CH4 Flashcards
economic development
improvements in living standards and in the quality of life
economic growth
measures only growth in economic production - may not reflect all aspects of economic development, as growth often results in negative impacts on the quality of life (eg. pollution)
2 main explanations of why some countries are wealthy and some are poor
geography & institutions
factors of production
the inputs used to produce a good or service in order to produce income - are fundamental determinants of output
value added
value of output - value of inputs used in production
is the basis for measuring production in the economy (avoids double counting)
factor abundance
the relative availability of the different factors of production
do highly developed countries have more labour or capital
capital, production relies more heavily on capital
do poor countries have more labour or capital
labour, which results in capital of lower quality
Production Function
mathematical expression of the joint effect on the factors of production
Production Function Equation
Yt = F(Kt, Lt)
if a firm had either no labour or no capital, the output of the production function would be:
zero
constant returns to scale
if we multiply each factor by the same number, output is also multiplied by that number
increasing returns to scale
output is multiplied by more than 2 if labour and capital are multiplied by 2
decreasing returns to scale
output is multiplied by less than 2
factor productivity
the contribution of each factor of production to output
average labour productivity
obtained by dividing national output by total employment in the economy; tells us how much on average one worker contributes to national output in a given year
capital intensity
how much capital there is per worker
marginal productivity
the output increase caused by an additional unit of labor (or capital) in the economy
diminishing marginal productivity
the more labour (or capital) added to the economy, the smaller the additional output that will be generated
factor shares
the share of national income used as payment for the share of capital (or labour) in production
growth accounting
estimates what percentage of an economy’s growth rate we can explain using the growth rate of the labour force, the growth rate of the capital stock, and residual factors
total factor productivity
the part of output that labour and capital cannot explain; the result of technological progress
steady state
population grows at rate n, savings rate is s, capital accumulation is such that the level of capital intensity remains the same period after period
human capital
the knowledge embodied in people
income convergence
poor countries should grow faster than rich countries because they have a higher marginal product of capital
is there a negative correlation between initial GDP per worker and growth?
no
this could be explained by differences in tech change across countries
endogenous growth theory
suggests growth is generated by endogenous technical change resulting from entrepreneurial innovation
non-rival good
good that can still be consumed by the seller even after it’s sold
excludable good
a seller can exclude others from its consumption
monopoly rents
extra profits derived from monopoly status
extractive/predatory institutions
intended to exploit a country’s resources
why does endogenous growth predict rich countries should grow faster than poor countries?
because their knowledge base is larger
solow model assumes:
diminishing marginal returns to capital
endogenous growth theory derives economic growth as based on:
technical change
role of geography as an explanation for large differences in income across the world (2)
1) economic activity is more difficult in tropical areas because of the head & tropical diseases
2) landlocked areas are more isolated & have less access to trade opportunities
solow model vs endogenous growth theory
exogenous growth model/ solow model
- assumes perfect competition, in which factors are paid according to their marginal productivity and capital accumulates until the marginal product of the last unit of capital invested is equal to the interest rate or rental price of capital.
- Innovation is exogenous
- Predicts convergence of income levels between poor and rich countries because poor countries with low capital intensity can acheive higher growth rates.
endogenous growth model/romer model:
- sees imperfect competition is necessary for growth. Monopoly rents provide incentive for innovation, which leads to growth.
- Innovation is endogenous and depends on stock of knowledge and r&d
- Predicts divergence of income levels between poor and rich countries bc rich countries will grow faster than poor countries due to their higher existing stock of knowledge. the theory holds that the more knowledge is in the economy, the higher its growth rate.
boundless knowledge based growth
The endogenous growth theory holds that economic incentives have the potential to bring about technological change that significantly reduces our use of finite resources and helps us transition to the use of renewable resources.
It considers the possibilities of knowledge production to be infinite.
Human capital vs knowledge
human capital: finite, w a limit to growth
- constrained by population growth because it exists in people
knowledge: can theoretically grow boundlessly because it is not necessarily embodied in people
- constrained by number of people doing research
In what circumstance can human capital grow faster than population?
where educational level is low, human capital can grow faster than population when progress is made in providing better quality education
What type of economic good is knowledge?
Knowledge is
1. non-rivalrous: can still be consumed by the seller even after it is sold
2. excludable: seller can exclude others from its consumption
Why innovate?
Entrepreneurs want to improve technology by either lowering costs for producers or delivering a new product to consumers. They do this in hopes of receiving the maximum amount of money from their innovations.
Incentive to innovation: monopoly rents =extra profits derived from monopoly status (exclusive rights to produce their innovation)
monopoly rents create imperfect competition but provides incentive to innovate
Romer model production function equation
Yt = Kt^alpha(At * LYt)^(1-alpha)
where
At = stock of knowledge
LYt = productive labor
such that
At*LYt = human capital in the productive sector
Romer model labor function
Lt= LYt + LAt
where
LYt = labor force in productive sector
LAt = labor force in research sector
Arguments for strict vs un-strict intellectual property rights enforcement
Un-strict enforcement:
Creates incentives required to motivate innovation, which will in the end benefit the poor.
Strict enforcement:
1. Alowing poor countries to produce innovations from rich countries gives poor the chance to catch up in growth rate and counter divergency
2. increases demand for innovation from innovating firms and rich countries
3. developing countries can achieve better economic outcomes if they have quicker access to technological transfers.
Knowledge externality tradeoff
overly strict enforcement of property rights is not optimal in terms of encouraging development in poor countries
tradeoff : incentives to innovation from strict enforcement vs benefits to developing countries from tech transfer from un-strict enforcement
2 geographic facts relevant to growth
- latitude (distance to the equator)
- poorest countries of the world are located in those tropical latitudes closest to the equator
- richest countries tend to be located in the more temperate zones, outside the tropics - geographic isolation
- much less population density in landlocked areas
What are the two competing hypotheses that explains differences in total factor productivity?
- Geography: differences in climate and geographical isolation cause differences in economic growth rates.
- Institutions: countries w strong institutions to protect property rights and investments will grow and develop faster than countries with weak institutions.
why does geography matter for growth and development?
- the tropics are less hospitable because of tropical diseases and intense heat
- disease –> increased mortality and negative impact on general health
- extreme heat –> reduces labor productivity, especially for farmers - the tropics experience significant volatility in rainfall amounts
–> negatively impacts the stability of agricultural production - landlocked areas have high transportation costs
- restricts trade (as compared to coastal areas w ports)
reasons why geography may not be the main cause of differences in development
- if geography played a major role in development, countries that were disadvantaged by geography should have always been poorer than countries located in more fortunate places
- but this is not always true
- ex Azetcs in Mexico and inca and peru were among most developed civilizations in the world but are now among the poorest areas
reversal of fortune study
- Acemoglu, johnson, and robinson documented trend of negative correlation between development in 1500 and development today
method
- proxy for development: level of urbanization (correlates to higher development since need high productivity of agriculture and well developed system of commerce and transport to sustain large cities)
- take measure of institutions from an indicator called “protection against expropriation risks”
results
- clear negative correlation between urbanization rates in 1500 and GDP per capita in 1995
- positive correlation between log GDP per capita and protection against expropriation risks
- institutional differences in developing countries are correlated with settler mortality at time of colonization
conclusion
- found that colonization by European powers destroyed civilizations and led to decline in development
- differences in development across world therefore likely more explained by institutions than geography
relationship between settler mortality and development
- some areas were inhospitable due to disease to settle in, even though they had valuable natural resources
- set up extractive institutions intended to exploit the countries resources
—> enslaved local native peoples and forced them to work, causing disease and death
ex congo - other areas were hospitable for settling, and so became neo-european states where institutions protecting property rights were established.
- type of institutions created long lasting effect on growth in former colonies
