, which require the solution of
maximization, or minimization problems .
84
 Key Features of Linear Programming
 Objective Function: LP aims to maximize or minimize a
linear objective function.
 Example: Maximize profit or minimize cost.
 Constraints: LP models include a set of linear constraints that
represent limitations or requirements.
 Constraints can include resource availability, time, budget, and
other factors.
 Non-Negativity Restriction: Decision variables in LP must
be non-negative, meaning they cannot take on negative values.
 Decision Variables: Variables that decision-makers will
choose values for, in order to achieve the best outcome.

85
 Assumptions of Linear Programming Technique
 The linear programming analysis is based on the
following assumptions
 The decision maker face a number of constraints with in
which it has to operate.
 It assumes a limited number of alternative production
processes.
 It assumes linear relations among the different variables
(linearity).
 Input output prices and coefficients are given and
constant.

86
Model Formulation
 When we formulate LP, mostly we follow the
following procedures.
 Identify the objective function for the problem, (may
be to maximize profits, or may be to minimize costs
or some other goal.
 Identify the activities (decision variables or simply,
variables) for the problem.
 Identify the objective function coefficients for each
activity.
 Set up the appropriate structural constraints in the
constraint set.

87
Mathematical Formulation

88
 Illustration

 A farmer has three types of crops, Corn, Rice, and Wheat.

 Each acre of Corn requires 2 units of fertilizer, 3 units of
pesticide, and 1 unit of labor.
 Each acre of Rice requires 3 units of fertilizer, 2 units of
pesticide, and 2 units of labor.
 Each acre of Wheat requires 1 unit of fertilizer, 2 units of
pesticide, and 3 units of labor.
 The farmer has 100 units of fertilizer, 120 units of pesticide,
and 90 units of labor available.
 If the profit per acre of Corn is ETB 100, of Rice is ETB 120,
and of Wheat is ETB 150.
 Formulate the standardized linear programming model?
 How many acres of each crop should the farmer plant?
 What is the maximum profit of the farmer?
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 The End
90