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MEC-004: Economics of Growth and Development

MEC-004: Economics of Growth and Development

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Assignment Code: MEC-004 / AST-1/2021-2022

Course Code: MEC-004

Assignment Name: Economics Of Growth and Development

Year: 2021-2022 (July 2021 and January 2022 Sessions)

Verification Status: Verified by Professor


Answer all the questions. Each question in Section A carried 20 marks while that in Section B carries 12 marks.



Section A



1) Discuss the main sources of economic growth. Discuss the main adverse repercussions on the economy that the process of economic growth can have.

Ans) Economic growth is a complex process that generally involves several interrelated factors. Economists stress the importance of three major sources of economic progress:


  1. investment in physical and human capital,

  2. technological advances, and,

  3. institutional and policy changes that improve the efficiency of economic organisation.


However, it is important to remember that economic considerations play a critical and essential part in a country's growth process. In most circumstances, the stock of capital and the rate of capital accumulation determine whether or not a country will grow at a certain rate at a given point in time. There are a few additional economic elements that influence development, but their significance pales in comparison to capital formation.


Greater capital generally equates to more production, and more production equates to more growth. Countries must invest in order to obtain capital, and the degree of investment may be a major determinant of future growth. As a result, capital development is critical in the process of economic growth. It is critical to increase the pace of capital creation in order to collect a large capital stock of machinery, tools, and equipment that can be used to drive quicker expansion in the level of output of products and services. Not only that, but capital formation necessitates the development of skill formation so that the physical apparatus or equipment developed can be put to use in order to increase production. "The level of production and material well-being a community can achieve is largely determined by the stock of capital at its disposal, i.e. the amount of land per capita and productive equipment in the form of machinery, buildings, tools and implements, factories, locomotives, engines, irrigation facilities, power installations, and communications," according to the Indian Planning Commission. The greater the stock of capital, the higher the productivity of labour and, as a result, the volume of goods and services that can be produced with the same amount of effort."


Other countries' experiences imply that a high rate of capital formation was reached to stimulate rapid economic expansion in those countries. Between 1913 and 1939, Japan's investment rate averaged 16 to 20%. The Soviet Union's First Five-Year Plan set a goal of net investment of "between a quarter and a third of national revenue," yet the rate of investment was reduced and stabilised at around 20% of national GDP in following plans. Gross investment rates in several East European countries, such as Czechoslovakia and Poland, varied from 20% to 25%.


Capital-Output Ratio: The capital-output ratio is another factor of economic growth. The number of units of capital required to produce one unit of output is referred to as the capital-output ratio. To put it another way, the capital output ratio measures the efficiency of capital in diverse sectors of the economy at a given point in time. The capital-output ratio is merely a brief depiction of capital productivity in the economy. The capital-output ratio varies by industry and by economy, and it also varies with time.


The process of economic growth has its own set of limits. Since a result, we must not lose sight of these in the rush for growth, as they may have major social and economic consequences (as happened in many of the Latin American countries).


Income inequity — Growth rarely distributes its gains fairly. As a result, the distribution of the fruits of the growth process becomes the first major constraint on economic growth. There is evidence to imply that growth tends to worsen income distribution, at least in the early phases of development. The relationship between growth and distribution, however, is far from clear. Rapid economic expansion, without a doubt, has the potential for reducing the poverty problem that affects practically all developing countries. This potential has been leveraged to dramatically reduce poverty incidence in East and Southeast Asian economies, as well as China, with enough governmental intervention. Economic growth can occur without the majority of the people benefiting, as the increased output benefits only a small segment of the wealthy population. However, such developments are immoral, as they would exacerbate social tensions and jeopardise economic policymaking that benefits only a few (Lewis, 1955).


Pollution (and other negative externalities) — the push for more output puts increasing strain on the environment, which often leads to increased pollution – air, water, and noise. This could be due to pollution of the water or air, but expansion also results in a considerable increase in noise pollution. Congestion and traffic growth are great instances of this.


Non-renewable resource depletion — the more we desire to produce, the more resources we'll need. The faster we use these resources, the shorter their lifespan will be. This invariably results in the depletion of nonrenewable resources such as oil, other minerals, forests, and so on. Economic growth allows people to achieve higher levels of material welfare for particular commodities by either expanding the overall availability of products and services or increasing their capability to do so. However, the process of economic growth may lower social welfare since increased output can often lead to relative scarcity of other resources or the same factors for future generations, making it more difficult for them to maintain their current level of welfare in the future.


2) What do you understand by technical progress? What is the relationship between technical progress and growth of total factor productivity? Discuss the various conceptions of neutral technical progress as put forward by Hicks, Harrod and Solow.

Ans) Technical change can be embodied or disembodied. Embodied technical change means that technical change assumes the form in the change in the type of factor of production, usually capital. In other words, embodied technical change is embodied in the form of new types of machines (a new process or new technology). Disembodied technical progress, on the other hand, means that regardless of the type of machines, new or old, the same number of factors can produce greater amounts of output, or the same amount of output can be produced using lesser quantities of inputs; in other words, the isoquant shifts inwards. The factor augmenting technical change that we studied in the previous section is a depiction of disembodied technical change. For most of this unit, we will have occasion to consider disembodied technical change. Only in the final section do we touch upon embodied technical change, and once you grasp the concept, you will find greater use of the concept in some of the later units. In embodied technical change, investment in new equipment or new skill is the essential vehicle of improvements in technique.


Another concept about technical change is neutrality. Neutrality broadly means that technical change is neither labour saving nor capital saving. We shall now present the classification of various types of technical change in terms of how neutrality has been viewed. We discuss Wicks's, Harrod's and Solow's concepts of neutral technical change.


Sir John Hicks presented a classification of technical progress in his book The Theory of Wages, published in 1932. Hicks looked at technical progress in terms of the effect of technical change on the ratio of marginal product of capital to that of labour. If after the technical change the ratio increases, in Hichs's terminology it is to be called labour saving. If the ratio stays the same it is neutral and if the ratio falls, it is called capital saving.


To explain this further, let us use some notation. Let

Fk(t l) be marginal product of capital before technical progress.

Fk(t 2) be marginal product of capital after technical progress.

FL(t 1) be marginal product of labour before technical progress.

F, (t 2) be the marginal product of labour after technical progress.


Then

If [FK(t2) / FL(t2)] > [FK(t1) / FL(t1)] then the technical progress is laboursaving according to Hicks


If [FK(t2) / FL(t2)] = [FK(t1) / FL(t1) ] then the technical progress is neutral in the Hicksian sense.


If [FK(t2)/ FL(t2)] < [FK(t1)1 FL(t1)] then the technical progress is capital saving in the Hicksian classification of technical change.



Technical progress is Hicks-neutral if, at any constant value of K/L, the ratio of relative

shares S = rK/wL stays the same, that is dS/dt is equal to zero.


It has been proved by Uzawa that Hicks-neutral technical progress is equivalent to

factor augmenting, that is equally labour and capital augmenting technical progress. In

other words, Hicks’s neutrality implies that the production function can be written as


Y = F (J(t)K, Z(t)L), or, equivalently as

Y = A(t)F (K, L).


Harrod's Classification of Technical Change

He defined as neutral technical change one where the capital coefficient (capital-output ratio) does not change in the presence of a constant interest rate. Broadly, he suggested that if, when the interest rate is constant, the distribution of the total national product between capital and labour stays constant, the11 it is neutral technical progress.


If we consider perfect competition and take interested rate as equal to the rental of capital and hence equal to the marginal product of capital. then Harrod-neutral technical progress is a statement about the relationship between capital-output ratio and the marginal product of capital. If we consider the per-worker production function, then an upward shift in the per-worker curve is said to represent Harrod-neutral technical change if at any constant value of capital output ratio, the marginal product of capital stays the same.


Technical change is said to be Lebow-saving in Harrod 's classification if, at any constant value of the capital-output ratio, the ratio of relative shares S = rK/wL is increasing, that is. if K/Y is constant and dS/dt is greater than zero. Technical change is capital saving in Harrod's sense if when K/Y is constant, dS/dt greater than 0 that is, S is decreasing. If in the presence of constant KY, S remains constant that is, dS/dt is = 0, then technical progress is Harrod-neutral. Thus, in Harrod-neutral technical progress, if K/Y is constant, rK/wL is unchanging.


Mrs. Joan Robins in 1938 provided a geometric proof that Harrod-neutral clinical

progress is exactly equivalent to labour-augmenting technical progress. In other words.

if technical progress is Harrod-neutral, and is proceeding at a constant rate u then the

aggregate production function can be Written as


Y - F (K, Z(t)L) with /dZ(t)/dt]/ Z(t) = U


Is there any form of technology where technical progress can be interpreted as either Hicks-neutral or Harrod-neutral that is the two forms of neutrality are equivalent? It can be shown that for this to Be true, the distribution of income will be the same at all levels capital labour ratio.  This can happen only if elasticity of substitution will be equal to one. 'The Cobb-Douglas production function.


Y =KclL1-cl is the production function where elasticity of substitution is constant and

equal to I.


Solow's Classification of Technical Change

Solow's classification of technical progress is like Harrod's and Hicks's classification except in one respect. Hicks's classification compares points on different per-worker output curves at points of constant capital-labour ratio and Hal-rod's scheme compares points on different per-worker output curves at points of constant capital-output ratio. Solow's classification compares points on old and new per-worker production at points at which the labour output ratio is constant. thus Solow-neutrality is when at points where-e L/Y is constant, dS/dt = 0 that is, the relative shares of capital and labour remains constant. It can be shown that a Solow-neutral technical progress is capital augmenting.



Section B



3). Describe the Mankiw-Romer-Weil extension to the neoclassical model to include human capital. Explain why diminishing returns to capital do not take place in the AK model.

Ans) Mankiw, Romer and Weil in a 1992 paper gave a marginal extension to the neoclassical model - include human capital (H) as a distinct factor of production. K and H are allowed to vary together across countries and arrive at decent results for the example discussed earlier. The Mankiw Romer Weil formulation maintains the Solow assumption of decreasing returns to the factor capital. Their model is thus within the tradition


The motivation and structure of the Mankiw, Romer and Weil (MRW) model can be presented as follows. Suppose we consider an economy which produces an output Y using physical capital in combination with human capital, according to a constant return to scale Cobb-Douglas production function


y = Ka (AH) i-a, where A represents labour augmenting technology that grows at Models

an exogenous rate g. HOW people accumulate human capital is modelled differently by different writers. According to Mankiw, Romer and Weil, people accumulate human capital the way they accumulate physical capital-by foregoing current consumption. Lucas on the other hand posits that individuals spend by in accumulating skills. The Lucas type of presentation is made here. This idea was first put forward by Kenneth Arrow in a 1962 article on 'The Economic implications of Learning by Doing'. In our economy, individuals accumulate capital by building and learning new skills and foregoing working for that period. Let q denote the proportion of an individual's time spent learning new skills, and let L be the total amount of raw labour used in production in the economy.


Let us assume that unskilled labour learning skills for time q generates skilled labour H according to the function

where 0 is a constant. If q = 0, the L = H, and all labour is unskilled. By raising q a unit of unskilled labour increases the effective units of skilled labour H.

In the economy, physical capital is accumulated by investing some output instead of consuming it, as in the Solow model:

Let us denote by lower-case letters variables divided by the stock of unskilled labour L,. We can rewrite the production function in terms of output per worker:

 Here H = epq.     The model assumes that q is constant and given exogenously. Since h too is a constant, this model implies that along a balanced growth path, y and k will grow at the constant rate g, the rate of technical progress. Let us divide the per worker production function by dividing by Ah we obtain


Y = k a


We can write the capital accumulation equation in terms of state variables as the steady-state

values of k and y are obtained by setting k = 0, which gives uss

substituting this into the production function in terms of equation involving y , we can find the steady-state value of the output technology ratio y:

If we rewrite this in the terms of output per worker, we get

Here t is introduced to stress that: some variables are growing over time.

 

This gives us some explanation into why some countries are rich and some are poor. Those countries that have a high investment rate in physical capital (That is, those that save more), have high levels of technology, and spend a high proportion of time accumulating skills are comparatively richer.

 

'Knowledge capital' or 'ideas' is slightly different from human capital and facilitates in the accumulation of the latter. In the new growth theories endogenous technological progress and human capital formation. New knowledge is produced by investment in the research sector. Once knowledge is treated as a public good, there are spill over effects that accrue to other firms. This is what we will discuss in the next section.

 

The AK model of endogenous growth is the basic type of formulation that captures the essence of endogenous growth. Sergio Rebelo in an article titled "Long Run Policy Analysis and Long Run Growlh" published in 1991, introduced the AK model, building upon earlier work by Romer and Lucas. The basic equation of the AK model is Y = AK . Here A is to be understood as factors that affect technology, and K includes physical as well as human capital. This model has no diminishing returns. One way to achieve this is to invoke externalities or spill overs. Another way to stave off diminishing returns is to postulate that an increasing variety or quality of intermediate inputs.

 

Let us look at the AK model in some detail. We have the basic equation. Suppose capital is accumulated as some of the aggregate output is saved by individuals. K = sY - 6K, where the dot on top indicates time derivative, s is the rate of saving and 6 denotes depreciation. Here whatever the initial quantity of capital, it will continue to grow since investment in this model is greater than depreciation since sY and 6K are both linear upward sloping lines, since saving is a constant function of Y, and Y is linear in K. We can show it as follows:

 

K=sY-SK

 

Dividing both sides by K, we have

On the right-hand side, substitute AK for Y and we get

Let us go back to the growth equation


Y=AK


Taking natural logarithms, we get


In Y = ln A – ln K


Differentiating with respect to time we get


Thus, we see that growth rate of the output is an increasing function of the rate of investment.


The general progression in that area has been to attribute a smaller fraction of observed growth to the residual and a higher fraction to the accumulation of inputs. The way that literature started out was a statement that technology is extremely important because it explains the bulk of growth. Endogenous growth theory admits that technology does not explain, by itself, most of the growth. Initially, these theorists overstated its importance. But some people say there is no need to understand technology, because it is such a small part of the contribution to growth. They argue that we can just ignore it. It does not follow logically. We know from the Solow model, and this observation has been borne out empirically, that even if investment in capital contributes directly to growth, it is technology that causes the investment in the capital and indirectly causes all the growth. Without technological change, growth would stop. If we look at AF {K, L) we find that there are increasing returns {to factor) in all the relevant inputs A, K and L We need to think of technology as a key input and one that is fundamentally different from traditional inputs. Technology makes increasing returns possible.


Let us look a little closely now at the notion of technology and how it is produced. The neoclassical growth model considers technology as exogenous and leaves it unmodeled, although technology is a key ingredient of that theory. The neoclassical model also does not explain differences in technology across economies. What is technology? In development economics the term technology denotes the way inputs to the production process are transformed into output. If we take a normal production function Y = f (K, L) , the function(.) represents technology because it explains how the inputs K and L are transformed into output. In the Cobb-Douglas production function.

A is an index of technology.


It is the generation of new ideas, and the ideas themselves, that improve the technology of production. New ideas allow a given bundle of inputs to produce more output or better output. Paul Romer, in a paper in 1986 and. another in 1990, presented a way of modelling ideas as an engine of growth. Romer's basic argument was that ideas are non-rivalrous in nature as a good. Romer suggested that nature of ideas as a non-rivalrous good implies the presence of increasing returns to scale. If increasing returns are to be present in a competitive environment with explicit involvement in research, we need to invoke imperfect competition.


Most economic good are rivalrous. This means that the use of a good, say, a shirt, excludes the use of that same shirt by anyone else. By contrast, ideas are non-rivalrous goods. Once an idea has been created, anyone with knowledge of the idea can take advantage of it. However, ideas share a characteristic with other goods: ideas are excludable, at least partially, the degree of excludability is the degree to which the owner of a good or service can charge a price for its use. In the case of idem, patents and copyrights allow the creators of ideas to charge a price or fee. Goods that are both non-rivalrous as well as very low or no excludability are called pure 'public, goods, like national defence. There are goods that are rivalrous but have low excludability like common property resources, like a fishing lake or grazing land. Endogenous Growth Ideas are non-rivalrous goods, but they vary in their degree of excludability. Goods Models that are excludable allow their producers to capture the benefits they produce. Goods that are non-excludable lead to externalities, which are spill overs of benefits not captured by their producers.


4) What are the main propositions of the Real Business Cycle model? Describe the basic structure of a prototype Real Business Cycle model.

Ans 'Real Business Cycle' is sometimes abbreviated as RBC, and we shall henceforth use this. RRC theory is technically based on the Brock Mirman model. Theoretically, it is a model that looks at the reason for macroeconomic fluctuations, that is, fluctuations in aggregate economic activity.


Basically, it makes two types of propositions. First, it says that although we usually look at long term growth and short-term fluctuations in economic activity separately, the same reasons that give rise to long run growth, also cause fluctuations in economic activity, or what traditionally have been called 'business cycles'. The RBC theorists prefer the use of the word 'fluctuations' to 'cycles', since the latter conveys a sense of regular recurrence, which might not actually be the case. The 'real' part of the RBC theory suggests that as a theory that attempts to explain business fluctuations, these models play down the role of monetary forces and believe, like the classical economists, that money is a veil. They insist that it is the real forces like production, supply stocks etc that lead to fluctuations.  Moreover, the RBC theorists play down the demand side of the economy and maintain that the Keynesian (and even the monetarist) approach lays too much emphasis on the aggregate demand. Because RBC theory emphasises on relative prices rather than the absolute price level, and believes that money is neutral, and, because it lays emphasis on supply side forces, this theory displays similarity with the earlier classical theorists of growth and development. It is for this reason that RBC theory is sometimes put together with some other theories and dubbed 'New Classical'.


There can be several kinds of shocks in the economy. These stocks are originated on the demand side as well as on the supply side. There may even be shocks to the economy emanating from monetary and fiscal policies. The RBC theorists focus on productivity shocks. Productivity shocks can be of several types. There can be development of new techniques of production, new management practices, crop failure, and supply shocks coming from outside the economy, and so on. Basically, a business cycle theory must describe the nature of shocks to the system and has to explain how these shocks affect the key macroeconomic variables like output, employment, investment. etc. RBC models not only look at productivity shocks, but also focus more on the propagation of shocks to the rest of the economy than other theories.


Now we develop the basic structure of a prototype RBC model. The RBC model builds upon the Brock-Mirman model of the case where discounting is present but extends that model. Basically, the RBG explicitly bring into the utility function a decision regarding labour and leisure, where it is assumed that leisure provides utility and leisure is the time left over from total time after labour has been provided. The structure is a dynamic optimisation-under-uncertainty case. We can present it as follows.


The idea is to think of maximising the following type of utility function



Here c and 1 denote the representative household’s consumption and leisure activities. p is a discount factor that lies between 0 and 1. Leisure is time not devoted to labour. E is the operator showing mathematical expectation, conditional upon information at time t. in the above formulation t denotes the time at which the optimisation exercise is carried out. In our earlier examples we had taken t = 0, and what we are denoting here by j, we had denoted by t


Each 'household' (in this formulation, the households are also the firms, the production unit) has access to a production technology of the type yt = zt f (nd t, k,td ) . Here z is the realisation of a random variable depicting technology. The other variables n and k denote labour and capital supplied during time t. the amount of labour supplied is 1 - l where I is leisure. The budget constraint of the household likes the following:

Here the superscript d denotes the amount demanded of the variable, w is the wage rate, and r is the rental for capital. In the last section, we had used w to denote wealth. Do not get confused and remember the context. What the budget constraint says is that the current consumption and the capital stock for the next period (determined by investment in the current period) has a random component and is used to pay wages and rental for capital.


The RBC model then goes on to carry out, using dynamic programming, a constrained optimisation exercise and further to make statements about shocks to the economy and the generation of fluctuations.


5) Compare and contrast Adam Smith’s theory of development with that of Ricardo’s.

Ans) Adam Smith is regarded as the foremost classical economist. His monumental work, An Enquiry into the nature and Cause of Wealth of nations published in 1776, was primarily concerned with the problem of Economics of Development. Though he did not expound and systematic growth theory, yet a coherent theory has been constructed by later day economists.


Smith posited a supply-side driven model of growth. Succinctly we can set out the story via the simplest of production functions:


Y = ƒ(L, K, T)


where Y is output, L is labour, K is capital and T is land, so output is related to labour and capital and land inputs. Consequently, output growth (gY) was driven by population growth (gL), investment (gK), land growth (gT) and increases in overall productivity (gƒ). Succinctly:


gY = φ(gƒ, gK, gL, gT)


Natural law – laissez-faire and self-interest contribute to growth. In economics, Adam Smith believed in the notion of 'natural law.' He believed that each individual was the best judge of his or her own interests, and that they should be allowed to follow them to their own gain. She/he would advance the general good by increasing her/his personal self-interest. Everyone was guided by a 'invisible hand' in order to achieve this. "We owe our bread not to the baker's goodness, but to his self-interest," Smith explained. Because every individual, if left to his own devices, will want to maximise his own wealth, all individuals, if left to their own devices, will aim to maximise collective wealth. Smith was adamantly opposed to government intervention in business and industry. He was a strong proponent of free trade and argued for a laissez-faire approach to economics. The "invisible hand" — the perfectly competitive market's natural equilibrating process – tended to maximise national wealth.


Division of Labor - Division of labour boosts productivity, which is proportional to market size. Smith's idea of economic progress begins with the division of labour. The most significant boost in labour productivity is achieved by division of labour. This improvement in productivity is due to I an increase in worker dexterity; (ii) a reduction in the time it takes to manufacture items; and (iii) the introduction of a large number of labor-saving machines. The last factor that contributes to increased productivity is capital, not labour. As a result, greater technology leads to division of labour under Smith's plan, which is dependent on the size of the market.


Capital Accumulation Process - Division of labour leads to capital accumulation, and capital accumulation leads to economic progress – Smith, on the other hand, emphasised that capital accumulation must come first. "As the buildup of stock must, in the nature of things, come before the division of labour, so that labour can be more and more subdivided in proportion only as stock accumulates," he wrote. Classical economists, like modern economists, saw capital accumulation as an essential condition for development economics. As a result, the ability of people to save and invest more in a country was a major issue in development economics. "That percentage of a person's annual savings is instantly used as a capital," Smith added. However, because practically all saving was based on capital investments or land rentals, only capitalists and landlords were considered capable of saving. The working classes lacked the ability to save. The 'Iron Law of Wages' supported this notion. The existence of a 'wages fund' was also believed by classical economics. The assumption was that 'wages' tend to equal the amount required for the labourers' subsistence. If the total wages fund rises over the subsistence level at any point in time, the labour force will expand, job rivalry will heat up, and salaries will fall below the subsistence level.


What motivates capitalists to invest? – Investments are made in order to profit – According to classical economists, capitalists made investments because they expected to profit from them, and future profit expectations were influenced by the current investment climate as well as actual profit. But, how do profits behave during the development process? When the rate of capital accumulation increases, earnings, according to Smith, tend to diminish with economic growth. Increasing capitalist competition tends to reduce profits. As the economy's capital stock grows, competition among entrepreneurs for scarce labour tends to drive up salaries, lowering profits.


Interest - Smith argued on the importance of interest in development economics, stating that as prosperity, progress, and people rise, the rate of interest declines, resulting in an increase in the availability of capital. The reason for this is that as interest rates decline, moneylenders will lend more in order to earn more money. When a result, as the rate of interest falls, the amount of cash available for lending rises. Moneylenders, on the other hand, are unable to lend more when the rate of interest decreases significantly, as they need to earn more to maintain their level of life. They will start investing and become entrepreneurs as a result of the conditions. As a result, even while interest rates are falling, capital accumulation and economic progress are increasing.


Farmers, producers, and businessmen, according to Smith, are the agents of progress and economic expansion. These three functions, however, are intertwined. Agriculture's expansion, according to Smith, leads to an increase in construction and commerce. When there is an agricultural surplus as a result of development economics, demand for commercial services and manufactured goods increases. This results in commercial advancement and the development of manufactured industries. When farmers utilise modern production techniques, however, their progress leads to a rise in agricultural productivity.


Natural resource scarcity halts growth – According to Smith, growth is a cumulative process. When there is affluence as a result of advancements in agriculture, industry, and commerce, it leads to capital accumulations, technical progress, population growth, market expansions, labour division, and a constant rise in profits. However, this is not an infinite process. Natural resource constraint is what finally brings expansion to a halt. Profits would be as low as feasible as a result of the businessmen's competition. Profits begin to decline and then continue to decline. Capitalism's result is a stagnant state, when investment begins to decline. When this happens, capital accumulation halts, populations become stationary, profits are at a bare minimum, salaries are at a subsistence level, per capita income and production remain unchanged, and the economy stagnates.


Ricardian Theory of Economic Development

In his work The Principles of Political Economy and Taxation, Ricardo offered his viewpoint on Economic Development in an ad hoc manner. Ricardo, like Smith, never proposed a theory of development; instead, he focused on the idea of distribution. Smith's concept of growth, on the other hand, remained the dominant model of Classical Growth. It was amended by David Ricardo (1817), who included diminishing returns to land.


The Ricardian model is built on the interdependence of three economic groups. They are landowners, capitalists, and labourers who share the total harvest of the land.


Rent, profit, and wages - (a) rent is the percentage of the earth's produce that is paid to the landlord in exchange for the use of the soil's inherent and indestructible powers. The difference between average and marginal product is what this term refers to. There would be no payment for using the land if it possessed the same features of unlimited supply and uniform quality. (a) At the subsistence level, the wage rate is determined by the wage fund divided by the number of workers employed. According to the model, rent has first right to the entire corn produced, and the remainder is divided between wage and profit, with interest included in profit.


Capital Accumulation - According to Ricardo, capital accumulation is the result of profit since profit causes wealth to be saved, which is then utilised to develop capital. The ability to save is more significant than the willingness to save when it comes to capital accumulation. The more the surplus, or profit, the greater the ability to save.


Profit Rate - The profit rate is equal to the profit to capital employed ratio. However, because capital is made up entirely of working capital, it is equivalent to the wage bill. Capital accumulation will occur as long as the profit rate is positive. Profits are determined by wages, wages are determined by corn prices, and corn prices are determined by the fertility of marginal land. As a result, wages and profits have an inverse relationship. When agriculture improves, the price of corn declines, subsistence wages fall, and profits rise, resulting in capital accumulation. This will increase demand for labourers, resulting in higher wage rates and lower profitability.


Other Capital Accumulation Sources: Economic development, according to Ricardo, is determined by the gap between production and consumption. Increased productivity or less unproductive spending can both raise capital. Labor productivity, on the other hand, can be improved by technology advancements and greater organisation. Capital accumulation can be increased in this manner. However, when more machines are used, fewer people are employed, resulting in unemployment. As a result, Ricardo considers technological conditions as predetermined and unchanging.

  1. Taxes: In the hands of the government, taxes are a source of capital accumulation. Taxes, according to Ricardo, should be imposed in order to decrease ostentatious consumption. Otherwise, taxes on capitalists, landowners, and labourers will move resources from these groups to the government, reducing investment opportunities. As a result, he opposes the imposition of taxes.

  2. Free Trade: Ricardo is a free trade supporter. Importing grain can keep the profit rate from falling. As a result, capital accumulation continues to remain high. As a result, the world's resources may be utilised more efficiently through trade.


Stationary Condition: According to Ricardo, the rate of profit in the economy has a natural tendency to diminish, resulting in the country eventually reaching a stationary state. When capital accumulation rises, profits rise, which raises output, which raises the wage fund, and population swells, which boosts grain demand and price. Land of lower quality is cultivated. The share of capitalists and labourers increases and decreases as rents on superior land rise. Profits plummet, and wages dwindle to starvation levels. The cycle of rising rents and falling profits continues until the marginal land's produce barely covers the pay of the employed labour and profits are zero. There is no rise in capital, population, or wage rate, yet rent is extraordinarily expensive, and the economy is stagnating.


6) Discuss the Harris-Todaro model of migration. What has been the impact of this model? What is its relevance for developing nations?

Ans) The growth model was created by John R. Harris and Michael P. Todaro. The model explains the seemingly conflicting relationship between rising urban employment and increased rural-urban migration. The Harris-Todaro model has four basic components:

  1. Rural-urban migration is aided by rational economic considerations of relative benefits and costs, primarily financial but also phycological.


  2. Expected rather than actual urban-rural real wage differentials influence migration decisions, with the expected differential defined by the interaction of two variables: the actual urban-rural wage differential and the probability of finding job in the city.


  3. The chances of getting an urban job are related to the rate of urban employment and inversely proportional to the rate of urban unemployment.


  4. In the face of a huge anticipated income gap between urban and rural areas, migration rates exceeding urban top opportunity growth rates seem not only reasonable, but also likely. High rates of urban unemployment are inescapable in most emerging countries due to huge economic disparities between urban and rural areas.


Implications of the Model

The model provides an adjustment mechanism by which workers allocate themselves between rural urban labour markets. At the same time, it suggests that there is a need for a comprehensive migration and employment ‘strategy. The key elements of such a strategy Carl stated as follows:


1) Achieving a proper economic balance between rural and urban areas

The strategy's main focus should be on integrated rural development, small-scale industry expansion, economic reorientation, and social investment in rural areas. On the one hand, a plan based on this feature would serve to alleviate the problem of urban and rural unemployment while also discouraging migration.


2) Industries that require a lot of labour

The focus should be on labor-intensive industries to decrease the pace of rural-urban migration and generate job prospects in rural areas. Small-scale and rural industry expansion can be aided directly by government investment and incentives, as well as indirectly by income transfer to the poor.


3) Labor-intensive manufacturing technology

The development experience of developing countries has shown that in the early stages of development, many countries became almost reliant on labour technology. One of the key concerns affecting long-term employment generating programmes in both urban industry and rural agriculture has been emerging countries' technological dependence on imported technology and equipment from wealthy countries. To lessen this reliance, domestic efforts should be made to build small-scale, labor-intensive, and low-cost methods of providing rural infrastructure needs, such as roads, irrigation, drainage, and basic health and education services.


4) Removing price discrepancies caused by factors

To increase employment possibilities and make better use of scarce capital, factor price distortions must be eliminated. This can be accomplished by reducing various capital subsidies and using market-based pricing to limit wage increases. Correct pricing strategies alone may not be sufficient to change the employment situation, thus how far and to what extent these policies succeed is a topic of discussion.


5) Education and employment are intertwined

The primary goals of development are education and employment. Theories of sustaining growth and development for developing countries to absorb modern technologies and create the capacity for self-sufficiency. Education is essential for improving the quality of human existence in underdeveloped countries and achieving economic and social growth. These educational advantages should be considered as a tool for creating jobs. A system of education must be linked to employment opportunities. A growing country's education system should be designed to fulfil the needs of rural development while also creating work opportunities for potential employees.


Relevance of the Model

The model is relevant to developing countries even if the wage is not institutionally determined. Recent literature on rural-urban migration has confirmed that emergence of high modern-sector wage alongside unemployment can also result from market responses to imperfect information, labour turnover and other common features of labour market. While this model focuses on the institutional determinants of urban wags rates above the equilibrium wags, others have sought wage explain this - phenomenon by focusing on the high cost of labour turnover in urban areas and the nation of an efficiency wage; an above-equilibrium urban wage enables employers to secure a high-quality work force and greater productivity on the job.


7) Explain the meaning of cost-benefit analysis. Describe briefly the usual steps taken in a typical cost-benefit exercise.

Ans) Cost–benefit analysis (CBA), sometimes also called benefit–cost analysis, is a systematic approach to estimating the strengths and weaknesses of alternatives used to determine options which provide the best approach to achieving benefits while preserving savings. For example, in transactions, activities, and functional business requirements. A CBA may be used to compare, completed or potential courses of actions. Also, to estimate (or evaluate) the value against the cost of a decision, project, or policy. It is commonly used in commercial transactions, business or policy decisions (particularly public policy), and project investments. For example, the U.S. Securities and Exchange Commission must conduct cost-benefit analysis before instituting regulations or de-regulations.


CBA has two main applications:

  1. To determine if an investment (or decision) is sound, ascertaining if – and by how much – its benefits outweigh its costs.

  2. To provide a basis for comparing investments (or decisions), comparing the total expected cost of each option with its total expected benefits.


CBA is related to cost-effectiveness analysis. Benefits and costs in CBA are expressed in monetary terms and are adjusted for the time value of money; all flows of benefits and costs over time are expressed on a common basis in terms of their net present value, regardless of whether they are incurred at different times. Other related techniques include cost–utility analysis, risk–benefit analysis, economic impact analysis, fiscal impact analysis, and social return on investment (SROI) analysis.


Cost–benefit analysis is often used by organizations to appraise the desirability of a given policy. It is an analysis of the expected balance of benefits and costs, including an account of any alternatives and the status quo. CBA helps predict whether the benefits of a policy outweigh its costs (and by how much), relative to other alternatives. This allows the ranking of alternative policies in terms of a cost–benefit ratio. Generally, accurate cost–benefit analysis identifies choices which increase welfare from a utilitarian perspective. Assuming an accurate CBA, changing the status quo by implementing the alternative with the lowest cost–benefit ratio can improve Pareto efficiency. Although CBA can offer an informed estimate of the best alternative, a perfect appraisal of all present and future costs and benefits is difficult; perfection, in economic efficiency and social welfare, is not guaranteed.


The value of a cost–benefit analysis depends on the accuracy of the individual cost and benefit estimates. Comparative studies indicate that such estimates are often flawed, preventing improvements in Pareto and Kaldor–Hicks efficiency. Interest groups may attempt to include (or exclude) significant costs in an analysis to influence its outcome.


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