AMERICAN UNIVERSITY
Department of Economics
Comprehensive Examination
Development Economics
June 2014
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Directions: Answer a total of four (4) questions; choose two questions from Part 1 and
two from Part II. Be sure to follow the instructions given.
PART 1: Development Microeconomics
Answer one question from Section A and one question from Section B. Read the
questions carefully, and make sure to answer what is asked. Answers are judged on
clarity of exposition and intuition, command of the relevant literature, and accuracy
and depth of technical detail.
Section A: Answer one question.
Question A1:
a) Describe the separability assumption in agricultural household models. Under what
conditions does this apply? Is this assumption violated in a collective model of the
household? If so, how does it (or does not) affect the results?
b) Demonstrate by means of any alternative household model, how the selection of the
household model (unitary vs. the chosen alternative) can affect the predictions and
influence policy by comparing their predicted outcomes. In your answer, compare and
contrast the main elements of the two types of household models. Can one introduce
intrahousehold allocation in the household model and still retain Pareto-optimal efficient
outcomes similar to that of the unitary household model?
c) From a methodological standpoint, what makes the test of intra-household dynamics
and allocation models particularly challenging? Explain your answer using any of the
empirical studies as an example.
d) A well-known economist gave a speech at a development conference arguing that the
global food crisis and prevalence of rural poverty in Asia and Africa are due to small
farmers’ resistance to agricultural innovations that can increase farm yield substantially.
Someone in the audience challenged this view arguing that the speaker clearly does not
understand farmers in developing countries nor the conditions they face. What would be
the main points that this person is likely to provide regarding poor farmers’ resistance to
adoption of new agricultural technology? Use diagrams or graphs to illustrate your
points.
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Question A2:
The Chinese government has hired you as a summer intern in their Ministry of Labor.
Your assignment is to help the government devise a way to slow down rural to urban
population which has resulted in problematic levels of unemployment in Shanghai,
Beijing and other cities in the Southern coastal region of China. Assume that the formal
(modern) sector urban wage is kept above the equilibrium level and has resulted in
dramatic increase in migration from the rural areas. Also, assume that the migrants from
the same rural communities tend to congregate and form neighborhood clusters in the
cities and that there is an urban informal sector.
a) Suppose that the average earning in the urban informal sector (IS) is equivalent to Ω,
which is 1/3 the amt of the urban manufacturing wage, Wm. Show how the decision rule
of a potential migrant and the Harris-Todaro migration model can accommodate the
inclusion of the urban informal sector. In the model, be sure to label your axes and
curves and provide a short explanation.
b) The government of China is considering a program to deal with the urban
unemployment or so-called ‘floating population’ problem. It is called a work-for-food
program. The program pays a wage that is below the modern sector wage but higher than
the rural wage. It is designed to employ people currently unemployed in the cities. What
is the effect of the proposed work-for-food program on the expected urban income and
migration? Then discuss the likely effects on urban unemployment and rural wages in
the medium term. State any assumptions if necessary.
c) Compare and contrast the depiction of the informal sector in the Harris-Todaro
migration model and that of Ranis-Stewart v-goods model. In your answer discuss also
the relationship(s) between the informal sector and the formal modern sector. Using the
Ranis-Stewart model, discuss how would a redistributive fiscal policy that promotes the
growth of the middle class influence the size and nature of the informal sector.
Question A3:
a) Carefully explain what is meant by the term vulnerability and how is it related to
poverty and inequality.
b) What are the varied ways of measuring vulnerability? Discuss the methodological
challenges and econometric difficulties associated with it. Provide an example to
illustrate your point. Then describe some of the methods for addressing this problem.
c) Discuss at least four mechanisms that risk-averse agricultural household may employ
to mitigate or reduce risk when production and output prices are uncertain and credit and
insurance markets are imperfect.
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d) What are the limitations of informal insurance schemes? Explain how you would test
for full insurance of consumption risk at the village level. Discuss the factors that might
limit the ability of households in a village to insure one another.
Section B: Select any one poverty-alleviation program or scheme.
You are asked by an international organization to design a study evaluating the welfare
impact of any one (1) of the following poverty alleviation programs, which Ghana is
considering adopting:
1.
2.
3.
4.
Microfinance (group lending) scheme to poor women
Conditional cash transfer program
Crop insurance program to small farmers
Land titling program
Prepare the proposal for the study by using the following guidelines and answering the
corresponding questions.
a) Research Question:
What is the aim of your study? What are you trying to learn from it?
b) Background and Significance:
i. What is the rationale for the poverty alleviation program?
ii. What are the sources of uncertainty regarding whether this is the right program to
adopt? Use economic reasoning to answer the questions.
c) Methodology:
i. Explain carefully the use of the sample data, taking into account treatment and
comparison groups. What are the main variables of interest? Justify your answer. ii.
Explain the regression model and econometric techniques that you would use to analyze
the data and provide a brief justification.
d) Empirical Analysis:
i. State briefly the results that you hope to obtain, which would likely validate your
hypotheses or predictions.
ii. Suppose that you are not able to validate your hypotheses, either because of nonstatistical significance or because you obtain an opposite correlation (opposite sign). How
would you go about looking for some plausible explanation?
(exam continues on next page)
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PART 2. Development Macroeconomics
Answer one question from Section A and one question from Section B. Read the
questions carefully, and make sure to answer what is asked. Answers are judged on
clarity of exposition and intuition, command of the relevant literature, and accuracy
and depth of technical detail.
Section A: Answer one question
Question A1: Growth Models
d) Lay out the basic set up of the Solow model and contrast this with that of the
endogenous growth theory. In the Solow model, provide algebraically the key
equilibrium condition and illustrate the result diagrammatically.
b) Explain the key dynamic properties of capital and then show diagrammatically why
the equilibrium is stable. Then demonstrate or explain why the golden rule level of
capital and the equilibrium level may not be the same.
c) Using the Solow growth model, show the combined effect of a decrease in population
growth rate and decrease in the savings rate on the equilibrium capital to output ratio and
steady-state growth.
Question A2. Empirical Analytics of Growth.
d) In an econometric setting, you are asked to explain how the following variables
affect growth: financial development, aid, income inequality, gender inequality,
and trade liberalization. Drawing upon the empirical literature, describe an
approach to assessing the effect of these different variables on growth. Make sure
to define your variables, explain expected results, and discuss any potential
econometric complications.
b) If you believed the relationship between inequality and growth was such that low
levels of inequality implied higher growth and as inequality rose eventually growth fell,
explain how you would try to capture that in your econometric specification (also explain
how you are measuring inequality).
c) Provide an example of a production function that could be used to assess the impact of
capital and labor accumulation on growth, in a Solow-type setting. Then provide a second
example of a production function that incorporates endogenous growth ideas. Explain the
difference.
d) Explain the difference between absolute and conditional convergence and indicate
what evidence Mankiw et al found in their seminal study on this topic.
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Section B: Select any one question.
Question B1. Fiscal Sustainability.
a) Critically compare and contrast the concepts of fiscal balance and primary fiscal
balance. Explain when is one or the other a more useful concept to use.
b) If the country’s debt to GDP ratio was 50 percent at the end of last year, the real
interest rate is 5 percent, the growth rate is 3 percent, the primary deficit is 3 percent of
GDP, and there is 2 percent of GDP in money creation, explain what would be the debt to
GDP ratio at the end of this year. Provide the equation of motion for debt and explain
your reasoning.
c) Discuss the relationship between the real interest rate and growth that provides a
shorthand to assessing whether a country’s debt to GDP ratio will be explosive or nonexplosive.
d) At what level of indebtedness does default become a serious concern? Justify your
answer. In your explanation, discuss the factors that contribute to a country’s rising
indebtedness and the factors that contribute to falling indebtedness. Contrast the recent
experience of advanced and emerging markets.
Question B2. Monetary and Exchange Rate Regimes.
You are asked to provide advice to a middle-income emerging market on the monetary
and exchange rate regimes that it should adopt. The country has a reasonably well
developed financial market and with a ratio of money to GDP of 60 percent; the
government has a chronic deficit but is not allowed to borrow directly from the central
bank to finance its deficit. The country mainly produces for export labor-intensive
electronics and imports a significant amount of food and fuel.
a) What would you recommend for a monetary regime, a reserve or broad money based
regime or inflation targeting? Explain your reasoning fully, including any additional
assumptions you make to present a case for one or the other regime.
b) What would you recommend for an exchange rate regime: fixed, floating, or in
between? Explain your reasoning and provide at least two characteristics of the economy
that influence your recommendation.
c) What would be a sensible level of international reserves for this country to target?
Explain your reasoning.
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d) You are asked to assess whether this country’s real exchange rate is in equilibrium.
Describe three different methodologies to assess whether the real exchange rate is
properly valued.
Question B3. Current Accounts, Currency Crises and Macroframeworks.
a) Derive the identity involving the current account in terms of saving and investment and
explain how current account deficits emerge.
b) Explain the key ideas of Krugman’s first generation models of currency crises and
provide an example of a country experience that illustrates these ideas well.
c)_ Explain the economic process by which destabilizing capital inflows can lead to real
exchange rate appreciation, how sterilized intervention can help to limit the effects of
these inflows, and why sterilized intervention might be limited in effectiveness.
d) Consider two countries. The first country has chronic fiscal deficits and a high level of
domestic and foreign indebtedness and an exchange rate that in principle is flexible but
appears to move in step with the U.S. dollar. Growth is anemic and inflation is low and
stable. The current account is weak but the overall balance of payments is roughly
balanced because of offsetting capital inflows.
The second country has modest fiscal deficits and a low level of indebtedness and the
same exchange regime as the first. It has a surplus in its current account and strong
capital inflows resulting in a significant balance of payments surplus. Growth is moderate
and inflationary pressures are rising.
Explain and contrast the vulnerabilities of these two countries in general, ignoring current
conditions in the world, and then contrast them in current global circumstances, where
the U.S. Federal Reserve is beginning to taper its expansionary monetary policies.