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Development ch.1.2022

The document provides an overview of key concepts in development economics, including: - Development economics examines economic growth, equality, poverty, and behaviors of lower-income countries. - It explores factors that influence economic growth rates in poorer nations and what can be done to improve living standards. - Classical economists like Adam Smith and David Ricardo believed economies would eventually reach a stationary state with no growth, while the Harrod-Domar model predicted instability without intervention. Karl Marx argued capitalist profits would decline, reducing investment and growth.

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Amgad Elshamy
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59 views4 pages

Development ch.1.2022

The document provides an overview of key concepts in development economics, including: - Development economics examines economic growth, equality, poverty, and behaviors of lower-income countries. - It explores factors that influence economic growth rates in poorer nations and what can be done to improve living standards. - Classical economists like Adam Smith and David Ricardo believed economies would eventually reach a stationary state with no growth, while the Harrod-Domar model predicted instability without intervention. Karl Marx argued capitalist profits would decline, reducing investment and growth.

Uploaded by

Amgad Elshamy
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Chapter (1)

Development Economics explains why the world has become sharply divided into rich and
poor nations. It answers the question of what can be done to improve our living conditions
(standards). It guides us to learn about how the economic growth rates in the poorer
countries of the world might be increased.

Development Economics is interested in economic growth; equality; poverty; and economic


behavior of the lower-income countries.

Development: a process or a state. Either the act of developing or else the state of having
developed. This can be demonstrated when recognizing the following terms.

Developing: the most common use of “developing” is in developing countries. It is one that
expresses optimism. In practice, it means relatively poor but carries an understone of hope.
This term covers both low-income and middle-income countries.

Development and growth: growth (economic growth) indicates increase in a country’s total
national income, while development means the increase in its national income per head of
population (per capita). From the computable side of economic advance growth can be taken
to denote an increase in national income per capita, however development is broader taking
into account not only this per capita material growth but also how additional income per
capita is distributed (with equality).

Economic Development: refers to growth in per capita (head) income.


Social Development: is used to cover all aspects counted as components of “development”;
degree of equality in income distribution, proportions of population below international
poverty lines, educational enrolments, literacy rates, life-expectancy, infant and maternal
mortality, nutrition standards, gender equality.

Underdevelopment: it is used for a state not a process. An underdeveloped country lacks


the attributes of a developed society. It is poor in a range of capabilities such as poor in
income terms, weak on most of other items of social or political development such as
educational institutions and enrolments, health statues, life expectancy, infant mortality,
nutrition, accessibility of safe water, sewerage provision, housing quality, extent of literacy,
extent of technical skills of the industrial and post-industrial age, opportunity for political
participation, gender equality.

Low-income, Lower-middle-income, Upper-middle-income, and High income countries:


According to the classification of World Bank (2008):
Low income (US$905 or less).
Lower-middle-income ($906 - $3595)
Upper-middle-income ($3596 - $11,115)
High-income ($11,116 or more)

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Developed Countries: high-income countries excluding economies that were heavily
dependent for their high –income on the production and export of one or few primary
commodities (like crude oil), or on government transfers as aid from outside, or on being the
site of a major power’s defense installations.

Industrialized Countries: the usual meaning is the same as “developed countries”, except
that a one-commodity-based economy, or a transfer-based or foreign-defense-based
economy.

Third World: it was common for a period in the 1970s and 1980s as a way of referring to the
developing countries (low-and middle-income class).

North-South: North referred to the industrialized countries and South referred to the rest.

The Classical Economists


Adam Smith theory of Growth:
- He asked what determines the growth rate, the wealth of nations?
- The expansion process in Smith’s growth model depends on three factors of production –
land, labor, and capital- and on technical progress ; suggesting a basic production
function of the form: 𝑌 = 𝑓(𝐿, 𝐾, 𝐻)
- Increases in the size of labor force (L), in the amount of capital (K), and in the available
land (H), all lead to increases in total output (Y).
- Growth in total output (Yg) will be caused by growth in labor force (Lg), in the capital
stock (Kg), and the supply of land (Hg). In addition, improvements in technology (Tg) lead
to expanded output by increasing the productivity of the factor inputs 𝑌𝑔 =
𝑓(𝐿𝑔, 𝐾𝑔, 𝐻𝑔, 𝑇𝑔)
- A Stationary Economy: it is the economy in which the labor force (and the population)
and the capital stock are constant, then output then also be constant – there will be no
economic growth.
- The real wage earned by labor will be just enough to provide a subsistence living with no
surplus to make possible an increase in population.
- Similarly, on the capital side, new investment (I), financed by new saving (S) of capitalists,
will be just enough to replace depreciation of existing capital goods, so there is no growth
in the stock of productive capital goods.
- And land, in the absence of new discoveries or improvements in fertility, is also effectively
fixed in quantity.
- The scenario starts with a stationary economy as stated. This situation may be disturbed
by an external “shock” such as a new invention.
- The invention improves efficiency of production or improved opportunities for
international trade.
- Increase output makes possible increased saving and investment, which in turn creates
conditions favorable for increasing the extent of specialization and further improving
productivity.

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- This scenario permits a rise in wages above subsistence level, encouraging population
growth and expansion of the labor force – a requirement for continued economic growth.
- However, a sustained increase in population and the labor force is likely to exert
downward pressure on the wage rate.
- Increased capital accumulation leads to a corresponding downward pressure on the profit
rate.
- These processes push the real wage rate and the rate of profit back to their original
levels. Once the original levels of wage and profit are re-established, the economy is back
a stationary state. The only difference from the starting point is that the population and
the capital stock are now larger.

David Ricardo Growth Theory


- Like Smith, Ricardo expected the macroeconomy to end up in a stationary state after a
phase of growth.
- Ricardo saw diminishing returns limiting agriculture production.
- As agriculture expands, the marginal productivity of labor and the marginal productivity
of capital are driven down.
- With wages at minimum subsistence level, increase in output results in a declining rate of
profit and redistribute income towards landlords, who are able to charge progressively
higher rents while showing little interest in spending this income on productive investment.
- Iron Law of Wages: An important element in Ricardo’s view of the growth process in his
Iron Law of Wages, formalizing the “Subsistence Theory” of wages which in the future of
all classical thinking on growth.
- The Iron Law of Wages suggests that a certain minimum level of consumption is necessary
to sustain life, and that the real wage tends to be driven down towards the floor level.

Keynesian Growth – the Harrod-Domar Model:


- Harrod-Domar Model was designed to extend Keynesian analysis into the growth area.
- The Harrod-Domar Model predicted serious inherent instability for capitalist economies
and much subsequent decision of growth focused on this issue.
- They found that most possible combinations of values of the savings rate, the level of
investment, the capital-output ratio, and the growth rate of labor force would result in a
tendency for the economy to be unstable with growing unemployment of either labor and
capital stock and to possess no self correcting mechanism.
- Our focus has been on the use of the basic equation of Harrod-Domar Model to estimate
the saving and investment requirements for particular rates of growth.
- The Harrod-Domar Model uses a very simple production function.
- This function says that there is a fixed, constant relationship between the amounts of
capital (K) invested and the amount of output (Y) produced using the capital. That is, the
capital output ratio (K/Y) is constant. let (V) to call the ratio.
- As constant returns to scale is assumed, it also applies to any increase in the capital stock
ΔK, and to the associated increase in the output ΔY, produced by this new capital stock.

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Example:
Given the following information for an economy, Saving rate is 30% (30 percent of output is
saved for investment purposes) and the capital output ratio is 3 (each additional unit of
output requires 3 units of capital to produce it), what is the growth rate of output.

Answer:
𝑆 30
𝐺= = = 10 𝑝𝑒𝑟𝑐𝑒𝑛𝑡 𝑎𝑛𝑛𝑢𝑚
𝑉 3
Karl Marx
- Like Smith and Ricardo, Marx believed that the profit rate would decline as capitalist
economies developed, and that this would reduce investment and therefore the rate of
economic growth.
- He saw the eventual demise of investment as resulting initially from the pressure of
capital accumulation on the labor market, which would tend to push up wages.
- He argued that capitalists might seek to resist this by direct action to hold wages down,
which would give rise to social conflict.
- They might increase the capital intensity of production by increasing the ratio of spending
on capital equipment and industrial raw materials, Marx’s Constant Capital, to the wage
bill (variable capital).
- However, increasing capital intensity absorbs more capital and reduces the profit rate,
and saw it is not a long term solution.
- Moreover, as machinery replaces men, the labor force (consumers who create effective
demand) can no longer purchase all of goods being produced, causing deficit Effective
Demand. And consequently, the system will collapse, leading to a transition to socialism.

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