Chapter 1: Introduction to Economic Development

Development Economist
Adam Smith (1776)- "Wealth of Nations"
First economic book
First ever development economist
"Father of Economics"
Adam Smith= moral philosopher
1st economist to write tangible material on the "laissez-faire" concepts that
physiocrats had been discussing for years
laissez-faire = free market
W. Arthur Lewis and Theodore Schultz
Instead of discussing the nature of an economy they saught to see the mechanisms
to influence an economy
Both talked about how to restructure an economy by making one sector profitable
During the 19th century, the chosen sector was predominately the agrarian sector
In this sector, there will be "useless labor" or excesses supply of labor that is not
used in the agrarian sector.
Hence that labor will go to the manufacturing sector where goods will be made.
Since the manufacturing sector is "inherently" a capitalist sector (profit max.) then
profits will be made
Those profits will be re-invested to the sector and growth occurs
Traditional Economics
Goal: Efficient resource allocation with optimal growth of these resources for future growth
and production
Characteristics of a Traditional Neoclassical Economy
Perfect markets, automatic price adjustment, utility maximizes, private profit and
equilibrium outcomes in product and resource markets
Economics "rationality" (axiom: more is better/utility max.) of self-interested
individuals
No market failure, no intervention, "The invisible hand" -> Price is determined by
demand/supply
Definition of Utility: the satisfaction of consuming a unit of a good or services
Efficient resource allocation- distribution such that demand is equal to supply (D=S) in every
market
Definition of Political Economy: Is a relationship between politics and economics
with an emphasis on the role of power in economic decision-making.
Development Economics
Scope of development economics is greater than that of the traditional economy
Must take into consideration the overall social system of a country
Definition of Social systems: the organizational and institutional structure of a
society, including its values, attitudes, power structure and traditions
Efficient allocation of scarce resources and their growth (traditional economics) as well as
economic, social, political and institutional mechanisms- both public and private

Economic cultural and political requirements for effecting rapid structural and institutional
transformation that will efficiently allocate the outcome of economic progress to the highest
possible percentage of the population- the role of the government
Focus on mechanisms that keep families, regions and nations in poverty traps and on the
effective strategies for breaking out of these traps
Includes a larger role of the government and a degree of coordinated decision making
Combines theories from traditional economics analysis and new models along with case
studies
there are no "blanket" policies that apply to all nations
especially in the developing world where differences amongst developing nations are
much more stark than in developed nations
What's Development?
Economic terms Development is: achieving sustained rate of growth of income per
capita to enable a nation to expand its output at a rate faster than the growth rate of
its population.
Levels and rates of growth of real per capita gross national income (GNI) are then
used to measure the overall economic well-being of a population
GDP
Gross Domestic Product
Measurements: Expenditure, Income, or Product
Condition: All values of measurements must equal to each other
Traditional Economic Measures
The capacity of a national economy to generate and sustain an annual increase in
GNI (Gross National Income) at rates between 5%-7% or more. Alternatively, the
rate of growth of per capita income.
The New Economic View of Development
Redefined in terms of the reduction or elimination of poverty, inequality and
unemployment within a growing economy.
Amartya Sen's Capabilities Approach
Definition of Capabilities: the freedoms that a person has in terms of the choice of
functionings, given his personal features (conversion of characteristics into functionings)
and his command over commodities"
"Economic growth cannot be sensibly treated as an end in itself. Development has to be
more concerned with enhancing the lives we lead and the freedoms we enjoy"- Amartya
Sen
In simple terms, growth does not equal development rather that growth can lead to
development
Sen stressed the capability to function meaning: What matters is not the things a person
has or the feelings these provide but what a person is, or can be, and does or can do
Definition of Functioning's- the various things a person may value doing or being. These
may vary from those such as being adequately nourished to personal states such as being
able to take part in the life of the community
Sources of disparity (constraints) between real incomes and actual advantages
Personal heterogeneities- age, disabilities, gender
Environmental diversities- clothing in cold, infectious disease, and impact of pollution
Variations in social climate- prevalence of crime and violence
Differences in relational perspectives

Distribution within the family

Gender often dictates (girls vs boys in terms of primary education)
income distribution is more equitable when women are head of the household
Traditional Measures of Development
Gross National Income (GNI)
Criticism: Per capita (an average figure) income doesn't represent the wealth gap in
nations
Gross Domestic Product (GDP)
Primary, secondary and finished products are included
GDP per capita (per head)
GDP vs. GNP
Definition of GDP: the money value of total amount of goods and services within the
geographical boundary over a year
Definition of GNI: the money value of total amount of goods and servces produced by the
nationals over a period of a year.
Using the core/periphery theory where:
the producer (core), consumer (periphery)
Underdevelopment occurs b/c the core wants to grow but is dependent on the
periphery to remain the same, hence producer makes more profits whilst the
consumer is remained unchanged
Cause of poverty
Several factors including political bias, lack of willingness, work culture, etc.
Population doesn't impede development but rather the production, allocation and
efficiency of the population in the work force can be an impediment towards
development.
Three Core Values of Development
These core values represent goals for both individuals and society as a whole
Sustenance- the ability to meet basic needs of food, shelter, health and protection
Self-esteem- to be a person with a sense of worth and self respect. The nature may vary
between societies and cultures
Freedom from servitude (Freedom of choice)- to be able to choose. Wealth to gain greater
control over nature. Freedom to choose greater leisure, to have or renounce goods and
services
Development and Happiness
Amartya Sen "Utility in the sense of happiness may well be included in the list of some
important functioning's relevant to a person's well-being"
The average level of happiness or utility increases as a country's average income increases
This relationship is only seen from $10,000 to $20,000, since most individuals at this
point have escaped extreme poverty
Financial security is an important determinant of happiness
Richard Layard's Seven Determinants of Happiness
Family relationships
Personal freedom

Financial situation
Work
Community and friends
Health
Personal values
Bhutan has created a "Gross National Happiness" Index to measure their nations happiness
Takes into consideration health, education, freedom, etc.
The Central Role of Women
Globally, women tend to be poorer than men
Women are primary child bearers
Studies show that women tend to spend a higher percentage of their income on their
children than men do
Women also transmit values to the next generation
The Three Objectives of Development
(Linked to sustenance) To increase the availability and widen the distribution of basic lifesustaining goods
Example: food, shelter, health and protection
(Linked to self-esteem) To raise levels of living
Example: higher incomes, provision of more jobs, better education, greater attention
to cultural and human values.
(Linked to Freedom from servitude) To expand the range of economic and social choices
available to individuals and nations by freeing them from dependence and servitude
Millennium Development Goals (MDG)
September 2000 at the United Nations Headquarters in New York
189 member countries adopted the 8 Millennium Development Goals (MDG)
Human development goals to be reached by 2015
Goals
Eradicate extreme poverty and hunger
Improve maternal health
Combat HIV/AIDS, malaria and other diseases
Achieve universal primary education
Reduce child mortality
Promote gender equality and women empowerment
Ensure environmental sustainability
Develop a global partnership for development

Chapter 2: Comparative Economic Development

Facts and Figures
GDP per capita (PPP) is $47,200 in the U.S. and $1700 in Bangladesh
Life expectancy at birth is 78.37 in the U.S and 38.76 in Angola
Literacy rate is 99% in U.K. and 47.9% in Bangladesh
Expenditure on health is 16.2% of GDP in the U.S. and 2.4% of GDP in India.

Source CIA factbook ; accurate as on January 1st, 2011

Questions
1. How have such great disparities persisted?
1. With any sort of growth in an economy and with the saturation of economies, how is
that the gap is getting bigger rather than smaller?
2. How have some of these gaps widened?
3. Why is it that some developing countries have made a great progress in closing these gaps
while others have made so little?
Features less developing nations have in common in comparison to developed nations
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

Lower levels of living and productivity

Lower levels of human capital
Higher levels of inequality and absolute poverty
Higher population growth rates
Greater social fractionalization
Larger rural populations but rapid rural-to-urban migration
Lower levels of industrialization and manufactured exports
Adverse geography
Underdeveloped financial and other markets
Lingering colonial impacts like poor institutions and varying degrees of external dependence
(politically, economically, etc.)

Classification system of the World Bank

208 countries with a population greater than equal to 30,000 are ranked by their levels of
GNI per capita.
Low-income countries, lower-middle-income countries, upper-middle-income countries,
high-income OECD countries, and other high-income countries.
Developing countries are LICs, LMCs or UMCs.
Low Income Countries - LICs GNI per capita (2005) less than equal to $875
Lower Middle Income Countries- LMCs - GNI per capita (2005) between $876-$346
Upper Middle Income Countries- UMCs GNI per capita (2005) between $3466 - $10725
Shortcomings/Limitations
High income countries w/ one or two highly developed export sectors, means
significant parts of pop. are undedicated or in poor health for the country's income
level. (Example: Saudi Arabia, UAE)
Upper-income economies include tourism dependent islands with lingering
development problems (Example: Portugal and Greece)
Other Bases of Classification of LDCs
A special distinction made among UMCs or newly high income economies, where some
have achieved relatively advanced manufacturing sectors are called newly industrializing
countries (NICs).
Degree of international indebtedness - severely, moderately and less indebted (made by
the World Bank)
Level of human development (UNDP), least developed countries (LDCs)

Basic Indicators of Development

Real Income - Purchasing Power Parity
Converting between currencies can use the PPP and exchange rates
Indicators of Health and Education
All three indicators compose the measures of development
GNI- A Measure of Economic Well-Being
Definition of Gross National Income: calculated as the total domestic and foreign value
added claimed by a countries residents without making dedications for depreciation (or
wearing out) of the domestic capital stock
GNI GNP
GNI GNP = GDP + (income residents earn abroad) (payments made to non-residents
who contribute to the domestic economy)
GDP = The total value of all goods and services produced within the geographical boundary
of an economy, over a period of one year.
Exchange Rates v/s PPP
In order to make GNI comparisons across countries, the local currency values of GNI must
be converted to a common currency, usually the U.S.$, using,
Exchange rates
Liquidity: amount of currency in the domestic market
Confidence: the value of the currency in the domestic markets
Definition of Purchasing Power Parity (PPP): The number of units of a foreign
countrys currency required to purchase the identical quantity of goods and services
in the local market as $1 would buy in the U.S.
PPP is more stable to compare the changes in economies, exchange rates is far too
volatile because of fixed exchange rates
Human Development Index
The annual series of Human Development Reports by the UNDP bases its analysis of the
comparative status of the socioeconomic development on the HDI. The HDI bases on 3
goals of development.
Longevity: measured by life expectancy at birth
Knowledge: measured by a weighted average of adult literacy and mean years of
schooling
Standard of Living: measured by real per capita GDP adjusted for the differing PPP
of every country s currency.
HDI Formula = 1/3 (income index) + 1/3 (life expectancy index) + 1/3 (education index)
Measurement scale
From 0 to 1, 0 being the lowest human development and 1 being the highest human
development
Definition of Human Capital: Productive investments in people, such as skills, vales and
health resulting from expenditures on education, on-the-job training programs, and medical
care
Classification
Low human development: 0.0 to 0.499
Medium Human Development: 0.5 to 0.799

High Human Development: 0.8 to 0.9

Very High Human Development: 0.90 to 1.0
Advantages of HDI
Reveals that a country can do much better than might be expected at a low level of income
while substantial income levels might not attain very high levels of HDI.
Disparities in income are greater than disparities in other indicators of development.
Health and education act as components of human capital
Criticisms of HDI
Gross enrollment overstates the amount of schooling.
Considers only those that enrolls, in many developing nations, many students drop
out of school after enrollment
Literacy does not mean education
Literacy is often determined by the ability to sign your own name, does not
effectively test ones ability to read
There is no formal justification for allowing 1/3 weight to every component.
There is no economic backing to support that each sector is worth 1/3
Income plays a more large role (>1/3) than the other indicators
Quality plays no role in the indices
Schools quality matters, not just the enrollment years
Quality of life matter as well, being sick in bed for a year vs. being healthy and wellfunctioning
GNI used over GDP
Int'l trade and globalization has put pressure to count the production of nations
outside the country as well
Rural-urban differences
The HDI value of a nation is not representative of the entire nation
Levels of human development vary drastically depending on whether the are is
urban or rural within a country
Comparing the HDI within a city center (Shanghai) vs. a small village town (Western
China)
The New Human Development Index (NHDI)
Introduced in November 2010, UNDP wanted to address criticisms of the HDI
Indices
Education
Health
Standrad of Living
Changes from HDI to NHDI
GNI per capita replaces GDP per capita
Education Index chaged. Two new components added:
Average actual educational attainment of the whole population
How educated the population are
Expected attainment of today's children
Ambiguous: It is an idea rather than an actuality
Prediction of the trend
Previous education index components: literacy and enrollment have been dropped

Maximum values in each dimension have been increased to the observed maximum
The minimum value for income has been reduced. This is based on estimates for
Zimbabwe in 2007
The common logarithm (log) to reflect the diminishing marginal benefit of income,
has been changed to natural logarithm (ln)
Other indexes are present as well
The Inequality-Adjusted Human Development Index (IHDI): imposes a penalty on the
HDI value that increases as inequality arose people becomes greater
Gender Inequality Index (GII)
Multidimensional Poverty Index (MPI)

Chapter 3: Classic Theories of Economic Growth and

Development
Approach to Classical Theories of Economic Development
Purpose: trace down the initial kind of thought process that would bring about growth and
development
The Theories and patterns of structural change and international-dependence revolution
inherently are against the linear stages of growth model
Linear stages-of-growth model
1950s to 1960s
Lays out the stages a country needs to go through to reach development
Says you must have enough domestic capital and production (savings, investment
and foreign aid) to reach development
Development was associated with rapid aggregate economic growth
Rostows' Stages of Growth
Theories and patterns of structural change
Replaced linear model in 1970s
Lewis Model
Create a sector in the economy that has the potential to help the economy mobilize
domestic resources
Usually this sector would be agricultural sector, each family would produce at a
subsistence level, no surplus for profits therefore no savings, no capital accumulation
and thus no growth
Jumping to a linear growth model is quiet difficult and complex
The goal is not to have investment and growth alone but through creating a sector in
which profits can be obtained through savings and investment
International-dependence revolution
Also, replaced linear model in 1970s
Underdevelopment --> international and domestic power relationships, institutional
and structural economic rigidities
Developing economies are developing because of external pressure
False paradigm model
Savings mobilized within the economy is not the basic constraint that prevents
growth and development within the economy, international, external pressure also

constrain the economy

The neoclassical counterrevolution
Perfect competition, perfect markets, hands off government policy, free market
Buyers and sellers will look at the "invisible hand" = price, that decisions will be
made so that all the goods are cleared and sellers generate exact amount of profit
from sales
This profit thus leads to saving, investment, capital accumulation ---> growth and
development
Solow model is a representation of this concept
Rostow's Stages of Growth
Made by economist, W.W. Rostow
Traditional society
Agro based economy
Family owned farmers, don't make profits
Subsistence
Pre-conditions to take-off
There is a slit change from traditional society to producing enough
Take-off
Start taking advantage of markets other than yourself (int'l trade)
Produce surplus
Mobilizaiton of domestic and foreign saving in order to generate sufficient investment
Drive to maturity
Total value of exports are enough to cover the total amount of imports
Age of high consumption
Imports are such that you have a large range of consumables in your economy
therefore you can offered to import what you do not have
Consumption of goods has a wide variety and selection
Pay for import with export earnings
Harrod-Domar
Definition: a functional economic relationship in which the growth rate of gross domestic
product (g) depends directly on the national net savings rate (s) and inversely on the
national capital output ratio (c)
A basic example of economic growth
Also known as, the AK Model
Based on a linear production function
Output given by capital stock, K, times a constant, often labeled A.
Background --> Keynesian economics, 1936
Demand will create supply, such that each are exact --> market clearing price
equilibrium
Total value of income = total value of output/production
Created in the Great Depression
Low demand/consumption
Excess supply --> inventory for the producer
Suppliers don't produce more, minimize inventory
Therefore, see if demand in market, must be supply (inventory)
If demand>inventory, produce more (underproducing)
If demand< inventory, signal to stop producing (overproducing)

Concept also represented by, capital output ratio

Units of capital input (investment, capital, savings) = unit of output over a
given period of time
Explanation of Harrod-Domar
Intuition
Since total capital stock, K bears a direct relationship to output Y, it follows that K / Y
is the capital-output ratio.
Define the incremental capital-output ratio as,
where, K / Y= c
or, K = c Y
Assumptions
Net national savings must equal net national investment, S=I
Given the assumption that GDP methods are all equal, therefore
GDP Ex. Method= GDP Income Method
C+I+G+Xn=C+S+T+M
I=S
Given:
S = sY
Net savings= proportion (s) of total income (Y)
I = K and
Addition to capital (K) is equal to investment (I)
c= K/Y
Capital Output Ratio
Result
Therefore, S = sY= cY= K = I
Or, sY= cY
Dividing both sides by Y and then by k, we obtain
Y / Y = s / c
Basically, rate of growth of income/GDP = proportion to save/capital-output
ratio
Basic explanation:
Harrod-Domar model states that the rate of growth of GDP is determined jointly by
the net national savings ratio (s), and the national capital-output ratio (c)
Furthermore, w/o gov't involvement, growth rate of national income = or > the
savings ratio, visa versa w/ gov't
Inversion of Capital-Output Ratio
Can be used to explain how savings and investment determines growth rate
Inverse of capital-output, 1/c --> output capital or output investment ratio
Other factors influencing growth rate other than investment; labor force growth and
technological progress
Constraints and Obstacles of Harrod-Domar
Increase growth by increasing savings proportion
Capital Constraint: Constrained by low level of new capital in poor countries
No new capital --> no new savings --> no new investment --> no increased
growth of economy
Solow Model

Background
Solow Model --> Study of convergence across an economy
Convergence --> same level of income = the same rate of;
savings, s
depreciation,
labor force growth, n
productivity growth of labor given time (t), A(t)
Used Harrod Domar model as basis
AK model --> Capital Labor model
Assumption
Labor (L) and Capital (K) are the two factors of production
The level of technology is exogenously given
There are Constant Returns of Scale (CRS)
Increase in FoP's (Capital, and Labor) = Proportional Increase in Gross output
(Y)
The production function is a Cobb-Douglas production function
An equation that defines the inputs and output of producing goods and
services
Diminishing marginal returns of inputs (capital and labor)
Explanation
Note: lowercase variables express per-worker values
Cobb Douglas Production Function to illustrate CRS
Y(t)=K(t)^a(A(t)L(t))^1-a
A(t), productivity of labor
OR yY=F(yK,yL)
y is a positive variable to show growth, where y=1/L
1/L*Y=f(K/L, 1) or y=f(k)
Final, y=Ak^a
Y=Ak^a
k, capital per worker
A, productivity of labor growth
a, constant variable
In English: output per worker is determined by the amount of capital per
worker
More capital, more output
Note: exponents of the Cobb Douglas function a (alpha) and B (Beta or 1-a)
represent output sensitivity of capital and output sensitivity of labor
respectively
Solow equation
Growth () of the capital-labor ratio, k (capital deepening) depends on
savings, sf(k), allowing capital required to service depreciation (k), and
capital widening, amount of capital per worker to net new workers going the
labor farce, (nk)
Solow Equation: k= sf(k)-(+n)k
Steady State
Assume, A is constant
Therefore, state where output and capital per worker no longer change -->
steady state
Basically, adding more capital will not effect workers productivity, therefore
k=0
Steady State equation: k=0 --> sf(k*)= (+n)k*

where * represents the point at which steady state is achieved

Effect on per capita basis
increasing saving rates
decreasing pop. growth rate
decreasing depreciation rate

Note: on the graph k is linear since it is a constant variable

Result
When sf(k)>(+n)k, k>0;
Savings > depreciation --> increase in capital stock --> growth of economy
Also, Capital per worker increases --> savings > compensation
Compensation is the cost of depreciation, meaning the cost of
replacing equipment
Therefore, economy grows to k*, steady state
Inversely, sf(k)<(+n)k, k<0; decrease capital stocks --> decrease of economy
Aggregate Effects
Aggregate capital and output, each grow at a rate equal to the rate of growth
of population (n)
Additional
Changing Savings rate (s)

Decreasing sf(k) --> decreasing output (y) --> decreasing capital (k* to k**), lower
steady state equilibrium
Inverse for increasing savings, s'f(k)>sf(k)
NOTE: INCREASE IN s = INCREASE IN EQUILIBRIUM, NOT RATE OF
GROWTH
B/c w/ an increase in savings, economy adjusts and increases the capital
labor ratio, output ratio also increases
Limitations
Rate of savings can be influence by technological progress, A, but this is assumed
constant, not in reality
Harrod Domar vs Solow Model
Harrod Domar assumes linear production function, Solow assumes
diminishing returns
Solow, increase in s will increase equilibrium not growth in long run.
Harrod Domar uses increase in s, increases growth
Conclusion
The per capita variables grow at a rate zero while the aggregate variables grow at a
constant rate of growth of population.
NOTE: Steady state reflect per worker, in aggregate, constant rate of growth
is assumed
A change in the rate of savings or depreciation can change the rate of growth
temporarily till the economy reaches a new steady state, where the rate of growth of
the per capita variables are zero once more.
A change in the rate of growth can only be brought about by a change in the level of
technology, which is exogenously given in the model.
The economy described in the model is a closed economy, so that the growth
potentials from foreign aids and loans have not been looked into

Structural Change and the Lewis Model

Structural Change
Process through which the economic, industrial and institutional structure of an
underdeveloped economy is transformed to replace traditional agriculture.
Increased savings and investment are necessary but not sufficient conditions for
growth. Structural changes required including change in production, composition in
consumer demand, international trade, urbanization and growth and distribution of
population.
Urbanization is good, urban giantism is not good because there too much
surplus labor, unemployed, etc.
International constraints make transition of developing countries differ from the
industrialized countries to the extent that they have access to capital, technology etc.
Hollis Chenery cross country times series
identified shift from agricultural to industrial production,
accumulation of physical and human capital,
change in consumer demands from food to diverse manufactured goods,
growth of cities, rural-urban migration etc. as features of development.
Background/Assumptions
The economy has two sectors- agricultural and manufacturing
The agricultural sector
Represents, over populated rural substance sector
Surplus labor --> MPL=0 (MPL= Marginal product of labor)
Land is finite, at a point the surplus labor is too much and can not be
efficiently utilized hence the MPL=0
Labor in the agricultural sector share the output equally such that wages are
determined by the average product
Wages = Average Product, W=MPL
The manufacturing sector
High productivity, modern, urban industrial sector
Output expansion= labor transfer and modern sector employment growth
Output expansion is determined by; capital accumulation, rate of industrial
investment
Investment due to excess profits, assumption reinvest profits
Assumed, wages are constant, given premium over a fixed average
subsistence level of wages (minimum wage)
All wages are consumed and all profit are saved in the manufacturing sector
The supply curve of labor is assumed to be infinitely elastic at the wage rate
Wm in the manufacturing sector
Explanation/Diagrams
The Traditional Agricultural Sector

First diagram, typical agricultural production function, shows total output (TPa)
determined by amount of labor (La), given fixed capital and technology
Subsistence, no savings all revenue to wages, therefore,
TP(a)/L(a)=W(a)=AP(LA)
Shows, MPL=0 since past point L(A), TP(A) remains constant, adding labor
does not effect output (excess surplus)
Second diagram, average and marginal product of labor curves
Derived from the total production curve from the 1st diagram
Thus, Quantity of agricultural labor (QLa) is the same in both diagrams
Important assumptions:
Wage=average product (not marginal product)
Shown in digram, where L(A) and AP(LA) intersect giving W(A)
MPL=0
Shown in diagram, at point L(A) since MP(L) (on the y-axis) is at
0

Modern Industrial Sector

TP(M) assumes constant capital stock, and technology, with a variable input of Labor
1st Diagram
In the modern sector, capital stocks can increase due to reinvestment of
profits by insturial capitalists
Therefore, TPm(KM1) --> TPm(KM2) --> TPm(KM3) = outward growth of the
production function
Labor also increases with increase in total production, more labor to produce
more output, hence
L1 --> L2 --> L3
Second diagram
Increase in capital stocks, is illustrated by the second diagram
Assumption: perfectly competitive, therefore MPL = Demand for Labor (D)
Proof: both curves are downward sloping

MPL=D=K(M)
K(M) is capital stock, which is assumed to be constant, hence
demand shapes MPL
W(A) is the wage from agricultural sector, or also, average rural income
assumed to be unlimited or perfectly elastic
Therefore, horizontal labor supply --> S(L)=W(M)
W(M), wage in modern sector
W(M) > W (A)
Because, at WM > WA, modern sector employers can hire as much
rural workers w/o increasing wage
Important: this diagram represents modern as well as agricultural
sectors
Modern sector gets labor from rural sector, since wages are
lower in agricultural sector
Industry is profit maximizing, produce more output --> employ more labor
Hire more labor until point F, marginal physical product is equal to real
wage
Demand curve intersects with supply curve, D1(KM1)=S(L) at W(M)
Therefore, the amount of labor employed will be at L1
The amount paid to workers in the form of wages is, 0*W(M)*F*L1
The remaining gap on the D1 curve, W(M)*F*D1, that is profit from
production
These savings are reinvested into production and allows for
capital stocks to increase
Therefore, move to TP(M2), D2, G, L2, but keeping S(L)
constant
The process of reinvesting savings into production is called "Self sustaining
growth"
Lewis Model Turning Point
Reinvestment and expansion occurs until all surplus labor is absorbed
Thereafter, additional labor withdraw from agricultural sector only at a
higher cost of lost food production
B/c declining labor-to-land ratio --> MPL(rural) is not equal to
zero
Criticisms
Surplus labor in rural areas and full employment in urban may not be an assumption
conforming to the real world
Competitive modern sector labor markets guarantees existence of constant real
urban wages until supply of rural labor is exhausted
Not true in reality
Companies can look to foreign labor markets for cheaper, abundant labor -->
Outsourcing
Rate of labor transfer and employment creation may not be proportional to the rate of
modern sector capital accumulation.
Reinvestment of profits in other sectors, example: laborsaving capital
equipment
Labor-saving capital accumulation: Employment implications

Demand curve, D2(KM2) is more negatively sloped that D1(KM1), shows addition to capital
stock embody laborsaving technical progress
Shows that investing in labor-saving methods will lead to decreased demand for
labor
Output increases: from 0*D1*E*L1 to 0*D2*E*L1
Total wages and labor remains the same
Represents: anti-developmental economic growth
all the extra income and output growth distributed to owners of capital, while income,
employment levels for the masses remain unchanged
This is common in the developing world, through poor management, uncompetitive
businesses, corruption
Model of Endogenous Growth Theory and The Romer Model
Motivation for Endogenous Growth Theory
According to the traditional theory,
There is no intrinsic characteristics of an economy that causes it to grow in
the long run.
In absence of shocks or technological change all economies converge to zero
growth.

Thus, rising per capita GNI was always considered a temporary phenomenon
resulting from;
Technological change
Or, a short term equilibrating process in which an economy
approaches its long run equilibrium
OR, due to the Solow Residual
Solow Residual
Definition of Solow Residual: the proportion of long term economic
growth not explained by growth in labor or capital and therefore
assigned primarily to exogenous technological change
Responsible for roughly 50% of historical growth in industrialized
nations
Criticisms/Limitations
Doesn't explain difference in residuals in countries w/ same
technology
Impossible to analyze the determinants of technology change -> independent of economic agents decisions
New Growth Theory
Also known as, endogenous growth theory
Definition of New Growth Theory: economic growth generated by factors
within the production process (e.g. increasing returns or induced technological
change) that are studied as part of growth model
Main Objective of this model
Explain existence of increasing returns to scale
Explain divergent long term growth patterns among countries
Analyzes endogenous growth (persistent GNI growth) determined by the
system governing the production process rather than by forces outside that
system.
Used to show; differing growth rates, greater proportion of the growth
observed
Explains the Solow Residual by explaining factors that determine the size of
, the rate of GDP growth
New Growth Theory vs. Neoclassical paradigms
Discards neoclassical assumption of diminishing marginal returns to capital
investments
Assumes increasing returns to scale to capital investments
Focus on the role of externalities in determining the rate of turn on capital
investment
Assumes increasing returns to scale to aggregate production, rather than
constant return to scale
New Growth models:
Focuses on externalities to determine rate of returns on capital
investments
Includes that savings and human capital investment is important for
growth
Does not assume diminish marginal returns to capital investments
Allows for increasing returns to scale in aggregate production
Explains anomalous international flows of capital that exacerbate
wealth disparities

Neoclassical theory use the Harrod Domar model as the core of their
argument, Y=AK
A= factor affecting technology, K= human/physical capital (includes
labor)
No representation of diminishing returns to capital
Doesn't explain the solow model production function, f(k),
diminish slope
Main conflicts
No force leading to equilibration of growth rates across closed
economies
National growth rates differ or constant across different
countries
No tendency for per capita income levels in capital poor countries to
converge with that of capital rich countries with similar savings and
pop. growth rates.
Romer Endogenous Growth Model
Illustrates New Growth Theory
Models technological spillovers (positive externality)
One firms or industries productivity gains lead to productivity gains in other
firms or industries
Assumption
Growth derived from the firm level, not aggregate
Industry produces w/ Constant Returns to Scale
Economy-wide capital stock, K bar, positively affects output at the industry
level --> increasing returns to scale
Each firms capital stock includes knowledge (public goods (economy wide
capital stock)--> technology spillover--> represented by A)
Learning by doing ---> is now: learning by investing
Romer Model Equation

For the firm;

Difference from Solow Model is the inclusion of K(bar) to Beta,
includes economy wide capital stock which positively affects output
For the industry;
Assumed to have same capital and labor
Showing endogenous growth;
Assume:
that "A" is constant, no technological progress
per capita growth = 0
No spillover

g is output growth rate, n is population growth rate,

However, Romer assumption of positive capital externality B>0, we
have that;
g-n>0 and that Y/L is growing
Therefore, proving endogenous growth
Criticisms of Endogenous Growth Theory
Remains dependent on a number of neoclassical assumptions. For example, there is
a single sector of production or that all sectors are symmetrical. This does not permit
the crucial growth generating reallocation of labor and capital among the sectors that
are transformed during the process of structural change
Endogenous growth theory overlooks complementary investments: growth impeding
inefficiencies arising from poor infrastructure, inadequate institutional structures and
imperfect capital and goods markets.
Fails to explain low rates of factory capacity utilization in low income countries where
capita is scarce
Neoclassical Dependence Model
The International Dependence Revolution
During 1970s, this gained increasing popularity resulting from discouraging
outcomes from the stages and structural models.
Definition: These models view developing countries as beset by domestic and
international institutional, political and economic rigidities, and caught up in a
dependence and dominance relationship with rich countries.
Three schools of thought
Neocolonial dependence model
False-paradigm model
Dualistic-development thesis
The Neocolonial Dependence Model
Indirect result of Marxist thinning
Attributes the existence of underdevelopment primarily to the historical evolution of
an unequal international capitalist system of a rich country and poor country
relationship.
Rich countries generally in northern hemisphere
The coexistence of rich and poor countries means that the rich nation
dominate the poor nations through economics such that the poor can not be
subsistent
This theory emerged out of the colonization movement
The coexistence of rich and poor nations in an international system is dominated by
an unequal relationship between the center and the periphery. Thus, attempts by
poor nations to be self-reliant and independent is difficult.
Core and periphery relationship is assumed here

Core needs periphery to sell surplus production and for a source of labor
(brain drain)
This practice creates a duality such that the status of rich and poor nations
does not change and continues to clash
Directly or indirectly, the small but powerful elite ruling class serve and are rewarded
by international interest power groups like MNCs, national bilateral and multilateral
agencies.
Bilateral and multilateral agencies are the World Bank and IMF
Rich countries influence are exercised by domestic actors known as the elite
or comprador groups
The False-Paradigm Model
Attributes underdevelopment to faulty and inappropriate advice provided by wellmeaning but uninformed, biased and ethnocentric international advisers from
developed-country assistance agencies and multilateral donor organizations
There are advisors and experts that make policy recommendations in good faith
however, this recommendations do not match the economic structure of your
economy
Fails to account for domestic conditions in developing countries;
Social structure, income disparities, etc.
The Dualistic-Development Thesis
Dualism: the existence and persistence of substantial and even increasing
divergences between rich and poor nations and people
In international dependence, dualist societies exist, the rich countries and
poor countries
Four Main Arguments:
1. Different sets of conditions, of which some are superior and others inferior can
coexist in a given space.
An example includes the Lewis model notion of the coexistence of the modern
and traditional methods of production in urban and rural sectors.
2. This coexistence is chronic; not transitional and not due to temporary
phenomenon
Simply: International coexistence of wealth and poverty is not simply a
historical phenomenon that can be resolved given time
3. Not only do the degrees of superiority or inferiority fail to show signs of diminishing
but they have an inherent tendency to increase
For the rich, the borrowing ability is higher because they have enough
collateral to access capital
For the poor, the borrowing ability is low due to low collateral hence they can
not produce enough to escape poverty
Therefore, the rich to poor gap simply keeps on getting bigger
4. Superior and inferior interrelations are such that the existence of superior
elements does little or nothing to pull up the inferior element, let alone trickle done to
it.
In fact, it may actually serve to push it down- to develop its underdevelopment
Constantly stuck in the poverty cycle
Implications
All three schools of though reject the exclusive emphasis on traditional neoclassical
economic theories
Emphasis on international power imbalances and need for both domestic and
international on economic, political and institutional reform
Criticisms/Limitations

Although they offer an explanations about why many poor countries remain
underdeveloped, they provide no insight into how countries initiate and sustain
development.
The actual economic experience of developing countries that have pursued
revolutionary campaigns of industrial nationalization and state-run production has
been mostly negative.
Basically, all revolutions have been "crushed" and has not been sustained
If taking these paradigms into reality, the only manner in which the imbalances can
be correct is through;
Policies of autarky: Closed economy, self reliant
However, stagnation can occurs.
Example; China in 1970s
Inwardly direct development
To rural areas rather than urban areas
Access marginalized/remote areas
Difficult to achieve, developing countries characterized by poor
infrastructure to access these areas
Trade with only developing countries
Contradicts assumption of free market, open trade

Chapter 4: Contemporary Models of Development and

Underdevelopment
Purpose
To understand that development is harder to achieve because it faces more number of
barriers than had been previously recognized
To conclude with a framework for appraising the locally binding constraints on the ability of
a developing nation to further close the gap with the developed world
Coordination Failure
Coordination Failure: a situation in which the inability of agents to coordinate their
behavior leads to an equilibrium that leaves all the agents worse off compared to an
alternative equilibrium
Complementarities exist in these situation
Complementaries: an action taken by one firm, worker, or organization
increases the incentives for other agents to take similar actions
Often refers to investments, return on investment depends on other investments
being made by other agents
Models derived from Coordination Failure and complementarities:
Big Push --> decisions taken by firms are mutually reinforcing
O-ring model --> value of upgrading skills depends on similar upgrading by other
agents
The middle income trap
This might occur despite perfect information about the alternative equilibrium
Preferred alternative not reached due to;
Difficulties in coordination,

Different people holding different expectations, and

Because everyone waits for someone to make the first move
Example of Complementarity: Firms using specialized skills and availability of workers who
have those skills
Firms won't enter a market that does not have firms w/ these skills
Therefore, worker will not acquire the skills if firms don't demand to employ them
Coordination problem--> economy stuck @ bad equilibrium
Low average income or growth rate
Or class of citizens in poverty trap
Firms and workers are better off w/ skills, but no agent provides
EXECPT: for government intervention through education
Example of Complementarity: Rural developing areas & commercialization of agriculture
The Underdevelopment Trap is an example of Complementarity
Definition of the Underdevelopment Trap: A poverty trap at the regional or
national level in which underdevelopment tends to perpetuate itself over time
Rural areas, specialize in agriculture, division of labor as well
Specialization MUST BE complemented with trade
Rural areas, producers can't go to market and trade, need for a middlemen
Middlemen, determines quality --> subjective process, hard to determine quality
Need for a sufficient concentrated number of middlemen
Often times not the case, rural producers are unaware of process, prone to
extortion
W/o effective middlemen, little incentive to specialize and produce surplus, reamin in
subsistence
Multiple Equilibria
Definition of Multiple Equilibria: A condition in which more than one equilibrium exits. These
equilibria may sometimes be ranked, in the sense that one is preferred to another, but the
unaided market will not move the economy to the preferred outcome
Multiple Equilibria Diagram

IMPORTANT NOTE: Axises compare expected investment levels by other agents vs.
individual investments levels
S-Shape curve = Privately rational decision function
Represents the expectations of decision makers --> Producers, investors, etc.
Shape is due to the benefits an agent receives is dependent positively on how many
other agents are expected to take the action or on the extent of this actions
First increases at an increasing rate, then at a decreasing rate
Initially, few agents take action, assumed isolation. Spillover is minimal -->
slow increase
After enough investment, spillover benefit begin, curve rises faster
Most investors have been positively affected and the important gains realized
--> rate of increase slows
Example: Underdevelopment trap, rural producers produce depending on the
number of active middlemen which determine the number of other farmers who
specialize in the same product
Equilibrium, is when the privately rational decision function (S curve) crosses the 45 degree
line (blue line)
The process of adjustment along the S curve continues until the level of actual
investment is equal to the level of expected investment
Basically when the x and y-axis are equal, when S-curve intersects blue line
Reasoning: Assume firm expects no investment but some firms invest, firm
then revise their expectations to be higher (expect investment) such that they
match the expectations of the few firms that did invest.

However, when investment is matched, other agents expect even more

investment, causing revision of individual expectations, hence a new
equilibrium is created.
This process continues, creating multiple equilibrium
There is no reason for firms to adjust their expectations any further at this point
Equilibrium occurs at three points--> D1, D2, D3
D1 and D3 are Stable Equilibria
S Curve cuts the blue line from above --> hallmark of stable eq.
If at these points, slight change to more or less than eq. levels, firms will
revise investment levels to go back to original eq. levels
D2 is an unstable equilibria
If expectations are lowered, then the equilibrium will shift to D1 rather than
having revision of investments downward
If expectations are increased, then the equilibrium will shift to D3 rather than
having revision of investments upward
D2 is an equilibrium only by chance, serves as a division between higher or
lower stable equilibrium
The Big Push
Background
Most famous model of coordination failures
Paul Rosentein-Rodan
Industrialization is difficult to achieve, stagnation often plagues development from a
subsistence economy to a modern economy (i.e. Argentina)
Big Push --> presence of market failures can lead to a need for a economywide and public policy led effort to get the long prices of economic
development underway or accelerated.
Workers spend income on variety of goods, not only to produce (shift away from
subsistence during industrialization)
Profitability of one firm depends on whether one opens, etc. (creating a market)
Coordination failure, dependent on other agents actions
Workers need to be trained. However, if other firms can employ these skilled workers
at a sightly higher wage given that they train them, no firm anticipating this will pay
for the training
Coordination failure
Key assumption: economy does not export
Assumptions
Labor is the only factor of production. Supply is fixed
Labor Market
Traditional sector, wages are fixed and are represented by the numeraire "1"
W(T)=1
If wage is 35 pesos, we say that wage is 1 for mathematical reasons
Modern sector, wages are greater than one, W(M)>1
Technology: there are N types of products
Traditional sector, 1 worker = 1 unit of output --> Constant Returns to Scale
Modern Sector,
Minimum of F workers must be employed to produce (fixed cost)
Modern sector production > traditional sector
L=F+cQ, where c<1 is the marginal labor required for an extra unit of
output

Domestic demand
No savings
All income spent on goods constantly and equally hence, Y/N is spent on
each good
International supply and demand
Economy is closed, no exports
Market structure
Traditional sector is;
competitive,
free entry,
no economic profit,
price set at 1
At most, one modern sector firm can enter the sector
Comes from Increasing returns to scale
Charges price of 1, b/c of potential competition from traditional
sector
Monopolist unit elastic demand
Diagram

Explanation
Suppose traditional economy w/o modern production in any market
Potential producers w/ modern tech. considers
1) efficiency of both sectors
2) wages in both sector

Price is 1 so P*Q=Q
Traditional sectors production function
Linear, slope of 1 --> constant returns to scale, one worker for one unit of
output
Wages are equal to production (no savings), hence traditional wages are the
same as the production function
Modern sector production function
Must acquire F amount of Labor to produce, so starts from F
Afterwards, linear technique w/ slope 1/c>1 --> signals more efficient
production
Wages must be higher than traditional, hence W>1
Point A
Modern firm will produce if it enters the traditional sector, given tradition firms
operating.
Entry is dependent on profitability
If W1 is the wage bill line,
W1 is below Point A, hence the production is greater than the costs (wages) -> profit is made
Enter the market, pay F amount of labor
Remember: all goods are equal, producing one goods can also mean other
goods, aggregate effect on all goods hence the economy through this
assumption
From Point A, the modern firm enters the market, produces all goods,
demand increases enough to move upward to Point B
This shows that coordination failure does not have to happen
If W2 is the wage bill line
This line passes between Point A and B hence causing a multiple equilibria
condition
Equilibrium 1
Greater than Point A, costs are greater than production --> incur losses
--> Don't enter the market
Equilibrium 2
If modern firms enter all market, wages increase to modern wage in all
markets --> REQUIRES COORDINATION AMONG AGENTS
Increase to Point B will greater demand through entry, realize profits
Price remains at 1
This will not occur b/c of coordination failure
If W3 is the wage bill one
Even if modern firms enter all markets, loses will still be incurred, traditional
firms remain
When wage bill line passes below Point A, industrialization occurs if above, no
industrialization
Criticism/Limitations
Doesn't assume technological externalities
Application of the Big Push in;
Intertemporal effects
Urbanization effects
Modern techniques prevent traditional techniques to consumed by urban
dwellers, need for a big push for urbanization to achieve industrialization and
develop traditional techniques

Infrastructure effects
when one product sector industrializes --> increase size of market -->
Increase use of infrastructure services that would be used by others --> more
profitable
No need for new firms to make a new railroad if its already built by already
present firms in the market
Training effects
Underinvestment in training facilities by firms b/c workers may be enticed by
higher wages offered by rival firms w/o training costs
Little demand by workers for training, they don't know what they need
O-Ring Model
Definition: the value of upgrading skills or quality depends on similar upgrading by other
agents
Explains existence of poverty traps
Key Feature --> models production w/ strong complementarities among inputs
Models production with strong complementaries among inputs
Modern production requires that many activities be done well together in order for
any of them to amount to high value
Concept of "q"
Production process as n tasks.
q --> level of skill required for production
0 q 1, the more q, the more level of skill --> the probability task will be
successfully completed
Flexible use of q, other interpretations include quality index for characteristics
Assume, probability of mistakes by different workers is strictly independent--> no
control of these factors.
O-Ring Production Function
BF(qiqj) = qiqj; B = 1
Multiplying the q values of each of the n tasks together,
Assumption here is that there are only two tasks hence only qi and qj.
This production function is multiplied by B, depends on the characteristics of the firm
Assumption
Firms are risk neutral
Labo markets are competitive
Labor supply is inelastic
Economy is closed
Positive assortative matching
Workers with high skills will work together and workers with low skills will work
together
Creating two categories of workers:
High skilled --> qH
Low skilled --> qL
Assume four-person economy, two high skilled worker and two low skill workers
Four workers can be arranged either as matched skill pairs or unmated skill pairs
Total output is higher under matching scheme b/c
qH2 + qL2 > 2 qHqL
Result: workers sort out by skill level

Cascade effect: Some firms and workers, even an entire low-icome economy can fall into a
trop of low skill and low productivity while others escape into higher productivity
Higher productivity workers will tend to group together, they are hired yb firms b/c it
is profitable to do
Leaving group of less productive workers stuck, other less competitive firms hire
them
Same applies with multiple skill levels, highest productivity workers--> second
highest--> third, fourth,etc --> low productivity workers
The cascade effect shows that the O-Ring Model is consistent with competitive
equilibrium
Positive assortative matching, dependent on two assumption;
Workers must be sufficiently imperfect substitutes, two different skilled worker
categories
Sufficient complementarity of tasks --> n tasks must be the same for both high and
low workers
Implications of the O-Ring Theory
Firms tend to employ worker with similar skills for their various tasks
Workers performing the same task earn higher wages in a high-skill firm than a lowskill firm
Low skill workers are incentivized to improve their skill level through investments due
to the presence of higher average skills. Remember: Competitive labor market
Economy-wide low-proudction-quality traps, due to externality at work, causes
policies to encourage quality upgrading
O-ring effects can magnify the impact of local production bottlenecks b/c such
bottlenecks have a multiplicative impact on other production
Bottlenecks also reduce the incentive for workers to invest in skills by lowering the
expected return to these skills

Chapter 5: Poverty, Inequality and Development

Questions on the relationship among economic growth, income distribution and poverty
What is the extent of relative inequality in developing countries?
How is this related to the extent of absolute poverty?
Who are the poor and what are their economic characteristics?
Do the poor benefit from growth, and does this depend on the type of growth a developing
country experiences?
What is so bad about high levels of inequality?
What kind of policies are required to reduce the magnitude and extent of absolute poverty?
Measuring Inequality
Income inequality (Definition): the disproportionate distribution of total national income
among households/individuals
Two principal measures of income distribution
Personal/size distribution of income
Functional/distributive factor share distribution of income
Personal/size distribution of income
Definition: the distribution of income according to size class of persons without

regard to the sources of that income

The measure most commonly used by economists
Deals with individual persons or households and the total incomes they receive.
Ignores sources of income (urban or rural, agriculture or manufacturing, invest or gift,
etc.)
Order individuals by ascending personal income and then divide the total population
into distinct groups and size.
Division of total population can be by either deciles (tenths) or quintiles (fifth)
Measuring personal income equality; Kuznets ratio and Lorenz Curve
Kuznet's ratio
Divide population into deciles or quintiles, use this division to get absolute
percentages of income share of sections of the population
Ratio of incomes received by the top 20% and the bottom 40%
Basically: Top 20% / Bottom 40%
The bigger the number, the larger the income inequality between low and high
income groups
Lorenz Curve
Definition: Plots cumulative income against percentage of population

Constructive Lorenz Curve

Figure out Income % of each decibel or quartile
Figure out Cumulative Income % of each decibel or quartile
Plot on graph
Cumulative percentages, not in absolute percentages

Example, at 20 mark, represents Bottom 20%, 60 mark, represents

Bottom 60%, so on and so forth
At 100 mark, represents all the income in the economy
Line of Perfect Equality
Represents the ideal goal of proportional income distribution
Percentage of income recipients = Percentage of income
Lorenz curve, shows actual quantitative relationship between % of income
recipients and % of income
The greater the Lorenz Curve is from the Line of Perfect Equality --> greater
the degree of income inequality
The smaller the Lorenz Curve is from the Line of Perfect Equality--> smaller
the degree of income inequality
Gini Coefficient

Definition: An aggregate numerical measure of income inequality raining from

0 (perfect equality) to 1 (perfect inequality), measured graphically by dividing
the area between perfect equality and the Lorenz curve by the total area lying
to the right of equality line in a Lorenz diagram
Large Gini coefficient --> more income inequality
Typically, 0.5 to 0.7
Small Gini coefficient --> less income inequality
Typically, 0.2 to 0.35
Lorenz Criterion

Whenever one Lorenz curve lies above anoth Lorenz curve, the economy of
the above Lorenz curve is said to be more equal
If two different Lorenz curves intersect at any point, require more information
or additional assumptions to make the distinction between which economy is
more equal
Dualistic Development and Shifting Lorenz Curves: Some Stylized Typologies
Three cases that limit dualistic development (modern/traditional sectors)
Modern sector enlargement growth typology; Two sector economy develops
by increasing the modern sector while wages remain the same in both
sectors. Same concept in the Lewis Model
Results: absolute income rises, absolute poverty is reduced, Lorenz
curves cross each other, indicating change in the proportionality of
equality distribution so that inequality is worser at first and improves
above the original Lorenz curve over time
Modern-sector enrichment growth typology; economic growth is limited to a
fixed number of people in the modern sector, with both the numbers of
workers and their wages held constant in the traditional sector
Results: higher incomes, less equal relative distribution of income, and
no change in poverty, Lorenz curve shift downward
Traditional-sector enrichment growth typology: benefits of growth are divided
among traditional-sector workers, with little or no growth occurring in the
modern sector.
Policies at achieving substantial reduction in absolute poverty (Sri
Lanka)
Results: higher incomes, more equal relative distribution, less poverty,
Lorenz curve shifts upwards
Criticism of the Lorenz Curve
Income measurements to determine poverty is politely, income is dependent
on currency which is determined in turn by exchange rate and thus is a

volatile measurement over a given period of time

Other measurements that are more stable in measurement include
consumption patterns and wealth in terms of real estate
However, income is an easier determinant of poverty to calculate
Functional Distribution of income (Factor share distribution of income)
Definition: to explain the share of total national income that each of the factors of
production receives
Diagram

Supply and demand curves determine the unit price of each productive factor
Unit price multiplied by the quantities employed on the assumption of efficient
(minimum costs) factor utilization --> total payment to each factor
In the diagram --> Labor Market
Assume two factors, capital (is fixed) and labor (variable)
In the labor market, wage rate = Price
Price determined by demand and supply of labor
Note: total output= payment to labor+profits
Total output= 0*R*E*L
Payment to labor (Wages) = 0*W*E*L
Profits=W*R*E
This is for labor market, can be replicated for other payments to FoP's
(rent, interest, and profits)
Criticisms
Doesn't factor non-market forces like bargaining through unions
Measuring Absolute Poverty
Definition of Absolute Poverty: The situation of being unable or only barely able to meet the
subsistence essentials of food, clothing and shelter
Absolute poverty is measured by the headcount (H) of those whose incomes fall below the
absolute poverty line (Yp)
Absolute poverty line --> $1.25 a day or $2 per day in PPP dollars

Determinants of Absolute poverty

Low per capita income
High unequal distribution of income
Headcount index/Headcount ration (HCR)
Definition: when the headcount is taken as a fraction of the total population (N)
Headcount = per capita
Index: H/N
Total Poverty Gap
Definition: measures the total amount of income necessary to raise every who is
below the poverty line up to that line
Calculated by adding up the amount by which each poor persons income, Yi, falls
below the absolute poverty line, Yp ,
H
Formula for Total Poverty Gap: TPG = i=1 (Yp Yi)
Simply: the amount of money per day it would take to bring every poor person in an
economy to minimum income standards
Total Poverty Gap Diagram

Poverty Gap Ratio

PGR= (Income of poor - (sum of the income of poor people/number of poor
people) / Income of poor
Average Poverty Gap
APG= TPG/N
Per capita basis
Normalized Poverty Gap
To measure the size of the poverty gap of the poverty line
NPG= APG/Yp
Measure lies between 0 and 1
Average Income Shortfall
Measures the average amount by which the income of a poor person falls
below the poverty line

AIS= TPG/H
Normalized Income Shortfall
NIS= AIS/Yp
The Foster-Greer-Thorbecke Index
Definition: a class of measures of the level of absolute poverty
Satisfies four characteristics
Anonymity & Population Independence
Our measure of the extent of poverty should not depend on who is
poor or on whether the country has a large r small population
Monotonicity
If you add income to someone below the poverty line, all other
incomes held constant, then the poverty line can't increase
Distributional Sensitivity
Other things held constant, income is transferred from poor to rich
persons, the economy is deemed strictly poorer
Headcount ratio measures anonymity, population independence and
monotonicity but not distribution sensitivity
Foster-Greer-Thorbecke Index measures Distribution Sensitivity
Formula
P = (1/N)Hi=1 [(Yp Yi) / Yp]
P --> class of poverty measures
Yi --> Income of the ith poor person
Yp-> the poverty line
N --> population
H--> headcount
Conditions
If =0 , P=P0= H/N (Headcount ratio)
If =1,
P=P1=APG/Yp=NPG
P=P1= HCR * PGR
If =2, P=P2=(H/N)[NIS^2 + (1-NIS)^2*(CVp)^2]
Used commonly in the World Bank and other agencies
Sensitivity to the depth and severity of poverty
Poverty, Inequality, and Social Welfare
Assumption, that social welfare depends on level of per capita but negatively on poverty
and inequality
Inequality among the poor is a critical factor in determine the severity of poverty. But why
should inequality among those above the poverty line, be of concern!
Extreme income inequality leads to economic inefficiency
Poor can not get loans to produce
Rich get loans but don't save and invest significantly larger proportions of
their income than other classes
Inefficient allocation of assets, high inequality --> focus on higher education
rather than universal primary education
Extreme income disparities undermine social stability and solidarity and strengthens
the political power of the rich and hence their economic bargaining power.
With high inequality, politics focuses on redistribution of existing economic pie
rather than expanding it

Extremem inequality is generally viewed as unfair

Veil of ignorance: the uncertainty of of the overall level of inequality on is born
in to
Different income levels gives workers the incentive to work, different income
thus entails that income inequality is present, hence a degree of inequality is
needed
Welfare Equation
W=W(Y,I,P)
Where W is welfare, Y is income per capita, I is inequality and P is absolute poverty
Note: inequality and absolute poverty reduce welfare, therefore they are negative
values
Meaning, welfare is a function of income per capita, inequality, and absolute poverty
Kuznet's Inverted-U Hypothesis
Definition: suggests that in early stages of economic growth, the distribution of income will
tend to worsen; only at later stages it will improve
Characterized by an "inverted U'' Kuznets curve
Diagram

Explanation
Reflects structural change ideas that inequality may worsen during early stages of
economic growth, Lewis Model where in early growth, modern sector is concentrated
on w/ limited employment and wages/productivity are high
Assuming modern sector enlargement growth, alternatively returns to education may
first rise as the emerging modern sector demands skills and then fall as the supply of
educated workers increases and the supply of unskilled worker falls
Poverty and Growth
Are poverty and growth complementary?
Traditional argument- Rapid growth is bad for the poor because they will be bypassed and
marginalized by the structural changes of modern growth
Five reasons; that promote rapid economic growth and reducing poverty are not mutually

conflicting objectives
1. Widespread poverty creates conditions in which the poor can not access credit
1. Can not finance child education, no improvement in skills or opportunity to enter
modern sector
2. W/o access to credit, poor can't act for themselves and exist poverty, slows potential
productivity
2. The rich in many poor countries are generally noted to not dave and invest substantial
proportions of their incomes in the local economy
1. Capital Flight--> Lack of reinvestment causes less growth in the economy
3. The poor are characterized by not only low income but also, poor health, nutrition and
education, which can lead to lower economic productivity and thereby directly/indirectly to a
slower-growing economy
1. Improving income also means improving living conditions which can increase
productivity
4. Raising the income levels of the poor will stimulate an overall increase in the demand for
locally produced necessity products f
1. Example; Food and clothing
2. Rich tend to spend income on luxury goods
3. Higher demand, raises local production/employment/investment --> rapid economic
growth
5. A reduction in mass poverty stimulates healthy economic expansion as a psychological
incentive to widespread public participation in the development process
1. Increased productivity boost from the psychological incentive
These goes of achieving both poverty reduction and economic growth are from policies that
encourage modern-sector enlargement
Economic Characteristics of High-Poverty Groups
Background
Magnitude of poverty results from a combination of low per capita incomes and
highly unequal distribution of the income
For any given distribution of income, the higher the level of per capita income, the
lower the numbers of the absolutely poor.
Higher levels of per capita income are no guarantee of lower levels of poverty
An understanding of the nature of the size distribution of income is therefore central
to any analysis of poverty problem in low income countries
Rural Poverty
Poor disproportionately in rural areas
Engaged in agriculture (about 2/3 of the very poor)
Most likely to be women/children than men working in agriculture
Concentrated along minority ethnic groups and indigenous peoples
Other engage in petty services (about 1/3 of the very poor)
In marginal/fringes of urban populations
Majority of government expenditures are directed towards urban areas towards
manufacturing and commercial sectors (urban modern sector bias).
Women and Poverty
Majority of the world poor are women
Women and children experience the harshest depreciation of the poor
Influencing factors: Prevalence of female headed household, the lower earning

capacity of women, and their limited control over their spouses income
Less access to education, formal sector employment, social security and
government employment programs
Wage differentials exist between men and women performing similar jobs. In many
cases women are banned from high paid jobs
Ethnic Minorities, Indigenous Populations and Poverty
In general the incidence of poverty in developing world falls heavily on minority
ethnic groups and indigenous populations
If higher income can be achieved poverty can be reduced since greater resources
are available to tackle problems
40% of states have more than five sizable minority groups
Face economic, social, political and cultural marginalization
Indigenous people's poverty, >300 million in >5,000 different groups in >70 countries
Majority of indigenous groups live in extreme poverty
Being indigenous increases the chances that individual is malnourished, illiterate, in
poor health, and unemployed
Policy Options on Income Inequality and Poverty
Four major elements in the determination of a developing economy's distribution of income;
1. Altering the functional distribution
1. Functional distribution= returns to labor, land and capital= wages, rent, interest
2. Mitigating the size distribution
1. Size distribution by knowledge of how ownership and control over productive assets
and labor skills are concentrated and distributed through the population
3. Moderating (reducing) the size distribution at the upper levels
1. Through progressive taxation of personal income and wealth
4. Moderating (increasing) the size distribution at the lower levels
1. Through public expenditures of tax revenues to raise the incomes of the poor
Policy recommendations, instead of one or two isolated policies but for a "package" of
complementary and supportive policies, four basic elements to include
1. A policy or set of policies designed to correct factor price distortions (underpricing capital or
overpricing modes sector skilled wages)
1. To ensure that market or institutionally established prices provide accurate signals
and incentives to both producers ad resource suppliers
2. Result: greater productive efficiency, more employment, and less poverty
2. A policy or set of policies designed to bring about far-reaching structural changes in the
distribution of assets, power, and access to education and associated income-earning
(employment) opportunities
1. Result: wil increase the chances of improving significantly the living conditions of the
masses of rural and urban poor
3. A policy or set of policies designed to modify the size distribution of income at the upper
levels
1. Through the enforcement of legislated progressive taxation on income and wealth
and at the lower level through direct transfer payments and the expanded provision
of publicly provided consumption goods and services (government spending)
4. A policy or set of policies designed to directly improve the well-being of the poor and their
communities

1. Beyond safety net schemes

2. Offer programs that build capabilities and human & social capital of the poor
3. Example: microfinance, health, education, agricultural development, environmental
sustainability

Chapter 6: Population Growth and Economic

Development
Purpose
A look at the historical and recent population trends and the changing geographic
distribution of the world population
Present some well-knwon economic models and hypotheses regarding the causes
and consequences of rapid population growth in LDCs
Controversies surrounding the significance of the population factor in general and
these models are explored
A range of alternative policy options that developing countries may wish to adopt
explore to influence the size and growth of their population is evaluated
Facts, Past, Present and Future
Doubling time - period of time that population or a unit of quantity requires to
increase by its present size
Human mortality lowest in human history
Due to technological advancement in medicine, and modern sanitation
Result: population growth increase worldwide
Structure of the World's Population
Geographic Region
More than 3/4 of world pop. in developing nations
Developing nation have highest populations (China 1st and India 2nd)
Fertility and Mortality Trends
Rate of population growth = natural increase - net international
migration
Natural increase = births rates - death rates = fertility - mortality
Developing nations birth rate: 15-40/1000
Developed nations birth rate: less than 15/1000
Total fertility rate (TFR) - number of children a woman would bare if living to
end of childbearing years (15-49 years) assuming age-specific fertility rates
Technological advancement ---> Modern medicine = drastic reduction in
death rates
Life expectancy at birth - number of years a newborn child is expected to
like given mortality risks at the time of birth
Under-5 mortality rate - deaths among children between birth and 5 years of
age per 1,000 live births
Age Structure and Dependency Burdens
Youth dependency ratio - the proportion of youth (>15) to working
population (16-64) in a given nation
Very high ratio in developing nation, more than 40% in some nations
Rapid pop. growth = greater youth dependency ratio, more difficult to
support
Hidden Momentum of population growth: population increases after birth
rates fall b/c large existing your pop. expands the pop. base of potential

parents
Due to high birth rates cannot be altered substantially overnight
Relates to age structure (population pyramids) - developing nations
tend to have bottleneck population pyramid --> reflect this
phenomenon
When youth reach adulthood, number of potential parents increase
equally
The Demographic Transition
Definition of Demographic Transition: The process by which fertility rate
eventually decline to replacement levels is illustrated by the concept of demographic
transition
Stages of Modern Population History - Developed Countries
Stage 1
Prior to modernization, stable or very slow growing population
Combination of high birth rate and equally high death rates
Stage 2
Modernization = improved diet, medicine, etc.
Reduction in mortality --> gradual raise in life expectancy (under 40 to over
60)
The decline in death rates not immediately accompanied by a decline in
fertility
Growing divergence b/w high birth rates and low death rates
Sharp increases in pop. growth ---> +2% per annum
Stage 2 marks the beginning of the demographic transition (low pop.
growth to high pop. growth)
Stage 3
Modernization and development --> cause decline in fertility
Reduced fertility = lower birth rates converging with lower death rates
Thus little or no pop. growth
Opposite to Stage 1
Decline in pop. growth rate depends on factor such as: pandemics and
disease, gov't policies (family planning, etc.)
The Malthusian Population Trap
Thomas Malthus, 1798 essay Essay on the Principle of Population
Theory of relationship b/w population growth and economic development
Compares population growth curve and aggregate income growth rates against
levels of per capita income
Concept of diminishing returns used
Diminishing returns to fixed factors (land, food supplies) --> increase
arithmetically
Declining marginal contribution to food production of added member of
population
Population growth --> geometric rate, doubling every 30-40 years
Tension b/w fixed factor and population
Food supply growth can't keep up w/ population growth --> per capita income
falls --> leads to stable population existing barely/slightly above subsistence
Malthusian Population Trap = Low level equilibrium population trap
Threshold population level : when an increasing population (geometric rate of
growth) due to life sustaining resource (arithmetic rate of growth) are
insufficient to support human population
Population Trap: low level of income, low population growth = stuck in

subsistence economy
Low production, medicine, poverty, living standards, etc.
Avoid poverty by having "moral restraint" ---> modern birth control movement
Diagram Explained
X-axis = level of income per capita
Y-axis = population growth and total income growth
Two curves
Population growth curve = (change in Population/total population)
Trend: Increases exponentially (3-4%) --> stable population is reached
(near 0%) --> then declines
Total Income Growth Rate = (change in income/total income)
Below the x-axis
Total income is very low --> starvation, diseases, etc.--> very low population
Population grows after reaching minimum level of income per capita
Increased income, improved nutrition, medicine
Per capita income growth = difference b/w income growth and population
growth = (Y/P)
Change in Income - Change in Population > 0 = Income per capita increases = shift
to the right
Change in Income - Change in Population < 0 = Income per capita decreases = shift
to the left
Change in Income - Change in Population = 0 = Income per capita is constant
This defines equilibria = therefore, this condition is present at A, B and C
Total incomes increases as economy and income per capita increases
Assumption: savings vary positively w/ income per capita (more savings =
more income growth)
Demographic transition and Malthusian
Stage 1 = A, Stage 2 = B, Stage 3 = C
Stable Equilibrium at A and C
Move left or right of A or C, return back to A or C
To the left of A or C = Total income growth > population growth --> income
per capita increasing --> shift rightward to A or C
To the right of A or C = Total income growth < population growth --> income
per capita decreasing -> shift leftward back to A or C
Unstable Equilibrium at B
Move left or right of B, don't return back to B
Malthusian Population Trap in the Diagram
Economy will always stay at point A (subsistence) unless checks (birth
control) are not made to reduce population growth and increases total income
--> therefore shifting towards B
Above A -> pop. growth > income growth --> decrease income per capita -->
stuck and back to A
High-Fertility Trap???
X-axis = expected fertility
Y-axis = family's own fertility decision
Upward sloping response of owner fertility to average fertility caused by:
Larger family increase likelihood of offspring getting modern jobs
Families follow local social norms about fertility
Equilibrium - expected and decision of fertility is met

Criticisms of the Malthusian Model

Determinant of pop. growth rates is assumed to be per capita income. Better option
to look at individual/family decisions on family size --> Microeconomic Household
Theory of Fertility (see below)
National rates of population increase are directly related to the level of national per
capita income
Relatively low levels of per capita income, expect population rates increasing
w/ increasing per capita income
Ignores the enormous impact of technological progress in offsetting the growthinhibiting forces of rapid population increases
Increasing rather than decreasing returns from technology help avoid
Malthusian Trap
Malthusian in 1798, could not predict the advancement in technology
Technological and Social Progress to Avoid the Population Trap
Alternative to Malthusian Trap, there can be no intersection of the two
curves
Due to technological progress --> shifts income curve up at any level
of per capita income
Social progress of civil society and institutions --> shifts pop. growth
curve down
Population trap eliminated --> economy remains self-sustaining
No intersection of income curve and population growth

Income per capita never decreases since total income growth >
population growth

Microeconomic Theory of Fertility

Definition: family formation has costs and benefits that determine the size of families
formed
Stems as a criticism of the Malthusian Population Trap
Microeconomic determinants of family fertility to explain fall in birth rate at Stage 3 of
the dem. transition
Using consumer behavior:
Individuals tastes and presences for a range of goods (utility function) to max.
satisfaction given budget constraints (income).
Theory of Fertility
Children= special type of consumption
Fertility = rational economic response to the consumers (family's) demand for
children relative to other goods
Assume income/substitution effect
Demand for Children
Direct relation with Y = household income

Inverse relation with Pc = Price of Children, Px = Price of other goods, tx=

tastes for other goods
Diagram
Demand for Children - Cd - on the x-axis
Household desire for children, expressed by indifference curves
Any point on a higher indifference curve represents a higher level of
satisfaction than any point on a lower indifference curve
Theory: infinite indifference curve, only four in the model
Children assumed to be normal goods
Original Budget constraint = line ab = slope of ab represents expected income
and relative prices of children and goods
Below the budget constraint --> financially attainable
Steeper the slope, the higher the price of children relative to other
goods
Optimal bundle - point f, given Indifference curve I2
Household income increases --> budget constraint shift outward from ab to
a'b'
Higher satisfaction --> increased indifference curve to I4
Consume both bundle of goods and children --> optimal bundle is now
h
Increase in price of children relative to other goods (increase in opportunity
costs) --> households substitute commodities for children
Lower indifference curve (f to e)
Budget constraint slope is steeper (from ab to ab'') --> shows
increased opportunity costs
Simultaneous increase in household income and cost of children
B/c of female employment opportunities
Budget constraint shift outward and downward ---> line cd
Utility max = less children per family (from f to g = c3 to c2)
Result: higher levels of living for low income families w/ relative
increase in price of children = motivate households to have fewer
children w/ improved welfare
Summary
Realistically, simultaneous increase in income and cost of children will occur
Expanded efforts for jobs, education, health for poverty groups and women -> better welfare economically and physically
Also contribute to motivate households to have small family size --> reduces
population size and still increase growth
Family planning programs can aid in adjusting this phenomenon

Population growth - Not a cause for concern

The problem is not growth of population but other issues
Population growth is a false issue deliberately created by dominant rich-country
institution to keep LDCs in an underdeveloped, dependent condition
For many developing countries population growth is desirable
Other Issues
Underdevelopment - w/ correct strategies = higher living standard, self-esteem,
freedom --> pop. take care of themselves
Some argue birth control programs will fail - no motivation to lower family size
Population distribution
Gov't should moderate natural spatial distribution of the population to
avaliable land and resources
Subordination of women
Pop. growth is a consequence of women's lack of economic opportunities
World resource depletion and environmental destruction
Increasing population -> increasing use of resources --> increasing
destruction of environment
Population Growth - A Real Problem
The Extremist Argument: Population and Global Crisis
Unrestrained pop. growth is a threat to humankind
Principle cause for poverty, malnutrition, environmental degradation
Reduction of world pop. (mainly in developing world) is needed
The Theoretical Argument: Population-Poverty Cycles and the Need for FamilyPlanning Programs

Population-Poverty Cycle Theory: explain how poverty and high population

growth become reinforcing
Pop. growth exacerbates economic, social problems of underdevelopment
Equation (from Solow) --> y= f (K, L, R, T)
K = capital, L =labor, R = resources, and T = technology
Holding resources fixed -> y- l = a(k-l) + t
y= rate of GNI growth, lowercases = rate of ___ growth , a = capital
elasticity of output (constant)
Assuming CRS, per capita income growth directly related to growth of
capital-labor ratio (k-l) and residual effects of technology
More capital --> more investment + savings to maintain growth in per
capita income
Development = incentive for lower family size, needs technological means of
achieving this
Negative consequences of population growth
Economic growth
Lowers Per Capita Income growth in most LDCs
Poverty and Inequality
Negative consequences of population growth falls most heavily on the poor
Therefore, poverty rises and inequality is exacerbated
Education
Large family size and low income often limits education access to children
Health
High fertility harms the health of mothers and children
Increases the health risks of pregnancy
Food
Feeding world pop is difficult with pop growth
World food production = arithmetic, pop growth = geometric, --> constant
tension
New technologies provide innovation to fill the gap
Environment
Rapid population growth contributes to environmental degradation in the form
of forest encroachment, deforestation, air pollution, etc.
International Migration
Legal and illegal int'l migration is one of the consequences of the population
growth of developing countries
Consensus on the Consequence of Population Growth
Population growth is not the main cause of low levels of living, inequalities, or low
freedom of choice in the developing world
Primary cause must be sought in the plight of poor families, failure of other aspects
of domestic and int'l development policy
The problem of population is not only of number but involves quality of life and
material well-being.
Thus LDC population must be viewed in connection w/ developed country
affluence in relation to the quantity, distribution and utilization of world
resources
Rapid population growth intensifies problems of underdevelopment
Policy Objectives
The primary objective of any strategy to limit further growth must deal with

Population, Absolute poverty, Gross inequality, Unemployment, Malnutrition

This can lead to lower family size
A fundamental motivational basis for the expanded freedom of the individual to
choose an optimal family size - through regulated fertility
Expanded freedoms facilitated by family planning programs through education
and technological means
Developed countries should help developing countries to achieve lower fertility and
mortality levels by:
Reducing their use of nonrenewable world resources,
By making commitments to the eradication of poverty,
Illiteracy,
Disease
Malnutrition.
How Developed Economies Can Do
Willingness of rich nations to be of genuine assistance to poor nations in forms of:
Expanded public and private financial assistance
Manipulating economic (dis)incentives: Tariff and quota-free access to
developed country market, etc.
Two activities more directly related to fertility moderation that int'l donor agencies,
NGOs and rich gov't's can assist are:
The area of fertility control, contraceptive pills, voluntary sterilization
procedures, etc.
The areas of family planning programs, public education, national population
policy, etc. through technology

Chapter 7: Urbanization and Rural-Urban Migration

7.1 - The Migration and Urbanization Dilemma
Trends
By 2050, world pop. exceed 9 billion
UN projects by 2030, 5 billion urban dwellers (nearly 5/8 of world pop. of 8.1 bill.)
Rise of megacities (pop of 10 mill. +), 2/3 of megacities in developing world
Facts
Positive association between urbanization and per capita income
The highest income countries such as Denmark are also the most urbanized.
The poorest income countries such as Rwanda are also the least urbanized
Rural-Urban Migration: The movement of people form rural villages, towns and farms to
urban centers/cities in search of employment
Direct cause for urban dwellings, part of blame on gov't's poor urban planning
7.2 - Role of Cities - Modern and Urban Informal Sector
The Role of Cities
Association b/w urbanization and development largely due to agglomeration
economies.
Agglomeration economies: cost advantages to producers and consumers from
location in cities, takes shape in two forms:

Urbanization economies: effects associated with the general growth of a

concentrated geographic region
Localization economies: effects captured by particular sectors of the
economy as they grow within an area.
Take the form of backward and forward linkage
Backward linkage: firms prefer to centralize together as to pool labor
supply of special/skilled workers, conversely, special/skilled workers
have an incentive to centralize in these locations for better job access
Given significant transportation costs, consumers of output by industries can benefit
from a centralized location
Industrial Districts
City: is an area with relatively high population density that contains a set of closely
related activities
Firms located in "industrial districts" --> firms benefit from "learning" from other firms
= spillover is a form of agglomeration economies
Firms benefit to contract out work easily given a large order materializing (flexible
specialization = agreement by firms for contracting work )
Passive collective efficiency - firms operating in collective locations, easy
consumer access --> creates industrial clusters
Active collective efficiency - benefits from collective action like; training facilities,
lobbying gov't for infrastructure as an industry than individual firms
Benefits can be realized by both efficiencies, passive is more common due to
coordination failure
Industrial clusters are now common in developing countries at stages of industrial
development ranging from cottage industry to advanced manufacturing techniques
Traditional cottage industry - collection of dispersed producers by
intermediary with contact w/ buyers
Industrial clusters are significant factors in emerging industrial
competitiveness
Gov't can aid by providing financial capital and other services
Critical factor is social capital (success of previous engagements, trust), this
must be organic
Efficient Urban Scale
Agglomeration economies of cities are externalities
Positive benefit of spillover of technology advancement in one industry to
another
Negative benefit due to the congestion costs
Cost of real estate increases --> physical dispersion of populous
(skylines)
Cost of transportation increases (traffic) --> demand higher wages
Black hole effect
Ideal theory of urban scaling
Cost of transportation of finished goods are high + consumers desire location
in city to avoid transportation costs = therefore, economic activity
concentrated to cities
Consequence: improve transportation costs less than maintaing expansion of
city
Theories of city size
Urban hierarchy model (Central place theory)
August Losch and Walter Christaller
Industries market radius is characterized by three factors

Economies of scale in production - larger the better for the firm

Transportation costs - lower the better for the firm
Demand for land is spread over space - low demand = low price
of real estate
Explains why small cities have small radii and large cities have large
radii
Applies better to non-export industries
Differentiated plane model
Alfred Wber, Walter Isard and leon Moses
Limited number of transportation routes linking industries in an
economy is vital
Internal nodes: urban concentrations are located at the crossing of
scarce transportation routes
7.3 - Urban Giantism Problem
Urban Giantism
Urban core can become too large to keep costs of the industries there
Developed countries
Urban core becomes too large to maintain industry costs --> develop other
cores in broad metropolitan region
Region gets benefit of agglomeration and some lowered costs
But, creating new urban core doesn't happen if there are advantages to
locating in places where other firms are already present
Example of chick and egg coordination problem = how goes first?
Therefore, agglomeration economies of cities are externalities
Less developing countries
Government less involved in the dispersal of economic activity
If involved, often less effective
First-City Bias
Definition of Urban Bias- governments in developing nations favor urban sector in
policies, thus widening the gap b/w urban and rural economies
Definition of First-City Bias- A form of urban bias that has often caused
considerable distortions
Receives a disproportionately large share of public investment and incentives
for private investment in relation to the country's second-largest city
Result
First-city receive disproportionate and inefficient amount of population and
economic activity
Creates large urban dwellings like huge slums and shantytowns
Causes of Urban Giantism
Summary
Local production given: high protection + transport cots + few adequate small
cities + capital in largest city + political logic of unstable democracies
Combination of hub-and-spoke transportation system and the locations of the
political capital in the largest city
Hub-and-spoke transportation system: capital cities located near sea
system to facilitate resource extraction, influenced by colonial era
(dependence theory)
Reinforced by political culture of rent seeking and capital market failures to
create new urban centers

Assuming import substitution (Paul Krugman)

There is a high level of protection, less int'l trade
Population and economic activity has incentive to concentrate in a single city
to reduce transportation costs therefore reduced price of goods
Circle of causation: attract firms to cities, consumer to cities due to lower
costs
Conversely, w/ less trade barriers --> less activity in the city center, incentive
to focus production on home market is reduced --> export to other nations
through ports
As a consequence of dictator's efforts to remain in power
Unstable dictatorships + regime consolidation = extreme urban bias toward
first city to appease the masses
Focus of national gov't spending on capital city = bread and circuses effect
Causation: migration to city center --> more people to appease --> harder for
gov't to maintain power
Firms located in urban core for easy access to government officials
For political favors from a regime
Reflects underdevelopment trap --> from corrupt bureaucracies
Democracy lowers incentive for concentration in political areas
7.4 - The Urban Informal Sector
Dualistic analysis applies to urban economy
Dualistic nature of developing nations (Development Theory) - modern urban
capitalist sector (capital intensive, large scale production) and the traditional rural
subsistence sector (labor-intensive, small scale)
Reflected in urban economy through informal and formal sector
Informal Sector: unregulated large number of small scale production and service activities
by individuals or family firms using labor-intensive technology
Limited financial and social capital of firms/individuals --> work productivity and
income less than formal
Benefits of the Urban Informal Sector
Trade off between informal and formal sector
Formal depends on informal sector for cheap inputs
Informal sector income and clientele depends on the growth of the formal
sector
Employment opportunities
Demand for employment > rate of outputs for the formal sector
Corrects failure from urban/rural formal sectors
Employ excess labor in informal sector
Avoid extreme rural poverty and underemployed
Informal sector incomes higher than poorest rural regions
Despite continued flow of rural-urban migration
Generates surpluses even in a hostile environment
Limited advantages from formal sector: such as credit, foreign exchange and
tax concessions
Low capital intensity
Cost of employment in informal sector is a fraction of the cost of employment
in formal sector
Offers savings to developing economies often plagued by capital shortages
Provides access to training at lower cost than formal sector institutions

Raises human capital

Generates demand for semi-skilled and unskilled labour --> unable to enter the
formal sector
Note: skilled works go to formal sector
Willingness to adopt appropriate technologies + use local resources --> allowing for
a more efficient allocation
Important role in recycling waste materials
Ensures an increased distribution of benefits of development to the poor (most of the
poor in the informal sector)
Avoids bureaucracy of starting a business in formal sector (red tape)
Disadvantages of the Urban Informal Sector
Rural-Ubran migration and Labor absorption in the informal sector
Migrants have high unemployment rates, little time to find job
Promoting informal sector increases migration to urban areas --> aggregate
urban unemployment problem --> not all excess labor can be absorbed by the
informal sector
Environment harm
Poor urban services in slums + congestion of informal sector (vendors, etc.) -> negative environmental effects
Revealed preference
Opening of employment chances in formal sector --> informal sector switching
to take these jobs
Lack of capital
No access to formal sector benefits like loans, credit, etc.
Women in the Informal Sector
Formal sector is dominated by men
Women = the bulk of the labor supply in the informal sector
Low wages, unstable jobs, no employee or social security
Rising proportion of urban households headed by single women
Tend to be poorer
Experience tighter resource constraints
Retain relatively high fertility rates
Women generally ineligible for small loans
Since mostly in informal sector
Credit, loans through the formal sector
Result: low productivity ventures and outputs
Legalization and economic promotion of informal-sector activities = improve women's
financial flexibility and productivity of their ventures
Governments must remove restrictions to women
Women's right to hold property, etc., to conduct financial transactions, or limit
fertility.
7.5 - Migration and Development
Migration in excess of job opportunities is a result and cause to underdevelopment
Rates of rural-urban migration exceeds rate of urban job creation = surpass capacity for
industry and urban social service absorption
Rural-Urban Migration
Important in long run development
Importance
Population share of cities is growing, despite the fact that fertility is much

lower in urban area and the difference is accounted for by rural-urban

migration
Potential of agglomerate economies in cities in stimulating economic activity
Other migration patterns exist (urban-rural, rural-rural, urban-urban)
Migration may worsen rural-urban structural imbalances in two direct ways
Supply Side: Internal migration disproportionately increases the growth rate of urban
job seekers relative to urban population growth
Depletes rural human capital supply and saturates urban labor supply
Demand Side: Urban job creation is generally more difficult and costly to accomplish
than rural job creation b/c of:
Need for substantial complementary resource inputs for most job in the
industrial sector
Result: rapid supply increases + lagging demand growth = short run resource
imbalances turn into long run chromic urban surplus labor
Any economic or social policy that affects rural and urban real incomes will directly or
indirectly influence the migration process
Result: Alters the pattern of sectoral economic activity, income distribution and
population growth
Economic policies indirectly influence the nature and magnitude of the migration stream:
Land tenure arrangements, commodity pricing, credit allocation, taxation, export
promotion, import substation, etc.
7.6 - Toward an Economic Theory of Rural-Urban Migration
Harris-Todaro Migration Model
Explains paradox of rural-urban migration in developing nations despite high urban
un(der)employment
Criticism of Lewis Model
Todaro Migration Model
Definition: Theory explaining rural-urban migration given high urban
unemployment. Migration occurs when urban expected income > average
rural income
Equilibrium form = Harris-Todaro Model
Definition of Harris-Todaro Model: An equilibrium version of the Todaro
migration model, predicts expected incomes will be equated in rural and
urban sectors when accounting for informal sector
Background
Migration proceeds in response to urban-rural differences in expected income of
urban areas rather than actual earnings(choice of maximizing expected gains)
Expected income in urban sector (the difference b/w returns and costs of
migration)
Returns of migration --> employment from positive urban-rural real income
differential
Costs of migration --> job seeking (unemployed for a period of time)
Migration occurs when urban expected income > average rural income
Therefore, migration = income differential
Migration directly influenced by both expected wages and employment
probabilities
Explains migration despite high unemployment
Chronic unemployment problem - due to excess labor supply in urban areas and
unskilled migrants

Factor of time, given time migrants can gain social capital to obtain jobs
Reason for migrants to stay in urban areas despite unemployment
Net stream of expected urban income / the migrants planning horizon >
expected rural income --> migration is justified ]
Rural-urban migration equates rural and urban expected incomes (defines whether
to migrate or not)
Rural wage 50, urban wage 100, 50% unemployment rate --> equated wages
(fact urban wages for unemployment rate)
Urban formal sector wages may be kept artificially high b/c of:
Trade unions
Government policy
Incentive to workers when monitoring costs are high
The Harris-Todaro Migration Model
Figure 1

Assumption --> Ideal neoclassical two sector labor market model

Two sectors - rural agriculture and urban manufacturing
Neoclassical, flexible wage, full employment market economy
Demand for labor in agriculture --> AA' curve (downward sloping)
Labor demand in manufacturing --> MM'
Total Labor Force --> OaOm
Equilibrium wages --> W(A*) = W (M*) --> Agri. wage rate = man. wage rate
Workers in agriculture ---> O(A) to L(A*)
Workers in manufacturing --> L(M*) to O(M)

Note: L(A) = L(M)

Therefore, full employment
Figure 2

Second Model - Real Wage Differentials

Urban wages are institutionally fixed (minimum wages in urban areas)
Shown as W(M), increased from W(M*) to W(M**)
Inflexibly downward
Urban sector wages fixed at a level higher than the eq. wage rate (incentive
for rural-urban migration)
Assumed by Todaro
Therefore, labor supply for manufacturing sector shifts to L(M)O(M)
Note that L(M)O(M) < L(M*)O(M)
Less demand for labor in manufacturing sector but higher supply (excess
labor)
Conversely, Wage of agriculture decreases from W(A*) to W(A**)
Agricultural labor supply increases from O(A)L(M)
Urban-Rural real wage gap exists from W(M) to W(A**) (aka unexplainable eq. wage
differential)
Despite low availability of jobs (O(M)L(M)), migrants are willing to risk favorable
higher paying jobs
W(A) = L(M) / [L(A*)O(M)] x W(M)
Probability of urban jobs success necessary to equate agri. income (W(A)) w/

urban expected income (LM/ [L(A*)O(M)])xW(M) --> migrant to become

indifferent of job location
Urban expected income - ratio of employment in manufacturing to total
urban labor pool
L(M) = ratio of employment in manufacturing
[L(A*)O(M)])xW(M) = total urban labor pool
Figure 3

Explanation
Locus of points of indifference b/w job location --> qq' curve
Equilibrium is at point Z
Urban-rural gap = W(M) - W(A)
O(A)L(A) workers in agriculture
O(M)L(M) workers in urban formal sector
L(A)L(M) workers are unemployed, low income informal sector
Note: wage is W(A**), less than agri. and man. wages
Explains existence of urban unemployment and private economic rational of ruralurban migration
Criticism of the Harris-Todaro Model
Figure 1 - assumes migrants w/o job have no income --> what about informal sector
employment?
Assume all urban migrants are equal, difference in human capital (education) which

influence employment probabilities

Previous migrants create positive externality for new migrants, known how to get
jobs, etc.--> reducing cost of migration which is not accounted for
Relevant model even if wages are not institutionally fixed
Higher wages due to labor turnover, imperfect info, efficiency wage payments,
etc.
Labor turnover- pay higher wages to retain trained/skilled workers and
prevent defection
Efficiency wage - desire to maintain high quality workers or high
productivity job means paying higher wages
Characteristics of Todaro migration model
Migration is a causation of rational cost/benefit economic considerations
The rural-urban migration is dependent on considerations of relative benefits and
costs.
Migration depends on expected rather than real wage differentials
Probability of getting urban job = urban employment rate
High rates of urban unemployment is an inevitable fallout of an imbalance in
economic opportunities between rural and urban areas, in the developing economies
Policy Implications of the Harris-Todaro Model
Imbalances in the urban-rural employment opportunities caused by the urban-bias
must be reduced.
Specifically the imbalance b/w the economic opportunities b/w the rural and
urban area need to be minimized
Urban job creation is not a sufficient solution for the urban unemployment problem
The traditional economic solution to urban unemployment may lead to a
situation that aids in creating higher levels of urban unemployment
Thus a policy will also lead to lower levels of agricultural output due to
induced migration
Indiscriminate educational expansion will lead to further migration and
unemployment
The heavy rural-urban migration at rates in excess of new employment
opportunities causes for rationing in selection of new employment
Given the same wages, more educated works are often selected, even
despite no additional value to performance
Wages subsidies and traditional scarcity factor pricing can be counter-productive
B/c ubran wages exceed the market wage, elimination of wage distortions (via
price adjustments or subsidies) will encourage more labor-intensive modes of
production
However, these can raise levels of unemployment as well
Programs of integrated rural development should be encouraged
Policies that operate on the demand side of urban employment (like
wage subsidies, direct government hiring, etc.) seem to be less effective in
the long run in alleviating the unemployment problem than policies designed
to regulate the supply of labor to urban areas.
A combination of the two is preferred.
7.7- Summary and Conclusions: A Comprehensive Migration and Employment Strategy
Summary
It is clear that industrial modernization, technological sophistication, and metropolitan

growth created substantial geographic and economic imbalances

Urban area, the growth and development of the informal sector, as well as its role
and limitations for labor absorption and economic progress, will assume increasing
importance
A Comprehensive Migration and Employment Strategy
Creating an appropriate rural-urban economic balance
Integrated development of the rural sector, rural non farm employment
opportunities, improved credit access, better agricultural training, etc.
Expansion of small-scale, labor-intensive industries
Directly through gov't investment and incentives, access to credit,e tc.
Indirectly through income redistribution to the rural poor
Eliminating factor price distortions
Eliminating capital subsidizes and curtailing growth of urban wages through
market based pricing --> increase employment opportunities and efficient use
of scarce capital
Choosing appropriate labor-intensive technologies of production
Developing nations have complete technological dependence of machinery
and equipment from developed world
Domestic, int'l efforts can reduce technological gap
Develop low cost, labor intensive methods for rural infrastructure (irrigation,
roads, etc.)
Modifying the linkage between education and employment
Massive quantitative expansion of educational systems (sp. in higher levels)
Formal education is a requirement for formal sector employment
Rural economic opportunities redirect educational system to rural
development
Reducing population growth
Decentralizing authority to cities and neighborhoods
Authority to municipalities, account for local conditions

Chapter 8: Human Capital: Education and Health in

Economic Development
Definition of Human Capital: term used by economists often used for education and
health and other human capacities that can raise productivity when increased
Facts
Education and health are basic objectives of development
Health is central to well-being and a prerequisite for increases in productivity.
Successful education relies on health as well
Education is essential for a satisfying life and plays a key role in the ability of a
developing country to absorb modern technology and to develop the capacity for
self-sustaining growth and development
Both education and health are treated together as issues relating to human capital
Purpose
A look at the connections b/w health and education since both are forms of human
capital
The relationship b/w income and health/education. Close relationship, but higher
household income need not have a guaranteed impact on improved health and
education
A close look at education and health systems in developing countries to identify the

sources of severe inequalities and inefficiencies that continue to plague them

Education and Health as Joint Investment for Development
Education + health = investment to humans
Greater health capital may improve the return to investments in education b/c health
is an important factor in school attendance and in the formal learning process.
A longer life raises the return to investment in education while improved
health conditions may lower the deprecation cost of education
Greater education capital may improve the return to investment in health b/c many
health programs rely on basic skills learned at school like personal hygiene and
sanitation, literacy and numeracy, etc.
An improvement in productive efficiency from investments in education raises the
return on a lifesaving investment in health
Improving Health and Education: Why Increasing Income is not Sufficient
Health and education levels are higher in high-income countries. The causality runs
both ways
People spend more on human capital when income is higher. However, even if
income could be raised w/o a large improvement in health and education, the
increased income may not be spent on children's education or health
The income elasticity of demand for calories among low-income people range from
near zero to 0.5. This disproportionate response is due to
Income spent on other goods besides food and
A part of the increased food expenditures is used to increase food variety w/o
increasing the number of calories consumed
Measuring calories does not equal measuring nutrition --> increase in income could
shift from consuming nutritious foods (beans,rice) to empty calories (soda, candy)
Formal knowledge (education, culture, civil society) positive directly affects decisions
regarding health
Spillover benefits of investments in health and education
Health --> less contagious, more useful to society than sick person
Education --> diffuse knowledge to others like reading, etc.
Market can not provide this service = market failure --> government must
correct market failure
Investing in Education and Health: The Human Capital Approach
Initial investment --> stream of higher future income --> from expansion of education
and improvements in health.
Rate of return can be deduced and compared w/ returns to other investments
Deduced by estimating the present discounted value of the increased
incomes stream made possible by these investments and comparing it w/
their direct/indirect costs
Education costs = Direct costs (tuition, books, uniforms, etc.) + Indirect costs
(the opportunity costs of going to school, 4 yrs of school = 4 yrs of not earning
income)
Formally income gains for additional education can be written as:
[ (Et Nt) / (1+i)t ]
Where E = income w/ additional education, N= income w/ additional
education, t= year, i= discount rate
Discount rate = annual rate at which future values are decreased to make
them comparable to values in the present
Rationale: a dollar today is more valuable than a dollar in the future
Discount rate is lowered, direct/indirect costs are lower or benefits are higher

--> Rate of return is higher

And the summation is over expected years of working life
An analogous formula applies to health w/ direct and indirect cost of resources
devoted to health compared w/ extra income gained in the future as a result of higher
health status
Access to credit limits low-income ability to further their education
Child Labor As Bad Equilibrium
Child Labor = individuals under the age of 15 working
Limits education potential, physical stunting is common, poor working conditions.
ILO major role in child labor discussion
Child Labor: either under the minimum age for work or above that age and
engaged in work that poses a threat to their health, safety or morals.
Global issue --> 215 million worldwide in Sub-Saharan Africa, Asia Pacific (largest
two) and also Latin America and Arab states
Assumption
Household w/ sufficiently high income would not send children to work
Child and adult labor are substitutes
Not true, adults can do equal and more than children
"Small finger" argument is debunked hear
Adult labor is more productivtive
Therefore, 1 child worker = (x)adult workers
Where x<1
x= level of productivity of child relative to an adult
Explanation
X-axis = supply of labor in adult equivalents
Perfectly inelastic, vertical adult labor supply curve --> AA'
Number of unskilled adults
Highly inelastic supply = reasonable among poor families needing children to
work
Each adult, regardless of skill, is involved in work to make the family survive
Decrease in Wage from "We1" to "Wh"
Children go to work --> only effects a few families = hence the steep Sshaped curve
Wage between Wh and WL = Along the S-shaped curve --> Falls flatter as wage
continues to reduce
If wage is below "WL" = supply curve is along TT'
TT' = aggregate labor supply = adult labor + (x)child labor (factor less
productivity of children)
Labor Demand = Dl
Inelastic = cuts AA' above wh and TT' below WL
Two stable equilibria= E1 and E2
Bad equilibrium = E2
Effective ban on child labor --> E2 moves up to E1
New wage is high enough for no family to have children working
Good equilibrium = E1

Effects of Banning Labor

Provides a good equilibrium
Children more likely to go to school
Employers worse off --> pay higher wages (We2 to we1)
Employers have incentive to prevent child labor laws -> Pareto efficient
Therefore --> intermediate approach needed (below)
Four Policy Approaches to Child Labor Policy
Recognizes child labor as an expression of poverty and recommend an emphasis on
eliminating poverty rather than directly addressing child labor
Strategies to get more children into school, including expanding school places and
conditional cash transfer incentives to induce parents to send their children to school
Compulsory schooling is a good idea, with complementary incentives (such
as welfare benefits) it is made more effective
Child labor is inevitable, in the short run and stresses palliative measures such as
regulating it to prevent abuse and to provide support services for working children.
Example: UNICEF
Banning child labor or at least in its most abusive form -- > the ILO's main platform
for child labor
Abusive form - trafficking, slavery, prostitution, etc.
Trade sanctions on nation permitting child labor or banning the goods on which
children make
Well intentioned, no effect in improving child welfare directly
The Gender Gap: Discrimination in Education and Health
Education and Gender
Young females member receive less education than young meals, in most low-

income countries.
The educational gender gap is especially great, in LDCs in Africa
Educational gender gap = male-female differences in school access and
completion
Measured by literacy, attendance, etc.
Education and Gender = Millennium development goals number 3
Empirical evidence shows educational discrimination against women hinder econ.
dev. in addition to reinforcing social inequality.
Closing the educational gender gap by expanding educational opportunities for
women, is economically desirable for at least three reasons
Rate of return on women's education is higher than that of men's in most
developing countries
Increasing women's education not only increases their productivity in the
workplace but also results in greater labor force participation, lower fertility,
improved child health, etc.
Since women carry a disproportionate burden of poverty, any significant
improvement in the role/status of women via education has an impact on
breaking the vicious cycle of poverty and inadequate schooling
Health and Gender
Health spending on men is often substantially higher than on women in developing
countries
Female gentile mutilation/cutting is a health and gender tragedy --> violation of
human rights due to customary laws of Sub-Saharan/Mid. East societies
Decline in FGM/C - overcoming coordination failure with local based NGOs, etc. and
awareness
Consequences of Gender Bias in Health and Education
Investment in education of women has one of highest rate of returns of any
investment
Cost-effective means of improving local health standards
Missing women mystery --> lack of women in key economic and social roles due to
gender bias
Greater mother education --> better chance for children to do better
Family income increases doesn't necessarily mean improved health status or
education attainment
The Political Economy of Educational Supply and Demand
Determinants of Demand for Schooling
More educated students prospects of earning considerably more income
through modern-sector employment viz. private benefits to the family
The educational costs, both direct and indirect that the family must bear
The amount of education demanded is thus a derived demand for high-wage
employment opportunities in the modern sector subject to individuals educational
past
Derived demand - demand for a good emerges indirectly from demand
for another goods
Supply Side
Quantity of school places in primary, secondary, and university levels is
determined largely buy political processes, often unrelated to economic
criteria.
With an increased political pressure in the LDCs for greater number of
schools at higher levels, the supply of these can be assumed as being fixed

by the level of gov't educational expenditure

The amount of education demanded largely determines the supply. Therefore,
a look at the determination of this derived demand is imperative
Derived Demand for Schooling
The amount of schooling demanded that is sufficient to qualify an individual for
modern-sector jobs appears to be determined by the combination of the following
variables.
Wage or income differential
Probability of success in finding modern-sector employment
Direct private costs of education
Indirect or opportunity costs of education
Social vs. Private Benefits and Costs
Social benefit of education - the payoff to society as whole from schooling of
individuals
Social costs of education
The opportunity cost to society resulting from the need to finance costly
educational expansion at higher levels when these limited funds might be
more productivity used in other sectors of the economy
Increase as the student climbs the education ladder, while the private costs
increase more slowly or may even decline
Private costs of education - costs borne by student themselves - increases more
slowly or may even decline
The widening gap b/w social and private costs provide a greater stimulus to the
demand for higher education than it does for education at lower levels
Private vs. Social Benefits and Costs of Education
Shows divergence b/w social and private benefits and costs --> can lead to
misallocation of resources when private interests supersede social investment
criteria

Explanation
First Diagram
Expected Private returns and actual private costs plotted against years of
completed schooling
As a student completes more years of schooling, expected private returns
grow at a much faster rate than private costs.
To maximize the difference b/w expected benefits and costs, the optimal
strategy would be to secure as much schooling as possible
Second Diagram
Social returns and social costs plotted against years of schooling
The social benefits curve rise sharply at first reflecting levels of productivity of
small farmers and the self employed that result from receipt of basic
education and vocational skills.
Thereafter, marginal social benefit of additional years of schooling rises more
slowly and the social returns curve begins to level off.
The social cost curve shows a slow rate of growth for early years of schooling
and then a much more rapid growth for higher levels of education.
Result = more expensive capital and recurrent costs of higher education
(note: most primary education in developing countries is heavily subsidized)
The optimal strategy - provide all students with at least B years of schooling
(Line connecting two points on 2nd graph).
Beyond B years, the MSC exceeds MSB so that public educational

investment in higher level school places will yield a negative net social
rate of return.
Shows conflict b/w optimal private and social investment strategies due to
divergence in latter years of education
Inappropriate public and private policies (wage differentials, educational selectivity,
etc.) ---> private expected value of education > social value of education =
unemployment
Contribution of universal primary education to development
Creating a more productive labor force and endowing it with increased knowledge
and skills
Providing widespread employment and income-earning opportunities for teachers,
schools, etc.
Creating a class of educated leaders to fill vacancies left by departing expatriates or
otherwise vacant or prospective positions in government services, public
corporations, private domestic and foreign businesses
Providing the kind of train gin and education that would promote literacy and basic
skills while encouraging modern attitudes on the part of diverse segments of the
population
Distribution of Education
Quantitative measurement of education = number of schooling years
Imperfect measurement --> doesn't measure quality of education
Quality (teaching, facilities and curricula) of education is preferred over
quantitative measurements
Measuring quality is far more difficult
Using Lorenz Curve and Gini coefficient, we can equate income inequality to
education equality to graphically display the disparities of education in a nation
Priority should be on upgrading existing facilities than expanding education facilities
Education, Inequality and Poverty
Educational system of developing nations often increase than decrease income
inequalities
Reason - positive correlation b/w level of education and level of lifetime earnings
Levels of earned income increases with increased years of completed schooling
Follows that large income inequalities are reinforced if students from middle/upper
income brackets are represented disproportionately in secondary and university
enrollments
If the poor are effectively denied access to secondary and higher educational
opportunities, the educational system can actually perpetuate and even increase
inequality across as well as within generations in developing countries
Private cost of primary education for the poor is greater than others, opportunity
cost of education is large --> reasons that poor don't peruse further education and
even drop out of early schooling
Alternative to education for poor --> child labor
Low attendance of poor is compounded by poor facilities and quality of education
Therefore, despite universal primary education, opportunity cost of the poor and poor
quality = poor often unable to go beyond primary years of education
Higher level of education, particularly in university, is subsidized by the government
Thus, those able to get into university (the high income earners) are able to
be educated by redistribution of wealth coming from the poor among others
Education, Internal Migration and the Brain Drain
Education positively influencing factor for rural-urban migration
Premise: individuals with higher education face wider urban-rural real-income

differentials and higher probabilities of obtaining modern-sector jobs than lower

levels of education
Brain Drain: the emigration of highly educated and skilled professionals and
technicians from the developing countries to the developed world
Brain drain is most evident in scientists, engineers, academics, etc.
Lack of environment to apply educational skills in developing nations actively
contributes to brain drain
Health Measurement and Distribution
Health Measurements = Life expectancy and under-5 mortality rates
Life expectancy - can misrepresent, high life expectancy can mean more vitality of a
nation or additional year of poor health or suffrage
Under-5 mortality rate is improving, omits consideration of the general health status
of the pop. beyond early childhood
Example: some live past 5 years but suffer lifetime health consequences
attained at birth (heart disease)
WHO definition of Health: state of complete physical, mental, social well-being not
limited to disease or infirmity
Regardless of measurement, health output will entail a common representation that
the poor are more likely to death sooner than the rich
Disease Burden
Developing countries face a greater disease burden
Disease - AIDS, malaria, parasites, malnutrition
Water contamination is common in developing countries, specifically in Africa -->
leads to diarreha, and other water born diseases
Malnutrition - a form of disease
Rate of improvement of malnutrition is slow, still a major cause of death in
children
Acquired immunodeficiency syndrome (AIDS) is the final and fatal stage of human
immunodeficiency virus (HIV)
Developing countries, AIDS primarily transmitted through heterosexual
intercourse or any form of blood/bodily fluid transfer
Antiretroviral drugs have been made to combat and limit the spread of HIV
These drugs are still scarce in developing nations
Most HIV/AIDS cases in developing nations, potential correlation w/ poor
health/hygienic standards (untreated STDs)
Malaria
1 million deaths per year
Pregnant women particularly at risk
Health, Productivity and Policy
Health positively correlated to productivity
Healthy population is thus a prerequisite for successful development
Cycle of causation: Better health --> more productivity --> more earnings --> more
investment in human capital --> better health
Height is a general indicator of health
Health systems: all the activities whose primary purpose is to promote, restore, or
maintain health
Health systems vary greatly among nations and among developing nations
Relation that more income = better life expectancy is not always true
Quality of health care services is a vital factor to account for
Investment into health care is not reciprocated in health services performance in
developing nations

Result: Large number of preventable deaths and lives

Health systems use public funds ineffectively
Poor health of adults --> unable to be productive --> threatens livelihood and
subsistence --> opportunity cost of education for children is too large --> must
work than get education to support family --> child labor --> result: Bad
equilibrium of child labor
Child labor, education, health are all correlated
Effective Government Role in Health Policy
Health is central to poverty alleviation, b/c people are uniformed about health
Households spend too little on health b/c neglect externalities of health
Market invest too little in health infrastructure and R&D and technology
transfer to developing countries due to market failures
Public helath programs in developing country have many proven successes

Chapter 9: Agricultural Transformation and Rural

Development

Agriculture and Employment based strategy of Economic Development

Low income countries - agricultural employment account for 80-90% of employment
An agriculture and employment based strategy of economic development requires
three basic complementary elements
Accelerated output growth through technological, institutional and price incentive
changes deigned to raise the productivity of small farmers.
Rising domestic demand for agricultural output derived from an employment-oriented
urban development strategy
Diversified, non-agricultural, labor-intensive rural development has come to be
regarded by many economists as essential to development
How does agricultural and rural development relate to overall national development
How can total agricultural output and productivity per capita be substantially
increased in a manner that will directly benefit the average small farmer while
providing sufficient food surplus to promote food security and support a growing
urban industrial sector?
What is the process by which traditional low-productivity peasant farms are
transformed into high-productivity commercial enterprises?
When traditional family farmers and peasant cultivators resist change, is their
behaviorstubborn and irrational, or are they acting rationally within their context of
their particular economic environment?
What are the effects of the high risks faced by farmers in low-income countries, how
do farm families cope with these risks, and what policies are appropriate to lessen
risk?
Are economic and price incentives sufficient to elicit output increases among
peasant agriculturalists or are institutional and structural changes in rural farming
also required?
Is raising agricultural productivity sufficient to improve rural life or must there be
concomitant off-farm employment creation along with improvements in educational,
medical and other social services?

Market Failures and the Need for Government Policy

A major reason for the relatively poor performance of agriculture in low income
regions has been the neglect of this sector in the development priorities of their
governments.
This neglect along with the bias towards investment in the urban industrial economy
can be traced to the misplaced emphasis on rapid industrialization via import
substitution and exchange rate overvaluation.
If agricultural development is to receive renewed emphasis, the role of the
government needs to be specified.
In 1980s a major theme of development agencies was to reduce government
intervention in agriculture.
Many of the early interventions did more harm than good to this sector.
An example : The requirement of the government to have farmers sell at low
price to state marketing boards in an attempt to keep urban food prices low.
Production subsidies now spreading like a contagion from high-income to middleincome countries are costly and inefficient.
Agriculture also faces market failures and include environmental externalities. The
public good character of agricultural research and development, economies of scale
in marketing, information asymmetries in product quality etc.
The government also has a role in agriculture simply because of its role in poverty
alleviation
Helping those lacking collaterals and thus credit.
Lack of information and missing markets therefore lack of insurance
Missing market and capital market failures limit the ability of poor farmers to take
advantage of opportunities of globalization when gov'ts liberalize trade
Three Systems of Agriculture
Agriculture-based countries, agriculture is still a major source of economic growth.
The World Bank estimates that agriculture accounts for 32% of GDP growth
on average in these countries.
More than 2/3 of the poor of these countries live in rural areas.
Around 82% of the population of sub-Saharan Africa lives in these countries.
Transforming countries
Some 2.2 billion of the worlds rural population live in the .
The share of the rural poor is these countries is high at around 80% though
agriculture now constitutes only 7% of the GDP growth.
Most population of the South and East Asia, North Africa and the Middle East
lives in these countries.
Urbanized countries,
Rural-urban migration has reached the point at which nearly half of the poor
are found in cities and agriculture contributes even less to GDP growth.
The countries are found mainly, in Latin America and the Caribbean
Note
Movement between systems is possible, example: China and India
Regional disparities within nations can be quite substantial --> India
Large land doesn't equate more productivity
Peasant Agriculture in Latina America, Asia and Africa
Large holdings of land by small class of powerful landowners (particularly in LA and
Asia)
Nature of agrarian system is different in these regions
Women
Women perform most of subsistence food production

Hard labor, primary tools

Time consuming nature of tasks, work longer hours than male
Much of the work is statistically invisible --> no payment
Africa
Subsistence farming - farming in which crop production, stock rearing, ad
other activities are conducted mainly for personal consumption
Africa dominated by low productivity subsistence farming
Importance of subsistence farming at local level
Existence of land in excess (diminishing rapidly)
Right of each family at the local level to have access to land and water
Challenges
Lack of cultivation and irrigation technology
Intensive cultivation = diminishing returns of increased labor inputs
Labor - underemployed and scarce
Result
Slow growth in face of population growth
Need for nonhuman inputs and new technologies
Asia
Fragmented and heavily congested dwarf parcels of land
Too many people and not enough land but distribution is more equal than LA
The landlord secured much of the gain
The money-lender captured the profits
The governments guaranteed price was never paid
Complementary inputs were never made available or their use was too
problematic.
Latin America
Peasants plight due to latifundio-minifundio system
Latifundios - very large landholdings (employment for 12 ppl +)
Used by wealthy as social status symbol than agriculture, less farmed
than other landholdings
Transaction costs are higher than using low effective cost minifundios
Minifundio - smallest farms (two workers max. = 1 family)
Also medium sized farms (up to 12 workers max.) = higher total productivity
than latifundia and minifundio
However, developed LA nations moving towards "nontraditional exports" like
Chile and Brazil
The governments guaranteed price was never paid
Complementary inputs were never made available or their use was too
problematic.
The landlord secured much of the gain
Distribution of land over time changes
Microeconomics of Farmer Behavior and Agricultural Development: The Transition from
Peasant Subsistence to Specialized Commercial Farming
Evolution of agricultural production can be divided into three broad stages:
1. Low-productivity, mostly subsistence-level peasant farm, still prevalent in Africa.
2. Diversified or mixed family agriculture, where a small part of the produce is grown
for consumption and a significant part for sale to the commercial sector as in Asia.
3. Modern farm, exclusively engaged in high-productivity specialized agriculture
geared to the commercial market, as in developed countries and often found in the
highly urbanized developing countries.

Agricultural modernization mixed-market developing economies are described in

terms of gradual transition from subsistence to diversified and specialized
production.
This involves more than reorganising the structure of a farm economy.
It requires adapting the farm structure to meet demand for increased
production, and profound changes affecting the entire social, political and
institutional structure.
Subsistence Farming: Risk Aversion, Uncertainty and Survival
Peasant farm:
Most output is for family consumption.
A few staple foods are the chief sources of nutrition.
Output and productivity and low.
Only simplest traditional methods and tools are used.
Capital investment is minimal.
Land and laborare the principal factors of production.
Much of the cash income is generated from non-farm activities.
Small scale farmers does not fit the traditional two factor neoclassical theory of
production
Traditional two factor neoclassical theory of production : Land = fixed factor,
diminishing returns from additional use of labor = low productivity.
Small-scale farmers are often resistant to technological innovation in farming
techniques, because access to information is imperfect and transaction costs
of obtaining information is high.
Price uncertainty --> the peasant faces a wide range of possible prices rather
than a single input price
Limited access to credit and insurance --> peasant behavior is risk-averse.
Small Farmer Attitudes Toward Risk: Why it is sometimes rational to resist innovation
Minimum consumption requirement (MCR) - necessary for farm family's physical
survival
Starvation minimum fixed by nature
Any output lower than this level is catastrophic for peasant family
Minimum desirable consumption level (MDCL) - given prevailing cultural or potential
productivity factors affecting village consumption standards
Assume this line increases given time
X-Axis = Time
At Time X
Farmer A - near the MCR = low output, barely surviving, no chance for crop
failure
Farmer B - near the MDCL = better performance, more output
Farmer B is more likely to innovate than Farmer A
B/c Farmer B is not immediately threatened by the chance of not
surviving
Result: Farmer A remains in poverty trap, self-perpetuating , inequality grows

Crop Yield Probability Densities of Two Different Farming Techniques

Alternative manner of assessing risk aversion
Graph displays hypothetical probabilities for crop yields
Technique A - production technology with lower mean crop yield of 10
Technique B - production technology with higher mean crop yield of 12
Greater chance of starvation due to lower probability of crop yield
Risk-averse farmers would prefer technique A, lower mean yield
Farmers pay for "self-insurance"
Insurance is important, reduces risks and encourages innovation

The Economics of Sharecropping and Interlocking Factor Markets

The phenomenon of risk aversion among peasant farmers in the presence of high
land inequality helps explain the prevalence of sharecropping throughout much of
Asia and Latin America.
Share cropping: occurs when a peasant farmer uses the landowners farmland in
exchange for a share of food output grown.
The poor incentive structure of share cropping lends itself to inefficiency
Diagram ---> Marshallian approach
X-axis = labor inputs --> number of hours of work or total effort
Y-axis = output per unit of labor
VMPL = value marginal product of labor
Farmer that owned land would work until VMPL = alternative wage or
opportunity cost of labor (Wa)
Lf = Efficient amount of work where VMPL = Wa
Sharecropper receives a fraction () of the farmers efforts = VMPL
Where <1
Result = sharecropper would have an incentive to put in an inefficiently low
level of effort, Ls
Incentives under Sharecropping

Monitoring Approach
Steven Cheung, 1960
Contract b/w sharecropper and farmer for production, if failed, employ another
willing hard worker to perform --> result = sharecropper is efficient
Contrast to Marshallian approach illustrated below
Screening hypothesis
Landlords offer sharecropping and pure rental contract
Pure rental contract are preferred by high-productivity workers
Screening by landlord by seeing which workers take pure rental contract
Alternative approach
Sharecropping is efficient
Sharecropping = compromise b/w risk to the landlord that the tenant will not
do much work and the risk to the tenant that a fixed rent willing some years
leave him no income
The Transition to Mixed or Diversified Farming
Diversified or mixed farming: represents a logical intermediate step in transition
from subsistence to specialized production.
In this stage, the staple crop no longer dominates farm output and new cash crops
such as simple animal husbandry.
These activities can take up slack in farm workloads during times when disguised
unemployment is prevalent.
Diversification can reduce impact of staple crop failure and provide security of
income
Transform traditional agriculture = farmers ability and skill in raising productivity+ the
social, commercial and institutional conditions
Access to credit, fertilizer, water, crop informationand marketing facilities + market
price for his output + insurance of direct benefit to family and farmer = farmer is open
to innovation

From Divergence to Specialization: Modern Commercial Farming

Specialized farm: Represents the most advanced stage of the evolution of
agricultural production in which farm output is produced wholly for the market
Represents advanced individual holding in a mixed economy, common in industrial
nations
Characterized by improved living standards, biological and technical progress, and
expansion of national and international markets
The provision of food for the family with some marketable surplus is no longer the
goal.
Pure commercial profit becomes the criterion of success and maximum per-hectare
yields derived from synthetic and natural resources become the object of farm
activity.
Concepts such as fixed and variable costs, saving, investment and rates of return,
optimal factor combinations, maximum production possibilities, market prices and
price supports are qualitatively and quantitatively significant.
The common features of all specialized farms are their emphasis on the cultivation of
one particular crop, their use of capital-intensive and labor- saving techniques of
production, reliance on economies of scale to reduce unit costs and maximize
profits.
Some large specialized farming operations are owned by large multinational
corporate business enterprises.
Core Requirements of a Strategy of Agricultural and Rural Development
Improving Small-Scale Agriculture
Technology and Innovation
Two problematic sources of technological innovation can increase farm
yield
Mechanized agriculture to replace human labor, can cause
unemployment for low skilled workers given abundant labor
supply
Biological (hybrid seeds), water control (irrigation) and chemical
(fertilizer) innovations - scale-neutral (apply equally on
large/small farms) - environmental challenges and costs
Institutional and Pricing Policies: Providing the Necessary Economic
Incentives
Social institutions and government economic policies not scale-neutral
for innovation of rural sector
They often serve the vested interests of wealthy landowners
Widening of gap b/w rich and poor, increased consolidation of
agricultural land in few progressive farmers.
Adapting to new opportunities and new constraints
Nations exporting horticulture (fruits, flowers) and aquaculture and other
nontraditional exports
Organic and Fair Trade products, coffee and spices
Small farmer needs special organization and assistance to take advantage
Constraint --> environment = climate change, global warming
Less access to water and irrigation --> major problem with small
farmers
Agrochemicals has large human and ecosystem costs
Conditions for Rural Development
Land Reform
Farm structures and land tenure patterns must be adapted to the dual

objectives of increasing food production and promoting a wider distribution of

the benefits of increasing food production and promoting a wider distribution
of the benefits of agrarian progress, allowing further progress against poverty
Definition: deliberate attempt to reorganize and transform agrarian systems
w/ the intention of fostering a more equal distribution of agricultural incomes
and facilitating rural development
Redistribution of rights of ownership or sue of land away from large
landowners in favor of cultivators with very limited or no landholdings
Government must work with all farmers
Securing provisions for tenure rights to individual farmers -> self-worth
Supportive Policies
The full benefits of small-scale agricultural development cannot be realized
unless government support systems are created that provide the necessary
incentives, economic opportunities, and access to needed credit and inputs to
enable small cultivators to expand their output and raise their productivity.
Example: Micro-financing
Integrated Development Objectives
Rural development, though dependent primarily on small-farmer agricultural
progress, implies much more. It encompasses
a) efforts to raise both farm and non-farm rural real incomes through
job creation, rural industrialization and other non-farm opportunities
and the increased provision of education, health and nutrition, housing
and a variety of related social and welfare services;
b) a decreasing inequality in the distribution of rural incomes and a
lessening if urban-rural imbalances in incomes and economic
opportunities;
c) successful attention to the need for environmental sustainability
limiting the extension of farmland into remaining forests and other
fragile areas, promoting conservation, and preventing the harmful
misuse of agrochemicals and other inputs;
d) the capacity of the rural sector to sustain and accelerate the pace of
these improvements over time