Week 5 - History, expectations, traps and multiple equilibria 1

Question 1

Why is discussing the proximate causes of underdevelopment e.g. low TFP, low Investment, not ideal?

Answer 1

Because these are not root causes of underdevelopment, they are just as much a symptom as they are a cause

Question 2

What is underdevelopment more likely to be as a result of?

Answer 2

Not as a failure of socio-cultural values or some economic parameter, but as an interactive outcome in a system, perhaps precipitated by some historical accident or inertia and path dependence.

Question 3

More specifically, what can we attribute differences in the steady state determinants to?

Answer 3

Intrinsic differences in the willingness or ability to save or to procreate.

Question 4

Why did we adopt the QWERTY keyboard?

Answer 4

To slow down mechanical writers so their typewriters won’t get jammed.

Question 5

Even though other keyboards are more efficient, why do we still use the QWERTY keyboard? (2)

Answer 5

1. For a single firm it does not make sense to switch to a different keyboard as retraining typists would be too high
2. Why would typing schools teach a different keyboard which no one uses?

Question 6

What is the key issue made apparent by the QWERTY keyboard example.

Answer 6

If everyone switched their keyboard, there would be substantial efficiency gains, but no one wants to switch. Return to switching depends on what everyone else does.

Question 7

What is complementarity?

Answer 7

When the number of adopters of a system depends positively on other adopters.

Question 8

What kind of externality does using a QWERTY keyboard exhibit?

Answer 8

Positive externality

Question 9

Where are the equilibria on the QWERTY/Dvorak cost diagram. State whether they are stable or not

Answer 9

Everyone uses QWERTY - stable
Everyone uses Dvorak - stable
50/50 - unstable

Question 10

What are some other examples of complementarities?

Answer 10

Social media: instagram, twitter, airbnb
Infrastructure with a fixed cost component
Evading taxes

Question 11

How does the Romer AK model exhbit complementarity?

Answer 11

An individual firm is more likely to invest if future productivity is high, which depends on the investment of all other firms. Therefore investment is more profitable if more other firms invest.

Question 12

What are the two stable equilibria in the complementarities in investment diagram?

Answer 12

When everyone invests
When no one invests

Question 13

True or False: Complementarities can lead to an economy to be trapped in a bad equilibrium

Answer 13

True - a better equilibrium is available if all agents appropriately coordinated their actions.

Question 14

How can underdevelopment by underinvestment be explained as a coordination failure?

Answer 14

A better equilibrium is available if only all agents could appropriately coordinate their actions. But no one invests because everyone thinks no one will invest.

Question 15

What is demand complementarity?

Answer 15

If one sector e.g. steel, is doing very well, then they want more coal to increase production of steel so the coal sector would experience an increase in demand. Many sectors of the economy are linked - they can all bring each other up or pull each other down

Question 16

What is Rosentein-Rodan’s idea of the big push?

Answer 16

Simultaneously raise investment in many sectors of the economy.

Question 17

What are 2 problems of this ‘big push’ idea?

Answer 17

1.Need immense, and presumably, public investment in many sectors at once. A gov’t in poor countries won’t have resources for this.
2. Need a fairly precise idea on how to allocate investment across sectors.

Question 18

What is Hirschman’s solution of unbalanced growth?

Answer 18

Selectively promote development of a few sectors and let the linkages with other sectors work their magic to bring us to the better equilibrium.

Question 19

How would you select these key sectors? (3)

Answer 19

1. Number of linkages
2. Strength of linkages - backward stronger than forward linkages
3. Intrinsic profitability of each sector. Focus on sectors that are important for the rest of the economy, but private investment isn’t that high.

Question 20

What is the underdevelopment trap based on?

Answer 20

The idea that history or initial conditions pin us down in a bad equilibrium, from which it is then very difficult to escape.

Question 21

True or false: If expectations change, we can move to a better equilibrium.

Answer 21

False

Question 22

Why are expectations alone not enough for someone to make an investment?

Answer 22

Making an investment is very costly, so it’s more prudent to wait a little bit until the returns build up (which you might be expecting it to) but if everyone does this then the investment won’t go up so no one will make an investment.

Question 23

Why might a poor country looking to develop an export sector that specialises in high value items not be able to?

Answer 23

Requires a constant supply of skilled engineers, but since there are currently none, the cost of investing is high for firms.

Question 24

If everyone expects people to move to the ‘new’ sector, why might this sector end up not getting developed?

Answer 24

Expectations ignore time - returns to skills do not adjust instantly when people move, so expectations alone are not enough to make people move. You wait until returns actually increase, but if everyone is waiting no one will join.

Question 25

True or false: People delay actions to allow returns to build up.

Answer 25

True

Question 26

When might expectations be enough to get people moving?

Answer 26

If there is some advantage to moving first e.g. better jobs, regional dimension: later movers face higher moving costs. In this case, agents might be willing to bear the lower current returns to get larger benefits or face lower costs in the future.

Question 27

Explain increasing returns to scale with a production function Y = F(K,L)

Answer 27

If you have a PF: Y = F(K,L)
and then multiply K and L by some factor λ >1, then F(λK,λL) > λY.
Average cost falls as production expands.

Question 28

What are some key things to keep in mind with IRS? (2)

Answer 28

Ability to realise gains from IRS depend on the size of the available market for the product.

size of the market might depend on the ability to expand production and pay income to employees

Question 29

How can IRS lead to a development trap, using an example of a domestic car market?

Answer 29

A small manufacturer designs a new car which is more efficient, but due to a higher average cost (due to the large manufacturer experiencing IRS) will have to operate at a loss whilst people take time to switch, which some the maunfacturer can’t afford.

Question 30

What are the 3 reasons the manufacturer cannot bring this to market?

Answer 30

1. IRS in production
2. People taking time to switch
3. Missing or incomplete credit markets