Development Economics

Harrod Domar Growth Model
Production Function

Production function with fixed coefficients
Leontief Isoquants (L-shaped) thus, no substitution between capital and labor.
Production function Y = k/v
v= constant in this model (ICOR) Incremental capital output ratio, measures the productivity of and additional k (more productive = lower v)

Harrod Domar Growth Model - Basic growth relationship

s/v - d = g
s = savings rate
v = constant (k/Y)
d = depreciation
g = growth rate

(change in K = sY - dk)

Thus if you save more, and make more productive investments, your economy will grow

Strengths of the Harrod Domar Growth Model

1) relatively simple
2) over short periods of time, in the absence of large economic shocks, it predicts growth rates well

Weaknesses of the Harrod Domar Growth Model

1) the Knife edge problem
2) no substitution allowed between K and L in the production function
3) no room for technological progress

Knife edge problem

If v=k/Y is constant, and K is doubled, Y must double. Then because there is no substitution between K and L, L must also double for Y to double. L doubles at the rate of growth of the population, and for L to double, this rate of population growth (n) must increase the same as the rate of growth of K, n= s/v - d AND THERE IS NO ECONOMIC REASON for K and L to grow at the same rate. (if k and l do not grow at the same rate, then neither one will be fully employed)

Solow (Neoclassical) Growth Model

allows for substitution between k and L in the production process---> therefore it is more appropriate for LDC's since it allows for growth with use of abundant resource - labor.

Solow (Neoclassical) Growth Model production function

expressed in per worker terms
Y/L = f(K/L, 1) y = f (k)
exhibits diminishing returns

change in k = sy - (n+d)k

sy >(n+d)k; change in k >0 = capital deepening

sy= (n+d)k; change in k =0, capital widening

Steady State in Solow

Where sy = (n+d)k ---> change in k=0

the long run equilibrium

to the right of steady state, sy<(n+d)k; ^k>0
to the left sy>(n+d)k; ^k<0

Advantages of the Solow growth Model

1) allows for substitution between K and L (more appropriate for LDC's)
2) Diminishing Returns-- production function is more realistic
3) role for population growth

Solow implications at steady state

change in k = 0, y is a constant, BUT y = Y/L and Y is growing at n
Implies developing countries are expected to grow faster than developed countries and to catch up to the same steady state A...

In the Solow model, if there are increases in the savings rate, the capital stock per worker

increases

if the rate of population growth increases

there is a lower level of income and capital stock per worker

Adding Technology to Solow

^k = sy - (n+d+T)k
(per effective worker)

y = Y/L --> Y is growing at the rate of T

Engel's Law

As income increases, the proportion of the budget spent on food decreases --> demand for agricultural products does not rise as fast as the demand for industrial products

As per capita income increases, the share industry (wages and output) of GNP ___ because...

__Increases__
as development increases, productivity increase; one farmer produces enough for 70-80 people, the rest of the labor is free to find employment in industry

Ricardo's assumptions for transition from agriculture to industry

1. agriculture sector subject to diminishing returns -- crops need land and land is limited
2. Labor surplus in agriculture = underemployment; many people would have MPL=0

Fei-Renis Model,

Look at notes!!

True or False
If the rate of depreciation is zero and ICOR=1, the basic Harrod-Domar relationship for an economy states that the growth rate is equal to the savings rate.

True
The basic Harrod-Domar relationship is g=(s/v)-d, where g is the growth rate, s is the saving rate, v=ICOR, and d is the rate of depreciation.
Therefore, if v=ICOR=1 and d=0, we get g=s, which says that the growth rate is equal to the savings rate.

True or False
Paying efficiency wages discourages the use of more labour-intensive production technologies.

True
The efficiency wage is above the market-clearing wage of w*. At w*, L* is the quantity of labor demanded and supplied at equilibrium. At the efficiency wage, the labor market does not clear, and only Lmin quantity of labor is demanded. If the efficiency wage falls to the equilibrium level of w*, more labor could be utilized.

True or False
A feature of the Harris-Todaro model is that an increase in the urban wage requires a decrease in urban unemployment to restore equilibrium.

False
Urban unemployment must increase to restore equilibrium. This is because at equilibrium, expected urban wage = rural wage. That is, wu*=wr => p* wu=wr; where p = Eu/(Eu+Uu).
Therefore, if wu increases, p must decrease to maintain equilibrium. And p falls if Uu rises, that is if urban unemployment increases

True or False
Two major structural changes accompanying economic development are a rising share of industry and a falling share of agriculture in total output.

Correct. This phenomenon may be explained by Engel’s Law and the increased used of machinery and other methods of raising crops that has made it possible for individual farmers to produce enough food to feed 70-80 people.

Total domestic supply must equal

production + imports + |export|

Per capita kg/year consumed =

food consumption / total population.

Per capita calories per year =

Per capita kg/year * Calories per kg

total of the non-consumption uses of good x=

total domestic supply of good x– food consumption of good x

True or False
The turning point in the Fei-Ranis model is the point in the development process where labour demand has increased enough to generate rising real wages in both agriculture and industry.

Correct. Industrialization can occur without a rise in real wages until all the surplus labour in agriculture is absorbed. Beyond that point, wages must rise in both agriculture and industry.

TRUE OR FALSE
(c) The Gini coefficients for South Korea (=0.331) and Peru (=0.443) reveal that income was distributed more equally in Peru.

Incorrect. A larger Gini coefficient implies more inequality. So, income was distributed more equally in South Korea, not Peru.

TRUE OR FALSE
Minimum wage policies generally hurt those with modern-sector jobs while benefiting the much larger group of workers in the informal sector.

Incorrect. Minimum wage policies are present in the urban sector. They thus benefit those with modern-sector jobs and hurt the much larger group of workers in the informal sector, since minimum wages create situations of unemployment in the urban sector.

True or False
Malnutrition can be widespread even if available calorie supplies, per capita, exceed 100% of the recommended requirements.

Correct. What matters is not national averages, but the distribution of nutrients among various income classes.

True or False
When the piece rate falls, the straight line depicting it becomes flatter.

Incorrect. When the rate falls, each unit of output brings in less income and hence the line must become steeper.

True or False
Differentials among the wages received by different skills and education levels are much narrower in developing countries.

Incorrect. Such differentials are much wider in developing countries – dispersions can be as high as 80%.

True or False
Implicit contracts and informal agreements are used to insure against uncertainty in developing countries.

Correct. These are some of the mechanisms used to insure “before the fact.” Such mechanisms allow for income smoothing and consumption smoothing, by ironing out fluctuations in wage income.