StudySpace: Economics in Development, 6th Edition

Worked Example

1. Table 9–4 provides data on per capita income (PPP) and six indicators of health and nutrition in the early 1990s for 23 low-income countries—all for data were available.

Click here for Table 9-4

a.

(i) Plot in Figure 9–1 the 23 observations for per capita income (column 1) and life expectancy at birth (column 2). Then draw in an approximate best-fit line corresponding to the data. Label this line LIFE.

FIGURE 9–1

(ii) Comment on the relationship indicated by the data.

b.

(i) Identify the country with the largest favorable deviation from the underlying average relationship.

(ii) Identify the countries with the largest unfavorable deviations (it’s a tie between two countries, with a third close behind).

(iii) What factors might explain such deviations?

c. Differences in life expectancy ought to be related to various indicators of health and nutrition. To investigate the empirical links more closely, you now are asked to analyze the data in columns 2 to 7, without explicit guidance on how to test relationships. At a minimum, you can just “eyeball” the data to look for a relationship. Or you can draw graphs, as done above. To be more accurate, you might want to calculate correlation coefficients or run simple linear regressions using any computer spreadsheet program or statistical software.

(i) The book explains that improvements in life expectancy at birth come about largely through reductions in mortality among the very young. Examine the data in columns 2 and 3 of Table 9–4. Do the cross-section data for low-income countries reveal a strong correlation between life expectancy and infant mortality? Explain.

(ii) What explains the differences in infant mortality rates? One hypothesis is that infant mortality is directly related to the extent of prenatal malnutrition among mothers. A good indicator for this is provided in column 4: low-weight births as a percentage of total births. From the data in columns 3 and 4, do you find a positive association between infant mortality rates and the percentage of low-weight births? Explain.

(iii) A second hypothesis is that the infant mortality rate depends inversely on access to health care. Is there a strong positive association between the data in columns 3 and 5? Explain.

(iv) Another test of the relationship between health care delivery and the infant mortality rate is to use the data in column 5 on population per doctor. It turns out that there is no hint of a correlation between these two variables. Why might this be so?

(v) Finally, one might suppose that the infant mortality rate is inversely related to the overall adequacy of food supplies. You can test this using the data in column 6 on calorie supply per capita as a percentage of requirements. Here, too, the relationship turns out not to be statistically significant. What would account for the absence of a strong correlation between infant mortality rates and the supply of calories per capita?

2. This exercise examines some of the problems faced in evaluating the rate of return to an investment in health improvement. You may wish to refer to Chapters 5 or 8 to review discounting and rate-of-return calculations.

A mosquito-spraying project is planned for 1997 in the province of Hinterland. The project will cost F1,000,000 (F stands for francs). Health officials expect the spraying to reduce the incidence of malaria for two years. In economic terms, the benefits consist of  

Increased production due to improved worker productivity plus an increase in the labor force due lower morbidity.

The direct value of better health itself.

Table 9 –5 shows estimates of these benefits. The spraying costs incurred at the beginning of the project do not need to be discounted. The 1998 benefits have to be discounted one year, while 1999 benefits are discounted two years.

Click here for Table 9-5

a. Economists at the Ministry of Finance argue that the direct health benefits (column 4) are far too subjective to be included in the analysis, so they limit their attention to the production benefits of reducing the incidence of malaria (column 5).

(i) If you ignore the direct health benefits shown in column 4, what is the net present value (NPV) of the project? Use a discount rate of 15 percent.

NPV = F .

(ii) What is the NPV using a discount rate of 10 percent?

NPV = F .

(iii) To the nearest percentage point, what is the internal rate of return on the project? Recall that the IRR is the discount rate for which NPV = 0.

IRR = %.

(Hint: the preceding calculations guarantee that IRR lies between 10 and 15 percent.)

 

b.

(i) Using column 6 as the measure of benefits, what is the NPV for the project using 15 percent as the discount rate?

NPV = F .

(ii) What is the NPV using 10 percent as the discount rate?

NPV= F .

This time the IRR equals 38 percent.  (You can check this if you want more practice with the calculation.)

c. Obviously, the return on this investment depends heavily on whether one includes an estimate of the direct health benefits and on how the estimate is made.  But what about measurement of the production benefits?  Is it likely that the figures shown in columns 2 and 3 of Table 9-5 are reasonably accurate?  Explain.

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