nCHAPTER – 3: QUANTITATIVE DEVELOPMENT PLANNING TECHNIQUES:

3.1 Meaning of Models in Economic Planning.

3.1.1. INTRODUCTION
The main thrust of this unit is to introduce you to the meaning of ‘Models of Economic
Planning’ as a concept and show its elements, highlight its various types. Planning
Model is a series of mathematical equations which help in the drawing up of a plan for
economic development. As a student of economics, you should know that a planning
model specifies the relationships between endogenous and exogenous variables and aims
at ensuring the consistency of the proposed plan for economic development. It is also
meant to yield an optimally balanced collection of measures known as Model Targets
which can help the planning authority in the drawing of an actual plan.

3.1.2. What are Economic planning models?

It is important for you to know that planning is essential in whatever we do both at micro
and macro level of human existence.

Quantifying what we want to achieved as set targets and how to realize them given the
limited resources at our disposal is of paramount importance to even the planning
authorities that is the government for them to meet up with the set targets of developing
the economy using available resources.

This can only be done using quantitative equations which expresses relationships among
economic variables to explain and predict past and future events under a set of
simplifying assumptions known as Model.
Planning models have been increasingly used in less developed countries for the drawing
up of plans for economic development.

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To start with, it important for us to examine what Planning models is all about. Let us
begin our understanding of the models of economic planning by first defining the word
‘Models’.
According to Jhingan M.L (2011), a model expresses the relationships among economic
variables which explain and predict past and future events under a set of simplifying
assumptions. In other words, a model consists of a series of equations each of which
represents the association among certain variables.

Planning Model therefore is a series of mathematical equations which help in the drawing
up of a plan for economic development.

A planning model, in other words sets out the relationship between the crucial (key)
variables in the process of planned economic development within the stipulated time
horizon of the plan. You should also know that most planning models belong to the
category of what are known as decision or policy models. In these models a set of plan
objectives is specified, policy measures to achieve these objectives are isolated and their
interrelationship worked out.

It is imperative to let you know that model may have endogenous and exogenous
variables.
1. Endogenous variables are those whose values are determined from within the
system, examples of such are national income, consumption, savings, investment
etc.
2. Exogenous variable are determined from outside the system, Examples of such are
prices, exports, imports, technological changes etc.

Therefore as a student of economics, you should know that a planning model specifies
the relationships between endogenous and exogenous variables and aims at ensuring the

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Consistency of the proposed plan for economic development. It is also meant to yield an
optimally balanced collection of measures known as Model Targets which can help the
planning authority in the drawing of an actual plan. It is also important to let you know
that there are important elements of development models

3.1.3 Elements In development planning model.

The following are the important elements of the development planning models.
a. Objectives
b. Instrument Variables
c. The functional Relationships

a. Objectives:

In a development plan, there should be a focus on what the planning authority is aiming
to achieve within the given time frame of the plan. For example the achievement of

 a certain rate of growth,

 a certain level of employment, or
 a certain balance of payment position should specifies in the plan as dependent
variables of the model.

Let us consider the vision (20 - 20 - 20) that is making Ethiopia to be one of the best
Twenty (20) economies by the year 2020. Part of the means of a achieving this objective
is to maintain a steady economic growth rate of which if it is sustained at the current
growth rate may lead to the achievement of the objectives of the vision plan. Therefore
objectives have to be specified by planning authorities in a given economic development
plan.

b. Instrument Variables:
Instruments are tools for achieving a definite plan.
For example, hammer and jackplane are part of a carpenter’s instrument that can be used
for carpentry table making work.

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Instrument variables are regarded as the policy measures that would be necessary to
achieve the objectives. For example
 the level of savings and investment in different sectors,
 the volume of imports and exports to be achieved,
 the supply of skills or workforce for projects to be built up or acquired, to mention
but few, are the principal instrumental variables operatives in development
planning models.
Therefore, let it be known to you that instrumental variables are the independent variables
of the model and it has to be specified and expressed in the plan.

c. The functional Relationship:

This is the third element in development planning model that shows the relationship
between the variables in the form of structural equations of the specified model.
The dependent (endogenous) and the independent (exogenous) variables have to be
functionally expressed in a related form of structural equations of the specified model.
These functional or (casual) relationship would show the responded of the dependent
variable when any design or expected change in the independent variables is specified.
These functional relationships are expressed in the form of co-efficient of the model.
Therefore, it is clear to say that in a policy model underlying a plan, the objectives to be
achieved would be the dependent variables and given the values of the independent
variables i.e. (the policy instruments) and the coefficient, the outcome can be determined
or the equations of the system worked out. You will understand this more when
discussing different types of planning models.

3.2 Types of Planning Models

Having understood what economic planning models and the elements of development
planning models are, It is important for us to discuss the various types of development or
economic planning models. Most development plans have traditionally been based

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initially on some more or less formalized macroeconomic model. Such economy wide
planning model can be divided into three basic categories.
1.Aggregate growth, Macroeconomic or Simple Models
2.Multi-Sector Models
3.Decentralised Models

1 Aggregate growth, Macroeconomic or Simple Models

The first category is the aggregate growth, macroeconomic or simple models which
involves macroeconomics estimate of planned or required changes in principal economic
variables.

It deals with the entire economy in terms of a limited set of macroeconomic variables
deemed most critical to be determined by levels and growth rates of national output; that
is savings, investment, capital stock, exports, imports, foreign aid etc.

The model provides a convenient method for forecasting output (and perhaps also
employment) growth over a three to five year period. Eg.HarrodDomar models are of
this type.

As the very name implies, this type of models try to provide solutions to the development
problems in terms of such aggregative variables like consumption, investment, savings,
imports, exports, labour supply, balance of payment etc which you are familiar with in
macroeconomic theory as macroeconomic variables. They are also regarded as simple in
the sense that the complexities involved in sectoral distribution of resources are done
away with. Such macro models are usually used to determine the value of the instrument
variables when the target rate of growth of national output is given. In the exercise, the
“constraints’’ such as the availability of foreign exchange

skilledlabour, taxable capacity etc may also be specified. A good example of this
category of planning model is the HarrodDomar model which shows the determination of
the relationship among the aggregative variables such as savings, investment, labour and

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capital productivity rate of growth of population etc which will determine the overall
growth rate of the economy.

In the absence of economic planning in the LDCs, the independence or natural growth
rate may be so slow to result to near stagnation prevalence situation. The task of the
planners is therefore to intimate and influence the aggregative instrument variables in
these economies and to ensure that the growth rate gets accelerated to a satisfactory and
desired target.
Let us now consider the Harrod-Domar model, According to the model, the growth rate
of an economy is determined by the level of net capital formation and its productivity.
Although, the net capital formation and its productivity. Although, the net capital
formation in LDC’s is constrained by the amount of savings available, savings are a
function of the level of income and productivity of capital is ascertained from the overall
or the global capital output ratio.

The growth rate ΔY/Y or what Harrod calls the warranted growth rate Gw as:
Gw = Yt – Yt-1/Yt = ΔY/Y = k.s

It shows that the rate of growth equals the output-capital-ratio times the constant
propensity to save.

In the above analysis, it shows that given the values of s and k and assuming them to be
constant over the plan period, the growth rate of the economy would be determined by
the ratio.
When a near stagnant LDC starts its process of planned economic development, it saves 5
– 6% of its national products. That was in fact the case when A country first 5 year plan
was launched in 1962, the process of its planned economic development saved about
5.6% of its national product. The (ICOR) Incremental capital output ratio of such an
economy may be between 2% & 4%,; thus if the value of S is assumed to be 6% (0.06)
and that of K= 3% (0.03), then growth rate=ΔY= 0.06 x 100=2%
Y 3

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2 Multi-Sector Models
The second category is the multi-sector models.

Multi-sector include input-output, and social accounting computable general equilibrium

(CGE) models which ascertain among other things, the production, resources,
employment and foreign exchange implication of a given set of final demand targets
within an internally consistent framework of inter-industry product flows.

It is a sophisticated approach to development planning in which the activities of the

major industrial sectors of the economy are interrelated by a means of a set of
simultaneous algebraic equations expressing the specific production processes or
technology of each industry.

All industries are viewed both as producers of outputs and users of inputs from other
industries. For example, the agricultural sector is both a producer of output e.g. (wheat)
and a user of input from the manufacturing sector e.g. (machinery, fertilizer), therefore
there is interdependence of industry which could lead to direct and indirect repercussions
of planned changes in the demand for the products of any one industry on outputs,
employment, and imports of all other industries can be traced throughout the entire
economy in an intricate web of economic interdependent.

This inter-industry model can be used to determine intermediate material, import, labour
and capital requirements with the result that a comprehensive economic plan with
mutually consistent production levels and resource requirements can in theory be
achieved.

3 Decentralized Models

The third stage or category of planning models is the decentralized models. It is the type
that have sector of project level variables which are used to prepare models for individual
sectors or projects.

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This type of models are useful in the early stages of a country’s economic development
when information is available for only individual sectors or projects, project evaluation or
project appraisal.

Social cost benefit Analysis are techniques that fit into this category.

The most important component of plan formulation is the detailed selection of specific
investment projects within each sector through the decentralized models.

3.3 Sectoral and sub-sectoral model of development planning.

The macroeconomic models provide only the first approximations to the problems of plan
formation. They yield the broad aggregative targets and the values of the aggregative
instrument variables. However, in order to make the plan an operational document,
sectoral models are presented.
The sectoral models may be Single Sector Project Model (SSPM) or complete main
sector planning models (CMSP).
a. In the case of the former, (SSPM) plan formulation starts from the project levels.
Individual projects are appraised for inclusion in the plan and thus, the aggregative
requirements of the plan are built up through the summation of projects.
For instance, if the saving, investment, imports and skill requirements of all appraised
projects come to an aggregative figure that is not feasible or difficult to achieve some
projects are excluded.
b. The Complete Main-Sector Planning (CMSP) Models, are some sophisticated form of
sectoral models, which divide the whole economy into a few main or broad sectors,
such as
 public and private sectors,
 consumption and investment goods sectors,
 domestic and exports sectors,
 Agricultural and none agricultural sectors etc.

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The investment skills, foreign exchange requirements etc, are worked out for each main
sector and consistent targets are set for each of them.

SIMPLE MAIN SECTOR MODEL: In a simplified main sector model, one, can
suppose that the entire economy is sub-divided into two main sectors, namely (i) the
consumption goods sector and (ii) the investment goods sector.
The two sectors has a total product functions, which is represented with x 1 and x2 where;
x1 =the total product of the consumption goods sector.
x2= the total produced of the investment goods sector and
GDP = the Gross Domestic Product of the economy.
C = denotes, the marginal (and average) propensity to consume.
S = denotes the propensity of save (and closely related to investment thus, S = I (I – C)
From the equations, a summation of x1 and x2 results to the Gross Domestic Product of the
economy.

Meaning that, the planner would require in the third example, 2 units in total product of
consumption goods sectors to obtain 3 units in investment goods sector.

THE INTER – INDUSTRY MODELS:

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The inter – industry models, make use of the technique and some of them make use of
even linear programming.
As it will be observed in the next section, the input – output table gives a synoptic view
of the inter – industry relations and transaction. It is however, necessary for building up
input- output tables that two conditions are satisfied as pre –requisites, and they are:
i. That a country should have developed at least a few manufacturing industries, so that
the inter – industry transactions are quite substantial.
ii. That sectoral data should be available so as to facilitate the construction of input –
output tables. Thus, only those LDCs satisfying these conditions should rely upon inter –
industry models in their plan formulation.
Whenever it is practicable to build inter – industry models (using input – output
technique), these turn out to be the most elaborate ones and can be really termed as
multispectral models. The entire economy is divided into as many sectors or industries
for as many as the requisite data can be mustered.

3.4.1 What is input-output technique.

In considering what input-output analysis is all about, we must consider its genesis and
how it originated. Input-output is a novel technique invented by
Prof.Wassily .W.Leontief a nobel prize winner in economics in 1951
It is a technique used to analyse inter-industry relationship in order to understand the inter
dependencies and complexities of the economy and thus the conditions for maintaining
equilibrium between supply and demand. It is also known as inter-industry analysis.

According to Todaroand Smith (2011), input-output is defined as a formal model

dividing the economy into sectors and tracing the flows of inter industry purchases
(input) and inter industry sales (output). Before analysing the input-output method, Let us
understand what the terms input and output means. According to Hicks (1979), an input
is something which is bought for the enterprise, while an output is something which is
sold by the enterprise. An input is obtained but an output is produced. This input

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represents the expenditure of the firm while output is receipts accrued to the firm. The
sum of the money values of inputs is the total cost of a firm and the sum of the money
values of the output is its total revenue. The input –output analysis tells us that there are
industrial inter relationships and inter dependencies in the economic system as a whole.
Let it be known to you that the inputs of one industry are the outputs of another industry
and vice versa, so that untimely their mutual relationships lead to equilibrium between
supply and demand in the economy as a whole for example, coal is an input for steel
industry and steel is an input for coal industry, although both are the outputs of their
respective industries. A major part of economic activity consists in producing
intermediate goods (inputs) for further use in producing final goods (outputs).There are
flows of goods between different industries. The supply side consists of large inter-
industry flows of intermediate products and the demand side of the final good. In essence,
the input-output analysis implies that in equilibrium, the money value of aggregate output
of the whole economy must equal the sum of the money values of inter-industry inputs
and the sum of the money values of inter-industry outputs.

3.4.2 INPUT – OUTPUT MODEL.

A. INTRODUCTION
It is good that we have familiarized ourselves with what input-output analysis, technique
or model is all about in the preceding unit which provides a basic foundational platform
that we shall be looking at in this unit. In this unit, we shall be looking at the input-
output model table, feasibility and consistency of the plan, input-output coefficients, the
Leontief solution, the dynamic input- output model. An in-depth explanation of the above
topics shall be provided. It is advisable that you critically concentrate as we move along
with explanations that will be given.

B. INPUT-OUTPUT TABLE.
The input- output table relates to the economy as a whole in a particular year. The table
shows the values of the flows of goods and services between productive sectors
especially inter –industry flows. For proper understanding, a three (3) sector economy is

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taken in which there are two inter –industry sectors, agriculture and industry and one
final demand sector. Look at the table below, it is called the input- output table which
provides a simplified picture of such economy.

Value added refers to payments to the factors of production.

In the above table 2.1, the total output of the industrial, agricultural and household sectors
is set in rows and divided into the agricultural, industrial and final demand sectors. The
inputs of these sectors are set in columns. Take a look at the first row total which shows
that altogether the agricultural output is valued at 300 million per year. Out of this total
100 million go directly to final consumption i.e. individual household and government as
shown in the third column of the first row. The remaining output from agriculture goes as
inputs, 50 back to agriculture and 150 to industry .similarly, the second row shows the
distribution of the total output of the industrial sector values at 500 million per year.
Columns 1,2, and 3 show that 100 units of manufactured goods go as inputs to
agriculture, 250 unit to industry itself and 150 unit for final consumption to the household
sector. Let us take the columns “read it downward”, the first column describe the input or
cost structure of agriculture industry. Agricultural output valued at 300million is
produced with the use of agricultural goods worth 50million, manufactured goods worth
100 and labour or management services valued at 150. In other words, it cost 300 million
to get a revenue of 300million from the agricultural sector.(50+100+150 = 300).

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Similarly, the second column explains the input structure of the industrial sector i.e( 150+
250 +100 =500). The third column corresponding to this column is the final demand
column which shows what is available for consumption and government expenditure. The
third row corresponding to this column indicated zero. This implies that household sector
is simply a spending (consuming) sectors that does not sell anything to itself. This means
that labour is not directly consumed.

3.5 SOCIAL ACCOUNTING MATRIX TECHNIQUE OF ECONOMIC

PLANNING

MAIN CONTENTS
1 What is Social Accounting Matrix (SAM)?
“A social accounting matrix is simply defined as a single entry accounting system
whereby each macroeconomic account is represented by a column for outgoings and a
row for incomings”
Social Accounting Matrix (SAM) is a technique related to national income accounting,
providing a conceptual basis for examining both growth and distributional issues within a
single analytical framework in an economy.
It can be seen as a means of presenting in a single matrix the interaction between
production, income, consumption and capital accumulation.

It is represented in the form of a square matrix with rows and columns, which brings
together data on production and income generation as generated by different institutional
groups and classes, on the one hand, and data about expenditure of these incomes, by
them on the other.
A Social Accounting Matrix (SAM) is a summary table, which refers to a given period,
representing the production process, income distribution and redistribution which occurs
between sectors, factors of production, actors in an economic system and the "Rest of the
World" (ROW), meaning, all actors outside the economic system were being studied.

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SAM represents the whole economic system, it highlights the inter-linkages and the
circular flow of payments and receipts among the different components of the system
such as goods, activities, factors, and institutions.
SAM has three main aims;
1) organize the information on the social and economic structure of a country for a given
period;
2) provide a synoptic view of the flows of receipts and payments in an economic system;
and
3) form a statistical basis for building models of the economic system, with a view to use
this to simulate the socio-economic impact of policies.

Let us look at it from an accounting perspective, the SAM is a two-entry square table
which presents a series of double-entry accounts whose receipts and outlays are recorded
in rows and columns respectively. According to Lorenzo(2012), accounts usually refer to
the following:
a) Goods and services: these accounts depict the origin of final goods available in the
economic system (production activities and imports) and their destination (activities as
intermediate inputs and institutions.
b) Production activities: these are basically the production activities of the economy
being analysed and generally refer to the defined sectors.
c) Factors of production: these accounts depict receipts from productive activities,
which pay for factor services, and payments to institutions, which provide those services.
They are usually distinguished in labour and capital, but may refer also to natural
resources, such as land and water.
d) Institutions i.e. (economic agents): , normally comprising households,
companies(corporations) and the government. These accounts record incomes of
institutions along the rows and expenditure on the columns.

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e) The capital account or saving-investment or accumulation account, which records
allocation of resources for capital formation and use of these resources for the purchase
of investment products and building up stocks of goods.
f) The rest of the world account or external account, in which the row records
payments received by the rest of the world from the economic system and the column
records the outlays of the rest of the world towards the economic system.
Each category is then normally split into several more detailed accounts which will be
shown in specific rows and columns.
Here, it must be stressed that the sequence of accounts in rows and columns are identical.
Regarding recording different flows in one SAM, all receipts from an account are
recorded in one row (i) and expenditure in one column (j). In this way, all monetary flows
(sij) in a cell
SAM's are square in nature that is (columns equal rows) in the sense that all institutional
agents (Firms, Households, Government and 'Rest of Economy' sector) are both buyers
and sellers. Columns represent buyers (expenditures) and rows represent sellers
(receipts). SAM's were created to identify all monetary flows from sources to recipients,
within a disaggregated national account. The SAM is read from column to row, so each
entry in the matrix comes from its column heading, going to the row heading. Finally
columns and rows are added up, to ensure accounting consistency, and each column is
added up to equal each corresponding row. In the illustration below for a basic open
economy, the item C (consumption) comes from Households and is paid to Firms.

Let us look at Table 3.1 below which shows a SAM of a simple 2-sector economy
(agriculture and industry) and two institutions (households and government).
The values are expressed in Monetary Units (MU).

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If we look at matrix S, column by column, it can be seen that to produce 110 mu of
output, the agricultural sector must pay 50 mu to the agricultural sector and 30 mu to the
industrial sector for intermediate consumption. It must also pay 20 mu in salaries to
households and 10 mu in taxes to the government (see "Agriculture" column).
Similarly, the industrial sector, in order to produce 80 mu of output, must pay 20 mu to
the agricultural sector and 30 mu to the industrial sector for intermediate consumption.
Furthermore, it must pay 10 mu in salaries to households and 20 mu in taxes to the
government. (see "Industry" column).
The third column shows household expenditure. Households spend 25 mu in final
consumption of agricultural products, 15 mu of industrial products and pay 5 mu in taxes.
The fourth column shows government expenditure: 15 mu are allocated to the agricultural
sector and 5 mu to the industrial sector through subsidies for production. Additionally, 15
mu are transferred to households (for example, in the form of transfers as income support
for poor households). Finally,2mu are made as an internal transfer to the public
administration.
In mathematical terms, this is defined as follows:
a) SAM elements. Each element in matrix S is indicated S ij , where i = 1,2,.....n ; is the
row index, j = 1,2,.....n is the column index. For example, for SAM in figure 2, where
i = 1,2,3,4 and j = 1,2,3,4 , s22= 30 , s13= 25.

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b) Column sums S.j= Σ sij are the column totals. In our example, S.1 = 110, S.2 = 80, S.3
= 45, S.37
(c) Row sums Si. = Σ sij are the row totals,
In our example, S1.=110, S2. = 80, S3. = 45, S4. =37
As already mentioned, for a given K account, expenditure is equal to receipts and is
shown by the fact that the sum of row is equal to sum of column as shown in the formula
below

If you divide each element in matrix S, Sij by the total of the corresponding column S.j,
you will get the column ratios or coefficients Cij= Sij
S.j

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The result of the above is presented in the table below which shows the coefficients of
one sector to the other sector. From the coefficients, economic planners can now forecast
their plans for effective planning.
Therefore, the column coefficients matrix (matrix c) will be:

3.6. LINEAR PROGRAMMING TECHNIQUE AND ITS APPLICATION IN

PLANNING

3.6.1. PRODUCTION CAPACITY TECHNIQUE

In plan formulation, the planners have to decide whether to use labour – intensive or
capital – intensive technique of production, depending on its outlay, They will choose
that technique which maximizes output.
Let us suppose that it is planned to produce a commodity Z. using X and Y inputs, its
objective is to maximize output. It has two alternative production processes, C ( capital –
intensive) and L (labour – intensive). The constraint is a given cost outlay MP as shown
in the figure. All other assumptions given above are applicable. The problem is explained
in terms of Fig. 4.1.

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Source: The Economics of Development and Planning, Jhingan M.L (2007)
FIG 3.1
Units of input Y per period are measured along the vertical axis and units of input X per
period are shown on the horizontal axis. If process C requires two units of input Y to
every unit of input X, it will produce 50 units of commodity Z. If the inputs of X and Y
are doubled to four units of Y and two units of X output is also doubled to 100 units of Z.
These combinations of X and Y, represented by a and b, establish the output scale along
the capital – intensive process ray OC. On the other hand, the same units (50) of good Z
can be produced by process L by combing three units of X with one unit of Y. And 100
units of Z can be produced by doubling the inputs X and Y to six units of X and two units
of Y. These output scales are established along the labour – intensive process ray Ol, as
represented by input combinations c and d. If the points a and c at the 50 units level on
the linear rays OC and OL are joined, they form an isoquant ( shown, dotted) lasc 1. At the
100 units output level, the corresponding isoquant is l 1bds. The cost – outlay constraint is
represented by the isocost curve MP and it places a limit on the production capacity of
the project The project can produce with either of the two available techniques C and L
within the area represented by the triangle Obd. It is not possible for it to produce outside
this ‘area of feasible solutions’ the ‘optimal solution’ which maximizes the output will

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occur at the point where the isocost curve touches the isoquant with the highest output. In
Fig. 4.1 the isocost curve MP touches the isoquant l1bds at point b on the process ray OC.
It shows that the project will use the capital – intensive technique C by using four units of
input Y and two units of input X and produce 100 units of commodity Z.

Source: The Economics of Development and Planning, Jhingan M.L (2007)

FIG 3.2
Take another project whose objective function is to maximize its revenue subject to
certain constraints of limited capacities. Suppose it produces two products, X and Y.
It has four departments each with a fixed capacity. Let these departments relate to
manufacturing,
Assembling, polishing, and packing the product which be designated as A,B,C and D.
The Problem is illustrated graphically in Fig. 4.2. The Production of X and Y is subject to
constraints, A,B, C and D. Constraint A limits the production of X To OA. Constraints B
limits the production of Y to OB. Constraint C limits the production of both X and Y to

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OC1, and OC respectively, while constraints D limits their production to OD 1 and OD.
The area OATSRB shows all combinations of X and Y that can be produced without
violating any combination at any point outside this area.
The original solution can be found out by taking an isoprofit line within the feasibility
zone. An isoprofit all combinations of X and Y which yield the same profit to the firm.
The optimal solution lies on the highest isoprofit line EF in the polygon OATSRB.This is
point S. Any point other than S lies outside the zone of feasible production.
Every linear programming maximization problem has its dual problem, that of
minimization. The original problem is known as the primal problem, which always has its
dual.If the primal problem pertains to maximization, the dual involves minimization, and
vice versa.
Now we take another planning problem. Suppose the planner undertake a project which
aims at minimization of costs. Two types of goods X1 and X2 are to be produced. Let the
planners attach weights of 3 and 8 to units of these goods. Let there be 2 units of resource
X1 and 6 units of resource X2. Let the production of 1 unit of X 1 use 1 unit of input C1 and
2 units of input C2. Similarly, Let the production of X2 use 2 units of C1 and 8 units of C2.
The problem can now be set in the linear programming form as;

Maximise 3X1 + 8X2 (R, i.e. revenue)

Subject to the constraints

X1+2X2 ≤ 2
2X1+8X2 ≤ 6
and none of these quantities is negative. The optimal solution is X1=2, X2= ½ and R=7
The dual problem is ;
Let P1 be the imputed price of X1 and P2 be the imputed price of X2,
Minimize 2P1+6P2 (C, i.e. cost).
Subject to the constraints
P1+2P2 ≥ 3
2P1+8P2 ≥ 8

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and that none of these prices is negative. The optimal solution is:
P1=11=1/2 and C=7.
These are the shadow or dual prices. But as all values have been imputed to the two
resources, the maximum value of the objective function C must equal R. Hence C=R=7.

Source: The Economics of Development and Planning, Jhingan M.L (2007)

FIG 3.3
Graphically line AB represents P1+2P2=3 and line CD respresents 2P1 + 8P2=8. The
feasible solutions lie on or above the thick line AZD in figure 4.3. The optimal solution is
at point Z where the isocost (dotted line) RK passes through the point of intersection of
AB and CD.

3.6. 2 LIMITATIONS OF LINEAR PROGRAMMING

Linear programming has turned out to be a highly useful tool of analysis in development
planning. But it has its limitations.

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As a matter of fact, actual planning problems cannot be solved directly by the LP
technique due to a number of restraints.
Firstly, it is not easy to define a specific objective function.
Secondly, even if a specific objective function is laid down, it may not be so easy to find
out the various social institutional, financial and other constraints which may be operative
in pursuing the given objective.
Thirdly, given a specific objective and a set of constraints, it is possible that the
constraints may not be directly expressible as linear inequalities.
Fourthly, even if the above problems are surmounted, a major problem is one of
estimating relevant value of the various constant co-efficients that enter into an LP
problem, i.e. population, prices, etc.
Fifthly, one of the defects of this technique is that it is based on the assumption of linear
relations between inputs and outputs. This implies that inputs and outputs are additive,
multiplicative and divisible. But the relations between inputs and outputs are not always
linear. In real life, most of the relations are non-linear.
Sixth, this technique assumes perfect competition in product and factor markets. But
perfect competition is not a reality.
Seventh, the LP technique is based on the assumption of constant returns in the economy.
In reality, there are either diminishing or increasing returns.

To further buttress this point, it is a highly mathematical and complicated technique. The
solution of a problem with linear programming requires the maximization or
minimization of a clearly specified variable. The solution of a linear programming
problem is also arrived at with the ‘Simplex method’ which involves a large number of
mathematical calculations. It requires a special computational technique, an electric
computer or desk calculator. Such computers are not only costly, but also require experts
to operate them. Mostly, the LP models present trial-and-error solutions and it is difficult
to find out really optimal solutions to the various economic problems.

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3.6.3 USES OF LINEAR PROGRAMMING IN PLANNING
Linear programming as a tool of economic development is more realistic than the input-
output approach.

In input-output analysis only one method is adopted to produce a commodity. It does not
take into consideration the bottlenecks (constraints) which a development project has to
face in underdeveloped countries. But in linear programming a definite objective is set to
maximize income or minimize costs.

All possible processes or techniques are taken into account for achieving the desired
objective. This necessitates even the substitution of one factor for another till the most
efficient and economical process is evolved. So projects and techniques which are too
uneconomical to implement are not undertaken.

By assuming certain constraints, linear programming as a tool of development planning is

superior to the input-output technique. In underdeveloped countries, the planning
agencies are faced with such constraints as the lack of sufficient capital and machinery,
growing populations, etc. Resources exist that cannot be used properly for want of the co
operant factors. Linear programming takes to due note of these constraints and helps in
evolving an optimum plan for attaining the objectives within a specified period of time.
Thus the LP technique has been used for constructing theoretical multi- sector planning
models for countries like India. Such models extend the consistency models of the input-
output type to optimization of income or employment or any other quantifiable plan
objective under the constraints of limited resources and technological conditions of
production.

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