Economic of Development

Briefly outline the motives for giving foreign aid to developing countries and discuss whether it [aid] has been effective in promoting economic growth.

Motives for giving aid to developing countries generally include humanitarian, strategic and political reasons, donor interest and recipient interest (the dual-gap model). Candidates are expected to discuss each of the above briefly. The second part of the question should discuss aid effectiveness. It should be noted that while early studies, following the work of Chenery and Strout (1966), reported a positive impact of aid on growth, later studies failed to find a robust relationship between the two variables. Excellent answers should discuss the contribution of Burnside and Dollar (1997, 2000) who argued that aid is effective in spurring growth within a good policy environment, although this finding has been refuted by subsequent studies.

Briefly explain why the market prices of factors of production may not reflect their true social cost.

There could be several reasons for this. First, the industrial wage is likely to exceed the cost to society of using labour in the presence of disguised unemployment on the land or petty service sector. Second, capital market price will be below its social cost if it is subsidised. Third, foreign exchange may be cheap from a social viewpoint if the exchange rate is kept artificially low by a policy of exchange controls. Moreover, the existence of external economies or diseconomies may also lead to a divergence between the prices of factors of production and their true social cost. If, for example, a project purchases inputs from a decreasing cost industry, the social cost is not based on average cost but on the lesser value of marginal cost. Additionally, externalities are often the cause of such divergence.

Consider the following diagram that shows an economy with a small amount of oil consisting of two industries only: oil and agriculture. The diagram shows marginal product of labour in these two industries; WA and WO are wages in agriculture and oil respectively. W (= WA = WO) is the equilibrium wage. Labour is freely mobile between these two industries but capital is industry specific. Oil explorations reveal a very large amount of oil in this country (Somalia is an example). What would you expect to be the impact of this find on the agricultural sector?

This is a question of the resource curse, or the Dutch Disease. We expect labour demand to increase in the oil sector, thereby generating mobility from agriculture to oil, and raising the equilibrium wage.

Assume R is defined as R = αY + F , where Y is the output on a specific plot of land, and α and F are parameters. Describe the condition(s) under which R would represent (i) a fixed rent contract, (ii) a sharecropping contract and (iii) a wage contract.

This is a very simple way to write the contract, and ignores input costs. If α = 0 and F > 0 then R = F , making the contract a fixed rent contract equal to F . If F = 0 and 0 < α < 1 then R = αY , and this is a sharecropping contract where α is the share of the landlord and 1 − α is the share of the tenant. If α = 0 and F < 0 then w = −F . This is a wage contract where the landlord pays F .

Empirical evidence supports the hypothesis that less developed (poorer) economies will converge to the same per capita income of more developed (richer) countries. True or false? Explain.

This is the Solow absolute convergence hypothesis. It states that countries with the same production function and parameters will have the same steady state per capita (per worker) income, hence the poorer country that is further away will have a higher growth rate. In steady state, with no technical change, the per capita income growth rate will be zero and the output growth rate will be equal to the rate of growth of the labour force/population. Empirical evidence presented in Ray, Section 3.5.3 clearly gives support against such convergence.

Assume a developing country, Protectoria, imports 100,000 cars under free trade. To reduce imports to 50,000 the authorities impose a tariff. (a) Analyse the static welfare effects of this tariff. (b) Now assume that the authorities decide to replace this tariff with a quota of 50,000. Show that this policy has the same effect as the above tariff. (c) Give at least one example where such protectionism can lead to a higher welfare in Protectoria. Support your answer with economic analysis.

(a) & (b) Assume that a tariff at a specific level, 't', achieves this objective. The answer to this is the two areas given by b and d in the diagram below. This is the standard static deadweight loss of a tariff and is the difference between consumer surplus loss (a+b+c+d), producer surplus gain (a) and government tax revenue (d). The case of a quota is similar. At the world price, if we restrict imports we will have excess demand. Price will rise until excess demand disappears. This will be the same price as the tariff price. Note that AB = 50,000. (c) There are at least three cases that students can discuss to support their answer to thisquestion. The infant industry argument is probably the most important one and should be presented here. An excellent answer would also include discussion of distortions in the commodity markets, and/or distortions in the factor markets.

In theory tariffs and quotas are equivalent. If this is the case then why are both instruments used by governments under the import substitution regime?

Although tariffs and quotas can mimic one another, there are fundamental differences in terms of their distributional effects. Under tariffs the revenue generated goes to the government, while under quotas revenues flow to the hands of the buyers. So depending on the power of various groups (government and business groups) both tools can be applied. In the presence of incomplete information (regarding the economy) the government might also want to use both tools.

Briefly explain how we measure inequality by a Lorenz curve and by the Gini coefficient. Consider the following graph. Will the Lorenz curve and the Gini coefficient rank the two countries in the same way?

A good answer must first explain the Lorenz curve and the Gini coefficient. The Lorenz curve is the plot of the cumulative population share versus the cumulative income share. We can only say that a country has less inequality if the Lorenz dominance is present. This means the country's Lorenz curve lies entirely within the other country's Lorenz curve and closer to the line of perfect equality, AB. The Gini coefficient is the ratio of ACB to triangle ADB. From the diagram, the two Lorenz curves cross and hence it is impossible to say which is more equal using the Lorenz curves. All we can say is that at the top of income distribution, the country represented by the dotted curve is more equally distributed, and in the middle the other country is more equally distributed, but at the bottom they are very similar. However, it is possible for the Gini coefficient to give the same ranking or different ranking to the two countries.

(a) Explain the Kuznets inverted-U hypothesis.(b) Outline its strengths and limitations. (c) Discuss whether it is supported by empirical evidence in the context of developing countries.

A good answer should note that the theoretical base of Kuznets' model is the Lewis dual sector model, where labour supply is unlimited. Given this unlimited supply of labour, as the economy grows, profits rise more than the wage bill - hence inequality rises. Once the unlimited supply of labour is exhausted, as the economy grows and therefore labour demand rises, the wage bill rises more than profit and so inequality falls. There are other explanations as to why inequality might worsen during early stages of development and then improve, although they all go back to the issue of structural change. Kuznets' contribution can be differentiated from the prevailing wisdom of the time in at least two important aspects. First, he focused on the household distribution of income and not on the class distribution of income. Second, for Kuznets the developing world is a non-homogeneous, two-sector system. At the empirical level, it should be noted that, while some cross-country studies appear to support the Kuznets hypothesis, time series studies find little support for it. In other words, once we single out the experience of individual countries, Kuznets' hypothesis does not hold. Another criticism of Kuznets' conclusion is that, in his sample, many of the middle income countries were in Latin America, a region with historically high levels of inequality. Cross country studies show that when some countries (usually Taiwan, China and Sri Lanka) are excluded, the inverted U is supported, but not otherwise. The best type of studies are country-specific studies. These show that, for some countries, inequality falls as development occurs; for others it rises and for some there is hardly any change. This indicates that pooling countries in a cross section analysis may give misleading results.

Explain what is meant by 'inflation finance' and examine its consequences in the context of developing countries.

A good answer should start by discussing how inflation can be used to mobilise domestic resources. To be sure, governments can finance expenditures in various ways. The quantity theory approach to the financing of development highlights the effect of inflation as a tax on real money balances. If the government uses money creation as a financing tool, in conditions where capital is fully employed, this expansion will lead to inflation. This gives the government a control over the real resources, whilst the price rise reduces the purchasing power of each monetary unit. Holders of money involuntarily give up the equivalent of the real resources obtained by the government. This process is referred to as inflation tax. In terms of its effects on developing countries, although inflation finance is closely related to the concept of demand-pull inflation, the discussion could centre around the effect of inflation on developing countries. Inflation can produce economic development by allowing the government, through inflationary finance, to control a large share of resources which can then be diverted to high priority sectors of the economy. It can also be used as a means of redistributing income from wage earners (who save less) to capitalists. In terms of the negative effects the discussion can outline the costs of inflation: for example, proliferation of a black-market economy, tax evasion, worsening inequality, market distortions, etc. Nafziger (2006, pp.486-87) provides a discussion on the potential costs of inflation. Finally, a discussion on the empirical evidence between inflation and growth can also be outlined. Indeed, it should be noted that the effect of inflation on growth is inconclusive as far as the empirical evidence is concerned.

Critically examine the financial repression argument.

A good answer should start by explaining the concept of financial repression. Indeed, financial repression refers to the view that a bundle of government policies, regulations, laws, and other restrictions stop the financial intermediaries of an economy from functioning at their full capacity. These policies generally include capital controls, interest rate and credit ceilings, high bank reserve requirements, liquidity ratio requirements, restrictions on market entry into the financial sector or restrictions on directions of credit allocation, and government ownership of banks. The main argument for financial restriction is that it allows a government to channel funds to itself more cheaply than would have been the case in a typical financial market. However, McKinnon and Shaw (1973) argue that such repressive policies would impede financial deepening and hinder efficiency of the financial system and thus impact negatively on economic growth. Indeed, McKinnon (1973) argues that money holdings and capital accumulation are complementary in the development process and therefore low interest rates would discourage agents in the accumulation of money balances and investment. Shaw (1973), on the other hand, highlights the importance of financial liberalisation and the beneficial effect of high interest rates on incentives to save and disincentives to invest in low yielding projects. High interest rates allow the banking system to increase its liability and, therefore, lend more resources to productive investment efficiently. Empirically, however, the case against financial repression is not as strong or unambiguous. Along the same line, Stiglitz (2000), for instance, argues that the recently increased frequency of financial crises was closely associated with financial market liberalisation in developing countries. A good answer should discuss the empirical evidence, including the specific experience of some countries.

Briefly outline the main limitations of the Human Development Index (HDI) as a measure of economic development.

Although the HDI has many advantages over income per capita as a measure of economic development, it does present some weaknesses. For example, it does not take into account gender disparities across countries: it assigns equal weight to both men and women in the calculation of the various indices included in its calculation. Moreover, it does not take inequality into account. It focuses on three specific elements: health, education and income. However, the Millennium Development Goals and their associated international development targets demonstrate that a set of other factors are equally important.

Briefly outline the major pitfalls of the privatisation process included in the structural adjustment policies designed by the World Bank in the 1980s and 1990s.

A well-functioning market requires a broad range of supporting institutions (e.g. efficient financial systems, competent government bureaucracies, low corruption, property rights, etc.). However, in many developing countries these institutions were weak. Consequently, the privatisation attempt did not spur growth, as expected.

Discuss whether the contribution of the agricultural sector to economic development is limited to providing surplus labour to the modern sector.

According to the Lewis model the agricultural sector provides labour to the modern sector. However, the agricultural sector also plays other important roles. For example, it helps fight poverty by providing income generating activities in the rural area; it provides food, which is consumed by the urban sector, as well as being crucial for combating famine. Other contributions include: provision of inputs to the modern sector, capital (via savings) market contribution, etc.

If high income per capita countries tend to have high human development index and low income per capita countries a low human development index, is it correct to say that increasing per capita income serves as a 'unilateral guarantee of success in human development' ? Explain.

Although high income countries tend to have high human development indices and low income countries the opposite it is not always true that this is the case. The construction of the human development index is based on three elements: income per capita, life expectancy and education. It could be that a country has a high income per capita but it could perform poorly in terms of the other indicators; compared to a country with a lower income per capita but which scores high in another component of the index. In other words, there is no guarantee that increases in income per capita will serve as a 'unilateral guarantee of success' in human development.

Because of high humidity in tropical areas, tropical countries have a higher depreciation rate of their capital stock. Hence, all other things being equal, per capita income in these countries will be lower than non-tropical countries. True or false? Explain using the Solow diagram.

As the depreciation rate is greater in tropical areas, dt > dnt, then the steady state income per worker, yt, will be lower than that of the non-tropical areas, Ynt. The diagram should look like this:

'The only way group lending micro-finance increases efficiency is by lowering transaction costs'. Critically discuss.

Assuming that borrowers have better information about each other than financial institutions have about them there are other ways that efficiency may be increased. For example assortive matching of borrowers will reduce adverse selection problems. Also by monitoring each other borrowers can reduce the moral hazard problem.

Using the information provided in the table below compute the Kuznets inequality measure for the two countries. (Briefly comment on your results).

Based on the information provided, you can derive an inequality measure defined as the ratio of the income received by the top 20% and bottom 40% of the population. This ratio is sometimes called a Kuznets ratio. For Jacusia this ratio is 3.31 and for Moonia 0.93. It is clear that Moonia has a more equal distribution of income.

How can we explain the finding by Subramanian and Deaton (1996) that, for the poor in Maharashtra, as income rises by 1% food expenditure rises by 0.75% and available calories only rise by 0.36%? Why do they use available calories rather than calorie intake?

Calorie availability differs from intake due to preparation methods, wastage, and food given to guests. For example, while two households might report buying 10 kg of potatoes in the sample, one might consume the whole lot and the other might throw away 5 kg (or give it to animals). These two would have the same calorie availability, but the intake for the second household is half that of the first one. Ideally we want to estimate intake but it is much harder to do this and National Sample Survey (NSS) data only show expenditure on food items not actual consumption of quantities. The difference between food expenditure and calorie availability, which seems to be missing, is explained by substitution away from poor quality food to better quality, better tasting food. The authors show that households move from cereals, with high calorific content, to meat, fruits and dairy, which has better taste but lower calories. So calorie intake rises with income but not by as much as we expect, because of this substitution.

(a) Show that a positive level of unemployment is a feature of the Harris-Todaro migration model, indicating that migration is simply a disequilibrium phenomenon. (b) Harris and Todaro argue that the only way to overcome this problem is a subsidy to the modern sector firms, and restriction on migration from rural to urban areas (coercion). Show that there is a unique solution to this problem that does not involve coercion.

Candidates should use the Harris-Todaro diagram to show that if the urban wage is fixed and a positive urban rural wage differential exits, then the model effectively becomes a model of equilibrium unemployment. This implies that when urban unemployment is less than the equilibrium, migrations flows occur, raising the unemployment level to equilibrium. Migration will cease when the level of unemployment reaches the equilibrium level. Under these arguments, some have proposed that the urban firms should be subsidised. Harris and Todaro have shown that we cannot get a rise of the equilibrium unemployment even if we subsidise urban firms, because this shifts the demand for labour out, leading to more migration, a phenomenon known as the Todaro paradox. Hence, subsidy should be complemented with restrictions on migration (coercion). There is, however, a unique level of subsidy that can eliminate this unemployment, if it is given to employers in urban and rural areas (this analysis is presented in Basu). This should be shown in the Harris-Todaro diagram.

Assume a family owns two plots of land, one cultivated by the husband and the other by the wife. If the family is an 'efficient household' then it must try to maximise income/output and only afterwards work out how to split the gains among the two cultivators. Does empirical evidence support this view?

Chris Udry (in Banerjee and Duflo, 2011, p.124) has tested this in Burkina Faso where each household member works a separate plot. Empirical findings reject the efficient household model. Plots cultivated by women were allocated less male labour, less child labour and less fertiliser. He argues that, especially in the case of fertilisers, using a little bit more on all plots would have increased output considerably more than using a lot on one (male) plot. By reallocating some fertiliser and a little bit of male labour to plots cultivated by women, the household could have increased output by 6 per cent without increasing expenditure.

Assume a family owns two plots of land, one cultivated by the husband and the other by the wife. Why is it so common that they would produce different crops?

In their study Duflo and Udry looked at this issue in Cote D'Ivoire (see Bannerjee and Duflo, 2011, p.125). They argue that what each person produces on his/her plot determines what they consume. Women usually grow bananas and vegetables and in general food crops that the family needs for survival (women are more likely to be survival maximisers). Men usually produce cash crops (coffee and cocoa). Different types of weather affect the output of plots cultivated by men and women differently. They found that when the weather was good for male-cultivated plots, and hence the cash crop increased, more was spent on alcohol, tobacco and traditional men's clothing. If the weather favoured food crops, more was spent on female luxuries but, more importantly, on food consumed by all the household.

In communities with high deforestation rates it is more effective to pay individuals to preserve the forest than to punish those caught illegally logging. Do you agree?Explain.

Deforestation is a major developmental problem. It is estimated that deforestation is responsible for around 20% of CO2 emissions. Moreover, the disappearance of forests leads to mass extinction of plants and animal species etc. Due to improper monitoring processes by the government or local authorities logging (even if legal) can go beyond the agreed quotas. Related to this is the issue of corruption as firms engaged in logging generally need to acquire permission from local officials and this is sometimes done illegally, through bribery. One potential solution to the problem, it has been argued, is to offer payments to individuals to preserve the forest. Jayachandran (2013) analyses the experiment undertaken in this context in Uganda. The results suggest that owners cutting there to sell are less likely to enter the scheme; whereas those clearing the forest for agriculture are more likely to sign up to the scheme. This is because of the timing of the payments. Selling trees will provide cash now, whilst the payment might come at the end of the year. Therefore, owners facing a liquidity constraint are unlikely to enter the scheme. While the idea of paying to preserve the forest might be a good idea there is no guarantee that it will be more successful.

Assume three agriculturalists live in a village. One produces only coffee, the second produces only wheat and the third produces both coffee and wheat. The village suffers from floods and half of each producer's output is destroyed. Assuming the starvation set is the same for all three, show how each can starve suffering from (a) direct entitlement failure (b) trade entitlement failure. Is it true that those who produce food are less vulnerable under these conditions?

Diagram (1) is the food producer. They can only starve if their food output is below the level indicated by the arrow. That will put this farmer in the starvation set, which is the area below the dotted line (production possibility frontier). Diagram (2) is the farmer producing a combined level of food and non-food. They initially produce at x. They can starve by either falling within the starvation set (x moving to xx) or by a rise of the relative price of food (the steeper price line). Diagram (3) is the coffee producer. Initially this farmer is at point A and exchanging coffee for food. This farmer also may starve through a fall in their output or a rise in the relative price of food. Sen argues that those who produce food only suffer from direct entitlement failure, whereas those who produce non-food may also suffer from trade entitlement failure, hence the latter group are more vulnerable. These concepts should be clearly defined and explained in your answer.

What are the likely effects of export instability on development?

Exports provide revenue and foreign exchange that can be used to pay for imports and fill in the foreign exchange gap in a two-gap model framework. As some of the imports are capital goods necessary for investment, exports instability will affect the performance of the economy through investment as well. Additionally, if less developed countries (LDCs) governments impose export revenue taxes, then export instability will affect government tax revenue, therefore budgetary position as well. All of the above suggest that there may be a negative relationship between export instability and economic development. However, a good answer should mention that some empirical studies have found a positive relationship between growth and export instability. Using a permanent income framework these studies argue that export instability leads to a reduction in consumption, and hence an increase in savings that in turn leads to increase in investment, leading to higher growth.

Policies to increase agricultural productivity would also help reduce rural-urban migration. Briefly discuss.

Factors holding back agricultural productivity in developing countries (e.g. urban bias, infrastructure, human capital, land tenure, etc.) generally lead to low income and poverty in rural areas. Policies designed to improve these factors will tend to reduce the push factors associated with rural-urban migration.

Standard of living differences between countries can be correctly measured by PPP adjusted real per capita GDP. True or False? Explain.

False. PPP adjusted per capita income is to adjust per capita income for purchasing power parity. Why is this important? The reason is that although the prices of goods may abide by the law of one price (more or less and in the long run), there is no force to make the non-tradable goods/services prices equalise. Hence $1 will always buy more goods and services in New Delhi than in New York. So we need to adjust for PPP. Even though this is probably the best measure we have, there are still problems, particularly because output in developing countries may be undervalued because output in subsistence agriculture is not monetised and hence not counted (i.e. a farmer may keep part of their rice output for next year's seed instead of buying from the market), the informal sector/black economy, and the value of housework and DIY. Standards of living are also affected by leisure time, and buying merit goods (such as free education and health), and public goods such as defence. To the extent that different countries are different in any of the above, standards of living cannot be precisely comparable. As an example, a thick coat is a necessity in Norway, but not in most of India. To buy a thick coat will mean making an expenditure so this cost will be higher in Norway than in India, and will be reflected in output/expenditure. But does it mean that standards of living in Norway are that much higher?

Assume an agrarian economy consists of two individuals, a landlord and a landless worker. The landlord is prepared to give a sharecropping contract to the worker as long as she gets r% of total output Q. Q is a function of labour input L, with Q'(L)>=0 and Q''(L)<0. The worker has an alternative, to work for the landlord for L hours and receive w per hour. Discuss why it is often claimed that the sharecropping contract is inefficient. Show that, given the above, these two contracts are equivalent.

For the first part of the question candidates should use the Marshallian diagram to show the Marshallian inefficiency, that is since the sharecropper gets (1-r)MP, then labour input will be sub-optimal compared to a wage contract of w per unit of labour (hour). For the second part candidates should write down the objective function of the landlord which is choosing r and L such that: Max rQ(L) subject to the sharecropper at least getting the same amount of income under this contract as with the wage contract, so subject to (1-r) Q(L)=wL. Solving the first order condition we get Q'(L)=w which implies that the sharecropper gets an income equal to MP, and solving for r and substituting in the objective function gets the objective: Max Q(L) -wL which is the objective function of a capitalist (profit maximising) farmer. Hence the two contracts are the same, which is the answer to the second part of the question.

Briefly discuss the arguments against economic planning in developing countries.

Generally, planning is thought to be useful when markets fail. It is argued, however, that planning is not necessarily effective in addressing markets' imperfections. A second argument against it is that many developing countries do not have the skilled manpower required to prepare and execute an efficient planning mechanism. These problems become acute when the bureaucracy in the country is corrupt. A further argument against planning is that the cost associated with plans is very large for many developing countries.

In developing countries many firms remain informal only because of high tax rates in the formal sector. True or false? Explain.

Gordon and Li (2009) offer a theoretical explanation for why so many businesses decide to remain informal in developing countries. They argue that the cost of formality is being taxed by the government. When the benefits of formality (i.e. access to credit) outweigh the cost of tax payments businesses choose formality. In other words, when higher tax rates would imply a smaller fraction of business costs it is preferable to choose formality. However, the other view is that burdensome entry regulations exclude businesses from the formal sector. Along these lines, a poorly-developed financial sector could limit the benefits of entering the formal sector because of a lack of formal credit. Capital intensive businesses, which receive larger benefits from access to finance, are more likely to be in the formal sector even if the tax rate is high but as long as they have financial access.

Explain why adoption of a high yield variety (HYV) seed is a 'complementarity'.

Green Revolution is a package. Farmers need to use the right amount/combination of fertiliser and other inputs (irrigation, pesticides etc.) to get the most benefit of HYVs. Therefore, adopting HYVs involves costly experimentation with inputs. Once farmers learn the right amount of inputs, HYV are much better than traditional seeds. If most of the farmers in an area have already adopted HYVs, neighbouring farmers can see the results of their experimentation and learn from their mistakes (positive externality). On the other hand, if no-one has chosen HYVs, farmers need to carry out several rounds of experimentation to learn the right amount of inputs. This is costly and may not lead to adoption.

Assume the European Union (EU) imports shoes from the rest of the world at AC20 and it takes AC12 worth of leather, at the free world price, to make a pair of shoes. Now assume the EU imposes a nominal rate of tariff of 30% on shoes but allows leather to be imported at the free trade price. What is the effective rate of protection in the EU?

In this case the value added in the EU is initially 8 (20 − 12). The tariff raises the domestic price to 20 + 0.3(20) = 26, but does not raise the leather costs, so the value added is now 26 − 12 = AC14. Hence the effective rate of protection is (14 − 8)/8 = 0.75 or 75% while the nominal tariff rate is only 30%. The general formula for ERP is:

Assume the pay-off to have an extra child to both father and mother is 10N, where N is the number of children. The cost of a child to the father is N^2 but for the mother it is 5N^2 because of higher childcare responsibilities. What is the optimal number of children if the mother and the father have equal bargaining power (50-50)? (Hint - You can either do this algebraically, or write down the pay-off for each child).

Pay-off for the father is maximum when N = 5 (pay off is 10N − N^2 - differentiate and set it equal to zero to find max N), for the mother when N = 1, but for the family, assuming 0.5 weight, it is 0 when N = 0, 7 when N = 1, 8 when N = 2 and then declines. So the answer is 2 children.

'In countries where tax revenue as a share of gross national income is low, it makes sense to resort to inflation to finance public expenditure.' Do you agree? (Explain your answer.)

Indeed, some governments in developing countries resort to inflation as a major 'tax' to finance public spending. Inflation can raise revenues for the government. It can also help increase private investment due to the increased profitability it brings to firms. It can also reduce government dependence on external financing and thus help reduce its debt burden. Another argument put forward is that inflation could help promote the growth of banks and other financial institutions. However, inflation can have detrimental effects on the economy. For example, it could distort the efficient allocation of resources. It could also reduce the country's competitiveness and worsen income inequality. On the empirical front the relationship between inflation and growth remains inconclusive.

It is often claimed that poor peasants farmers are irrational because they neither maximise utility nor profit. Critically discuss this statement.

In standard neoclassical economics individuals/households maximise utility and firms maximise profit. The problem with poor peasant households is that they are both units of consumption and production. So should they maximise profit or utility? And if they do not maximise either utility or profit, are they irrational? The argument in the context of poor peasant households is that they are rational, but they actually maximise survival. When the risk of the loss or output is high, or if the price of their product is likely to fall, they would not go for maximising behaviour. The subject guide provides a model to show this (pp.68-70). However, empirical evidence suggests that when they satisfy their food requirements they then behave in a maximising way, as a producer. This tends to explain multi-cropping, food and cash crop at the same time, in many less-developed economies.

Using national income equations show and briefly discuss how the dual gap (in relation to foreign aid) can be explained.

National income when calculated on the expenditure side, is: Y = C+I+(X-M) Savings (S) = Y-C So Y = C+S Combining (3) and (1) gives: C+I+(X-M) = C+S Or I = S + (M-X) If M exceeds X the country has a deficit in its balance of goods, services and income. If we assume that the deficit is financed from foreign sources (F) we can write equation 5 as: I = S+F This equation states that a country can increase its investment through its own domestic savings (S) and by inflows of capital from abroad (F). In other words, the amount of aid needed would be determined by the savings investment gap.

In the Lewis dual-sector model are workers in the traditional (agricultural) sector paid their marginal product? Explain.

Since there is surplus labour, which is the main assumption of the Lewis model, in this model workers in the traditional (mostly agricultural) sector income-share so they are paid their average product and not their marginal product, as in the neoclassical model. Therefore workers share the output equally.

By distinguishing between 'trade entitlement failure' (TEF) and 'direct entitlement failure' (DEF) discuss the contribution of Sen's entitlement approach to the understanding of famines. Does empirical evidence provide support for the entitlement approach as a cause for famines?

Sen's approach argues that it is not FAD (food availability decline) that causes famines, but not having entitlement to food. He ignores illegal entitlements (such as looting) and basically looks at the ability to buy/exchange or the ability to produce food. Direct entitlement to food = price of food*quantity of food produced = quantity of food produced. DEF occurs, therefore, if a drought or a flood destroys the food crop of the producer. In this case only the output effect affects the food producer. Trade entitlement is px*qx/pf where f is food and x is whatever the peasant produces, say tobacco. In this the peasant will suffer if the tobacco crop is wiped out, or for a given production of tobacco the relative price of tobacco falls. Hence, he argues that the peasant is more vulnerable if she does not produce food since there will be two sources of entitlement failure. There are many examples, cited by Sen (in Poverty and Famines, 1983), showing that famines have occurred with no tangible reduction in food supply. He gives many examples of TEF, in West Bengal, and in Ethiopia, where the rise in relative price of food causes starvation. You should give evidence from at least one of these cases. However, there are weaknesses in the approach. Sen admitted to five points. If property rights are not well defined individual entitlements are not well specified. Secondly, some entitlements occur illegally, such as looting. Thirdly, some deaths in famine periods occur because of disease, and not starvation. Fourthly, the approach assumes people facing starvation consume as much food as they can. A person starves because either she cannot acquire food or because she can but does not, say because of laziness or ignorance, or simply because the utility for consuming medicine may be higher than that of consuming food (Svedberg). Finally, it ignores intra-household distribution issues.

Assume in a remote village villagers pool their income to help each other (perfectly insure). Now assume one villager experiences a fire in his farm that destroys his crop. No other farm is affected. Is there a need for government intervention in this case?

Shock effects can be modelled in the following way. In a particular village Yi = A + θ + εi. Yi is villager i's income, A is the global average, θ is the village level shock and ε is idiosyncratic shock to each villager. If everyone in the village pools their income and consumes the average income, then average Y = A + θ. Since all individuals pool their income, then consumption = average Y = A + θ. The individual farm's fire damage affects εi so the affected individual is covered and there is no need for government intervention.

Assume in a remote village villagers pool their income to help each other (perfectly insure). Now assume the village experiences a drought. Is there a need for government intervention in this case?

Shock effects can be modelled in the following way. In a particular village Yi = A + θ + εi. Yi is villager i's income, A is the global average, θ is the village level shock and ε is idiosyncratic shock to each villager. If everyone in the village pools their income together and consumes the average income then average Y = A + θ. Since all individuals pool their income then consumption = average Y = A + θ. In this case θ is affected, which means that all villagers are affected. Hence the pooling mechanism is not likely to able to protect villagers and there is a need for government intervention.

What are the main causes of the 'Green Revolution'? Analyse the impact of the Green Revolution on income distribution in developing countries.

The 'Green Revolution' consists of the use of modern (or high yield) varieties of crops and dates back to research in Mexico and the Philippines on wheat and rice respectively. Various factors have contributed to the Green Revolution. First, the high population growth of the 1950s and early 1960s led to a reduction in real income growth and more importantly food availability. Faced with the urgent need for feeding the extra population there was a need to introduce technical progress in agriculture. Second, in the mid-1960s The Indian sub-continent was hit by a severe drought which led to famine and starvation. As a result, the governments in this region took serious steps to avoid similar future scenarios. This led to the introduction of a new high yielding variety of 'miracle' seed (first developed in Mexico) for the production of rice and wheat. Third, the rise in the use of fertiliser has raised yield and food production in developing countries. Many governments have given large amounts in subsidies for the use of fertilisers and thus keep farm production costs low. Fourth, another factor that played an important role is the availability of irrigation systems and controlled water supply. Finally, the use of tractors and other machinery in agriculture also contributed to the Green Revolution by raising yield per unit of labour. The adoption of new technology will potentially raise the incomes of farmers. The increase in production will also lead to an increase in the absolute income of all factors of production. However, the relative changes in factor shares depend on the neutrality or non-neutrality of technical progress; changes in the sum of production elasticities under technical progress; and changes in the capital-labour ratios after the introduction of innovations in agriculture. For example, if demand is price elastic, an increase in a crop production will increase total revenue, depending on the degree of elasticity of demand. This rise in supply will tend to lower the price per unit of crop. If the small farmers fail to raise crop production, their total revenue would fall.If the demand is price inelastic, a rise in supply reduces the price and total income of farmers. If the small farmers fail to contribute to an increase in supply, they will end up with a lower aggregate income and profit. Large farmers, in contrast, would generally end up with an increase in income. As a result there will be a widening of the income gap between the different classes of farmer. However, it is important to stress that empirical studies suggest that average income and real wages have increased for most classes of farmer.

Assume that the target growth rate for a Growthmania is 5%, total savings is $5 million, output $50 millions and capital-output ratio is 4. Using the Harrod-Domar growth model with no depreciation state whether Growthmania reaches its desired growth rate.

The Harrod-Domar growth model (in its simplest form) shows that g = s/k, in other words, growth is equal to savings ratio divided by the capital-output ratio. S = 5 and Y = 50 == > s = S/Y = 0.1 or 10%. With k = 4, s/k = 10/4 =2.5% which is below the targeted growth rate.

Explain what is meant by 'financial liberalisation' and discuss the arguments against it.

The answer should start by discussing what is meant by financial repression. Indeed, financial repression refers to the view that a bundle of government policies, regulations, laws, and other restrictions stop the financial intermediaries of an economy from functioning at their full capacity. These policies generally include capital controls, interest rate and credit ceilings, high bank reserve requirements, liquidity ratio requirements, restrictions on market entry into the financial sector or restrictions on directions of credit allocation, and government ownership of banks. The main argument for financial restriction is that it allows a government to channel funds to itself more cheaply than it could in a typical financial market. However, McKinnon and Shaw (1973) argue that such repressive policies would impede financial deepening and hinder efficiency of the financial system, and thus would impact negatively economic growth. Indeed, McKinnon (1973) argues that money holdings and capital accumulation are complementary in the development process and therefore low interest rates would discourage agents from pursuing the accumulation of money balances and investment. Shaw (1973), on the other hand, highlights the importance of financial liberalisation and the beneficial effect of high interest rates on encouragement to save and discouragement to invest in low-yielding projects. High interest rates allow the banking system to increase its liability and, therefore, to lend more resources to productive investment efficiently. Empirically, however, the case against financial repression is not as strong or unambiguous. Along the same line, Stiglitz (2000), for instance, argues that the recently increased frequency of financial crises was closely associated with financial market liberalisation in developing countries. Good answers should refer to the empirical literature related to financial liberalisation and growth. For example, it should be noted that on empirical grounds, the financial liberalisation-growth relationship is not strong. Excellent answers might also discuss how financial liberalisation might also lead to financial crises.

Clearly explain the Harris-Todaro model of migration. Contrary to the competitive labour market model with labour mobility (migration) in which there will be no unemployment, in the Harris-Todaro model there is an equilibrium level of unemployment. What policy (or policies) would you recommend to eliminate this unemployment?

The answer to the first part is standard. The Harris-Todaro model has a fixed urban wage, and consequently the market does not clear in the normal sense. You should derive the equilibrium condition of the model, which is wR = p*wU . wR is the expected rural wage (= the actual rural wage) p*wU is the expected urban wage, p being the probability of finding an urban job (= number of urban employed/(urban employed + urban unemployed)) and wU being the urban wage. There is no unemployment in the rural area. You should show that even though migration occurs, wages do not equalise and hence there will be urban unemployment. Harris and Todaro argue that this unemployment is not likely to disappear and hence we need to reduce the pull and push factors that encourage migration. Basu shows that, theoretically, there is a solution and that is a subsidy to both sectors. You should show the size of this subsidy using an appropriate diagram. A good answer should also state that even though it is theoretically possible, the size of this subsidy is likely to be so large that it is prohibitive.

Banning child labour will not always make children better off. Briefly discuss.

The answer to this question requires a brief description of the child labour model by Basu. This model gives multiple equilibrium points, one stable with child labour, another stable without child labour, and the one in the middle not stable. There ia a possibility that the adult wage may be too low so that the adult wage plus the child income is sufficient for survival, but the adult wage without the child income is not. Under these circumstances it is not advisable to ban child labour since the household will suffer. The diagram in Todaro and Smith clearly shows this and is necessary for a good answer.

Assume output Q = aL + bL2 and PQ = 1 where Q is output, PQ is price per unit of output, L is labour and a and b are parameters. If L is the only factor of production and w is the wage rate, which is same for all workers, derive an expression for the maximum investable surplus in the economy.

The first step is to define investable surplus - the amount that is potentially available for investment. This is the value of output less cost of production. Given that we have only one factor of production investable surplus S = value of output - the wage bill = PQ * Q - wL= aL + bL^2 - wL = L (a + bL - w). To maximise we need to get the first order condition, dS/dL = a + 2bL - w = 0, so S is max if L = (a-w)/2b so: Max S = (a-w/2b) (a-w + b [a-w/2b]) = [a-w]^2/4b.

Discuss the contribution of the 'big push theory' of industrialization to understanding of development in LDCs.

The starting point of this analysis is to make a very simple assumption, that there are no exports. If this is the case then who, in a very poor developing country, would buy the output of the first industrialising firm? This model was pioneered by Risenstein-Rodan and recently popularised again by Vishney, Murphy and Shleifer (VMS). The argument is that there is a coordination failure which impedes development, and requires a big push. The model, with its assumptions, is clearly presented in Todaro and Smith. A good answer here is expected to provide the VMS diagram, and explain why a 'super-entrepreneur' cannot solve the problem.

Does foreign aid displace domestic savings? Briefly support your arguments with empirical evidence.

The discussion here could focus around the savings displacement hypothesis. As Griffin (1970) points out, foreign aid will be perceived as a permanent income and therefore used for consumption purposes rather than increasing total savings. Furthermore, aid might discourage government revenue collection effort, therefore reducing public savings. All things being equal, this would lead to a fall in total savings. A survey of the empirical literature appears to support this argument.

Explain why, contrary to the predictions of dual gap theory, an increase in foreign aid inflows might not necessarily bridge the savings gap.

The discussion here could focus around the savings displacement hypothesis. As Griffin (1970) points out, foreign aid will be perceived as a permanent income and will therefore be used for consumption purposes, rather than increasing total savings. Furthermore, aid might discourage government revenue collection effort, therefore reducing public savings. All things being equal, this would lead to a fall in total savings. The idea of the savings gap is that the desired investment is greater than the actual savings. This gap can be filled by foreign aid. However, if the foreign aid intended to fill this gap actually reduces savings, then the gap will not be filled. Empirical evidence could be used to support this argument. It would also be useful to draw the Griffin diagram.

What factors contribute to high unemployment in developing countries? What effective policies can governments in these countries use to reduce the unemployment rate?

The factors that contribute to unemployment in developing countries are generally linked to inappropriateness of the technology due to rigid factor constraint of the production process in most industries. Indeed, many of these countries are characterised by the existence of a dual economy: a manufacturing sector and an agricultural sector. However, the organisational methods and ideas required for the modern sector are generally imported from advanced countries, which have high wages and relatively abundant capital. This technology could be unsuitable in developing countries where wages are low (in comparison to the wage in advanced countries) and capital scarce. When capital-labour ratios in industries are rigid the scarce capital available in developing countries would generally limit the potential for employing all the labour force. Another cause of unemployment in developing countries is associated with the factor price distortions (wage in modern sector above the market clearing wage, and interest rates and foreign exchange costs lower than the market clearing rates). In many developing countries the enforcement of minimum wage tends to reduce employment (as confirmed by wage-employment studies). Low capital costs have also been argued to increase unemployment. The low foreign exchange price and the preference for imported capital goods tend to lower the price of capital below its equilibrium price. In the presence of wages that are higher than the market clearing wage, firms would tend to use more capital-intensive techniques and thus would tend to employ fewer workers. High unemployment may also be the result of unemployment among the educated - which in turn is explained by how the labour market adjusts to an influx of new graduates.In terms of the policies for reducing unemployment, they include population policies (slow population growth), appropriate technology, policies to improve on the push factors of rural areas, policies to reduce factor price distortions, education policies, and growth-oriented policies as implemented in South Korea and Taiwan.

Explain the Harrod-Domar model of economic growth. What are the weaknesses of this model? The Chinese economy has experienced a dramatic increase in the rate of growth of output in the last two decades with no noticeable change in its savings rate. Discuss three possible reasons how this could have been achieved.

The first part of the question is straightforward. It requires the derivation and discussion of the Harrod-Domar model. The derivation is based on the following simple equation, that involves making assumptions that should be made clear in the answer: sY=S=I=ΔK From this a simple manipulation gets us g=s/v where g is the growth rate, s the savings rate and v is incremental capital output ratio. Good answers would derive this model with depreciation rate included as well. For the second part of the question a good answer should include the discussion of a number of important issues. The first is the discussion of the fact that the model is unstable. This requires explaining the warranted, and the actual rates of growth and showing why if the two rates are not the same the economy is not stable. Furthermore, the model assumes that K and L are used in fixed proportions, and their prices are fixed, which does not hold in reality. It also assumes that savings is a necessary but also sufficient condition for growth, and that there is no technological change. Moreover, v is insensitive to policy changes. A better answer may mention endogeneity of s or population growth, n. For part (c) you can mention anything that may be included in the Total Factor Productivity part of the neo-classical/endogenous model. This may include improvements in human capital, technical change, migration from rural (low productivity jobs) to urban (high productivity jobs), market reform improving efficiency, better management, etc. The reasons you give could be hypothetical. The answer does not require specific knowledge of the Chinese economy but such knowledge would be welcome.

Assume output Q = aL + bL^2 and PQ = 1 where Q is output, PQ is price per unit of output, L is labour and a and b are parameters. If L is the only factor of production and w is the wage rate, which is same for all workers, derive an expression for the maximum investable surplus in the economy.

The first step is to define investable surplus - the amount that is potentially available for investment. This is the value of output less cost of production. Given that we have only one factor of production investable surplus S = value of output - the wage bill = PQ * Q - wL= aL + bL^2 - wL = L (a + bL - w). To maximise we need to get the first order condition, dS/dL = a + 2bL - w = 0, so S is max if L = (a - w)/2b so: Max S = (a - w/2b) (a - w + b [a-w/2b]) = [a w]^2/4b.

What are the main causes and consequences of the 'Green Revolution'? Analyse the impact of the Green Revolution on income distribution in developing countries.

The focal point of this question is on the 'Green Revolution' and its impact on income distribution. A starting point, for a good answer, would be to define the concept. Indeed, the Green Revolution consists of the use of modern (or high yield) varieties of crops and dates back to research in Mexico and the Philippines on wheat and rice respectively. Various factors have contributed to the Green Revolution. First, the high population growth of the 1950s and early 1960s has led to a reduction in real income growth and more importantly food availability. Faced with the urgent need for feeding the extra population there was a need to introduce technical progress in agriculture. Second, in the mid-1960s The Indian sub-continent was hit by a severe drought which led to famine and starvation. As a result, the governments in this region took serious steps to avoid similar future scenarios. This led to the introduction of a new high yielding variety of 'miracle' seed (first developed in Mexico) for the production of rice and wheat. Third, increased use of fertiliser has raised yield and food production in developing countries. Many governments have given large amounts in subsidies for the use of fertilisers and thus keep farm production costs low. Fourth, another factor that played an important role is the availability of irrigation systems and controlled water supply. Finally, the use of tractors and other machinery in agriculture contributed to the Green Revolution by raising yield per unit of labour. The adoption of new technology will potentially raise the incomes of farmers. The increase in production will also lead to an increase in theabsolute income of all factors of production. However, relative changes in factor shares depend on the neutrality or non-neutrality of technical progress; changes in the sum of production elasticities under technical progress; and changes in the capital-labour ratios after the introduction of innovations in agriculture. For example, if demand is price elastic an increase in crop production will increase total revenue, depending on the degree of elasticity of demand. This rise in supply will tend to lower the price per unit of crop. If the small farmers fail to raise crop production, their total revenue will fall. If the demand is price inelastic, a rise in supply reduces the price and total income of farmers. If the small farmers fail to contribute to an increase in supply, they will end up with a lower aggregate income and profit. Large farmers, in contrast, would generally end up with an increase in income. As a result, there will be a widening of the income gap between the different classes of farmer. However, it is important to stress that empirical studies suggest that average income and real wages have increased more for most classes of farmers.

Consider a case where the cost of adopting a high yield variety (HYV) seed is always below the cost of traditional variety crops, as shown in the diagram below. Explain why there may be two equilibria in such a case. Why is it that a traditional farmer at A may not adopt HYVs? How can the government help in this case?

The model may have two equilibria, one in which everyone is doing traditional agriculture with low levels of production and the other where everyone has adopted the HYV with a high level of production. If we start with a situation where there are no traditional farmers, HYVs are the better option because they involve lower adoption costs. However, starting from an existing pool of traditional farmers (for example at point A), the HYVs are not taken up because of the high adoption cost at B. If the government gives a temporary subsidy for adoption of HYV, then we might move from the old variety equilibrium to the HYV equilibrium. The subsidy will reduce the cost of adoption, and encourage traditional farmers to adopt HYVs. Once they all adopt the subsidy can be removed and all move to a point such as C.

Clearly distinguish between the 'nominal rate of protection' and 'effective rate of protection'.

The nominal rate of protection is simply pt- p/p, or the deviation of cum-tariff price pt and no-tariff price, p, over p. The effective rate of protection is v'-v/v, where v' is value added, in terms of domestic output, with protection, and v is value added without protection. In this case an example would be useful, and very good answers should state why effective rate of protection is a more useful concept to measure the degree of protection.

Assume the world consists of two countries, Tariffstan and Protectoria. The pay off matrix of with and without protectionism is presented below. Using the information from the table show that the Nash Equilibrium and the Social Optimum solutions are not the same and discuss why an institution such as the World Trade Organization (WTO) may perform a useful role in this case.

The pay-off matrix shows that the best position for both countries is free trade (200,200), but if they agree to free trade, then each country has the incentive to cheat, and gets a better pay-off if it does that (250, 100) or (100, 250). However, if one imposes a tariff, say medium level, then the other country can immediately raise the pay-off to 140 by retaliating. Now we have two countries with medium tariff levels, again each has an incentive to cheat and apply a high tariff level, and so on. Under these circumstances an institution such as the WTO, by using retaliation as a weapon, may encourage countries, as long as they are far-sighted enough, to agree to free trade.

Griffin (1970) argues that foreign aid would 'displace' domestic savings. Briefly explain how.

The question here is: does aid promote growth? The simple answer would be yes, since it raises the quantity of resources in the economy. The displacement argument states that aid will be seen as a permanent transfer, thus encouraging the recipient government to use it for the purpose of consumption. Moreover, aid will discourage revenue collection efforts by government, thus reducing public savings - which in turn will affect total savings.

'Ensuring environmental sustainability' is at the heart of the Millennium Development Goals. Explain why this is important in the context of developing countries. Discuss some 'effective' policies that could help in tackling the issue of environmental degradation.

The question refers to the environmental challenges faced by developing countries and the link between the environment and development. A good answer will note that in order to reduce environmental degradation, solutions to the problem will often involve the reversal of inappropriate public policies (for example, subsidised credit or tax concessions for resource use or extraction). These policies can, generally, take two forms. The first form could be characterised as domestic environmental policies, which could be direct (provision of financial aid to help reforestation or to fund soil stabilisation programmes, anti-salination measures, etc.) or indirect (increasing spending in education, encouraging grants of legal title to property, etc.). The second is in the form of global environmental policies (reduction in the emission of greenhouse gases, improvement of emitting technologies, etc.). Excellent answers will also touch on the issue of the environment and social cost-benefit analysis.

'Booming primary exports may fail to stimulate development because of Dutch disease'. Briefly explain what is meant by this statement.

The simple national income = expenditure model argues that increase in exports will increase national income. However, the problem is that if a country has an exportable that its trading partners want, then it will increase the demand for the country's currency. This will cause an appreciation in the currency, which in turn will decrease exports and increase imports, and lead to a deterioration of the current account and a fall in national income. Referring to empirical evidence of the Dutch disease would raise the quality of the answer.

Standard of living differences between countries can be correctly measured by the differences between Gross Domestic Product converted by the official exchange rate. True or False. Explain.

There are a number of points to be mentioned even before attempting to look at standards of living. The answer should mention that we need to look at (a) real GDP, (b) accounting for different sizes of population or per capita GDP, and finally (c) PPP adjustment so we need real per capita PPP adjusted GDP for comparison purposes. A good answer may mention the Balassa-Samuelson effect. Even then there may be problems. This comparison ignores inequality, consumption of public goods, different needs, the value of leisure, externalities, etc. For example, GDP per capita may increase if all workers work more hours, but this reduces leisure. Does this then raise or reduce wellbeing? This obviously depends on our taste for leisure versus our ability to buy more goods and services. UNDP uses a better measure - the Human Development Index - which also incorporates education and health, as well as income. While this Index covers more factors that we might wish to include in a measure of standard of living, it does not include all.

Contrary to expectations empirical evidence shows that smaller farms have a higher average output per acre. True or false? Explain.

There are a number of reasons to expect that larger farms would have a higher output per acre. Farming has high fixed costs, such as tractors, bullocks etc., which might not be divisible. Larger farms have better access to finance and adopt technology easier and faster (for example HYVs). However, empirical results show a negative relationship between farm size and productivity. At least two reasons can be put forward. Smaller farms are usually owner-operated and owners have self-interest, i.e. have incentives to do better. Larger farms either use hired labour or do sharecropping and both these contracts reduce incentives. The other case is land quality. As land gets subdivided through either distress-sales or inheritance we get a positive correlation between size and quality. In other words, farmers keep the best quality land and sell the less superior parts. This is what explains the higher productivity of smaller farms.

(a) Discuss the impact of population growth on developing countries. (b) Assume the population growth rate is non-linear, as shown in the following diagram, where n is the population growth rate, d is the depreciation rate, s is the savings rate, and y is income per worker. Can this be the cause of a poverty trap? (Explain what the poverty trap is and refer to the diagram to give your answer).

There are many positive and negative arguments around population growth. A few points that a 'population pessimist' may make are as follows: • Malthusian doomsday - starvation occurs as diminishing returns to land set in • capital widening occurs, rather than capital deepening • there is a higher dependency rate, leading to 'tragedy of the commons' (negative externalities, etc). On the other hand there are positive points, promoted by 'population optimists' such as J. Simon's argument that: • humans are the ultimate resource • demand drives supply response • economies of scale should be taken into account • technical change is induced by population growth. For any k below that of point A (see diagram above), savings is greater than the investment required to keep k constant, so k will rise. Between A and B it is lower so k will fall. Therefore for any k between those values there is a poverty trap. After point B, savings is greater again, hence k will rise and this takes us to the next stable equilibrium.

Discuss the major (at least three) measures of foreign debt sustainability in a developing country.

There are many ratios that help us to understand the debt sustainability of LDCs. The major ones are mentioned here but candidates can go beyond these. Major liquidity measures are debt service ratio (proportion of export earnings needed to service debt), or the budget service ratio (government's ability to finance debt service from domestic resources). Three measures of solvency would be: present value of external debt/export earnings, present value of external debt/domestically generated budget revenue and present value of external debt/GDP.

Assume savings is endogenous so savings is given by s(k) f(k) or sy, where y is output per worker, and k is capital labour ratio. The diagram below shows multiple equalibria. Briefly discuss what is meant by a low level equilibrium trap (poverty trap), and how a 'big push' can overcome the problem.

This is the neoclassical growth model with four equilibrium points. They will be, in turn, unstable (o), stable (k1), unstable (k2), and stable (k3). A developing country below k1 will reach k1 (needs to be briefly explained) but one above k1 will not experience a higher income per worker unless it can increase capital labour ratio beyond k1 and that requires a sufficiently large investment, which may be beyond the country's capability. Hence, this country is stuck in a low level trap and will not potentially catch up with a rich country that is at k3. The big push implies the sufficiently large investment to push k to k3. You are not expected to discuss the Big Push Theory, but may do so.

Briefly discuss potential causes of export instability in developing countries' export.

This problem was highlighted in the 1950s and 60s. Generally the argument is the nature of the less developed country (LDC) exports, primary products, low elasticity of demand and income for those products, specialisation in production of only a few products (many LDCs are single product exporters), and marker or geographical concentration of destination.

Assume all potential candidates for the three types of agricultural contract, wage labour, sharecropping, and fixed rent, have the same entrepreneurial ability. Show that these three contracts are identical if the landlord chooses his share in the sharecropping contract such that his income is maximised. Now assume potential candidates for these three contracts have different levels of ability. Show that, depending on the range of ability, individuals will self-select into different contracts.

This question can be answered either mathematically or diagrammatically. It can be shown that the landlord will aim to maximise his share, aQ(L) subject to (1 − a)Q(L) = wL, where a is the share of the landlord, Q is output, w is wage and L is labour supply (hours). The constraint is that the sharecropper must at least earn the same amount in the sharecropping contract as in a wage contract. Otherwise they will not enter the sharecropping contract. Deriving first order conditions, one can show that the outcomes of the three contracts are the same. However, Hallagan has shown that if the potential candidates have different levels of ability, then the most able will take the fixed rent contract, the middle group will take the sharecropping contract and the low ability group will take the wage contract. This tends to explain what are usually called 'agricultural ladders'.

Assume we are in a Harris-Todaro world which is in equilibrium. The urban wage is R2000. There are 1 million workers in the urban sector, 75% of whom are employed. Derive an expression for the rate of urban unemployment and calculate the rural wage.

This question is about the Harris-Todaro migration model. Specifically, it is looking for the migration equilibrium condition. This is stated as: E[WU] = E[WR] or when expected rural and urban wages are the same. E[WR]=WR, E[WU]= p*WU, where p = probability of finding an urban sector job = EU/LU. Therefore, (EU/LU) WU = WR or (EU/LU) = WR/WU where EU is urban employment and LU is urban employment + unemployment. Urban unemployment is therefore 1 - EU/LU = 1 - WR/WU so 0.75= WR/2,000 so WR = 1,500 and urban unemployment rate is 25%.

Official statistics of many countries does not correctly reflect the extent of deforestation and hence is not a good measure of the potential environmental impact of deforestation. Therefore we should use satellite data to see this effect. Do you agree? Briefly explain.

This question is about the extent of illegal logging that is not reflected in official figures. Burgess et al. used data from Moderate Resolution Imaging Spectroradiometer to construct a measure of deforestation for each 250 metre by 250 metre of forest during 2001-2008 in Indonesia. Satellite data show large areas being cleared and does not pick up selective logging. Therefore clever illegal loggers can still reduce the number of trees without it being noticed and hence satellite data underestimate the true logging effect.

Assume that country Pindya has a target growth rate. In Pindya savings is 897, investment requirement is 1,234, import requirement is 978 and export revenue is 550. Based on the dual-gap framework, how much aid will the country require to achieve its target?

This question is about the two gap model. The amount of aid required is determined by the larger of the two gaps. The two gaps are calculated as follows: I − S = 337 and M − X = 428. Therefore, the amount of aid required will be $428 million.

McNamara (1973) states: 'The greatest single obstacle to the economic and social advancement of the majority of the peoples in the underdeveloped world is rampant population growth'.

This question relates to the effect of population growth on economic development. The discussion should start with the Malthusian argument that, in the long run, population growth keeps per capita income at a subsistence level. The argument is that population is endogenous, and as wages rise above subsistence, procreation occurs and they fall back to subsistence. Other negative effects include the lowering of aggregate savings, increase in poverty, high unemployment, exacerbating rural-urban migration, environmental degradation, etc. The second part of the discussion should point to the positive effect of population growth. Indeed, population growth can also boost economic growth by increasing the labour force by spurring technical progress/innovation (due to high population density). Although not required, excellent answers might want to discuss the policy options used by some countries to reduce population growth. Some of these policies include family planning, financial incentives (India in the 1970s), education of women, compulsion or the one-child policy (China).

'Agriculture is a vital development tool for achieving the Millennium Development Goal that calls for halving by 2015 the share of people suffering from extreme poverty and hunger.' (World Development Report, 2008). Critically examine the above statement. You should support your discussion with evidence.

This question relates to the role of agriculture in development in general and the specific role that it can play in helping in the achievement of the Millennium Development Goals (MDGs). Although the question can be approached from various angles, it is important to note that three out of four people living in developing countries live in rural areas and most depend on agriculture for their livelihood. Thus a more inclusive and dynamic agriculture can be used to reduce rural poverty, helping to meet the Millennium Development Goal on poverty and hunger. Agriculture acts as an important economic activity in many countries, contributing to GDP and employing a large share of the population. It provides government with the revenue required to finance pro-poor expenditures (e.g. health, education) which are at the heart of the MDGs. Agricultural production is also important for food security because it is a source of income for the majority of the rural poor and a source of livelihoods for an estimated 86 per cent of rural people. Empirical evidence suggests that GDP growth originating in agriculture is at least twice as effective in reducing poverty as GDP growth originating outside agriculture. For example, in China and Latin America agricultural growth is estimated to be, respectively, 3.5 and 2.7 times more effective than growth outside agriculture in reducing poverty. Other examples include Ghana. Agriculture can also be a lead sector for growth, as the experiences of China, India and Vietnam suggest. However, although agriculture is essential for development and could help achieve the MDGs, it is by no mean an end in itself. Reliance on agriculture should decline as a country develops. Moreover, other policies (related to inequalities, weak institutions etc.) should be put in place not only to enhance the role of agriculture in reducing poverty but also to help reduce poverty.

"In poor developing economies where the majority of people might be living at subsistence level, it is likely that the rate of time preference for consumption is high, and hence there is little demand for a sustainable productive system". Discuss.

This question requires a brief discussion of sustainable development. There are different views about this. Conservationists express this in terms of the earth's capacity to support human life. Economists argue that this depends on inter-temporal (and intergenerational) gains and losses. Inter-temporal decision making requires an understanding of the rate of time preference. When most people are poor, the society will have a high rate of time preference in consumption, and hence will have little inclination to avoid taking risks with the environment. In these societies income elasticity for basic commodities and services will be high and income elasticity for environmental protection will be low.

Randomised controlled trials (RCTs) can help mitigate the issue of selection bias. True or false. Explain.

True. Selection bias arises when participants in a programme are systematically different from non-participants. Many evaluations compare programme participants to non-participants in order to infer the effect of the programme. RCTs, however, are types of studies where individuals are generally assigned randomly to treatment and control groups. The main purpose of the random assignment is to prevent selection bias by distributing the characteristics of participants that may influence the outcome randomly between the groups, so that any difference in outcome can be explained only by the treatment (policy).

Evidence shows that more accountable governments are more successful in dealing with disasters. True or false? Explain.

True. Sen showed that the more left-wing states of India dealt with famines better than others, as they mobilised public works programmes faster and to a greater extent. Besley and Burgess (2003) showed that the states in India where there was a higher circulation of newspapers were significantly more responsive to food shortages that resulted from droughts. In addition, elected state governments spent more on food distribution programmes during disaster periods in these areas. Hence empirical evidence tends to support the hypothesis that the more accountable governments are more successful in dealing with disasters.

In a world where poor household have many children, children of those household receive less education. True or false. Explain.

True. This is the classic Becker's argument regarding the quality-quantity trade off (specified in Banerjee and Duflo, 2011, page 108-09). When a household has many children, the parents devote fewer resources to each (in terms of food, health expenditure and schooling) and hence they are less healthy and educated. There are many studies that have empirically tested this. Angrist et al. (2005) found that large family size has no negative effect on the education of children in Israel, even among the Israeli Arabs, who are mostly poor. An experiment in Bangladesh introduced family planning in Matlab as well as improved health care for the participating children. The women who participated reduced their fertility (to 1.2 fewer children on average) and the experiment resulted in improved child health and hence survival; however, it did not increase height, weight, school enrolment or years of education of the participating children. In general, therefore, evidence tends to support the statement.

In a world where poor households have many children, children of those households receive less education. True or false? Explain.

True.This is the classic Becker's argument regarding the quality-quantity trade off (specified in Banerjee and Duflo, 2011, pp.108-09). When a household has many children, the parents devote fewer resources to each (in terms of food, health expenditure and schooling) and hence they are less healthy and educated. There are many studies that have empirically tested this. Angrist et al. (2005) found that large family size has no negative effect on the education of children in Israel, even among the Israeli Arabs, who are mostly poor. An experiment in Bangladesh introduced family planning in Matlab as well as improved health care for the participating children. The women who participated reduced their fertility (to 1.2 fewer children on average) and the experiment resulted in improved child health and hence survival; however, it did not increase the height, weight, school enrolment or years of education of the participating children. In general, therefore, the evidence tends to support the statement.

Explain why rural-urban wage differentials could generate beneficial gender effects.

Wages, rates and earnings tend to be higher in urban areas than in rural areas. For many incoming workers, migration allows a net improvement in their standard of living compared with their rural situation. The advantages of a move to town are likely to be particularly important for female migrants, who tend to be marginalised in the rural environment due to, in particular, tradition. In addition to being freed from cultural norms, women also enjoy expanded opportunities (a wider range of jobs available to them). Moreover, better healthcare (including reproductive healthcare) improves the health status of those women and their families.

In countries with recurrent high levels of famine it makes more sense to alter the composition of aid in favour of food aid. Do you agree? Explain.

While this is a plausible solution in the short term, in the long term it might be counter-productive. Firstly, a country which experiences recurrent famine is more likely to be facing other challenges, including budget shortfalls. Part of development aid is indeed used to support the budget. Other types of aid (for example project aid) might also be required to build the country's infrastructure. More importantly, in the long term, food aid can have a detrimental impact on agricultural production by eroding incentives for local production of food. The agricultural sector could be hit as a consequence of food aid provision and this in turn will impact on the farmers' income (which has other ramifications). Evidence also suggests that in areas with conflict the provision of food aid is generally associated with an increase in the duration of the conflict.

Assume the world is divided into two parts, rich, R, and poor, P . Both parts have the same production function AKaL1−a. Derive an expression for output per worker in these two parts and assuming income per worker in R is 5 times that of P and a = 0.5 calculate the ratio of capital per worker in R compared to P .

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