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YED and business decisions

S:\triplea_resources\DP_topic_packs\economics\student_topic_packs\media_microeconomics\images\cd.jpgSignificance of YED for sectoral change (primary - secondary - tertiary) as economy grows

Economic growth is the increase in productive capacity of the economy and is best measured by the increase in real GDP (output) over a period of time. (Remember that the term real takes into account levels of inflation in an economy).

Typically, as economic growth occurs and real incomes and living standards rise over time, the primary sector tends to become relatively less important, while the secondary and tertiary sectors tend to become relatively more important. Fundamentally, this is because of the importance if YED.

In general, the products of the primary sector e.g. fruit, vegetables, rice, tend to have a low YED i.e. as real incomes rise, there tends to be a less than proportionate rise in demand for these products. No matter how rich you are, there is a limit to how much fruit and vegetables you can eat, so an increase in income may not stimulate a large increase in consumption of these goods. Consequently, the primary agricultural sector is likely to grow only slowly as living standards rise.

However, this would not be true for oil and other extracted minerals such as copper, iron and, also, diamonds and other precious and semi-precious stones, for example. Economies rich in primary resources will find that such products would have a relatively higher YED than basic agricultural products. Minerals, oil and gas, and gems for example, will have a derived demand inasmuch as they will be demanded for their use in the manufacturing sector. A study of a country such as Qatar in the Middle East will demonstrate how the primary sector plays a key and highly lucrative role in its GDP.

The demand for manufactured goods and the services of the tertiary sector, however, tend to have a very high YED. As we become better off, there tends to be a more than proportionate increase in demand for electrical equipment, furniture, banking, travel and tourism etc. Hence the secondary and tertiary sectors grow much more rapidly than the primary sector as living standards rise.

In the more developed countries, the tendency is for the tertiary sector to grow the most rapidly in response to rising real incomes. This is not because people in rich countries fail to buy more manufactured goods as they become better off. Rather, it is often the case that these goods are imported from other countries, often newly industrialised countries, which may be able to produce the manufactured goods with a comparative advantage, i.e. relatively more cheaply.

Thus YED has an important effect on resource allocation within an economy and the speed and nature of sectoral change as countries develop.