Planning Models and Techniques: Unit 5

UNIT 5
PLANNING MODELS AND

TECHNIQUES
The present unit contains major planning models concerning the use of
investment criterion. The unit contains input-output analysis in lesson-1,
linear programming in lesson-2, social accounting matrix in lesson-3,
computable general equilibrium model in lesson-4, cost-benefit analysis in
lesson-5 and logical framework approach in lesson-6. The linkages or
inter-relationships between different production sectors and industries
are extremely important for formulating a consistent plan. Input-Output
analysis can capture such linkages. Social accounting matrix (SAM)
which includes institutions that make up the economy (e.g. firms,
households, government) in the output model table and hence gives a more
comprehensive account of the economy. The linear programming which
uses similar information as the two previous models in order to arrive at
the optimal allocation of resources for the economy for a given objective
function. Project appraisal is the most microeconomic and most commonly
employed tool of planning. Project appraisal is based on the theory of
social cost-benefit analysis. The purpose of logical framework (or
logframe) approach is to undertake participatory, objectives-oriented
planning that spans the life of project or policy work to build stakeholder
team commitment and capacity with a series of workshops.
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Economic Development and Planning Page-236

Bangladesh Open University
Lesson 1: Planning, Input-Output Models

Objectives
After studying this lesson, you will be able to:

 Use input-output analysis
 Form input-output table
 Explain the general solution of input-output model
 Explain the limitations of input-output model
Planning
In free market economy, according to theory, resources are allocated by
the ‘invisible hand’ of the market in accordance with consumed demand.
The theory says that market prices act as signals to producers, consumers
consume till marginal utility equals price and producers produce to the
point where marginal cost is equal to the price. Thus, theory postulates
that resources will be optimally allocated since the marginal utility of
production will just equal the marginal cost. There are many problems of
the postulation in real life.
Planning in different forms has been accepted as an important policy

instrument to attain specific targets.
The case for planning:

 State intervention in the form of planning is necessary since the factor
and product markets in the developing economies are imperfect and
may not lead to efficient allocation of resources.
 As private investors are less likely to provide much attention to the
dynamic externalities generated in the process of development and
difference between marginal net social benefit (MNSB) and private
net private benefit (MNPB), planning may intervene to remove
differences between MNSB& MNPB.
 In the pursuance of goal of maximising profit in the short-run, the
private investors may lead to a resource allocation which may not be
socially optimal.
 It is argued that planning may intensify acceleration of the developing
countries task of achieving of higher growth path.
 Planning may exert and create conditions for institutional and
structural reforms which act as determinant of achieving rapid
economic growth.
 Planning may prove to be better alternative for the most productive
use of limited resources of the developing economies.
The case against planning:
 If planning envisaged necessary for market imperfections, the task

should be to remove imperfections in the market, not planning.
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 For removing the differences between MNSB &MNPB, the best

alternative are either imposition of tax or granting of subsidies.
 Given the lack of efficient human resources to tackle planning and

wider spread intervention of the state,, an inefficient and corrupt
bureaucracy may increase waste of resources that otherwise could
have avoided.
 The planning, by way of intervention, may lead to creating distortions

in the market.
Despite such arguments for and against economic models are frequently
used to construct economic planning with a view to:
 achieve consistency between demand and supply in different sectors;
 comprehend whether investment demand is enough to produce a
target output;
 determine intermediate demands for inputs including capital and
labour;
 enable the planner to test the feasibility and optimality of different
projects with a plan.
Input-Output Analysis
Input-Output (I-O) analysis is frequently used as an aid to development
planning. The I-O analysis records or measures the transactions in respect
of inputs needed for the output. Wassily Leontief 1used the first input-
output tables for United States for the year 1919 to 1929 which earned
him Nobel prize in 1973.
Input-Output (I/O) table captures the economy by dividing it into sectors

and tracing the flow of inter-industry purchases (inputs) and sales
(outputs). The I-O table presented in matrix form shows the distribution
of output horizontally along its rows, and the composition of inputs
vertically down its columns.
The fundamental idea of the I-O analysis may be illustrated with the
example of computer. For the simplicity, it is assumed that production of
computer requires hardware and software. Now assume an increase in the
demand for computer. This will require an increase in output of the related
industry – hardware and software and in other industries too. For
example, an increase in the demand for hardware means changes in the
production of motherboard, processor, cables, cases, electric ware, etc.
And so and so forth. In the I-O analysis, all changes – direct, indirect or
induced – are accounted to predict the total output of various inter-linked
activities to meet a given changes in the demand for a product.
1
Leontief W. W. (1951), The Structure of the American Economy, New York:
Oxford

The Uses of Input-Output Analysis
The Input-Output analysis is useful in several ways. The various ways of

use of the tool is described below:
Input-output analysis may have used for projection and forecasting

purposes. After some manipulation an inter industry transaction matrix
can provide information on how much of commodities X1, X2, etc. will be
required at some future date assuming a certain growth rate of national
income or final demand. Information of this nature is important if
planning is to achieve consistency and if future bottlenecks in the
productive process are to be avoided.
Input-output analysis can be used for simulation purpose. The simulation

of development is concerned with what is economically feasible, as
opposed to forecasting, which is concerned with what one expects to
happen on the basis of a certain set of assumptions. With some
manipulation, the inter-industry transactions matrix can be used for
providing answers to such questions as: how will the production
requirements of the economy be altered if a new steel mill is introduced; or
what will be the repercussions on the economy if a series of import-saving
schemes are introduced?
The I-O analysis can be used to:

 forecast import requirements and the balance of payments effects
of given changes in the final demand.
 forecast investment requirements consistent with a given growth
target if information is available on incremental capital-output
ratios.
 calculate the matrix multiplier attached to different activities; that
is, the direct and indirect effects on the total output of all
activities in the system from a unit change in the demand for the
output of any one activity.
 show the strength of linkages between activities in an economy.
 illustrate the technology of an economy.
Input-Output framework
The basics of input-output framework and some of its economic

implications are discussed in the section. In order to make use of I-O
method, certain simplifying basic assumption are to be made. These are as
under:
 No substitution takes place between the inputs to produce a given unit

of output and input coefficients are constants. The linear input
functions imply that the marginal input coefficients are equal to the
average.
 Joint products are ruled out, i.e. each industry produces only one
commodity and each commodity is produced by only one industry.
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 External economics are ruled out and production is subject to the

operation of the constant returns to scale.
An input-output table focuses on the interrelationships between industries

in an economy with respect to the production and uses of their products
imported from abroad. In the following table the economy viewed with
each industry listed across the top as a consuming sector and down the
side as supplying sector.
Table A highly simplified input-output accounting framework
Industries Net Final demand Total output

Industries F Y X
Value added (Primary inputs) V
Total input X
Table below shows a simplified set of accounts distinguishing three

procedures and showing the input-output flow matrix describing their
transactions. The values in the square box representing intermediate
consumption, i.e. uses of products as input s in the process.
Table Input-output flow table and accounts
Industry Industry Industry Final Total

A B C Demand output
Industry A 0 20 45 35 100
Industry B 30 0 30 140 200
Industry C 0 80 0 70 150
Value added 70 100 75
Total input 100 200 150
Input-output analysis became an economic tool when Leontief introduced

an assumption of fixed-coefficient linear productions relating inputs used
by an industry along each column to its output flow, i.e. for one unit of
every industry's output, a fixed amount of input of each kind is required.
The fixed relationship is introduced in the following table. The entries in
each column of table are obtained by dividing the entries in the column by
the total input of the consuming industry.
Table Input-output coefficient table inputs per unit of output
Industry A Industry B Industry C

Industry A 0.00 0.10 0.30
Industry B 0.30 0.00 0.20
Industry C 0.00 0.40 0.00
Value added 0.70 0.50 0.50
In the above table, for example, one unit of output of industry B requires
0.10 unit of output of industry A, 0.40 unit of output of industry C, and

generates 0.50 unit of value added. Thus in order to produce output XA,
XB and XC, the amount of product A (out of industry A) required as
intermediate input is equal to
(1.1) 0.00XA - 0.00XB - 0.00XC
Equation 1.1 calculates the total amount of product A used as

intermediate input in the production process of an economy. If the
remaining value of the same product left for net final demand, i.e., 35 in
table 1.2 is further added to intermediate consumption, the total output of
industry A is obtained in equation 1.2.
(1.2) 0.00XA - 0.00XB - 0.00XC + 35 = 100
It is possible to check the equality property of equation 1.2 by replacing

the values of XA, XB and XC in table 1.2 by their actual values. the results
are shown in equation 1.3.
(1.3) 0.00 X (100) - 0.10 X (200) - 0.30 X (150) + 35 = 100
The utilisation of products B and C as intermediate inputs of production

may be similarly calculated. In general, the ratios shown in the box in
table 1.2 could be written in more abstract terms, such as those in table
1.4, so that an input-output model may be formulated.
Table 1.4 Input-output coefficient table in more general terms
Industry 1 Industry 2 Industry 3 Industry 4

Industry 1 a11 a12 a13 Y1
Value Added V1 V2 V3
The relationship in equations 1.1, 1.2, 1.3 using general terms of table 1.4
can be shown as follows:
a11X1 + a12X2 + a13X3 + Y1 = X1
a21X1 + a22X2 + a23X3 + Y2 = X2 (1.4)
a31X1 + a32X2 + a33X3 + Y3 = X3
In matrix form, equation 1.4 can me written as follows:
a11 a12 a13 X1 Y1 X1
a21 a22 a23 X X2 + Y2 = X2 (1.5)
a31 a32 a33 X3 Y3 X3
In a more general form with n industry and n product, where a11 stands for
input i (products of industry i) used in the production of one unit of output
on industry j, systems of equations 1.4 and 1.5 can be written as follows:
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a11X1 + a12X2 + ...... + a1nXn + Y1 = X1

a21X1 + a22X2 + ...... +a2nXn + Y2 = X2 (1.6)
+ + + +
a31X1 + a32X2 + ...... +a3nXn + Y3 = X3
and in matrix form
a11 a12 a1n X1 Y1 X1

a21 a22 a2n X X2 + Y2 = X2 (1.7)
.................. .... ... ...
an1 an2 ann Xn Yn Xn
The computation of the coefficient matrix can be described in the

following mathematical form:
Fij
aij =
Xy
where Fij stands for an element of the flow table as described in a square
box of table 1.1 equation 1.7 is usually written from, as
(1.8) AX + Y = Y
Relationship 1.8 is the basic input-output system of equations. Matrix A

is called the input-output coefficient matrix, vector X is the vector of
output and vector Y is the vector of net final demand. The dimension
(size) of matrix A is constrained only by the statistical information on
inputs and outputs available to statistics since some countries have
constructed input-output tables up to almost 500 industries.
The limitations of the use of the IO model:
There is no doubt about the usefulness of the I-O tool for development
planing, but it also suffers from some limitations. This is particularly so in
the less-developed countries.
First, the IO analysis assumes that the input coefficients would remain
unchanged. However, these coefficients may not remain constant when
growth is taking place. In the long run the validity of the assumption of a
constant coefficient is all the more questionable as technical progress
gains momentum, substitution possibilities and returns to scale might be
rising instead of being constant. Marginal input coefficients might no
longer be equal to the average.
Second, if the linkages among the different sectors are rather weak or non-
existent, then the IO table will provides only very limited information.

Third, the IO analysis assumes that the composition of demand is

constant. In the long-run this is unlikely to be valid and any change in
demand composition is likely to impact upon input coefficients.
However, it should be pointed out that some of these limitations in the

application of the IO analysis can be removed by continuously updating
the IO tables to incorporate any effects of change in technical progress
and/or demand pattern on sectoral input coefficients. Also if the IO
analysis is used to make short, rather than long run predictions, and if the
data are reliable, then the margin of errors is unlikely to be large.
Finally, the IO analysis further assumes that each industry has only one,
way of producing; a given product. But it is conceivable that there could
be more than one process or activity to produce a commodity. IO analysis
cannot help to find out which process among two or more activities would
use the minimum amount of resources. In short, IO analysis cannot help to
solve the choice of optimal technique of production.
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Questions for review
1. Input-output model was first developed for

A. UK
B. Australia
C. Bangladesh
D. USA
2. Input-output model has the best use in

A. Preparing Budget
B. Preparing plans
C. Review annual production of a firm
D. Calculate profit ad loss of an economy
3. Lentief won Nobel Prize in

A. 1919
B. 1929
C. 1968
D. 1973
Answer 1.D, 2.B, 3.D,
Short Questions
1. What does input-output table show?
2. What are the major purposes of the input-output analysis?
3. What are the limitations of input-output analysis?
Essay type questions

1. Explain the statement that there is no doubt about the usefulness of
the I-O tool for development planning, but it suffers from serious
limitations.
2. Construct a simple I-O table for a hypothetical country.
Further Readings:
1. Dervis, K., Melo, J. and Robinson, S., General Equilibrium Model
for Development Policy, The World Bank, Washington D.C., 1982.
2. Arrow,K., S. Karlin, and P. Suppes,eds., Mathematical Methods
in Social Sciences, Standford, Califf., Standford University Press,
1960.

3. Bacharach, M., Biproportional Matrices and Input-Output

Change, Cambridge: Cambridge University Press, 1970.
4. Carter, A., and A. Brody, eds., Contribution to Input-Output
Analysis, Amsterdam: North Holland, 1970.
5. Polenske,K. R. and J. Skolka, eds., Advances in Input-Output
Analysis, Cambridge, Mass.:Ballinger, 1976.
6. Peacock A T and Dosser, D, “Input-Output Analysis in An
Underdeveloped Country: A Case Study,” Review of Economic
Studies, October, 1957.
7. Thirlwall A.P., Growth and development, Macmillan, 1994
8. Todaro M, Economic Development, Addison Wesley Longman pte
Ltd., 2001
9. Kasliwal P, Development Economics, South Western College
Publishing., 1995
10. Lal A N K, Economics of Development and Planing, Vikas
Publishing House Pvt. Ltd., 1997
11. Allen, R. G. D., Mathematical Economics, London, Macmillan,
1960.
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Appendix-1: Input-Output Analysis using Matrix
Basic assumption of the input-output analysis
 No substitution takes place between the inputs to produce a given unit

of output and input coefficients are constants. The linear input
functions imply that the marginal input coefficients are equal to the
average.
 Joint products are ruled out, i.e. each industry produces only one
commodity and each commodity is produced by only one industry.
 External economics are ruled out and production is subject to the

operation of the constant returns to scale.
The above assumptions require that to produce one unit of the jth good, the
required ith input would be constant and let us call it aij. Thus the
production of each unit of the ith good would need, say a1j of the first
commodity, a2j of the second , and a nj for the nth input. Here note that the
first subscript refers to the input and the second one refers to the output.
Hence if aij = 0.20 paisa , it means that 20 paisa worth of the ith
commodity is necessary as an input to produce a 1 taka worth of the jth
good. The symbol aij is regarded as the input coefficient.
Let there be n number of industries in the economy. The input output table
in the form of a matrix A=[aij] would state the input coefficients. So the
availability of the input-output table is thus an important condition for any
calculation. Actually the table shows the inter industry flows where each
column shows the necessary input for producing one unit of output of a
certain industry. If any element in the matrix is zero, it shows that the
input demand is zero. The input coefficient can be written as:
Xij
aij = i= 1,2,……..,n
Xj
j = 1,2,……..,n
where Xj = total output of the jth industry

Xij= number of units of ith goods used by jth industry.
The IO table usually given in the following matrix:

Output
Input I II III N
a11 a12 a13 a1n
A= a21 a22 a2n
an1 ann
However the IO table in the above form considers only inter-industry

flows and ignores final demand. An open IO table can be easily
constructed where a final demand for each product of the industry is
included. Corresponding to the demand for the products, the IO table now
be expanded to include supplies of the primary inputs. For example.
If the household sectors final demand for output is now included it is also
necessary to include the labour supplied by the households as inputs. It is now
obvious that because of the supply of the labour inputs, the sum of elements in
each column of the matrix A would be less than one because in the absence of
primary input costs (labour supply) the sum of each element in any column
would be exactly equal to one. Thus,
n
a i 1
ij 1 (j= 1,2 ,………….,n)
It follows that the value of primary input required to produce one unit of
the jth good is given by:
n
1- a
i 1
ij
Now for the industry 1 to produce enough output to cater for the final
demand plus the input demand of n industries, the equation below must
hold:
or
x1  a 11 x1  a 12 x 2  .....  a 1n xn  D 1
(1  a 11 ) x 1  a 12 x 2 .........  a 1 n x n  D 1
where D1= final demand for the output of the second industry 1,similarly
for the second industry, the equation can be set out as below:
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 a 21 x 1  (1  a 22 ) x 2  .........  a 2 n x n  D 2
Thus
 an1 x1  an 2 x 2  .....  (1  ann) xn  Dn

The system of equation can be written as in the following matrix form:
(1-a11) -a12 -a1n x1

D1
-a21 (1-a22) -a2n x2
D2
(I-A)x = =
-an1 -an2 (1-ann) xn

Dn
where the identity matrix is given by:
1 0 0 0
0 1 0 0
1=
0 0 0 1
that is, all the elements in the principal diagonal are 1and elsewhere zero.
Now solving for x, we have:
x  1  A D
1
The rule for matrix inversion can be given as

1
A1  A*
A
The following example can be given:
 a 11 a 12 
Let A   
 a 21 a 22 
Then A  a 11 a 22  a 12 a 21
And A*= a22 -a12

-a21 a11
A-1=[1/ A] a22 -a12

-a21 a11

A numerical example can help us to understand the solution more clearly.

To simplify the analysis we are concerned with only two sectors
agriculture (X1) and textiles (X2)., then the IO table would be
Agriculture Textiles
Agriculture 0.6 0.2
Textiles 0.4 0.3
Then A= 0.6 0.2

0.4 0.3
Now I-A = 1 0 0.6

0.2
0 1 0.4
0.3
= 0.4 -0.2
-0.4 0.7
[I-A]-1 = 0.7/0.2 0.2/0.2

0.4/0.2 0.4/0.2
= 3.5 1
2 2
Let the final demand given by

D= 10
5
We know x = [I-A]-1D
Thus x= 3.5 1 10
2 2 5
= 40
30
Thus the agricultural sector (X1) would produce 40 units and the textile
sector (X2)would produce 30 units. Note that the effect of change in the
final demand on the production of X1 and X2 can easily be found. Further,
given the employment coefficient, the effect on employment can be traced
out. The IO analysis can be extended to include many other sectors like
foreign trade and the balance of payments.
The limitations of the use of the IO model:
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The assumptions set out at the outset of the discussion of the IO analysis
help us to understand the major limitations of this analysis.
First, the IO analysis assumes that the input coefficients would remain
unchanged. However, these coefficients may not remain constant when
growth is taking place. In the long run the validity of the assumption of a
constant coefficient is all the more questionable as technical progress
gains momentum, substitution possibilities and returns to scale might be
rising instead of being constant. Marginal input coefficients might no
longer be equal to the average.
Second, if the linkages among the different sectors are rather weak or non-
existent, then the IO table will provides only very limited information.
Third, the IO analysis assumes that the composition of demand is

constant. In the long-run this is unlikely to be valid and any change in
demand composition is likely to impact upon input coefficients.
However, it should be pointed out that some of these limitations in the

application of the IO analysis can be removed by continuously updating
the IO tables to incorporate any effects of change in technical progress
and/or demand pattern on sectoral input coefficients. Also if the IO
analysis is used to make short, rather than long run predictions, and if the
data are reliable, then the margin of errors is unlikely to be large.
Finally, the IO analysis further assumes that each industry has only one,
way of producing; a given product. But it is conceivable that there could
be more than one process or activity to produce a commodity. IO analysis
cannot help to find out which process among two or more activities would
use the minimum amount of resources. In short, IO analysis cannot help to
solve the choice of optimal technique of production.

Lesson 2: Linear programming and development

planning
Objectives:
Linear programming (LP) is a mathematical tool used for the analysis and
derivation of optimum decisions. Theoretically, it offers optimal solutions
to rational decision-making. Its use in the field of development planning is
of much interest chiefly because it helps the planner to allocate resources
optimally among alternative uses, within the specific constraints.
 Understand basic feature of linear programming.
 Use linear programming
 Explain limitations of linear programming
Introduction
The technique of linear programming is of use for solving problems

relating to allocative efficiency. At the micro-level, programming
technique could be used to find out optimal and efficient (least expensive)
methods of production. LP can be regarded as a complementary tool
which can be used to analyse the IO tables in order to solve the problems-
of choice of techniques on the supply side as well as the problem of choice
of final demand. It is important to emphasise that the LP technique helps
to tackle the major problems of investment planning:
(a) consistency between sectors;
(b) feasibility of plans; and
(c) optimality in resource allocation.
However, it should be pointed out that the important assumption of

linearity is contended for not being realistic in all cases. On the other
hand, if the relationships among the variables are non-linear, then the non-
linear programming can be used to solve the problems.
Linear programming technique has been used in the context of developing

countries for:
 choosing between different techniques for making the same
commodity:
 deciding the best combination of outputs with given techniques and
factor endowments:
 resolving whether it is more efficient to produce commodities at home
or buy them from abroad;
 determining the efficient spatial location activities.
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General Formulation
In a LP exercise, the usual objective is to maximise or minimise some

linear function of the variables given, say, r variables. The programmer
seeks to obtain non-negative values of these variables subject to the
constraints and maximise (or minimise) the objective function. More
formally
Max V=C1X1+....................+Cr Xr
with m inequalities or equalities in r variables, i.e.
ai1 xl + ..............+ a ir x r { , = , }bi , i = 1,

………...,m
and xj = O, j= l,...r
where aij, bi ;and cj, are given constants.
The problem is sometimes written in a more compact way, e.g.
Maximise Z = ∑ cij xj,
Subject to ∑aijxj = ri (i=I,2,…....m)
and xj = 0, (j = 1, 2, n)
where cj and aij are the given coefficients and ri symbols show the
constraints. In a matrix form, aij helps us to find out the exact location of
each coefficient.
Let us assume a simple case of two variables to illustrate

diagrammatically the LP solution. Let the objective function be to
maximise
Max. V = 5 X1 + 3X2
Subject to 3X1 + 5X2  15
5X1 + 2X2  10
X1, X2 = 0
Graphical Interpretation
At first lets convert the inequalities into equalities,
3X1+5X2 = 15 --------------------------------------------(1)
and 5X1 + 2X2 = 10 --------------------------------------------(2)

5X1 + 2X2 = 10
C
V1
A
K V2
N
P
O M D B X1
We get lines AB for equation (1) and CD for (2) in the figure. Here note
that any point on or below the line AB satisfies the inequality 3X1 + 5X2 =
15; similarly any point on or below CD satisfies the inequality, 5 XI +
2X2 = 10. No point above AB (or CD) which satisfies the above
inequalities. The points which will satisfy both the non-negativity
constraints are given by the area OAKD. This area is then regarded as a
feasible region. Any point such as P is regarded as feasible because of
X1 and X2 at point P does not violate the constraints. Note that a feasible
solution could lie at a point like O (at the origin). But such a feasible
solution should imply that no production of (XI and X2 would take place.
In order to obtain the optimum feasible solution it is necessary to find out
the point at which the iso-profit curve is tangent to any point lying on
AKD. Any iso-profit line such as V1 which lies inside the area OAKD
does not yield the optimum profit because profit could always be
increased by moving further away to a higher iso-profit line like V2 which
just touches the area AKD at K. Similarly, the iso-profit line V1, although
indicating higher profit, is not attainable. Thus, the optimum profit is
given at the point K where OM of X 1 and ON of X2 will be produced.
Thus at K the objective function V = 5X1 + 3X2 is at a maximum. It is
necessary to point out here that given the above profit equations, iso-profit
lines are straight lines. Since constant returns to scale operate, the further
we move away from the origin along the iso-profit line, the greater is the
level of profit. The iso-profit lines, i.e, V1, V2 etc. are parallel to one
another.
To obtain the optimal values of XI and X2, it is necessary to solve the two
equations for lines AB and CD at K.
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So we have:
3X1 + 5X2 = 15
5X1 + 2X2 = 10
Solving for X1 we have X1 = 1.053, for X2 = 2.368. The maximum profit

now is V = 12.37.
The above example of solving the LP problem is highly simplified. In

reality, it is generally found that an optimum solution has to be found
subject to some inequalities in the constraints. These inequalities are
usually converted into equalities by adding extra or 'slack' variables for
solving the equations. Optimum solutions are then derived by using the
'simplex' method. In the simplex method, the optimum solution is reached
via an iterative procedure. According to the rules of LP, any corner
solution such as O, A, K, D, in the figure is a basic solution. In the
simplex method, starting from any basic solution (e:g. O), we move to the
adjacent corner solution (e.g.. either A or K) to improve upon the value of
the objective function until the optimum reached optimal.
Limitations
While it is apparent that techniques of linear programming have important

uses, the technique is constrained by several limitations. Some of them
are:
1. Linearity handicap: The basic shortcoming of the technique arises

from the linearity condition involved in it. The limitations arising out
of this can be spelt out in terms of two central properties of linearity;
additivity and mutiplicative relations. These two properties can hold
in some cases, but not necessarily in all.
2. Useful in reality and approximate reality: The above criticism is no

doubt valid because in real world situation is largely non-linear. It is
not easy to find by established means the non-linear equations which
express how prices and costs vary with output. Even if one had the
equation, they would be difficult to solve unless they were
unrealistically simple.
3. Statistical difficulties: The statistical difficulty arises more seriously

in respect of industrial technology, in particular of industries, which
do not exist or which are not yet established.

Questions for review
1 Linear model is applicable for

a. Only one variable
b. Two variables
c. More than two variables
d. None of the above
2. Why linear model is unrealistic?

A. In real world situation is mostly non-linear.
B. In real world situation is mostly linear.
C. None of the above
D. Both A and B
Answer 1.B, 2.A,

Short questions
1. What are the usages of Linear Programming?
2. What is feasible region?
3. What is "simplex method"?
4. Why is it necessary to use simplex method?
Essay Type Questions
1. “The linear programming provides systematic examination of a
number of feasible alternatives,” – explain using diagrams and
equations.
2. Assume two commodities x and y. At their prices each x earns a
profit of Tk. 1040 and each y earns a profit of Taka 900. The x
commodity requires 80 hours for processing and 48 hours for
finishing. The y commodity requires 50 hours of processing and
60 hours for finishing. The firm has 800 hours of labour and 720
hours of labour for processing and finishing respectively in a
week. How many of each commodity x and y firm should
produce?
Further Readings:
1. Lal A N K, Economics of Development and Planing, Vikas
Publishing House Pvt. Ltd., 1997
2. Arrow, K.J., L. Hurwicz, and H. Uzawa, eds., Studies in Linear and
non Linear Programming, Standford, Calli: Standford University
Press, 1958.
3. Hadley, G., Linear Programming, Mass.: Addison-Wesley, 1962.
5. Allen, R. G. D., Mathematical Economics, London, Macmillan,
1960.
6. Arrow,K., S. Karlin, and P. Suppes,eds., Mathematical Methods in
Social Sciences, Standford, Califf., Standford University Press, 1960.
Unit-5 Page-255
School of Business
Lesson 3: Social Accounting Matrix (Sam)

Objectives:
Social accounting matrix is designed to serve mainly two purposes: the

first is concerned with the organisation of information (i.e. information
about economic and social structure of a country in a particular year) and
the second is related to provide the statistical basis for the creation of a
plausible model.
 Understand the framework of the SAM
 Use SAM
Introduction
The Social accounting matrix (SAM) is double account book keeping, it

deals with the series of accounts of which incomings and outgoings must
balance; that means what is incoming into one account must be outgoing
from another account. In this sense SAM embodies the information
normally included in the national account. Here double entries are gained
by only a single entry in a matrix. Each consists of one row and one
column.
The following example would be very useful to us to understand the

operation of SAM. Let us assume that Robinson is engaged in only one
production activity, say the picking of coconuts. In some given period, he
picks 1,000 coconuts. This represents at the same time the level of
production, the level of his income, and the level of his demand for
products (sometimes called "wants"). All three are equal, as they must be
in such an economy.
The SAM for Robinson Crusoe

Expenditure Total
1 2 3 4 5 6
R 1 Income 1000 1000

E
C 2
E Demand 1000 1000
I 3
P
T 4 ……….
S
5
Production 1000 1000
………
6 Total 1000 1000 1000

The structure of this economy is set out in the table, in which two columns
and rows have been left, blank because they are not being used for the
time being. The final column and row around the border show the total of
each row or column. Within the border there are three entries, each of
them equal to 1,000. These constitute the SAM for Robinson Crusoe. In a
SAM the rows represent incomings and the columns outgoings. For
example, row 1,which is labeled "income," receives 1,000 from column 4,
labeled "production." In other words, Robinson Crusoe's income derives
from production and equals 1,000. Now, turning to column 1, we see the
corresponding entry 1,000, which represents the outgoings of income in
row 2, which is labeled "demand." Column/row 1, in effect, describes
Robinson Crusoe's role as an income earner.
In column/row 2, we look at him as a consumer. His demand arising from

income in row 2 is balanced by what he spends on production in column 2
(row 4). The third leg of this process is in row 4 and column 4, where he
turns up a third time as producer: his demand for production is 1,000 and
income arising from production is also 1,000. These various identities
could be set out in the form of double entry accounts, but, although not so
apparent yet, the matrix is more economical since it requires one entry for
each item, whereas conventional accounts require two.
It will be noted that there is a circular process. If one put the three entries
in the table in co-ordinate form with the row first and column second, they
would appear like this: (1, 4); ( 4, 2 ); and ( 2, 1 ). Thus, the matrix
illustrates the circular process of demand leading to production leading to
income, which in turn leads back to demand. Of course, this rather
complicated way of setting out the trivial structure of the Robinson
Crusoe economy might well be considered much ado about nothing. We
present it this way, however, because it is so self-evident and can serve as
an introduction to the more complex relationships in an actual economy.
In real life, Robinson Crusoe as a member of a society may, indeed, fill all
three roles-as income earner, consumer, and producer-but he would do so
as a member of different sorts of units or subdivisions, according to his
function. In the accounts for a whole society, income may be subdivided
into many different categories, among which income to labour and income
to capital are only the first tier. That income accrues to a variety of
domestic institutions, which are the source of demand: households with
different characteristics, firms, and government (central or local). The
outgoings or expenditures of these institutions are spread over a variety of
products, as indeed Robinson Crusoe's must have been; production thus
can be divided into as many sectors or subsectors as is desirable or
practical.
Unit-5 Page-257
School of Business
The uses of SAM
The uses of SAM fall into two categories: those in which the whole corpus
of information in the SAM is used and those in which only a part is used.
Of course, in the latter case, it is not necessary to have the complete
SAM. But the construction of the complete articulated SAM means that
one has at one's disposal a multipurpose tool and does not have to
construct separate subsets of accounts for each purpose.
One of the principal ways in which the whole corpus of information in a

SAM can be brought to bear is through multiplier analysis, which shows
how changes in one or more elements of a SAM generate changes
elsewhere in the matrix. Here we will only consider a simple example to
illustrate the approach.
The starting point is to assume a simple economy and a high1y aggregated

SAM which has accounts only for the private sector, government
production, the rest of the world, and a combined capital account. To keep
things even simpler, it is assumed that only the private sector buys goods
from the rest of the world. Corresponding to this simple economy, we
assume we have a SAM for some base period, and we ask the question,
"What would happen if demands on production activities were increased
by increasing government expenditure (by an amount i2), investment (by
an amount i3), and exports (by an amount i6)?" Without loss of generality
we can put the sum of the i's equal to one.
The first part of the answer to this question is that whatever the processes
of consequential changes might be, the end result will be a new SAM for
our simple economy. Moreover, those elements of the initial SAM that are
zero by definition will remain zero. Because our model assumes that only
the private sector buys goods from abroad, the purchases of such goods
by the government, for example, will remain zero.
Given the accounting rules and model assumptions, the difference between
the new SAM and the original one will imply an incremental SAM in
which many cells have zero entries. This incremental SAM is shown in
table. At this stage we know the items i2, i3, and is, because these are the
changes that we have exogenously postulated. We also know that the
blank entries in the table are zeros, because these follow from our model
and accounting conventions. The question then is, "What can be said
about the nonzero entries apart from i2, i3, and i5?”
Not much can be said about these nonzero entries without making further
assumptions about what will happen, for example, to prices, monetary
policy, and how people choose to spend any extra income. We will
assume, for simplicity, that private sector income goes up by an amount
M, and then explore what the incremental SAM in table can say about the
relationships between M and the i's.

Table: Multiplier effects in the form of SAM
Expenditure Total
Receipts 1 2 3 4 5 6
1 Private Sector M M
2 Government Mp2 Mp2
3 Capital Account Mp3 Mp2-i2 i3
4 Production Mp4 i2 i3 Mp5-i5 M
5 Rest of the World Mp5 i5 Mp5
6 Total M Mp2 i3 M Mp5
Note:M(1-p4) = Σ p = Σi
p2 = marginal propensity to tax
p3 = marginal propensity to save
p4 = marginal propensity to consume (domestic)
p5 = marginal propensity to import
M = Multiplier
i2 = Impulse from increased government expenditure
i3 = Impulse from increased investment
i5 = Impulse from increased exports
Because in this simple model the private sector gets all its income from
production activities and because these activities pay all value added to
the private sector, row 1 and column 4 of the incremental SAM are very
simple and contain zeros apart from the entry in row 1, column 4, which is
M.
The increase in private income (row 1) must match the increase in private
expenditures in
column 1. The latter must now be spread over the different components of
private expenditures. This spread is assumed to take place in the
proportions P2, P3, P4, and P5, which can be referred to as the marginal
expenditure propensities of the private sector. Because all the extra
income M must be spent or saved, the accounting balance for row/column
1 implies that
p2 + p3 + p4 + p5 = 1.
Unit-5 Page-259
School of Business
We might also be prepared to assume that these propensities are constant.

But if we do, then this is clearly a behavioural assumption, not an
accounting rule.
Because Mp2 is the only increase in income for the government,

row/column 2 of table must have sums MP2. From column 2, this implies
that the entry in row 3, column 2-the increase in government savings-must
be MP2 -i2. For now, we skip over the details of accounts 3 and 4 and
move to the rest of the world account (6). Here, the only increase in
receipts is Mp5 because only the private sector imports in this model. This
then implies that the entry in row 3, column 6, must be Mp5 –i5. This entry
measures the extent to which foreign savings, or a reduction in domestic
reserves of foreign exchange, finances the increased investment, i3.
Returning now to account 4, the fact that row and column sums must be
equal implies that
M = Mp4 + i2 + i3 + i5 = Mp4 + 1,
or
M = l/(l -p4).
In other words, the value-added M must be equal to the aggregate

increases in government expenditure, investment, and exports, inflated by
the factor l/(1 -p4). This factor is the familiar expenditure multiplier; it is
the reciprocal of the complement of the marginal propensity to consume
domestic goods. Hence, while the SAM does not tell us what value to give
to M or to p4, it does show that once one value is fixed, the other is also
fixed; and in that sense it defines the relationship between the initial
increments in expenditure (the i's) and the increase in total value added
(the M).
At this stage we have discussed the balancing of four of the five accounts
of the incremental SAM. That is all that is necessary, because it is always
true that within a SAM the last account will balance if all the others
balance. To illustrate this point, the rule requires that, for our account 3,
i3 = Mp3 + (Mp2 -i2) + (Mp5 -i5),
or
i2 + i3 + i5 = (p2 + p3 + p5) M.
Since the sum of the i's and the sum of the p's are each equal to one, this
can be written as:
1 = ( 1 -p4) M.
Hence the condition for account 3 to balance is the same as that for
account 4, that is to say:
M = 1/(1 -p4).

This result simply repeats that obtained previously. If all but one account
are balanced, then all accounts are balanced, and the story of the
incremental SAM shown as table is thus completed.
The application of multiplier analysis with a complete SAM is little

different in principle, though it is far more complex. It takes into account
all the interactions with1n each step of the process of linkages among
incomes, expenditures, and production. The linkages could include, for
example, the effects on other industries of expansion with1n a particular
industry. There is, however, no longer a single multiplier, but an entire
matrix of multipliers, which potentially shows the effect of expansion in
one cell of the original SAM on any other cell. How these effects are to be
interpreted must always be approached with care because the effect of one
variable on another ultimately depends on economic behaviour and not
just on accounting constraints. However, the approach has some value in
distinguishing accounts or subaccounts that are likely to be affected from
those that are likely to be bypassed. This distinction may well have
importance in considering the effect of exogenous changes on the
distribution of income. The analysis may also serve to identify the
important elements that result in changes in government accounts or in the
balance of payments.
Unit-5 Page-261
School of Business
Review Questions
1. What is SAM?
2. Construct SAM of Robinson Crusoe economy?
3. Analyse multiplier effect in the form of SAM?
Further Readings:
1. Pyatt, G., and J. Round (1979a), ‘Social Accounting Matrices for

Development Planning’, The Review of Income and Wealth, Series
23, no.4, pp-339-64.
2. Pyatt, G., and J. Round (1979b), ‘Accounting and Fixed Price

Multipliers in a Social Accounting Framework,’ Economic Journal,
Vol.89,pp-850-73.

Lesson 4: Computable General Equilibrium Model2

Objectives:
Computable general equilibrium (CGE) models combine features from the

different types of planning techniques that are discussed in the preceding
lessons. They are based on socio-economic structure of SAM with its
multisectoral multiclass disaggregation, incorporating initial inputs from
input-output table. The CGE models have been used for policy analysis to
comprehend shocks, changes in economic polices, etc.
 Discuss the basic structure and equations of Computable General
Equilibrium Models.
 Understand the construction of the CGE Model
 Discuss the solution strategies of CGE Model
Introduction
A CGE can be described by specifying the agents and their behaviour, the
rules that bring the different markets in equilibrium and the
macroeconomic characteristics.
Structure of CGE Models

In a CGE producers are profit maximisers and chose their levels of
production and purchases on the basis of prices. Domestic products and
imports are imperfect substitute and the composition of domestic supply
depends on their relative prices. Household maximise their utility and
choose levels of consumption based on income and prices.
In a CGE all the accounts are endogenous and thus must be in

equilibrium. Producers sell their total production, factors distribute their
income, firms and households spend their income and investment is
determined by available savings. Excepting the government which is
balanced by letting its savings, or deficit if negative residually computed,
others occur through the markets. The standard rule is one of price
flexibility and endogenous determination of the equilibrium process.
There are four macroeconomic components in a CGE. These are: the

balance of payment, the savings-investment equilibrium, the government
budget and aggregate supply of primary factors of production. The
balance of payment is constrained to an externally defined level of deficit.
Except in the structuralist models, total investment is assumed to total
savings. The budgetary consequences of all policies are accounted for in
CGE. In most models capital is considered fixed and fully utilised.
2
Based on Dervis K., De Melo J., Robinson S. General Equilibrium Model for
Development Policy. World Bank. Washington, D.C. 1982.
Unit-5 Page-263
School of Business
The behavioural assumptions of a CGE model are usually that agents

respond to relative prices rather than to the absolute level of any price. All
demand and supply functions are homogenous of degree zero in all prices.
It is standard procedure to set one price or a price index constant.
Construction of Computable General Equilibrium Model3
The production technology for primary factors is described by a

neoclassical production function that allows smooth substitution among
factor inputs. The degree of substitutability is governed by the elasticities
of substitution (in this case constant elasticity of substitution production
function).
According to a two-level production function where gross outputs are

related to input the equation will be
Xi = fi(At/, Kt/,Lia,Via)--------------------------------------------(1)
where Xi = sectoral output

At/ = a shift parameter that will dynamically reflect
disembodied technical progress.
Kt/ = the stock of the aggregate capital goods assumed to be
fixed by sectors.
Lia = an aggregation labour inputs.
Via = an aggregation index of intermediate inputs.
Given both the shares among different intermediate inputs in a sector and
the ratios of intermediate inputs are fixed, the demands for intermediate
inputs will be
Vij = aij Xj --------------------------------------(2)
where aij are the input-output coefficients. Now for getting total
intermediate demand by sector of origin it can be written
Vi = Vij = aijXj ---------------------------------------(3)

j j
The sectoral labour input is assumed to be an aggregation of labour of

different skill categories. The function will be represented by the equation
( with m types of goods)
Lia = Lia(Li1……………….Lim)-----------------(4)
3
K. J. Arrow, H. B. Chenery, B. S. Minhas, and R. M. Solow, ‘Capital-Labour
Substitution and Economic Efficiency,’ Review of Economic and Statistics,
August 1961,pp- 225-250.

This equation is given by the CES function with a single elasticity of

substitution among all labour categories.
The specification of the production set of the economy is incomplete

without a set of factor availability constraints; writing in the form of
excess demand functions for labours
 Lis - Ls/ = 0-------------------------------(5)

i
where Ls/ denotes the fixed supplies of the various categories of labour.
Each sector in the economy is treated as made up of many similar firms

maximising profits; the assumption of perfect competition in product
markets amounts to assuming that firms take commodity prices as given.
Under this circumstances, one can treat each sector as one large price
taking firm. The aggregate sectoral profit functions are given by
i = Pi(1-tdi)Xi -  PjaijXi-  Ws Lis----------------(6)

j j
Where Ws is the wage of labour of type s and tdi is the indirect tax rate. 4
The profit equation can be rewritten as
i = PNiX -  Ws Lis
j
where n
PNi = Pi(1-tdi) -  Pjaij-------------------------(7)
j=1
is the or value-added coefficient, this time net of indirect taxes.
Labour demands are given by

PNidXi/dLia dLia /dLis= Wi-------------------------------(8)
This equations give the demand functions by sectors for labour and may
be written as
Lis = Fis (W1…………….Wm,,PN1, Kt/)-------------------------(9)
The equations for the factor markets which essentially underlie the
aggregate supply or production transformation set considered is collected
together in the following table.
4
The primary concern in this simple model is not with policy formulation, the
inclusion of a government sector leads to naturally to the inclusion of indirect
tax and direct tax in the system.
Unit-5 Page-265
School of Business
Tablie1: Factor market and product supply equations:
No of
equations
Production function: 1
Xis = f(k/1, Li a,V1,……..,Vm) n
Intermediate goods demand
Vij = aij Xj n.n 2
Vi = Vij j
Labour aggregation
Lia = Lia(Li1, Li2 ……. Lim) n 3
Net prices
PNi = Pi -  Pjaji -tdi Pi n 4
j
Labour demand equations n.m 5

PNi dXi /dLi a dLi a /dLis= Wi
Aggregate labour demands m 6

Lds =  Lu
Aggregate labour supply
Li s = L/ m 7
Excess demand for labour equations
Li s = Lss =0 8
Total: 4n+3m+n . m+n. n m 9
Endogeneous variable number
Xi s Sectoral Production n
Vij Intermediate goods demand n.n
Vi Aggregate intermediate goods demand n
Li a Aggregate labour by sector n
PNi Net prices n
Lis Labour demand by sector and prices n.m
Lsd Aggregate labour demand by type m
Lss Aggregate labour supply by type m
Ws Wage of labour by type m
Total:4n + 3m+n.m+n.n
Tablie2: Product market equations:
No of equations
Household capitalist and government income:
Yi = Wi ,Lis(1-ti ) m 10
Yi = [PMi Xi - Lis](1-ti ) one 11
Yi = {ti /(1-ti )}Ys + {ti /(1-ti )}Ys +tdi Pi Xi one 12
Total Savings
TS = SsYs +SkYk +Sg Yg one 13
Consumer Demand

Ci d =  Cisd + Cikd + Cigd n 14
Investment Demand
Ui =sij Pj n 15
Ki =Hi / [TS/Ui ] n 16
Zi =sijKi n 17
Aggregate Excess Demand

Xdi =Ci d+Zi +Vi n 18
Xdi - Xsi =0 n 19
Price Normlisation
Pi i =P/ one 20
Total: 4n+3m+n . m+n. n
Endogeneous variable number
Ys Labour Income by type m

Yk Capital Income by type one
Yg Government revenue one
TS Total Saving n.m
Ci d Aggregate consumption demand n
Cisd Consumer Demands by labour house n
holds n
Cikd Consumer demands by capitalist n
Cigd Government Consumption n
Ui Capiral goods price n
Ki Real Investment n
Zi Investment goods demand by sector of n
origin n
Xdi Aggregate demand by sector
P/ Prices
Total:4n + 3m+n.m+n.n
The endogenous variables in these equations describe all the flows in the
first column of the social accounting matrix. In real life employment,
intermediate demand, and product supply are covered here and in terms of
monetary flows, they give payments for intermediate goods, labour,
capital, and indirect taxes. Table 2 shows the equations for the product
markets in the model economy. The endogenous variables describe the
flows in the last four columns of the social accounting matrix. They give
the distribution of factor income to "institutions" {households and
government); its allocation among taxes, consumption and saving; and
finally the resulting demand for products.
The presentation in Tables 1 and 2 emphasises the market-clearing role of

wages and prices in the core model. For any given set of product prices Pi
there are as many equations in Table 1 as there are endogenous variables.
The heart of the problem is to find a set of average wages such that, given
Unit-5 Page-267
School of Business
the labour demands from Eq. (6), there is zero excess demand in the
markets for labour of different categories. The solution of the excess
demand equations for labour for different sets of product prices defines
the summary numerical supply function given in Eq. (11).
In Table 2 the product market equations can, by simple substitution, be

reduced to the set of excess demand equations. Note that the number of
equations is one greater than the number of variables. As we have
discussed, the equations are not independent, so' that the n excess demand
equations can determine only n - 1 relative prices. The price normalisation
equation (20) is required to set the absolute price level.
The product market equations include the flow of funds among the various
institutions in the economy. They thus include the flows that are the focus
of demand-driven macro models. We are focusing on issues of sectoral
structure, resource allocation, and trade, and so are not attempting to
determine endogenously variables such as the price level. However in any
CGE model, the flow of funds accounts must specify the entire circular
flow in the system - There are no leakages.
The treatment of investment
In the equations presented in Table 2, the sectoral share parameters for

investment (Hi/) are simply assumed to be fixed. The level of total,
investment, however, is determined endogenously. In the capital account
row in the SAM, total savings (and hence investment) are determined; by
applying exogenous savings rates to the income of each institution in the
economy. Total investment is thus determined by savings behaviour and is
thus also a function of the distribution of income among the different
households and the government (assuming that their savings rates differ).
This model of total savings and investment is very classical in spirit,
except that we have added government to the usual capitalist and labour
classes.
There is no shortage of theories of investment in economics -the problem

is more that there is no widespread agreement on which theories are best.
In a planning model such as CGE model; a number of different choices
seems reasonable.
Solution strategies
There are several ways to solve CGE models but it is useful to distinguish
between a solution strategy and a solution algorithm. A solution strategy
refers to the way in which the equations of the model are substituted and
rearranged so as to reduce the solution problem. A solution algorithm
refers to the actual numerical algorithm used to solve the reduced set of
equations. In devising a solution strategy for CGE models, it is important
to take advantage of our knowledge of the economic properties of the
system of equations.

In choosing a solution strategy, two criteria are most important. First, how
hard is it to solve the reduced equations numerically? Second, how hard is
it to reduce the model equations to the chosen set, especially when, as is
often the case, one wants to be able to experiment with a variety of
analytic formulations ?Reducing a CG E model to sets of market excess
demand equations is usually a straightforward procedure requiring, with
one exception, simply the evaluation of the equations of the model in
order. The only place where numerical techniques may have to be used is
in the derivation of labour demands by firms given wages -the marginal
revenue product equations.
All solution algorithms will follow the same general procedure. They will
all start with some initial set of wages and prices (which .satisfy the
normalisation rule), calculate the excess demands in both factor and
product markets, and then revise wages and prices iteratively based on
calculated excess demands. The iterations stop when equilibrium is
reached; that is, a set of wages and prices is found such that all excess
demands are sufficiently close to zero. Different algorithms use quite
different techniques for revising wages and prices given the excess
demands from the last iteration, and there are a variety of such algorithms
from which to choose.
Unit-5 Page-269
School of Business
Review Questions
1. Describe structure of a CGE Model.
2. How is the investment treated in CGE model?
3. Discuss solution strategies of a CGE model.
Further Readings
1. Arrow, K. and F. Hahn(1971), General Competitive Analysis, San
Fransisco Holden-Day.
2. Arrow, K.J., L. Hurwicz, and H. Uzawa, eds., Studies in Linear and
non Linear Programming, Standford, Calli: Standford University
Press, 1958.
4. Arrow,K., S. Karlin, and P. Suppes,eds., Mathematical Methods in
Social Sciences, Standford, Califf., Standford University Press, 1960.

Lesson 5: Cost-Benefit Analysis (CBA)

Objectives:
The choice of project and allocation of resources has been dominated by
social cost benefit analysis. The technique, in the post 1970s era, has been
recommended for the appraisal of publicly financed investment projects in
order to achieve allocative efficiency.
 Explain the meaning of social cost-benefit analysis.
 Explain how the cost benefit analysis of a project to society may
differ from the cost-benefits to the private entrepreneur.
 Describe the decision rules in CBA.
 Explain the reason for using CBA in LDCs.
Introduction
How should a project’s social benefits and costs be measured? What

common units of account should the benefits and costs be expressed in,
given a society’s objectives especially in circumstances when it has
trading opportunities with the rest of the world? There are several ways of
undertaking such questions.
Benefits and costs may be measured at domestic market prices using

consumption as numeraire, with adjustments made for divergence
between market prices and social values, and making domestic and foreign
resources comparable using a shadow price of foreign exchange. This is
sometimes referred to as the UNIDO approach [Dasgupta, Marglin and
Sen(1972)]
Benefits and costs may measured at world prices to reflect the true
opportunity costs of outputs and inputs using public saving measured in
foreign exchange as numerair.(i.e. Converting everything into its foreign
exchange equivalent). This referred to as the Little-Mirrlees approach
[Little and Mirrlees (1969) and (1974)]
Basic Principles of CBA
Here the objective is to choose the project that high yields high positive
Net Social Benefit (NSB) where the NSB is defined as
NSB = Benefits (willingness to pay) -Costs (compensation needed).
Unit-5 Page-271
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NPV
D
P S1
P1
E
A
O
O Rate of Discount
M M1
Quality
Demanded
All benefits and costs are expressed in monetary units. The willingness to
pay is given by the area under the demand curve, but the actual total price
paid is given by the price times the quantity .In other words, the amount of
consumer surplus reflects the size of gains.
So in the figure though the consumers are willing to pay ODSM for OM
quantity, they actually pay OPSM and hence the area DPS measures
consumers’ surplus.
Now lets suppose that a cost saving device is used in project, prices fall to
OP1 from OP, and an increase in the goods provided is shown by MM1.
Here the total willingness to pay is given by ODS1M1 which is greater
than ODSM by MSS1M1 out of which MM1S1E accounts for actua1
payments and as such, the change in consumer surplus is given by the
shaded area ESS1. This is equivalent to the NSB for the society.
Many problems lie with the estimation of this social benefit. For example,
the demand curve is assumed to be linear, marginal utility of income is
supposed to remain fixed; utility is supposed to be measurable cardinally,
prices of all other goods are expected to remain unchanged; there are some
intangibles which cannot be measured. Hicks tried to tack1e some of these
problems by allowing changes in the marginal utility of income and by
using the indifference curve analysis. Also, Kaldor and Hicks pointed out
that to increase social welfare, it is only necessary to show that the gainers
should be able to compensate the losers and still remain gainers.
Moreover, as Scitovsky points out, if the gainers can compensate the
losers in accepting a change and the losers can bribe the gainers back to
the ‘status quo’ then a clear contradiction emerges as there is no way to
tell whether social welfare has increased or discreased.

The decision rules in CBA

To take decisions regarding project choice, the project planner confronts
the following sets of problems:
(a) the problem of identification of the benefits and costs;
(b) the problem of valuation of these benefits and costs at prices

which would be relevant to society;
(c) the problem of choosing an appropriate rate of discount for

evaluating such benefits and costs;
(a) the problem of identifying the actual constraints;
(e) the problem of uncertainty.
At this point the planner tries to find out the Net Present Value (NPV)
discounted by a certain rate of discount and if the NPV > 0, then the
project should be accepted. If the projects are mutually exclusive, then the
one which yields the highest NPV should be accepted. Note that NPV
means prescient discounted value of benefits less present discounted value
of costs. More formally, if the net benefits arc given by P1, P2,
NPV =  Pt/ (1 + i t)
where i = rate of discount. This could be a social rate of discount or

opportunity cost of capital. In practice. the choice is rather difficult. It is
obvious that the higher rate of discount the lower will be the NPV (see
Figure), and at a certain rate of discount, the NPV = 0. Such a rate is
called internal rare of return (IRI) or OA in Fig.
More formally,
[Pt / (1+ µ )t] = 0
where A = internal rate of return. If µ > i then the project should be

accepted if not, the project should be rejected.
Reasons for undertaking CBA in LDCs

Several reasons are given for undertaking CBA for the LDCs to make a
realistic estimated of the net social benefits (NSB)
1. Inflation in many LDCs, emanating chiefly from the supply

inelasticities, alters the relative prices and government's intervention in the
form of price controls results in the distortion of NSB.
2. In most LDCs, exchange rates of the, domestic currencies are kept

artificially high. This again leads to an excess demand for foreign
exchange and when the government imposes import restrictions, market
Unit-5 Page-273
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prices of goods exceed their world price and such market prices tend to
overestimate the NSB within the country.
3. Given the imperfections of the labour market in the LDCs, different

modes of production (e.g. use of family labour rather than wage labour
and the absence of a unique
relationship between marginal productivity of labour and wages) and the
presence of large-scale unemployment, it is argued that wages paid to
labourers in LDCs tend to overestimate their true social opportunity costs.
Hence a shadow wage rate should be calculated to work out the true cost
of labour to society.
4.Given the imperfections of the capital market in most, the interest rate is
kept artificially low, particularly when capital is very scarce in supply.
Here again, a shadow rate of interest should be calculated to remove the
underestimation of the cost of capital to sociery.
5. Since large projects are likely to yield significant secondary benefits to

the economy, it is not enough to count only the primary benefits of a
project.
6. Since many LDCs have decided to industrialise their economies behind

protectionist walls by using tariffs, quotas, exchange controls, etc., market
prices within the economy would fail to reflect the NSB.
7. Saving deficiency and public income Given the dearth of savings in

LDCs, the government can value an extra unit of saving more than the
extra unit of consumption and impose appropriate taxes (which of course
imposes some costs) to raise, such savings. It is assumed that money at
the disposal of the government of any country is worth more than private
consumption because while money in the hands of the government could
be invested to produce future consumption, it would be wasteful if left in
the hands of private individuals who have very high propensity to
consume.
8. The problem of inequalities in the distribution of income and wealth is

very much present in the LDCs. Such a problem would be lessened if
public savings could substitute for private savings by the rich in LDCs.
9. It is argued that whenever externalities are present say, in the presence

of diminishing costs in certain industries with a large investment project),
such externalities should be fully taken into account in the project
appraisal for the LDCs.
The Equivalence of the Little-Mirrlees Formulation of the Shadow

Wage and the Unido Approach
In the Unido approach, the optimal shadow wage is given by

W* = PA + s* ( PINV -1) W ------------------------------------(1)
Where s* is the capitalists propensity to save,

W* is the wage
PINV measures the price of investment in terms of consumption.
Assuming that the propensity to save of capitalists is unity (s*= 1) and all
wages are consumed, equation (1) may be written as
W* = PA + ( PINV -1)C ------------------------------------(2)
Where ( PINV -1)C represents the present value of aggregate consumption

lost (assuming PINV  1) because of the increased consumption of workers
which reduces savings for future consumption.
Now for the two approaches to give the equivalent cash flows, which ever
numeraire is taken, PINV must equal So, so that equation (2) may be
written as:
W* = PA + (S0 -1)C ------------------------------------(3)
Now the little Mirrlees formulation of the shadow wages is:
W* = PA + (1 -1/S0)(C-m) ------------------------------------(4)
Which, on the assumption that PA= m , may be written as
W* = PA /S0+ (1 -1/S0)C ------------------------------------(5)

Comparing equation (4) with the UNIDO equation (3) it can be see that
the UNIDO formula is S0 tomes the Little-Mirrlees formula because the
UNIDO numeraire is 1/S0 times as valuable as the Little-Mirrlees
numeraire.
A Comparison of Little-Mirrlees and UNIDO Approaches
Little-Mirrless UNIDO
Y0 Y1 Y0 Y1 Y2
Y2
Cost of
investment(k) 1.Foreign cost Tk.1250
1.Foreign $1000 converted into taka
component at shadow exchange
rate of 1.25
2.Local
Component= 2.Local component
1000
convesion
factor of 0.8 $800 Tk.1000
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Input Cost(C)
1.traded 1.Traded inputs
inputs $1000 $1000 converted into taka Tk.1250
at shadow exchange Tk.1250
2.Non-trade rate of 1.25
inputs=
1000 $800 $800 2.Non-traded inputs Tk.1000
convesion Tk.1000
factor of 0.8
Benefit Benefit flows in

Flow(v) $3000 Taka Tk.3750
$3000 Tk.3750
Net Benefit $1800 Net Benefit in Taka Tk.2250

$1200 Tk.1500
$1200 Tk.1500
A Numerical Example:
Assume that the world price are measured in dollars and domestic price
are measured in taka(Tk.); that the shadow exchange rate is 1.25 taka per
dollar; that the shadow price of foreign exchange (PF)=1.25 and the
standard factor for converting non-traded goods prices into world prices
is0.8 . Assume further that :
1. All output is exported with an annual value of $3000
2. The cost of investment has a foreign component of $1000 and a local
component of Tk. 10000.
3. There are traded inputs of $1000 and nontraded inputs of Tk.1000.
4. The accounting rate of interest is equal to the consumption rate of
interest.
We can apply our net present value formula using two approaches.
Remember that using Little-Mirrlees approach we must convert all the
prices of nontraded goods into world prices using the standard
conversation factor of 0.8, and using UNIDO approach we must convert
all the values at world prices($) into domestic prices using the shadow
exchange rate of 1.25
We will do the analysis for three periods only (see table). We see that the
results of using the Little-Mirrlees approach and the UNIDO approach
will differ only to the extent that the shadow exchange rate is different
from the actual exchange rate. To obtain the net present value, the net
benefit stream in years 1 and 2 must be discounted by the appropriate
discount factors which we assume here to be the same using both
approaches. Assuming the discount rate of 10 percent we have:

Little-Mirrlees: NPV = [$1200/1.1]+[$1200/(1.1)2]-$1800=$282.6

UNIDO: NPV= [Tk.1500/1.1]+[Tk.1500/(1.1)2]-Tk.2250=Tk.353.2
Little Mirrlees result will yield the same Tk. value if the actual exchange
rate of dollars into taka is equal to the shadow exchange rate of 1.25.
Little-Mirrlees conclude their own evaluation of the two approaches by

saying ‘there is no doubt that the two works adopt basically the same
approach to project evaluation’.
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Review Question
1. What is the meaning of social cosy-benefit analysis?
2. Explain hoe the cost benefit analysis of a project to society may differ
from the cost-benefits to the private entrepreneur?
3. What are the decision rules in CBA?
4. Why should CBA be used in LDCs?
Further Readings
1. Janos Kornai, ‘Appraisal of Project Appraisal’, in Micheal J.
Boskin (ed.), economics and Human Welfare: Essays in Honor
of Tobor Scitovsky (New York, Academy press, 1979), pp. 91-
96.
2. P. Thirlwall (1970) ‘The Shadow Wage when Consumption is
Productive’, Bangladesh Development Studies, Oct-Dec.
3. M. Scott, J. Macarthur and D. Newbery (1976) Project
Appraisal in Practice. (London: Heinemann)
4. G. B. Baldwin (1972) ‘A Layman’s Guide to Liltte-Mirrlees’,
Finance and Development, vol. 9, no.1.
5. M. D. Little and J. Mirrlees (1974) Project Appraisal and
Planning for Developing Countries, (London: Heinemann)
6. M. D. Little and J. Mirrlees (1969) Manual of Industrial Project
Analysis in Developing Countries, vol.II Social Cost-Benefit
Analysis (Paris: OECD)

5
Lesson 6: Logical Framework Approach (LFA)
Objectives:
The Logical Framework Approach (LFA) described in this section is

based on the "Logical Framework " method, which is a way of structuring
the main elements in a project, highlighting logical linkages between
intended inputs, planned activities and expected results.
The purpose of the lesson is to:

 Explain the planning procedure which enables institutions to design a
programme or project.
 Describe the advantages of using LFA
 Explain stakeholder analysis.
 Explain the vertical and horizontal logics within project planning
matrix.
Introduction
The logical framework (or logframe) approach provides a set of designing

tools that, when used creatively, can be used for planning, designing,
implementing and evaluating projects. The purpose of LFA is to undertake
participatory, objectives-oriented planning that spans the life of project or
policy work to build stakeholder team commitment and capacity with a
series of workshops.
The first "Logical Framework" was developed for U.S.AID at the end of
the 1960's, and has since been utilized by many of the larger donor
organizations, both multilateral and bilateral. OECD's Development
Assistance Committee is promoting use of the method among the member
countries. The Nordic countries have also shown interest in the use of the
"Logical Framework", and in Canada the approach is used not only in
development aid but also in domestic public investment in general.
Institutions in partner countries also use the LFA in their management of
projects and programmes.
The Advantages of LFA
The advantages of using LFA are the following:

 It ensures that fundamental questions are asked and weaknesses are
analysed, in order to provide decision makers with better and more
relevant information.
 It guides systematic and logical analysis of the inter-related key
elements which constitute a well-designed project.
5
Based on The Logical Framework Approach: Handbook for Objectives-
oriented Planning, NORAD, January 1999 and materials used for
UNDP/UNSO Capacity Building Workshop for Dryland Management
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 It improves planning by highlighting linkages between project

elements and external factors.
 It provides a better basis for systematic monitoring and analysis of the
effects of projects.
 It facilitates common understanding and better communication
between decision-makers, managers and other parties involved in the
project.
 Management and administration benefit from standardized procedures
for collecting and assessing information.
 The use of LFA and systematic monitoring ensures continuity of
approach when original project staff are replaced.
 As more institutions adopt the LFA concept it may facilitate
communication between governments and donor agencies. Widespread
use of the LFA format makes it easier to undertake both sectoral
studies and comparative studies in general.
Steps in an LFA
There are 4 major steps in conducting an LFA, each with a set of

activities to be carried out as outlined below:
Situation Analysis
(1) Stakeholder Analysis

(2) Problem Analysis
(3) Objective Analysis
Strategy Analysis
Project Planning Matrix

(1) Matrix
(2) Assumptions
(3) Objective Indicators
(4) Verification
Implementation
Step - I. Situation Analysis
The LFA approach begins by analysing the existing situation and

developing objectives for addressing real needs.
A situation analysis has as its core task to find out the actual state of
affairs with respect to an issue to be analysed; it is focussed by problems
and an attempt to understand the system which determines the existence of

the problems. As problems are always connected to unfulfilled objectives,

a situation analysis comprises of an Objectives’- as well as a
Problems’-Analysis. And as it is always people’s problems and objectives
which make up a situation, the analysis includes a Participants’-Analysis.
The analysis phase is the most critical, yet most difficult, phase of the
logframe approach. The analysis phase consists of three stages,
 Analysis of stakeholders
 Analysis of problems
 Analysis of objectives.
The situation of the proposed project or programme needs to be analysed.

Answers to the following questions are needed:
 What are the general areas of concern, or themes, that the project
will focus on?
 What is the project aiming to achieve?
 At what spatial levels will the project focus, in terms of subject
(broad/macro to specific/micro) and or geography (local to
global)?
 What political, socio-economic, technological and biophysical
environment will the project operate within?
 Who are the major stakeholders?
 How will stakeholders be involved in the process of design,
implementation, monitoring, evaluation and reporting?
 Who is working on the issues already? What are they doing?
 What is the niche of the project?
 Who will implement the project?
 What is the intended duration of the project?
 What is the anticipated level of funding?
 Who will fund the project?
Stakeholder Analysis
Projects are influenced by many actors. Their different interests,
potentials, deficiencies and other characteristics play a role in the process
of designing and implementing a project. It has been a frequent experience
in development that marginal groups were not sufficiently considered in
the planning, and hence caused poor implementation. Thus it is usually
necessary and expedient to analyse stakeholders in a project as part of the
planning process.
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In using the LFA approach, the stakeholder analysis is an analysis of the

problems, fears, interests, expectations, restrictions and potentials of all:
- important groups
- organisations and institutions
- implementing agencies
- other projects and
- individuals
who may have an influence on a situation/(intended) project or are
themselves affected by it. Those analysed in detail should be limited to
those who are perceived to:
- be able to contribute to questions to be answered

- be important with regard to decisions to be taken.
They should constantly be referred to in developing the LFA. Key

questions to ask in preparation for developing the logframe are:
 Who will be involved in the logframe development?

 Where will the development be conducted?
 Who will facilitate the development of the logframe?
 What background materials, papers and expertise may be needed?
 What materials and logistics are required?
Analysis of Problems
The analysis phase usually begins with an analysis of problems. The
problem analysis is undertaken by identifying the main problems and
developing a 'problem tree' through an analysis of cause and effects.
The guiding principle in the Analysis of Problems is: problem-focused

analysis combined with a systems’ understanding
Problem-focused analysis means:

 analyse only those issues which are identified to be problematic, be
guided by problem view
 narrowing the focus with respect to the scope of analysis and at the
same time digging deep into these problems and their causal factors.
System’s understanding means:
 understand how the An example of brainstorming rules:

system (in which the
problem and its causing (1) All ideas are accepted without
factors occur) operates argument
 widening the view with (2) Aim for quantity rather than quality
respect to analysing the (3) No debate about whether ideas are
interlinkages and feed- accepted or not, only about whether the
back mechanisms idea has already been listed.
(4) No evaluation now (limit the
discussion on the significance of the
material and concentrate on getting full
cross-section of ideas)
between components of the system
Brainstorming techniques can be used to identify the main problems.

Before the brainstorming exercise commences it is important that the
facilitator explain the process and the group agrees on some rules for
brainstorming.
Developing the Problem Tree
The substantial and direct causes of the focal problem are placed parallel
underneath it. The substantial and direct effects of the focal problem are
placed parallel on the line above it. Causes and effects are further
developed along the same principle to form the problem tree. If a
workshop decides that the high number of accidents should be considered
the focal problem. The following problem tree of substantive and direct
causes and effects can be established
Objectives Analysis
The objectives-analysis and the
An objectives’-analysis in a wide problems-analysis influence each
sense is a procedure for other: the more information one
systematically identifying, has about the problem situation,
the more specifically one can
formulate objectives; the kind
and outline of the objectives
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of problems.
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categorising, specifying and - if required - balancing out objectives of all

parties involved in a specific situation (for which those objectives apply).
The problem tree is transformed into an objectives tree by restating the

problems as objectives. The objectives tree can be viewed as the positive
mirror image of the problem tree. It is usually necessary to reorder the
position of objectives as you develop the tree. The objectives tree can also
be considered as an 'ends - means' diagram. The top of the tree is the end
that is desired and the lower levels are the means to achieving the end.
If the workshop decides to add "training of drivers" as a means to make
drivers more responsible.
Step – II: Strategy Analysis

A strategy analysis or analysis of
Alternative strategies can
alternatives is a systematic way of
only be analysed as different
searching for and deciding on problem
means (the “how”: doing the
solutions. It follows the problems and
thing right) to reach a pre-
objectives analysis and is a
defined end (the “what”:
prerequisite to designing action
doing the right thing).
strategies.
Analysing the strategies thus
is not a once for all exercise,
Choices among different solutions to
but it is a continuous task in
problems may concern
project management.
 overall concepts, strategic

plans, objectives
 people, target groups, organisations, agencies
 methods, procedures, processes
 technologies, services, products, outputs
 measures, actions, materials, inputs
All alternative strategies considered must contribute to solving a problem,

or in other words: they must be suitable steps towards the attainment of
identified guiding objectives (relevance).
Based on the situation analysis and the ordering sequence of the problem
and objective trees, the strategy analysis involves clustering objectives and
examines the feasibility of different interventions. The main objective
becomes the project purpose and the lower order objectives become the
outputs or results and activities.
The strategy analysis phase involves the selection of a strategy to achieve

the desired results. The strategy comprises the clusters of objectives to be
included in the project. In addition to examining the logic, strategy
analysis also looks at feasibility of different interventions. This may mean
that the focus of the project shifts, therefore once the strategy has been
selected, the project purpose and overall objectives are finalised.
The process of making choices should be carried out in a very methodical

way, giving due consideration to the ends/means relationship in the
objectives tree. An example of a strategy analysis is shown below. First
objectives which cannot be achieved should be eliminated. If the workshop
decides that improved road conditions are entirely outside the reach of any
of the bus companies.
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It has to be agreed upon which criteria should be used to assess the

viability of the different options. The three alternatives bear the following
result:
Option 1 is limited to a training programme. The chance of success is

low if the buses are still in bad condition. Option 2 is more expensive,
and there is no guarantee that the result will be positive unless the
drivers also improve. A third option would be to combine option 1 and
option 2. It would be the most expensive alternative, but has a higher
probability of success.The result is that one of the options are chosen
as the project strategy, in this case option 3.
Step – III: Project Planning Matrix (PPM)
The Project Planning Matrix is developed from the strategy analysis by
filling in the columns of the matrix as shown below. The goals, purpose,
outputs/results and inputs/activities are transposed from the strategy tree
to the columns and rows in the matrix.
The main project elements are listed in the left column of the PM. Some of
the elements can be derived from the objectives tree. Note that the outputs
are the results that can be guaranteed by the project, while the purpose is
outside the direct reach of the project.

Determining the Assumptions

Some of the assumptions can also be derived from the objectives tree. In
this limited example there is only one such factor listed, namely "improved
roads" which we assume is necessary in order to reduce the frequency of
bus accidents.
Establishing the Indicators

The indicators specify how to verify the attainment of objectives and
outputs. Some indicators can be derived from the objectives tree. An
indicator of the purpose specifies exactly how much the frequency of bus
accidents should be reduced and by which date. It will then be possible to
verify whether the purpose have been achieved or not.
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Means of Verification (MOV)

Once indicators have been assigned, the source of information and means
of collection should be established fore each indicator. The Means of
Verification indicate:
(1) How to acquire evidence that the objectives have been met’ and
(2) Where to find proof, which will provide the data/information, required
for each indicator.
Vertical and Horizontal Logic within the PPM
The matrix functions on two dimensions, vertical and horizontal.
Vertical: The vertical logic can proceed from very specific inputs moving
up to a general goal. It can also be considered in reverse from a general
goal to the necessary specific inputs.
If the project or programme has good causality, then the vertical logic
should be correct and demonstrable. Testing the vertical logic is important
becomes it makes explicit the relationship between the particular inputs
and outcomes. LFA also causes project participants to examine not only
the causality of their project but also the resource requirements.
Intervention Strategy Important Assumptions

Goal Assumptions for
sustaining the
goal in the long term
Project Purpose Achieved plus assumptions for
achieving the
goal
Outputs/Results Achieved plus assumptions for
achieving the project
purpose
Inputs/Activities Carried out plus Assumptions for
achieving the
outputs/results
Horizontal: The horizontal logic of the matrix considers how to determine

the status of inputs, outputs, achieving the project purpose and
contributing to the overall goal by listing the indicators and verification
and the assumptions overarching the project implementation.
Below is a simplified example of a filled out matrix with the overall goal
to improve human nutrition.

Narrative Objectively Means of Important

Summary Verifiable Verification Assumptions
Indicators
GOAL/ Improved human Quantitative Having more food
OBJECTIVE nutrition measures available produced will
from public increase availability
Improving sources or records and improve
human of the project nutrition
nutrition in X
PROJECT Increased food Quantitative Better yields will
PURPOSE production measures available lead to increased
from public production
increase food sources or records
production of the project
OUTPUTS/ Increased quantities Quantitative Using irrigation
RESULTS of vegetables measures available water will increase
from public yields
increased sources or records
yields of of the project
vegetables
INPUTS/ Irrigation water Quantitative Irrigation water is
ACTIVITIES measures available available and can be
from public distributed
Irrigation sources or records
water of the project The increased yields
will be available to
the people
Step – IV: Implementation
The operational phase of a project commences when implementing

activities begin in order to achieve the expected outputs/results. In many
cases this may be one or two years after the project concept had been
established at the end of the design phase (as laid down in the PPM of the
project appraisal). In the meantime framework conditions may have
changed, so that a verification of the PPM must take place during the
operational planning. The project purpose and development goal,
however, should be altered only in exceptional cases when major changes
have occurred.
Implementation should have a plan of operations i.e. the detailed plan for
the implementation of project. It is established by the project team and
will be documented as:
 workplans / work schedules
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 project budget / resources plans
 personnel plans
 material and equipment plan / procurement plan / staff training

plans.
The work plan and the project budget constitute the core of the Plan of
Operations.
Weaknesses with Logical Frameworks
LFA provide a valuable set of tools for project designing, but they also
have a number of weaknesses. Such weaknesses include, but are not
limited to the following:
1. One of the main criticisms that project designers have of the LFA
approach is that it begins by identifying problems. There are three
problems that emerge from beginning with problems:
 Beginning with the problem analysis often produces poor

results because the initial negative focus pervades the rest of
the LFA process. This often results in limited vision of
potential solutions.
 Beginning with the problem analysis can be particularly

serious problem in cultures that consider it inappropriate to
openly discuss problems or criticise.
 Beginning with the problem analysis is not suited to situations

where there is a great deal of uncertainty or where agreement
cannot be reached on the main problem. The LFA approach
assumes the nature of the problems can be readily determined
at the beginning of the planning process. This does not allow
for an exploratory style project that seeks to learn from
experience.
2. The LFA is often developed and used rigidly. This can stifle innovative
thinking and adaptive management.
3. LFAs are often developed after the project has been designed rather
than used as the basis for design. The use of the LFA late in the design
process can often be attributed to:
 a lack of understanding of the LFA approach
 the LFA is seen as a requirement of funding

agencies and not as a design or management tool.
4. LFAs do not readily enable monitoring unintended consequences.

5. LFAs are rarely considered by project managers to be a key planning

tool.
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Conclusions
The logical framework approach provides a powerful set of tools for

designing projects and project evaluations. However, like all tools, LFAs
are not the complete answer to effective project designing. LFAs are best
used towards the end of the project design cycle after information has been
collected and analysed, needs assessed, views of stakeholders sought and
the external environment of the project understood.

Questions for Review

Multiple Choice Questions
1. The top of the problem tree is
a. the main problem or the effect b. causes
c. root causes d. objective
2. The lower levels of the problem tree are :
a. the main problem or the effect b. causes
c. Means of verification d. indicators
3. The top of the objective tree is
a. root causes b. main problem or the effect
c. the end desired d. means to achieve the end
4. A matrix in LFA functions on
a. four dimensions b. three dimensions
b. multi-dimensions d. two dimensions
Answers: 1. a, 2. b, 3. c and 4. d
Short Questions
1. What are the advantages of using LFA?
2. What is stakeholder analysis?
3. What are the vertical and horizontal logics within project planning
matrix?
4. What do the means of verification indicate?
Essay-type Questions
1. The logical framework approach provides a powerful set of tools
for designing projects and project evaluations – explain.
2. Do you agree with the view that LFAs are not the complete
answer to effective project designing?
Further Reading
1. Gesellschaft für Technische Zusammenarbeit (GTZ). 1991.
Methods and Instruments for Project Planning and
Implementation. Eschborn: Germany.
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Switzerland.
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UNIT 5

PLANNING MODELS AND

Economic Development and Planning Page-236

Lesson 1: Planning, Input-Output Models

After studying this lesson, you will be able to:

Planning in different forms has been accepted as an important policy

The case for planning:

 If planning envisaged necessary for market imperfections, the task

 For removing the differences between MNSB &MNPB, the best

 Given the lack of efficient human resources to tackle planning and

 The planning, by way of intervention, may lead to creating distortions

Input-Output (I/O) table captures the economy by dividing it into sectors

Economic Development and Planning Page-238

The Uses of Input-Output Analysis

The Input-Output analysis is useful in several ways. The various ways of

Input-output analysis may have used for projection and forecasting

Input-output analysis can be used for simulation purpose. The simulation

The I-O analysis can be used to:

The basics of input-output framework and some of its economic

 No substitution takes place between the inputs to produce a given unit

 External economics are ruled out and production is subject to the

An input-output table focuses on the interrelationships between industries

Table A highly simplified input-output accounting framework

Industries Net Final demand Total output

Table below shows a simplified set of accounts distinguishing three

Table Input-output flow table and accounts

Industry Industry Industry Final Total

Input-output analysis became an economic tool when Leontief introduced

Table Input-output coefficient table inputs per unit of output

Industry A Industry B Industry C

Economic Development and Planning Page-240

(1.1) 0.00XA - 0.00XB - 0.00XC

Equation 1.1 calculates the total amount of product A used as

(1.2) 0.00XA - 0.00XB - 0.00XC + 35 = 100

It is possible to check the equality property of equation 1.2 by replacing

(1.3) 0.00 X (100) - 0.10 X (200) - 0.30 X (150) + 35 = 100

The utilisation of products B and C as intermediate inputs of production

Table 1.4 Input-output coefficient table in more general terms

Industry 1 Industry 2 Industry 3 Industry 4

a11X1 + a12X2 + ...... + a1nXn + Y1 = X1

and in matrix form

a11 a12 a1n X1 Y1 X1

The computation of the coefficient matrix can be described in the

Relationship 1.8 is the basic input-output system of equations. Matrix A

The limitations of the use of the IO model:

Economic Development and Planning Page-242

Third, the IO analysis assumes that the composition of demand is

However, it should be pointed out that some of these limitations in the

Questions for review

1. Input-output model was first developed for

2. Input-output model has the best use in

3. Lentief won Nobel Prize in

Answer 1.D, 2.B, 3.D,

Essay type questions

Economic Development and Planning Page-244

3. Bacharach, M., Biproportional Matrices and Input-Output

Appendix-1: Input-Output Analysis using Matrix

Basic assumption of the input-output analysis