Global Econ Issues Exam 1

After 1820 Karl Marx

- A German born social scientist - He saw people working long hours for low wages in unhealthy conditions. - CHILD LABOR was widespread during that time - REBELLED against the increasingly ugly uneven distribution of income during the industrial revolution - He saw society as evolving and changing overtime. - He built his ideas on the CLASSICAL economic model - According to Marx, income was split into: o WAGES to the workers (the proletariat) o PROFITS to the owners of capital (the bourgeoisie) o RENT to the landed aristocracy Marx saw huge INEQUALITIES in income and living conditions which prevailed that time as a major problem in society Marx suggested that the solution to this problem was to SPREAD the ownership of the factories to people who worked in factories. Marx incorporated social and political processes in an economic model. This differentiated him from the classical school. His model was therefore much more HOLISTIC.

International Trade and Factor Accumulation

- Adam Smith's model: understand the entire model both graphically and in words - Smith sought to explain how a nation's economy could increase the wealth of its citizens.

Economic development

- Describes a full range of changes in humanity's economic, social and natural environments that are perceived by people as making life more pleasant and satisfying - Fact: poor countries are normally less developed, but rich countries could be less developed - Today there is a huge economic and social differences between developed countries and the rest of the world

After 1820 *Assumptions MARXIST*

- ECONOMIC GROWTH was a result of investment by the bourgeoisie, that is, capitalists controlled the principal means of production in the economy. - He gave NO explicit role to agriculture, maybe because he was in London. - CAPITALISM had a role in economic growth, i.e. good for technological innovation. - he saw serious INTERNAL inconsistencies associated with CAPITALISM - Argued that capitalism did not generate SUSTAINABLE economic and social development. He believed that each successive SOCIAL SYSTEM was an improvement on earlier systems. - such improvements are achieved through the application of logic, reason and the acquisition of new knowledge He saw capitalism as: 1. SUPERIOR to pre-capitalist way of life 2. GENERATOR of technological progress 3. De-humanizing, i.e. resulted into a system that turned people into mere labor machines which he termed the commodification of labor The two main shortcomings of capitalism: commodification of labor and generation of huge income inequalities were enough to make capitalism bad despite the technological progress it brought according to Marx.

Malthus' theory of population

- Eventually, the rate of population growth will outpace that of food. He argued that this cannot occur indefinitely and that population growth will be restrained in two ways: - War, famine, disease and malnutrition - Celibacy - Abortion - Postponement of marriage === Malthus was mostly interested in this.

Real GDP

- Production of goods and services - Valued at constant prices - Designate one year as base year - Not affected by changes in prices

Nominal GDP

- Production of goods and services - Valued at current prices

economic growth

- an increase in material output per capita, which is measured by GDP or GNP. But an increase in per capita GDP does not lead to a higher standard of living if growth is not evenly distributed - Economic growth is a precondition or necessary condition for economic development

Three ways in which specialization and economic growth are linked

1. Smith noticed that specialization leads to economies of scale in production o production needs to be organized into larger business organizations in order to exploit economies of scale 2. By permitting individual resources to be allocated among different tasks according to their abilities and capacities, specialization increases economic efficiency o Smith advocated for Free Trade and international specialization across countries. o Specialization allows for gains to trade to be realized through comparative advantage . 3. Specialization/division of labor allows an economy to benefit from learning by doing. o Specialization makes it more likely that people develop new tools and technology.

a) the production function will shift upwards b) a downward shift in the savings function c) a downward shift in the depreciation line d) a downward shift in both savings function & depreciation line

According to the Solow Growth Model, all other things equal, the decline in population growth will lead to.. (c)

Specialization and exchange

Adam Smith suggested that division of labor/specialization was a fundamental characteristic of economic growth.

After 1820 An evaluation of the classical model

An evaluation of the classical model - The model is viewed as Disapproved hypotheses, i.e. predictions of eternal poverty. - The model explained what was going on back in the 1800s and not today. - Population Grew tremendously over the past 200 years. - The classical model failed to anticipate that world output would grow FASTER than population and permit real output to grow continuously over the last 200 years.

no obstacles indefinitely

As long as there are ______ to division of labor, economic growth will continue ______ according to the Smithian model.

Philosophers and speculators

By philosophers and speculators, Smith was talking about what we call entrepreneurs today. These are energetic and risk-loving individuals who come up with innovative ideas.

Cost of the basket: Cost in Year 1 - (3x10)+(4x12)=$78 -- Cost in Year 2 - (3x12)+(4x15)=$96 -- Cost in Year 3 - (3x14)+(4x18)=$114 Using Year 1 as the base year, compute the index: - CPI in Year 1 = (78/78)x100 = 1x100 = 100 - CPI in Year 2 = (96/78)x100 = 1.2308x100 = 123.08 - CPI in Year 3 = (114x78) = 1.4615x100 = 146.15 Inflation rate for Year 2: [(146.15-123.09)/123.08] x 100% = 18.74% Inflation rate for Year 3 [(146.15-123.08)/123.08]x100% = 18.74

Calculate the inflation rate Calculate the cost per basket Calculate CPI Year 1 - Price of footballs $10 - Price of basketballs $12 Year 2 - Price of footballs $12 - Price of basketballs $15 Year 3 - Price of footballs $14 - Price of basketballs $18

After 1820 Marx's model of capitalist development

Capital accumulation by the bourgeois capitalist was driven by profit He referred to profit as a surplus denoted by R in: He argued that the long run rate of growth of output depends on the INCOME of the bourgeoisie, the surplus. The surplus, R, provides the savings to fund capital investment. Marx hypothesized that the ratio of surplus to output would DECLINE overtime. According to Marx, the bourgeoisie's attempts to maintain profits in the face of declining demand would end up triggering a social revolution that replaces the capitalist system with a communist system whose key feature was the 'abolition of private property'. To increase profits, the bourgeoisie introduced more efficient production methods by investing in new and better productive facilities. In this wake: · profits would decline because of high UNEMPLOYMENT · CAPITLIST would replace labor with machines and technological improvements in productive efficiency. The end result is · High UNEMPLOYMENT · fall in DEMAND for output · fall in capitalists' SURPLUS Marx's model suggests that the capitalist's profit share on output increases if: 1. the WAGE declines 2. the amount of labor employed DECLINES 3. the cost of capital DECLINES 4. the amount of capital needed to produce output DECLINES Capitalists therefore want to keep wages low. Marx recognized that there are limits to how far capitalists can reduce wages. · If people have low incomes, they are less productive. If wages are reduced to subsistence levels, capitalists will replace workers with machines. Labor saving technologies led to a lower the wage bill. Marx noted that capital DEPRECIATES · The more capital is employed, the more capital depreciates and must be replaced to maintain production. Marx's focus on income distribution and the potential for shifts in the distribution of income to investigate social and political change was an important contribution to our understanding of the process of economic development. His assumption that profit drives innovation and investment has been used in later models of economic growth and technological change. ***Marx explicitly linked the development of an economy to social class conflicts, political shifts and cultural change.

Avoiding diminishing returns to labor

Diminishing returns to labor can be avoided if the quantity of land expanded proportionately along with labor.

GDP per capita

GDP dived by the world's population

Harrord-Domar model (focus only on the supply side of the model presented in class)

Harrord -Domar model (focus only on the supply side of the model presented in class) You should be able to: · recall the Harrord-Domar model's assumptions 1. The marginal product of capital is CONSTANT. a. Each additional unit of capital increases final output by the same amount. b. capital inputs do not suffer from diminishing returns 2. CAPITAL does not suffer from depreciation 3. Productive investment is always equal to PRODUCTIVE SAVING This model will be presented in mathematical form because the mathematics involved is simple. 1. The economy's supply of output (Y) consists of two categories of commodities, consumption goods(C) and investment goods (I). That is, Y= C + I (1) 2. Investment can be represented by the change in the stock of capital, , where signifies "the change in." All savings are invested productively. Substituting into equation (1), we have (2) The assumption that the change in capital stock is equal to investment implies that the stock of existing capital[JH11] does not suffer any depreciation. That is, Harrod and Domar implicitly assumed that the existing capital stock never wears out or becomes obsolete and thus investment always increases the total stock of capital. This is a weakness in the Harrod-Domar model; in the long-run, most capital depreciates. 3. Harrod-Domar assumed a constant capital output ratio: (3), where is a constant. Now let us move Ys in equation (3) to the right hand side (4) Now let us divide both sides of equation (4) by to move to the left hand side. We have or (5) It is clear in equation (5) that output is proportional to the stock of capital. Now let us define A as equal to . We can rewrite equation (5) as: (6) There are no diminishing returns to capital in this model. The Harrod-Domar model assumes that there is an unlimited stock of other factors, such as labor, available to combine with capital so that there are constant returns to scale. · recall the Harrord-Domar model's conclusions · The Harrod-Domar model concludes that the rate of growth in output is DIRECTLY PROPORTIONAL to the rate of saving. · How can we show their conclusion here? · Notice that the constant capital-output ratio, A, also implies that the change in output is proportional to the change in the stock of capital. That is, · (7) · For the economy to invest in capital, it must save. We assumed above that all savings, S, are indeed invested productively and therefore generate output in accordance with equation (6). Thus, if people save the fraction of their income, then the change in the capital stock will equal to: · (8) · · If we put equations (7) and (8) together, it follows that · (9) · Dividing both sides by Y, we have: · (10), where refers to the growth rate of Y. · What do we learn about economic growth from this model[JH12] ? · · · This model tells us that the rate at which the economy can grow is a constant determined by the economy's rate of savings, and the technical capital-output ratio, . As long as investment increases the stock of capital, growth will continue indefinitely. Economic growth is exclusively a result of factor accumulation. · Suppose that the savings rate is 20% of income and every $100 of output requires capital valued at $500 (implying that ). The equation (10) tells us that output will grow by: · Suppose savings rate was 30% and the capital output ratio . The growth of output can be sustained at 0.3/5 = 6[JH13] % =4 · calculate the growth of GDP according to the Harrod-Domar model

Malthus' hypothesized..

He hypothesized a function linking population growth directly to real income. If people are well off they - can afford to eat well - live Longer - have more surviving children Decreases in real per capita income will lead to - an increase in death rate - an increase in starvation and disease - shortened life expectancy reduces birth rate

[(GDP2014-GDP2013)/GDP2013]*100%

How to calculate the growth rate per capita GDP For 2014 and 2013

After 1820 Income distribution according to the Classicals

Income distribution according to the Classicals - Classicals saw many owners of industries becoming WEALTHY. They concluded that land owners are the only ones who gain from economic growth.

When an increase in specialization lead to new gains to trade emanating from comparative advantage and economies of scale

Increases in specialization may be due to: - institutional changes, - advances in transportation - the invention of money - technological progress

The production function assumed by the Classicals

Let's assume the following production function of the general form, Y = f(L,N), where Y is output, L is labor and N is land. Further assume land is fixed in supply. In the absence of technological progress, the only way to increase output is therefore to increase the amount of labor. Because labor is combined with a fixed stock of land, it is subject to diminishing returns. As more and more labor is added to the production process, output rises by smaller and smaller increments. (see notes) figure 4.

Malthus' theory of population

Malthus hypothesized that the "passion between the sexes" would cause population to grow in a geometric progression, but food production was constrained to grow arithmetically because of the limited power of the earth to produce subsistence.

Classical Economists and Diminishing Returns

One of the concepts that have become central to modern growth models is diminishing returns. Thomas Malthus, David Ricardo, John Stuart Mill and other early 19th century economists applied this concept to the process of economic growth.

The Malthusian Population Function

P= Population Change in P/P = population growth, Delta P = change in population Y/P = real per capita income. If real per capita income, Y/P, is above y2, death rate is less than birth rate and the population grows. If real per capita income, Y/P, is below y2, death rate is greater than birth rate and the population shrinks. At y2, death rate = birth rate, there is zero population growth or ZPC. Interpretation - The model suggests that humanity is destined to remain at subsistence levels of real per capita income. - Our children cannot expect to be better off than us/parents. - Technology has no lasting effects on living standards. A dismal new equilibrium Malthus's model fails to capture such an improvement in human welfare - e.g. the discovery of the smallpox vaccine early in the twentieth century which reduced the death rate. All other things equal, the population function shifts upward from pp to p'p' - This leads to a fall in the ZPG line which implies an equilibrium at a hihgerpopulation. - Real per capita income falls, and poverty increases.

o Economic, o Environmental o geopolitical o Societal o technological

Recall the 5 categories of Global risks/issues used by the World Economic Forum

2017: 1. Unemployment or underemployment 2. Energy price stock 3. Fiscal crises 4. Failure of national governance 5. Profound social instability 2018: 1. Unemployment or underemployment 2. Fiscal crises 3. Failure of national governance 4. Energy price stock 5. Profound social instability

Recall the top 5 Global Risks/Issues of highest concern when doing business in 2017 and 2018.

**Institutions**

Smith recognized the need for institutions. A variety of institutions need to be established for markets to work properly. These include: · Laws · Rules · Regulations · Customs · Justice systems · Traditions · Religions · Other social pressures that constrain or encourage people in their quest maximize welfare - Smith saw Limited government interference in an economy as necessary for specialization to help stimulate an economy through innovation.

· Over time other things do not remain the same. · The complex interactions between the economic, social and natural spheres guarantee that nothing stays the same in the long run

Such microeconomic analysis is of little use for development economics because:

Diminishing Returns and Population Growth

The evidence available to the classical economists in 1800 shows population growth had adverse effects on standards of living. In fact, population growth consistently caused living standards to revert to back to subsistence levels. The evidence suggests that in a world where production is subject to diminishing returns and technological progress is very slow, population growth is detrimental to economic growth.

International Trade's Role in the Growth Process

The role of international trade in the classical or Malthusian model of diminishing returns is obvious.

- Extreme weather events (1) - Large scale involuntary migration - Major natural disasters - Large scale terrorist attacks -Massive incident of data fraud/theft (5)

What are the 2017 Global Risks according to Impact (top 5) and the likelihood of occurrence (top 5).

- Extreme weather events (1) - Natural disasters - Cyberattacks - Data fraud or theft - Failure of climate change mitigation and adaptation (5)

What are the 2018 Global Risks according to Impact (top 5) and the likelihood of occurrence (top 5).

Impact: 1. Weapons of mass destruction 2. Failure of climate-change mitigation and adaptation 3. Extreme weather events 4. Water crises 5. Natural disasters Likelihood 1. Extreme weather events 2. Failure of climate-change 3. mitigation and adaptation 4. Natural disasters 5. Data fraud or theft Cyber-attacks

What are the 2018 Global Risks according to Impact (top 5) and the likelihood of occurrence (top 5).

- the need to raise living standards in less developed countries(LDCs) - the cold war

Why was there interest in economic growth and economic development after WWII?

Economic change

any change in the performance or structure of an economy

Increases in specialization

drive innovation; the resulting technology growth in turn drives further specialization, which then stimulates further innovation.

Standard models of international trade

how that trade increases the efficiency with which an economy's resources are transformed into welfare-enhancing goods and services. - The expansion of international trade represents a spurt of Technological progress.

A graphical representation of the Smithian model

look in notes for this model At time=0 The level of per capita income is A, and it's a result of past factor accumulation and innovation. Between time=0 and time = 1 Innovation, research, discovery and learning by doing are continually taking place Per capita income grows to B The growth path is Ab. The slope of this path depends on the amount of innovation. At time=1 Money is introduced. The introduction of new money permits a sudden increase in specialization and raises per capita income to C. Innovation, research , discovery and learning by doing continue at a higher rate due to increased specialization The growth path cd rises at a more rapid rate than it did before the increase in specialization At time = 2 Suppose a second institutional change occurs at time =2 e.g. a switch to Free trade (open economy) We will witness another sudden jump in specialization causing per capita income to rise from D to E. The new growth path for the economy rises more steeply after time = 2 due to increased specialization.

An increase in the Level of specialization is likely to be associated with the discovery of easier and readier methods of production.

more specialization accelerates the rate of technological progress

Diminishing Returns and Technology

notes

Static models

o Designed to generate an equilibrium without explicit reference to the path followed in moving the economy toward that equilibrium over time. o Before and after centered. o No concept of time. o Focused on the allocation of resources in the economy under the static all other things equal assumption. o Completely ignores the long run evolution of an economy.

Heterodoxy versus orthodox economists

o Development economists adopted a more holistic approach, heterodox economics o Most development economists rejected the neoliberal paradigm o They continued to address issues that were not incorporated in simple mathematical models (orthodox) e.g. poverty, hunger, famine, oppression, colonialism, income inequality, population growth, discrimination, ethnic conflict, corruption and many more.

Sustainable economic development

o Economic change and development that maximizes the needs and aspirations of the current generation without sacrificing the ability of future generations to meet their needs and aspirations

Classical economists

o Holistic approach o broad topics over and above economics

Prior to 1800

o Positive productivity shocks occurred, with the expansion of trade or improvements in machines o The positive productivity shocks were not frequent enough to overcome diminishing returns to the gradually rising population. o Trade grew slowly but people's standards of living Barely changed. There was no apparent correlation between trade and growth.

Neoclassical Economists

o Scientific reductionist approach o Only focused on the economic sphere o Focused on how individual markets worked, assuming that the overall economy is a fixed system, a simple sum of its components. o Reliance on static models

Holistic science

o Studies complex systems o Recognizes the presence of dynamic feedback within complex systems. o Takes an interdisciplinary perspective in order to achieve an understanding of complex systems.

After 1820

o The growth of international trade coincided with humanity's escape from poverty toward ever-higher real per capita incomes, a process that continues today. o In sum, international trade is important for economic growth.

Economic Model

o a simplification of reality that explicitly highlights key relationships that we deem important to understanding and analyzing certain economic issues. ex. The model of demand and supply. o can be linear or non-linear o can be stated mathematically, graphically or verbally

Gross Domestic Product (GDP)

refers to the total value of goods and services produced in an economy

Holism

the explicit recognition that the component parts cannot be understood in isolation and their functions cannot be predicted without knowing the whole environment in which they exist.

Process of economic development

will continue with institutional changes, advances in transportation, the invention of money, and continuous technological progress between the sudden jumps.

Te Solow Growth Model

· Increases in saving and investment only lead to medium-run economic growth as the economy transitions to a new steady state and not permanent growth. · An economy will experience PERMANENT economic growth if it experiences technological progress. The Solow growth model explains how medium and long run economic growth are related to investment and technological progress. Recall the impact of gains to trade on the Solow Growth equilibrium. · An increase in international trade brought about by a shift in trade policy will: · Shift the economy's steady state · Cause medium-run growth as the economy transitions to a new steady state. · The composition of trade, consumption, capital goods or both, influences the medium-run growth. · An increase in trade cannot generate permanent economic growth unless the economy experiences continued technological progress. · International trade can only contribute to permanent economic growth if it directly influences an economy's rate of technological progress. Recall the shortcomings of the Solow growth model · Investment and technological progress are assumed to be determined outside of the model. · The model does not explain how economic policy might be able to influence the rate of saving and the rate of technological progress. · The Solow model provides a great service by highlighting where we need to look for the determinants of long-run economic growth.