2. Infrastructure is the prerequisite for the development of any economy.
It is synonymous with development, and the lack of infrastructure
services signals barriers to growth and overall development.
Infrastructure plays a crucial role in society and economy by providing
services to households and industry.
It includes:
• Education, health and family welfare
• Water and sanitation
• Transport (roads, railways, ports and civil aviation), power and
irrigation
• Communications and informatics
3. The linkage between infrastructure and economic growth is
multiple and complex. Infrastructure creates many direct and
indirect externalities, and involves large flows of expenditure
thereby creating additional employment.
Infrastructure affects output in two ways:-
One is the direct channel where infrastructure increases the
output by reducing the cost of intermediate goods.
The other channel is through externality effect. This channel
works through higher human capital returns due to education,
good quality health.
4. The following flow chart gives the various linkages of
infrastructural development which finally leads to economic
growth:-
Source: Journal of Business Management and Social Sciences
Research (JBM&SSR)
5. OBJECTIVE:
To show macroeconomic impact of infrastructure development on the output
of a nation. We shall be showing the impact through the AD-AS model with
unemployment.
This unemployment arises due to wage indexation and not due to the effective
demand problem.
1. There are two types of capital stock in the economy i.e. Kp(private capital
stock) and Kg(public capital stock)
2. There are two types of Investment, Ip(private investment) and Ig(public
investment).
6. Aggregate supply side of the economy:
3. Production Function
Y = Y (L,Kp, Kg) where, L = Labour
Kp = Private Capital Stock
Kg = Public Capital Stock
(Infrastructure)
4. Private Investment Function
Ip = Ip(r, Ig) where, r = interest rate
Ig = Public Investment
Private function is not only a function of interest rate (inverse
relationship) but also is positively related to Public Investment. There is
complementarity between public and private investment in India.
7. Aggregate Demand side of the economy:
5. Commodity market
Y = C(Y-T) +Ip( r, Ig ) + Ig + G
where, G = Government Consumption Expenditure
C = Private Consumption Expenditure
6. Money Market
M/P = L (Y, r) ; 𝐿 𝑟 < 0 and 𝐿 𝑌 > 0
where, M/P = Supply of real balance
L(Y,r) = Demand for money
ASSUMPTION:
Price is flexible and wage is indexed to price level.
8. We shall use the concept of Wage Indexation to show the impact of an
increase in public investment.
We note that unemployment that arises due to wage indexation and is not
attributable to the effective demand problem.
W = A.Pα where, W = Nominal wage
A = constant, say W0
P = Price
α = Indexation parameter
The above expression can also be written as:
𝑊
𝑃
= A*𝑃 𝛼−1
From the profit maximising behaviour of the firm we have,
MPL =
𝑊
𝑃
= A*𝑃 𝛼−1
⇒ FL ( L, 𝐾 𝑝 ,𝐾𝑔 ) = A*𝑃 𝛼−1
⇒ FLL dL = (α—1)* A*𝑃 𝛼−2
dP
=> dL/dP =
α—1 ∗𝐴∗𝑃 𝛼−2
FLL
≥ 0 according as (α—1)≤ 0 or α≤ 1
9. The following two cases shall be considered:
Case 1: 0<α<1
Here, we get a positively sloped AS curve and a negatively
sloped AD curve to obtain the equilibrium price and quantity as P*
and Y* respectively.
Y
Y*
10. Now, we see what happens to the equilibrium price and output when Ig is
raised.
In the short run, we assume that an increase in public investment does not
change the public stock of capital i.e. Kg remains constant.
As there is no change in Kg, there is no change in the AS curve.
However as Ig rises, it has an indirect impact on private investment and
hence Ip rises. Thus, the AD curve shifts to the right. In the short run,
equilibrium is attained at a greater price and output.
11. Overtime, Kg also rises.
This leads to a rightward shift in the MPL curve and as a result, L and then
supply of Y rises.
The supply side expansion of output will moderate the price level. It
will increase, decrease or remain unchanged depending on the
proportion of shift in the AS curve.
12. Case 2: α =1
In this case,
dL/dP = 0 and thus,
dY/dP = 0.
Hence, the AS curve is
vertical.
As there is no change in Kg, there is no change in the AS curve. It
remains vertical.
However as Ig rises, the AD curve shifts to the right. In the short
run, equilibrium is attained at a greater price while output remains
unchanged.
13. Overtime, Kg also rises. This leads to a rightward shift in the MPL curve and
as a result, L and then supply of Y rises. However, change in price level
depends on the shift in the AS curve.
Hence, we see that an increase in public investment has a dual
effect. It increases not only public capital, but also provides a
stimulus to private investment. Thus there is an unambiguous
increase in output.
15. Trend of public and private investment during the 10th year
plan of the Indian Government.
16. Illustrative Relationship between Infrastructure and Development
in South Asia
SOURCE: IDI scores were taken from Kumar and De (2008), and PCI
scores were sourced from World Bank.
NOTE: PCI stands for Per Capita Income and IDI stands for
Infrastructure Development Index.
17. ADB studies suggest that meeting the requirements for infrastructure
development to maintain the current growth level until 2020 requires a
total investment of $8 trillion. This is a huge amount. Infrastructure
Development demands active public sector involvement.
Empirical studies help us understand the complex relationship between
infrastructure and economic performance, which is measured in terms of
economic growth. Infrastructure achieves this by creating additional jobs
and economic activities, reducing production costs through
improvements in transport and connectivity, etc.
