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Módulo de Macroeconomía Básica y Economía del Desarrollo
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WOLAI TASODOUNI VERSI TY COLLEGEOFBUSI NESSANDECONOMI CS DEPARTMENTOFECONOMI CS MODULENAME BASI CMACROECONOMI CS ( MACROECONOMI CS&DEVELOPMENTECONOMI CS) Compi l edBy : Af ewor kBer hanu( Assi st antPr of essor ) Bi r hanuHankamo( Assi st antPr of essor ) Wol ai t aSodo, Et hi opi a Mar ch, 27/ 2023 Tabl eofCont ent s 1 Chapt erOne 5 I nt r oduct i ont oMacr oeconomi cs 5 1. 2TheSt at eofMacr oeconomi cs:Ev ol ut i onandRecentDev el opment s 5 Chapt er -Two 8 Nat i onal I ncomeAccount i ng 8 Real GDPv er susNomi nal GDP 9 GDPDef l at or 9 Ot herMeasur esofI ncome 10 TheConsumerPr i ceI ndex( CPI ) 11 Measur i ngJobl essness: TheUnempl oy mentRat e 12 TheBusi nessCy cl eandt heOut putGap 13 CHAPTERTHREE 15 AGGREGATEDEMANDI NTHECLOSEDECONOMY 15 3. 1Foundat i onsoft heTheor yofAggr egat eDemand 15 TheMoneyMar ketandt heLM Cur v e 20 TheTheor yofLi qui di t yPr ef er ence 21 I ncome, MoneyDemand, andt heLM Cur v e 22 CHAPTER-FOUR 24 AGGREGATEDEMANDI NTHEOPENECONOMY 24 ExchangeRat es 29 Exchanger at eDet er mi nat i on/ Fi xedv er susFl exi bl eExchanger at eRegi mes/ TheMundel l Fl emi ngModel 30 31 Smal l OpenEconomywi t hPer f ectCapi t al Mobi l i t y CHAPTERFI VE: AGGREGATESUPPLY 32 37 TheLongRun: t heVer t i cal Aggr egat eSuppl yCur v e 38 Cour seTi t l e: Macr oeconomi csI I 41 Chapt erOne 41 Behav i our al Foundat i ons: Theor i esofConsumpt i on JohnMay nar dKey nesandt heConsumpt i onFunct i on 41 41 Secul arSt agnat i on, Si monKuznet s, andt heConsumpt i onPuzz l e 43 I r v i ngFi sherandI nt er t empor al Choi ce 44 Fr ancoModi gl i ani andt hel i f ecy cl eHy pot hesi s 47 Mi l t onFr i edmanandt hePer manent I ncomeHy pot hesi s 48 Rober tHal l andt heRandomWal kHy pot hesi s 49 CHAPTERTWO 49 2 I NVESTMENTTHEORY 49 Thr eet y pesofI nv est mentSpendi ng 49 Resi dent i al I nv est ment 54 Chapt er3: MoneyDemandandMoneySuppl y 56 Chapt er4: TheLabourMar ket 61 Neocl assi cal Mi cr oeconomi csModel OfTheLabourMar ket 61 TheNeocl assi cal Theor yofLaborSuppl y 61 TheNeocl assi cal LaborMar ket 64 Unempl oy menti nt heNeocl assi cal Model 64 Keynesi anvi ewsoft heLaborMar ket 65 CHAPTERFI VE 68 Macr oeconomi cPol i cyDebat es: St abi l i zat i onPol i cy 68 Chapt erSi x 71 Model sofMacr oeconomi cGr owt h 71 TheHar r od-DomarGr owt hModel 71 TheSol owNeocl assi cal Gr owt hModel 73 Gr owt hi nt heCapi t al St ockandt heSt eadySt at e 74 EndogenousGr owt hTheor y 78 Chapt er7:Macr oeconomi cTheor i esandAf r i canEconomi es Macr oeconomi cTheor i esandAf r i canEconomi es: Anov er v i ew 80 80 DEVELOPMENTECONOMI CSMODULE 82 DEVELOPMENTECONOMI CSI 82 CHAPTERONE 82 Economi csofdev el opment : concept sandappr oaches Chapt ert wo 82 86 St r uct ur al f eat ur esandcommonchar act er i st i csofdev el opi ngcount r i es Thesi zeoft hecount r y( geogr aphi car ea, si zeofpopul at i on, andi ncomel ev el s) 86 86 I t shi st or i cal andeconomi cal backgr ound 87 I tendowment sofphy si cal andunmanr esour ces 87 I t set hni candr el i gi ouscomposi t i on 88 Ther el at i v ei mpor t anceofi t spubl i candpr i v at esect or 88 Thenat ur eofi t si ndust r i al st r uct ur e 89 I t sdegr eeofdependenceonex t er nal economi candpol i t i cal f or ces 89 Thedi st r i but i onofpowerandt hei nst i t ut i onal andpol i t i cal st r uct ur ewi t hi nt henat i on. 90 3 CommonChar act er i st i csofDev el opi ngCount r i es 90 Lowl ev el sofl i v i ng, char act er i zedbyl owi ncome, i nequal i t y , poorheal t h, andi nadequat e educat i on 91 CHAPTERTHREE 94 Gr owt hModel sandTheor i esofDev el opment 94 Gr owt hModel s 95 TheHar r odDomarGr owt hModel 95 TheSol owModel 97 Theor i esofDev el opment 98 Rost ow’ sSt ageofEconomi cgr owt h 98 CHAPTERFOUR 100 Hi st or i cGr owt handCont empor ar yDev el opment : Lessonandcont r ov er si es CHAPTERFI VE 100 105 I NEQUALI TY, POVERTYANDDEVELOPMENT 105 I nequal i t yandAbsol utPov er t y 108 DEVELOPMENTECONOMI CSI I 110 CHAPTERONE 110 Popul at i onGr owt handt heQual i t yofLi f e 110 Wor l dPopul at i onGr owt ht hr oughHi st or y 111 TheHi ddenMoment um ofPopul at i onGr owt h 112 Thecausef orhi ghf er t i l i t yi nLDCs 112 Mal t husi anPopul at i onTr ap 112 TheMi cr oeconomi cHousehol dTheor yofFer t i l i t y UNI T TWO 112 114 HumanCapi t al : Educat i onandHeal t hi nEconomi cDev el opment Chapt ert hr ee 114 117 Rur al ur bani nt er sect i on, mi gr at i on, andunempl oy ment 117 TheUr banI nf or mal Sect or 118 Ur banUnempl oy ment 119 Mi gr at i onandDev el opment 120 Towar danEconomi cTheor yofRur al Ur banMi gr at i on 120 UNI TFOUR 122 AGRI CULTUREANDECONOMI CDEVELOPMENT 122 TheSt r uct ur eofAgr ar i anSy st emsi nt heDev el opi ngWor l d 123 TheEconomi csofAgr i cul t ur al Dev el opment 125 4 TheTr ansi t i ont oMi xedandDi v er si f i edFar mi ng 125 Fr om Di v er gencet oSpeci al i zat i on: Moder nCommer ci al Far mi ng 126 Towar daSt r at egyofAgr i cul t ur al andRur al Dev el opment : SomeMai nRequi r ement s 127 CHAPTERFI VE 128 I nt er nat i onal t r adeandeconomi cdev el opment : t het r adepol i cydebat eand i ndust r i al i zat i on 128 Tr adeTheor yandDev el opmentExper i ence 128 I mpor t anceofExpor t st oDi f f er entDev el opi ngNat i ons 129 Chapt erOne 5 Macr oeconomi csI&I I I nt r oduct i ont oMacr oeconomi cs 1. 1WhatMacr oeconomi csi sabout ? Economi csi st hest udyoft heeconomyandt hebehav i orofpeopl ei nt he economy . Tr adi t i onal l y , economi csi sdi v i dedi nt omi cr oeconomi cs&macr oeconomi cs. Mi cr oeconomi cs,whi chst udi est hebehav i orofi ndi v i dual sandor gani zat i ons ( consumer s, f i r msandt hel i ke)atadi saggr egat edl ev el , and Macr oeconomi cs,whi ch st udi es t he ov er al loraggr egat e behav i oroft he economy . Macr oeconomi csi sconcer nedwi t ht hebehav i oroft heeconomyasawhol ewi t hboomsandr ecessi ons,t ot alout putofgoodsandser v i ces,t hegr owt hof out put ,t her at eofi nf l at i on,unempl oy ment ,t hebal anceofpay ment s,exchange r at es… Macr oeconomi csf ocusesont heeconomi cbehav i orandpol i ci est hataf f ect : consumpt i onandi nv est ment , t r adebal ance, pr i ces, monet ar yandf i scal pol i ci es, t hemoneyst ock, gov er nmentbudget i nt er estr at e, andnat i onal debt 1. 2TheSt at eofMacr oeconomi cs:Evol ut i onandRecent Devel opment s ( School soft hought si nMacr oeconomi cs) 1970s–pr esent ( t he new Cl assi cal ( 1776–1870) Neocl assi cal ( 1870–1936) cl assi cal , new Keynesi ans, Key nesi an( 1936–1970s) Monet ar i sm) Cl assi cal ( 1776–1870) I nt hi sper i odt hedi st i nct i onbet weenmi cr oandmacr owasnotcl ear .The cl assi cal shav emadeanampl econt r i but i ont ot hedev el opmentofeconomi c sci ence.Wi t hr egar dt ot hel abormar ket ,t heycont endt hatl abordemandand l aborsuppl yar ebr oughti nt oequi l i br i um byt her ealwage.Asar esul tt her ei s noi nvol unt ar yunempl oyment . Wi t hr egar dt ot hef i nanci almar ket ,f orcl assi cal ssav i ngandi nv est mentar e 6 br oughti nt oequi l i br i um byt hei nt er estr at eandi nv est mentr espondt ot he i nt er estr at e. I nt hemoneymar ket ,moneydemandi ssi mpl yat r ansact i ondemandand moneyhasnoanyef f ectont her ealeconomyandhencer ai si ngt hemoney suppl ysi mpl ypushes up pr i ces ( i . e.i nf l at i onar y ) .The i mpl i cat i on i st hat , gov er nmenthasnoanyr ol ei nt heeconomyt hr oughi t smonet ar ypol i cy . Tot hi s end,t hecl assi calar et hepr oponent sofl ai ssezf ai r e( nogov er nmentr ol e) .I n gener al ,f ort hi sschoolmar ket s( bei t ,commodi t y ,f act or ,andmoney )wor ks besti fl ef tt ot hemsel v es. Neocl assi cal( 1870–1936) Basi cal l yt heneocl assi calschooli snotdi f f er entf r om t hecl assi calschool .The mai ndi st i nct i oni st het ool ofanal y si s, suchast hemar gi nal anal y si s. Key nesi an( 1936–1970s) Themai nt hesi soft heKey nesi anst r eam i st hatt heeconomyi ssubj ect edt o f ai l ur eso t hati tmaynotachi ev ef ul lempl oy mentl ev el .Thus,gov er nment i nt er vent i oni si nevi t abl e.Thi sschoolv i ewst hel abormar keti nt hatwor ker sand f i r msbar gai nf oramoney( nomi nal )wage,notf orr ealwage.Moneywages adj ustsl owl yand wor ker sr esi stanydr op i nt he moneywage.Unl i ke t he cl assi cal s,f orKey nesi anssav i ngandi nv est mentar ebr oughti nt oequi l i br i um by changesi ni ncome.I nv est menti snoti nf l uencedbyamer echangei ni nt er est r at e; r at heri ti saf f ect edbyexpect at i onsoft hef ut ur e, whi chi suncer t ai n. Moneydemandi saf f ect edbyt r ansact i ons,butal sobyot hert hi ngs,i npar t i cul ar f ear , whi chmayl eadt oa“ specul at i v edemand”f orhi ghmoneybal ances. 1970s–Pr esent .Ther ei snodomi nantschooloft houghtofmacr oeconomi cs. Ther ehav ebeent womai ni nt el l ect ualt r adi t i onsi nmacr oeconomi cs. Oneschooloft houghtbel i ev est hatgov er nmenti nt er v ent i oncansi gni f i cant l y i mpr ov et heoper at i onoft heeconomy .Theot herbel i ev est hatmar ket swor kbest i fl ef tt ot hemsel v es. I nt he 1960s,t he debat e on t hese quest i ons i nv ol v ed Keynesi ans,i ncl udi ngFr ancoModi gl i aniandJamesTobi n,ononesi de,and monet ar i st s,l edbyMi l t onFr i edman,ont heot her .I nt he1970s,t hedebat eon mucht hesamei ssuesbr oughtt ot hef or eanew gr oup-t he new cl assi cal macr oeconomi st s,whobyandl ar ger epl acedt hemonet ar i st si nkeepi ngupt he ar gumentagai nstusi ngact i v egov er nmentpol i ci est ot r yt oi mpr ov eeconomi c 7 per f or mance. Ont heot hersi dear et henew Key nesi ans;t heymaynotshar emanyoft he det ai l edbel i efofKey nesi anst hr eeorf ourdecadesago,exceptt hebel i eft hat gov er nmentpol i cycanhel pt heeconomyper f or m bet t er . Key nesandEconomi cPol i cy monet ar yexpansi on/f i scalexpansi on ForKey nest odoaboutr ecessi ons,t hef i r standmostobv i oust hi ngt odoi st o makei tpossi bl ef orpeopl et osat i sf yt hei rdemandf ormor ecashwi t houtcut t i ng t hei rspendi ng,pr ev ent i ng t he downwar d spi r alofshr i nki ng spendi ng and shr i nki ng i ncome.The wayt o do t hi si s si mpl et o pr i ntmor e money ,and somehow geti ti nt oci r cul at i on.Sot heusualandbasi cKey nesi ananswert o r ecessi onsi samonet ar yexpansi on. ButKey neswor r i edt hatev ent hi smi ghtsomet i mesnotbeenough, par t i cul ar l yi f ar ecessi onhadbeenal l owedt ogetoutofhandandbecomeat r uedepr essi on. Oncet heeconomyi sdeepl ydepr essed,househol dsandespeci al l yf i r msmaybe unwi l l i ngt oi ncr easespendi ngnomat t erhow muchcasht heyhav e;t heymay si mpl yaddanymonet ar yexpansi ont ot hei rhoar di ng.Suchasi t uat i on,i nwhi ch monet ar ypol i cyhasbecomei nef f ect i ve,hascomet obeknownasa“ l i qui di t y t r ap” . I nsuchacase, t hegov er nmenthast odowhatt hepr i v at esect orwi l lnot :spend. Whenmonet ar yexpansi oni si nef f ect i v e,f i scalexpansi onmustt akei t spl ace. Suchaf i scalexpansi oncanbr eakt hev i ci ousci r cl eofl ow spendi ngandl ow i ncomes and get t i ng t he economy mov i ng agai n. Howev er , Key nesi an macr oeconomi cswassubj ectt oongoi ngcr i t i ci sm. Monet ar i sm,asadv ocat esoff r eemar ket ,st ar t edchal l engi ngKey nes’ st heor yi n t he1970s.Mi l t onFr i edman, t hef ounderofmonet ar i sm, at t ackedKey nesi deaof smoot hi ngbusi nesscy cl eont hegr oundt hatsuchact i v epol i cyi snotonl y unnecessar ybutact ual l yhar mf ul ,wor seni ngt hev er yeconomi ci nst abi l i t yt hati t i ssupposedt ocor r ect ,andshoul dber epl acedbysi mpl e,mechani calmonet ar y r ul es.Thi si st hedoct r i net hatcamet obeknownas“ monet ar i sm. ” Pol i cyRul eunderMonet ar i sm I feconomi csl umpsbegi nwhenpeopl espont aneousl ydeci det oi ncr easet hei r moneyhol di ngs,t hent hemonet ar yaut hor i t ymustmoni t ort heeconomyand pumpmoneyi nwheni tf i ndsasl umpi si mmi nent .I fsuchsl umpsar eal way s 8 cr eat edbyaf al li nt hequant i t yofmoney ,t hent hemonet ar yaut hor i t yneednot moni t ort heeconomy ;i tneedonl ymakesur et hatt hequant i t yofmoneydoesn’ t sl ump. I not herwor ds,ast r ai ght f or war dr ul e-“ Keept hemoneysuppl yst eady” -i sgood enough,sot hatt her ei snoneedf ora“ di scr et i onar y ”pol i cyoft hef or m,“ Pump moneyi nwheny oureconomi cadv i ser st hi nkar ecessi oni si mmi nent . ” TheNewCl assi calSchool The new cl assi calmacr oeconomi cs r emai ned i nf l uent i ali nt he 1980s.Thi s schoolofmacr oeconomi csshar esmanypol i cyv i ewswi t hFr i edman.I tseest he wor l dasonei nwhi chi ndi vi dual sactr at i onal l yi nt hei rsel f i nt er esti nmar ket s t hatadj ustr api dl yt ochangi ngcondi t i ons.Thegov er nment , i ti scl ai med, i sl i kel y onl yt omaket hi ngswor sebyi nt er v eni ng. Thecent r alwor ki ngassumpt i onsoft henewcl assi calschoolar et hr ee: Economi cagent smaxi mi ze.Househol dsand f i r msmakeopt i maldeci si ons gi v enal lav ai l abl ei nf or mat i oni nr eachi ngdeci si onsandt hatt hosedeci si onsar e t hebest . Expect at i onsar er at i onal , whi chmeanst heyar est at i st i cal l yt hebestpr edi ct i ons oft hef ut ur et hatcanbemadeusi ngt heav ai l abl ei nf or mat i on. Mar ket scl ear . Ther ei snor easonwhyf i r msorwor ker swoul dnotadj ustwages orpr i cesi ft hatwoul dmaket hem bet t erof f .Accor di ngl ypr i cesandwagesadj ust i nor dert oequat esuppl yanddemand; i not herwor ds, mar ketcl ear . TheNewKey nesi ans NewKey nesi aneconomi csi st heschooloft houghti nmoder nmacr oeconomi cs t hatev ol v edf r om t hei deasofJohnMay nar dKey nes.Key neswr ot eTheGener al Theor yofEmpl oyment ,I nt er est ,andMoneyi nt het hi r t i es,andhi si nf l uence among academi cs and pol i cy maker si ncr eased t hr ough t he si xt i es. I nt he sev ent i es,howev er ,newcl assi caleconomi st ssuchasRober tLucas,ThomasJ. Sar gent ,andRober tBar r o cal l edi nt oquest i onmanyoft hepr ecept soft he Key nesi anr ev ol ut i on.Thel abel" new Key nesi an"descr i best hoseeconomi st s who, i nt heei ght i es, r espondedt ot hi snewcl assi calcr i t i quewi t hadj ust ment st o 9 t he or i gi nalKey nesi an t enet s.The new Key nesi ans ar gue t hat mar ket s somet i mesdonotcl earev enwheni ndi v i dual sar el ooki ngoutf ort hei rown i nt er est s. MuchnewKey nesi anr esear chat t empt st or emedyt hi somi ssi on: MenuCost sandAggr egat e- Coor di nat i onFai l ur e DemandExt er nal i t i es Ef f i ci encyWages TheSt agger i ngofPr i ces Chapt er -Two Nat i onalI ncomeAccount i ng Def i ni t i on:Nat i onali ncomeaccount i ngr ef er st ot heaccount i ngsy st em usedt o measur eGDP andmanyr el at edst at i st i cs.Thi schapt erf ocusesont het hr ee st at i st i cst hateconomi st sandpol i cy maker susemostof t en.Gr ossdomest i c pr oduct ,orGDP,t el l sust henat i on’ st ot ali ncomeandt het ot alexpendi t ur eon i t sout putofgoodsandser v i ces.Theconsumer pr i cei ndex,orCPI ,measur es t hel ev elofpr i ces.Theunempl oy mentr at et el l sust hef r act i onofwor ker swho ar eunempl oy ed. Thesi ngl emosti mpor t antmeasur eofov er al leconomi cper f or mancei sGr oss Domest i cPr oduct( GDP) . TheGDP i sanat t emptt osummar i zeal leconomi c act i v i t yov eraper i odoft i mei nt er msofasi ngl enumber ;i ti sameasur eoft he economy ’ st ot alout putandoft ot ali ncome.I not herwor dsGDPi st hev al ueof al lf i nalgoodsandser v i cespr oducedi nt heeconomyi nagi v ent i meper i od ( not et hatGDPi saf l ownotast ock) . Ther ear et woway st ov i ew t hi sst at i st i c.Onewayt ov i ew GDPi sast het ot al i ncomeofev er y onei nt heeconomy .Anot herwayt ov i ew GDPi sast het ot al expendi t ur eont heeconomy ’ sout putofgoodsandser v i ces. RealGDPv er susNomi nalGDP Not i cet hatGDPcani ncr easeei t herbecausepr i cesr i seorbecausequant i t i es r i se. GDP=Q* P Thati s,t hi smeasur edoesnotaccur at el yr ef l ecthow wel lt heeconomycan 10 sat i sf yt hedemandsofhousehol ds,f i r ms,andt hegov er nment .I fal lpr i ces doubl edwi t houtanychangei nquant i t i es,GDPwoul ddoubl e.Yeti twoul dbe mi sl eadi ngt osayt hatt heeconomy ’ sabi l i t yt osat i sf ydemandshasdoubl ed, becauset hequant i t yofev er ygoodpr oducedr emai nst hesame.Economi st scal l t hev al ueofgoodsandser v i cesmeasur edatcur r entpr i cesnomi nal GDP.Thus, i t i si mpor t antt ocor r ectf orchangesi npr i ces.Todot hi s, economi st sv al uegoods att hepr i cesi nsomegi v eny ear .Thi si sknownasr ealGDP.RealGDPmeasur es t heout putpr oducedi nanyoneper i odatt hepr i cesofsomebasey ear . GDPDef l at or Fr om nomi nalGDP andr ealGDP wecancomput eat hi r dst at i st i c:t heGDP def l at or .TheGDP def l at or ,al socal l edt hei mpl i ci tpr i cedef l at orf orGDP,i s def i nedast her at i oofnomi nal GDPt or eal GDP: Nomi nalGDP ◦ GDPDef l at or= RealGDP TheGDPdef l at orr ef l ect swhat ’ shappeni ngt ot heov er al ll ev elofpr i cesi nt he economy . ◦ Nomi nalGDP=Real GDP*GDPDef l at or . Nomi nalGDP ◦ RealGDP = GDPDef l at or Component sofGDP Thenat i onal i ncomeaccount sdi v i deGDPi nt of ourbr oadcat egor i esofspendi ng: ◦ Consumpt i on( C) ◦ I nv est ment( I) Thus, l et t i ngYst andf orGDP: ◦ Gov er nmentpur chases( G) ◦ Netexpor t s( NX) Y=C+I+G+NX Ot herMeasur esofI ncome I ti si mpor t antt obeawar eoft hev ar i ousmeasur es, becauseeconomi st sandt he pr essof t enr ef ert ot hem. Gr ossnat i onal pr oduct( GNP) : i ti st hev al ueoff i nal goodsandser v i cespr oduced bydomest i cal l yownedf act or sofpr oduct i onwi t hi nagi v enper i od.Toobt ai n GNP,weaddr ecei pt soff act ori ncome( wages,pr of i t ,andr ent )f r om t her estof 11 t hewor l dandsubt r actpay ment soff act ori ncomet ot her estoft hewor l d: GNP=GDP+Fact orpayment sf r om abr oad-Fact orpayment st oabr oad. Wher easGDPmeasur est het ot ali ncomepr oduceddomest i cal l y , GNPmeasur es t het ot ali ncomeear nedbynat i onal s( r esi dent sofanat i on) . Netnat i onalpr oduct ( NNP) : To obt ai n netnat i onalpr oduct( NNP) , wesubt r actt hedepr eci at i on of capi t al -t heamountoft heeconomy ’ sst ockofpl ant s,equi pment ,andr esi dent i al st r uct ur est hatwear soutdur i ngt hey ear : NNP=GNP-Depr eci at i on. I nt henat i onali ncomeaccount s,depr eci at i oni scal l edt heconsumpt i onoff i x ed capi t al . Nat i onal i ncome( NI ) : Nat i onal I ncome=NNP−I ndi r ectBusi nessTaxes Nat i onal i ncomemeasur eshowmuchev er y onei nt heeconomyhasear ned. Thenat i onali ncomeaccount sdi v i denat i onali ncomei nt of i v ecomponent s, dependi ngont hewayt hei ncomei sear ned. Per sonalI ncome=Nat i onal I ncome ( -Cor por at ePr of i t s-Soci al I nsur anceCont r i but i ons-NetI nt er est+Di v i dends +Gov er nmentTr ansf er st oI ndi v i dual +Per sonal I nt er estI ncome) Di sposabl e Per sonalI ncome = Per sonalI ncome -Per sonalTax and Nont ax Pay ment s. Wear ei nt er est ed i n di sposabl eper sonali ncomebecausei ti st heamount househol ds and noncor por at e busi nesses hav e av ai l abl et o spend af t er sat i sf y i ngt hei rt axobl i gat i onst ot hegov er nment . TheConsumerPr i ceI ndex( CPI ) Adol l art odaydoesn’ tbuyasmuchasi tdi d20y r sago.Thecostofal most ev er y t hi nghasgoneup.Thi si ncr easei nt heov er al ll ev elofpr i cesi scal l ed i nf l at i on. The mostcommonl y used measur e oft he l ev elofpr i ces i st he consumerpr i cei ndex( CPI ) . TheCPIt ur nst hepr i cesofmanygoodsandser v i ces i nt oasi ngl ei ndexmeasur i ngt heov er al ll ev elofpr i ces.TheCPIi st hepr i ceof t hi sbasketofgoodsandser v i cesr el at i v et ot hepr i ceoft hesamebasketi n 12 somebasey ear . Pr i cesofbasketofgoodsandser v i cei ncur r enty ear CPI= pr i cesoft hesamebasketi nt hebasey ear Thei ndext el l sushowmuchi tcost snowt obuyagi v enbasketr el at i v et ohow muchi tcostt obuyt hesamebasketi nt hebasey ear . TheCPIandt heGDPDef l at or Ther ear et hr eekeydi f f er encesbet weent het womeasur es. Thef i r stdi f f er encei s t hatt heGDPdef l at ormeasur est hepr i cesofal lgoodsandser v i cespr oduced. Wher eas,t heCPImeasur est hepr i cesofonl yt hegoodsandser v i cesboughtby consumer s.Thus,ani ncr easei nt hepr i ceofgoods boughtbyf i r msort he gov er nmentwi l lshow upi nt heGDP def l at orbutnoti nt heCPI . Thesecond di f f er ence i st hatt he GDP def l at ori ncl udes onl yt hose goods pr oduced domest i cal l y.I mpor t edgoodsar enotpar tofGDPanddonotshowupi nt heGDP def l at or . Hence,ani ncr easei nt hepr i ceofaToy ot amadei nJapanandsol di nt hi s count r yaf f ect st heCPI ,becauset heToyot ai sboughtbyconsumer s,buti tdoes notaf f ectt heGDPdef l at or . Thet hi r dandmostsubt l edi f f er encer esul t sf r om t hewayt het womeasur es aggr egat et hemanypr i cesi nt heeconomy .TheCPIassi gnsf i xedwei ght st ot he pr i cesofdi f f er entgoods, wher east heGDPdef l at orassi gnschangi ngwei ght s.I n ot herwor ds,t heCPIi scomput edusi ngaf i xedbasketofgoods,wher east he GDPdef l at oral l owst hebasketofgoodst ochangeov ert i meast hecomposi t i on ofGDPchanges.Economi st scal lapr i cei ndexwi t haf i xedbasketofgoodsa Laspeyr esi ndexandapr i cei ndexwi t hachangi ngbasketaPaaschei ndex. Measur i ngJobl essness:TheUnempl oy mentRat e Theunempl oy mentr at ei st hest at i st i ct hatmeasur est heper cent ageoft hose peopl ewant i ngt owor kbutwhodonothav ej obs. Aper soni sempl oy edi fheorshespentsomeoft hepr ev i ousweekwor ki ngata pai dj ob. Aper soni sunempl oy edi fheorshei snotempl oy edandhasbeenl ooki ngf ora j obori sont empor ar yl ay of f . Cat egor i esoft hepopul at i on 13 Empl oy ed:wor ki ngatapai dj ob Unempl oy ed: notempl oy edbutl ooki ngf oraj ob Laborf or ce: t heamountofl aborav ai l abl ef orpr oduci nggoodsandser v i ces; al l empl oy edpl usunempl oy edper sons( 1665) Noti nt hel aborf or ce: notempl oy ed, notl ooki ngf orwor k( <16, >65) i .Unempl oy mentr at e: per cent ageoft hel aborf or cet hati sunempl oy ed i i .l aborf or cepar t i ci pat i onr at e: t hef r act i onoft headul tpopul at i ont hat “ par t i ci pat es”i nt hel aborf or ce Comput i ngl aborst at i st i cs: U. S.adul tpopul at i onbygr oup, May2009 Numberempl oy ed = 140. 57mi l l i on Numberunempl oy ed = Adul tpopul at i on 235. 45mi l l i on = 14. 51mi l l i on Uset heabov edat at ocal cul at e t hel aborf or ce t he l aborf or ce par t i ci pat i on r at e t henumberofpeopl enoti n t heunempl oy mentr at e t hel aborf or ce Dat a:E=140. 57,U=14. 51,POP=235. 45 l aborf or ce L=E+U=140. 57+14. 51=155. 08 noti nl aborf or ce NI LF=POP –L=235. 45–155. 08=80. 37 unempl oy mentr at e U/ Lx100%=( 14. 51/ 155. 08)x100%=9. 4% l aborf or cepar t i ci pat i onr at e L/ POP x100%=( 155. 08/235. 45)x100%=65. 9% TheBusi nessCy cl eandt heOut putGap Thebusi nesscy cl edescr i best heupsanddownsi nar eal GDPov ert i me. Al t hough no busi ness cy cl es ar ei dent i cal ,t hey al lhav ef ourdi st i nct 14 phasepeak, cont r act i onorr ecessi on, t r ough, andexpansi on. Peak: I st hehi ghestl ev el ofr eal GDPi nt hecy cl e Endofeconomi cexpansi onandbegi nni ngofr ecessi on Unempl oy mentr at ei sr el at i v el yl ow Cont r act i on/ r ecessi on Out putandempl oy mentdecl i ne/ f al l Unempl oy mentl ev el i ncr eases Rat eofchangei snegat i v e Tr ough/ depr essi on Bot t om l ev el oft hecy cl e l owestl ev el ofr eal GDPobser v edov ert hecy cl e Excessi v eamountofunempl oy ment 15 Expansi on/ r ecov er y Out putandempl oy mentgr ow Real GDPi ncr eases Unempl oy mentl ev el decl i ne Rat eofchangei sposi t i v e I nf l at i on,gr owt h,andunempl oy mentar er el at edt hr ought hebusi nesscycl e. Thebusi nesscy cl ei st hemor eorl essr egul arpat t er nofexpansi on( r ecov er y ) andcont r act i on( r ecessi on)i neconomi cact i v i t yar oundt hepat hoft r end gr owt h.Atacy cl i calpeak, economi cact i v i t yi shi ghr el at i v et ot r end;andata cy cl i cal t r ough, t hel owpoi nti neconomi cact i v i t yi sr eached. Thet r endpat hofGDPi st hepat hGDPwoul dt akei ff act or sofpr oduct i on wer ef ul l yempl oyed.Overt i me, r eal GDPchangesf ort het wor easons. Fi r st , mor er esour cesbecomeav ai l abl ewhi chal l owst heeconomyt opr oduce mor egoodsandser v i ces,r esul t i ngi nar i si ngt r endl ev elofout put .Second, f act or sar enotf ul l yempl oy edal lt het i me.Thus,out putcanbei ncr easedby i ncr easi ngcapaci t yut i l i zat i on. Dev i at i onsofout putf r om t r endar er ef er r edt o ast heout putgap. Theout putgapmeasur est hegapbet weenact ualout put andt heout putt heeconomycoul dpr oduceatf ul lempl oy mentgi v ent he exi st i ngr esour ces.Ful l empl oy mentout puti sal socal l edpot ent i alout put . Out putgap=pot ent i al out put–act ualout put Okun’ sLaw Ar el at i onshi pbet weenr ealgr owt handchangesi nt heunempl oy mentr at ei s knownasOkun’ sl aw,namedaf t eri t sdi scov er er ,Ar t hurOkun. Hi sl aw say s t hatt heunempl oy mentr at edecl i neswhengr owt hi sabov et het r endr at eof 2. 25per cent .Speci f i cal l y ,f orev er yper cent agepoi ntofgr owt hi nr ealGDP abov et het r endr at ei ssust ai nedf oray ear ,t heunempl oy mentr at edecl i nes byonehal fper cent agepoi nt . The r el at i on i s st at ed as:ΔU =.Wher e ΔU-i s change i n 0. 5( y2. 25) unempl oy mentr at e, yi sper cent agegr owt hr at e. I nf l at i on–Unempl oy mentDy nami cs:ThePhi l l i psCur v e ThePhi l l i pscur v edescr i best heempi r i calr el at i onshi pbet weeni nf l at i onand 16 unempl oy ment : Thehi ghert her at eofunempl oy ment , t hel owert her at eofi nf l at i on. Thecur v esuggest st hatl essunempl oy mentcanal way sbeat t ai nedby i ncur r i ng mor ei nf l at i on and t hatt he i nf l at i on r at e can al way s be r educedbyi ncur r i ngt hecost sofmor eunempl oy ment . I not herwor dst hecur v esuggest st her ei sat r adeof fbet weeni nf l at i onand unempl oyment . CHAPTERTHREE AGGREGATEDEMANDI NTHECLOSEDECONOMY 3. 1Foundat i onsoft heTheor yofAggr egat eDemand • Ofal lt heeconomi cf l uct uat i onsi nwor l dhi st or y ,t heonet hatst andsoutas par t i cul ar l yl ar ge,pai nf ul ,andi nt el l ect ual l ysi gni f i canti st heGr eatDepr essi onof t he 1930s.Dur i ng t hi st i me,t he Uni t ed St at es and many ot hercount r i es exper i encedmassi v eunempl oy mentandgr eat l yr educedi ncomes.I nt hewor st y ear , 1933, onef our t hoft heU. S.l aborf or cewasunempl oy ed, andr ealGDPwas 30 per centbel ow i t s 1929 l ev el .Thi s devast at i ng epi sode caused many economi st st o quest i on t he val i di t yofcl assi caleconomi ct heor y. Cl assi cal t heor yseemedi ncapabl eofexpl ai ni ngt heDepr essi on. • Af t ert heonsetoft heDepr essi on, manyeconomi st sbel i ev edt hat: • A new modelwasneeded t o expl ai n such al ar ge&sudden economi c downt ur n&t osuggestgover nmentpol i ci est hatmi ghtr educet heeconomi c har dshi psomanypeopl ef aced. • I n1936t heBr i t i sheconomi stJohnMay nar dKey nesr ev ol ut i oni zedeconomi cs wi t hhi sbook:TheGener alTheor yofEmpl oyment ,I nt er est ,andMoney. Key nes pr oposed a new wayt o anal y ze t he economy ,whi ch he pr esent ed as an 17 al t er nat i v et ocl assi cal t heor y . • Keynespr oposedt hatl owaggr egat edemandi sr esponsi bl ef ort he: • l owi ncomeandhi ghunempl oymentt hatchar act er i zeeconomi cdownt ur ns. • Hecr i t i ci zedcl assi calt heor yf orassumi ngt hataggr egat esuppl yal one—capi t al , l abor ,andt echnol ogy —det er mi nesnat i onali ncome.Economi st st odayr econci l e t heset wov i ewswi t ht hemodel ofaggr egat edemandandaggr egat esuppl y. • I nt hel ongr un,pr i cesar ef l exi bl e,andaggr egat esuppl ydet er mi nesi ncome( cl assi calmodel ) .Buti nt heshor tr un,pr i cesar est i cky , sochangesi naggr egat e demandi nf l uencei ncome-( Key nesi anmodel ) .Themodelofaggr egat edemand dev el opedi nt hi schapt er ,cal l edt heI S–LM model ,t hel eadi ngi nt er pr et at i onof Key nes’ st heor y .Thegoaloft hemodeli st oshow whatdet er mi nesnat i onal i ncomef oranygi v enpr i cel ev el . Ther ear et woway st ov i ewt hi s: • Wecanv i ewt heI S–LM modelasshowi ngwhatcausesi ncomet ochangei nt he shor tr unwhent hepr i cel ev el i sf i xed.Orwecanv i ewt hemodel asshowi ngwhat causest heaggr egat edemandcur vet oshi f t .Thet wopar t soft heI S–LM model ar e-t heI Scur v eandt heLM cur v e. • I Sst andsf or“ i nv est ment ’ ’ and“ sav i ng, ’ ’ and • t heI Scur v er epr esent swhat ’ sgoi ngoni nt hemar ketf orgoodsandser v i ces. • LMst andsf or“ l i qui di t y ’ ’ and“ money , ’ ’ and • t heLMcur v er epr esent swhati shappeni ngt ot hesuppl yanddemandf or money . TheGoodsMar ketandt heI SCur ve • TheI Scur v epl ot st her el at i onshi pbet weent hei nt er estr at eandt hel ev elof i ncome t hatar i ses i nt he mar ketf orgoods and ser v i ces.To dev el op t hi s r el at i onshi p,west ar twi t habasi cmodelcal l edt heKey nesi ancr oss.Thi smodel i st hesi mpl esti nt er pr et at i onofKey nes’ st heor yofnat i onali ncomeandi sa bui l di ngbl ockf or t hemor ecompl exandr eal i st i cI S–LM model . TheKeynesi anCr oss • I nhi sGener alTheor y,Keynespr oposedt hataneconomy ’ st ot ali ncomewas,i n t heshor tr un,det er mi nedl ar gel ybyt hedesi r et ospendbyhousehol ds,f i r ms, andt hegover nment .Themor epeopl ewantt ospend,t hemor egoodsand ser v i cesf i r mscansel l . 18 • Themor ef i r mscansel l ,t hemor eout putt heywi l lchooset opr oduceandt he mor ewor ker st heywi l lchooset ohi r e.Thus,t hepr obl em dur i ngr ecessi onsand depr essi ons,accor di ng t o Key nes,was i nadequat e spendi ng. We begi n our der i v at i onoft heKey nesi ancr ossbydi f f er ent i at i ngbet weenact ualandpl anned expendi t ur e. • Act ualexpendi t ur ei st heamounthousehol ds,f i r ms,andt hegov er nmentspend ongoodsandser v i cesandi tequal st heeconomy ’ sgr ossdomest i cpr oduct ( GDP) . • Pl annedexpendi t ur ei st heamounthousehol ds, f i r ms, andt hegov er nmentwoul d l i ket ospendongoodsandser v i ces. • Assumi ngt heeconomyi scl osed,sot hatnetexpor t sar ezer o,wewr i t e pl annedexpendi t ur eADast hesum ofconsumpt i on( C) ,i nv est ment( I )and gov er nmentpur chase( G) E=C+I+G…………………………………………( 1) • Consumpt i oni saf unct i onofdi sposabl ei ncome( YT) C=C( Y-T) ………………………………. …………………( 2) • Thi sequat i onst at est hatconsumpt i ondependsondi sposabl ei ncome( Y-T) , whi chi st ot al i ncomeYmi nust axesT. • Tokeept hi ngssi mpl e,f ornow wet akepl annedi nv est mentasexogenousl y f i xed: …………………………………………. ……………( 3) • wef ur t herassumet hatf i scalpol i cy —t hel ev el sofgov er nmentpur chasesand t axes—i sf i xed: ……………………………. …………………………( 4) • Combi ni ngt hesef ourequat i ons, weobt ai n: • Thef i gur eabov egr aphspl annedexpendi t ur easaf unct i onoft hel evelof 19 i ncome. • Thi sl i nesl opesupwar dbecausehi gheri ncomel eadst ohi gherconsumpt i on andt hushi gherpl annedexpendi t ur e.Thesl opeoft hi sl i nei st hemar gi nal pr opensi t yt oconsume,t heMPC:i tshowshow muchpl annedexpendi t ur e i ncr easeswheni ncomer i sesby$1.Thi spl annedexpendi t ur ef unct i oni st he f i r stpi eceoft hemodel cal l edt heKey nesi ancr oss. TheEconomyi nEqui l i br i um • Theeconomyi ssai dt obei nequi l i br i um whenAct ualexpendi t ur ei sequalt o pl anned expendi t ur e.Thi s assumpt i on i s based on t he i dea t hatwhen peopl e’ spl anshav ebeenr eal i zed,t heyhav enor easont ochangewhatt hey ar edoi ng.Wecanwr i t et heequi l i br i um condi t i onas: Act ual Expendi t ur e=Pl annedExpendi t ur e Y = E TheAdj ust mentt oEqui l i br i um • I nsummar y ,t heKey nesi ancr ossshowshow i ncomeY i sdet er mi nedf or gi v enl ev el sofpl annedi nv est mentIandf i scalpol i cyGandT.Wecanuset hi s modelt oshowhowi ncomechangeswhenoneoft heseexogenousv ar i abl es changes. Fi scalPol i cyandt heMul t i pl i er :Gov er nmentPur chases( Ref ert ot hegr aph) • Thegr aphshowst hat ,ani ncr easei ngov er nmentpur chasel eadst oanev en gr eat eri ncr easei ni ncome. 20 • Thati s,ΔY>ΔG.Ther at i oΔY/ ΔGi scal l edt hegov er nmentpur chasesmul t i pl i er ; i tt el l sushow muchi ncomer i sesi nr esponset oa$1i ncr easei ngov er nment pur chases. • An i mpl i cat i on oft he Key nesi an cr oss i st hatt he gov er nment pur chases mul t i pl i eri sl ar gert hanone. Whydoesf i scalpol i cyhav eamul t i pl i edef f ectoni ncome? • Ther easoni st hat ,accor di ngt ot heconsumpt i onf unct i onC =C( Y-T) ,hi gher i ncomecauseshi gherconsumpt i on.Whenani ncr easei ngov er nmentpur chases r ai sesi ncome,i tal sor ai sesconsumpt i on,whi chf ur t herr ai sesi ncome,whi ch f ur t herr ai sesconsumpt i on,andsoon.Ther ef or e,i nt hi smodel ,ani ncr easei n gov er nmentpur chasescausesagr eat eri ncr easei ni ncome. Howbi gi st hemul t i pl i er ? Thet ot al ef f ectoni ncomei s • I ni t i al Changei nGov er nmentPur chases=ΔG • Fi r stChangei nConsumpt i on =MPC*ΔG • SecondChangei nConsumpt i on=MPC2*ΔG • Thi r dChangei nConsumpt i on =MPC3*ΔG .. .. .. .. • ΔY=ΔG( 1+MPC+MPC2+MPC3+... ) . • Thegov er nment pur chasesmul t i pl i eri s ΔY/ ΔG=1+MPC+MPC2+MPC3+... • Thi sexpr essi onf ort hemul t i pl i eri sanexampl eofani nf i ni t egeomet r i cser i es. 2 Ar esul tf r om al gebr aal l owsust owr i t et hemul t i pl i eras ΔY/ ΔG=1/( 1-MPC) . • Forexampl e, i ft hemar gi nal pr opensi t yt oconsumei s0. 6, t hemul t i pl i eri s 2 3 ΔY/ ΔG=1+0. 6+0. 6 +0. 6 +... =1/( 1-0. 6)=2. 5. • I nt hi scase,a$1. 00i ncr easei ngov er nmentpur chasesr ai sesequi l i br i um i ncomeby$2. 50. Fi scalPol i cyandt heMul t i pl i er :Taxes( Ref ert ot hegr aph) • Justasani ncr easei ngov er nmentpur chaseshasamul t i pl i edef f ecton i ncome, sodoesadecr easei nt axes. • Asbef or e, t hei ni t i alchangei nexpendi t ur e, nowMPC×ΔT, i smul t i pl i edby1/ ( 1−MPC) . Theov er al l ef f ectoni ncomeoft hechangei nt axesi s ΔY/ ΔT=−MPC/( 1−MPC) . • Thi sexpr essi oni st het axmul t i pl i er , t heamounti ncomechangesi nr esponse t oa$1changei nt axes.Forexampl e, i ft hemar gi nal pr opensi t yt oconsumei s 0. 6, t hent het axmul t i pl i eri s 21 ΔY/ ΔT=−0. 6/( 1−0. 6)=−1. 5. • I nt hi sexampl e,a$1. 00cut( decr ease)i nt axesr ai sesequi l i br i um i ncomeby $1. 50. Themul t i pl i eri mpl i est hatt axesandi ncomear ei nv er sel yr el at edanda uni tdecr easei nt axesi ncr easei ncomebymor et hanpr opor t i onat el y . TheI nt er estRat e, I nv est ment , andt heI SCur v e • TheKey nesi ancr ossi sonl yast eppi ngst oneonourpat ht ot heI S–LM model . • Yeti tmakest hesi mpl i f y i ngassumpt i ont hatt hel ev elofpl annedi nv est mentI i sf i xed. • Her e we setan i mpor t antmacr oeconomi cr el at i onshi p bet ween pl anned i nv est mentand t he i nt er estr at er . I fi nt er estr at ei ncr eases,pl anned i nv est mentf al l s,andsodoesout put .Thushi gherl ev el sofi nt er estr at ear e associ at edwi t hl owerl ev elofout put . Toaddt hi sr el at i onshi pbet weent he i nt er estr at eandi nv est mentt oourmodel ,wewr i t et hel ev elofpl anned i nv est mentas, I=I ( r ) . • I nessence,t heI Scur v ecombi nest hei nt er act i onbet weenrandIexpr essed byt hei nv est mentf unct i onandt hei nt er act i onbet weenIandYdemonst r at ed byt heKey nesi ancr oss. • Becauseani ncr easei nt hei nt er estr at ecausespl annedi nv est mentt of al l , whi chi nt ur ncausesi ncomet of al l , t heI Scur v esl opesdownwar d HowFi scalPol i cyShi f t st heI SCur v e • TheI Scur v ei sdr awnf oragi v enf i scalpol i cy ;t hati s,whenweconst r uctt he I Scur v e, wehol dGandTf i xed.Whenf i scal pol i cychanges, t heI Scur v eshi f t s. Fi gur e bel ow uses t he Key nesi an cr oss t o show how an i ncr ease i n gov er nmentpur chasesbyΔGshi f t st heI Scur v e.Thi sf i gur ei sdr awnf ora gi v en( const ant )i nt er estr at eandt husf oragi v enl ev el ofpl annedi nv est ment . 22 TheKey nesi ancr ossshowst hatt hi schangei nf i scalpol i cyr ai sespl anned expendi t ur e and t her eby i ncr eases equi l i br i um i ncome f r om Y1 t o Y2. Ther ef or e,an i ncr ease i n gov er nment pur chases shi f t st he I S cur v e out war d.( Pl ease, r ef ert ot hegr aph) • I nsummar y , t heI Scur v eshowst hecombi nat i onsoft hei nt er estr at eandt he l ev elofi ncomet hatar econsi st entwi t hequi l i br i um i nt hemar ketf orgoods andser v i ces. • TheI Scur vei sdr awnf oragi venf i scalpol i cy. • Changesi nf i scalpol i cyt hatr ai set hedemandf orgoodsandser v i cesshi f t t heI Scur v et ot her i ght .Changesi nf i scalpol i cyt hatr educet hedemandf or goodsandser v i cesshi f tt heI Scur v et ot hel ef t . TheMoneyMar ketandt heLM Cur v e • TheLM cur v epl ot st her el at i onshi pbet weent hei nt er estr at eandt hel ev elof i ncomet hatar i sesi nt hemar ketf ormoneybal ances. • Tounder st andt hi sr el at i onshi p,webegi nbyl ooki ngatat heor yoft hei nt er est r at e, cal l edt het heor yofl i qui di t ypr ef er ence. TheTheor yofLi qui di t yPr ef er ence • Thi si sat heor yofi nt er estr at edet er mi nat i oni nshor tr un.I tar guest hati nt er est t ar e,i nt heshor tr un,i sdet er mi nedi nt hemoneymar ket ,wher et hedemandand suppl yofr ealmoneybal ancesi nt er sect .Justast heKey nesi an cr ossi sa bui l di ngbl ockf ort heI Scur v e, t het heor yofl i qui di t ypr ef er encei sabui l di ngbl ock f ort heLM cur v e. • Todev el opt hi st heor y ,webegi nwi t ht hesuppl yofr ealmoneybal ances.I fM st andsf ort hesuppl yofmoneyandPst andsf ort hepr i cel ev el ,t henM/ Pi st he suppl yofr ealmoneybal ances.Thet heor yofl i qui di t ypr ef er enceassumest her e i saf i xedsuppl yofr eal moneybal ances. Thati s, • Themoneysuppl yM i sanexogenouspol i cyv ar i abl echosenbyacent r albank, suchast heNat i onalBank.Thepr i cel ev elPi sal soanexogenousv ar i abl ei nt hi s model ( i nt heshor tr unwhent hepr i cel ev el i sf i xed. ) • Theseassumpt i onsi mpl yt hatt hesuppl yofr ealmoneybal ancesi sf i xedand,i n par t i cul ar , doesnotdependont hei nt er estr at e.Thus, whenwepl ott hesuppl yof 23 r ealmoneybal ancesagai nstt hei nt er estr at ei nf i gur ebel ow, weobt ai nav er t i cal suppl ycur v e. Next , consi dert hedemandf orr eal moneybal ances. • Thet heor yofl i qui di t ypr ef er enceposi t st hatt hei nt er estr at ei sonedet er mi nant ofhowmuchmoneypeopl echooset ohol d.Ther easoni st hatt hei nt er estr at ei s t heoppor t uni t ycostofhol di ngmoney :i ti swhaty ouf or gobyhol di ngsomeof y ourasset sasmoney . Whent hei nt er estr at er i ses,peopl ewantt ohol dl essof t hei rweal t hi nt hef or m ofmoney . We can wr i t e t he demand f or r eal money bal ances as, • Accor di ngt ot het heor yofl i qui di t ypr ef er ence,t hesuppl yanddemandf orr eal moneybal ancesdet er mi newhati nt er estr at epr ev ai l si nt heeconomy .Thati s, t hei nt er estr at eadj ust st oequi l i br at et hemoneymar ket . ( pl easer ef ert ot he gr aph) I ncome, MoneyDemand, andt heLM Cur v e • Sof arweassumedt hatonl yi nt er estr at edet er mi nest hequant i t yofr ealmoney bal ancesdemanded.Butmor e,r eal i st i cal l y ,t hel ev elofi ncomeYal soaf f ect s moneydemand. • Wheni ncomei shi gh, expendi t ur ei shi gh, sopeopl eengagei nmor et r ansact i ons t hatr equi r et heuseofmoney .Thus,gr eat eri ncomei mpl i esgr eat ermoney demand.Wecanexpr esst hesei deasbywr i t i ngt hemoneydemandf unct i onas, • Thequant i t yofr ealmoneybal ancesdemanded i snegat i v el yr el at ed t ot he i nt er estr at e and posi t i v el yr el at ed t oi ncome. Usi ng t he t heor y ofl i qui di t y pr ef er encewecanseewhathappenst ot hei nt er estr at ewhent hel ev elof i ncomechanges.Forexampl e,consi derwhathappenswheni ncomei ncr eases f r om Y1t oY2. 24 • TheLM cur v epl ot st hi sr el at i onshi pbet weent hel ev elofi ncomeandt hei nt er est r at e. • Thehi ghert hel ev elofi ncome,t hehi ghert hedemandf orr ealmoneybal ances, andt hehi ghert heequi l i br i um i nt er estr at e.Fort hi sr eason,t heLM cur v esl opes upwar d, asi npanel ( b)ofFi gur eabov e. HowMonet ar yPol i cyShi f t st heLM Cur v e • I fr ealmoneybal anceschange—f orexampl e, i ft heFedal t er st hemoneysuppl y t heLM cur veshi f t s. • Supposet hatt heNat i onalBankdecr easest hemoneysuppl yf r om M1t oM2, whi chcausest hesuppl yofr ealmoneybal ancest of al lf r om M1/ Pt oM2/ P. Hence,adecr easei nt hemoneysuppl yshi f t st heLM cur v eupwar d. ( pl easer ef er t ot hegr aph) • I nsummar y,t heLM cur veshowst hecombi nat i onsoft hei nt er estr at eandt he l evelofi ncomet hatar econsi st entwi t hequi l i br i um i nt hemar ketf orr ealmoney bal ances.TheLM cur vei sdr awnf oragi vensuppl yofr ealmoneybal ances. • Decr easesi nt hesuppl yofr ealmoneybal ancesshi f tt heLM cur veupwar d. • I ncr easesi nt hesuppl yofr ealmoneybal ancesshi f tt heLM cur vedownwar d. TheShor t RunEqui l i br i um • Themodelt akesf i scalpol i cy ,GandT,monet ar ypol i cyM,andt hepr i cel ev el Pasexogenous. • Gi v ent heseexogenousv ar i abl es,t heI Scur v epr ov i dest hecombi nat i onsofr andYt hatsat i sf yt heequat i onr epr esent i ngt hegoodsmar ket , and 25 • TheLM cur v epr ov i dest hecombi nat i onsofrandYt hatsat i sf yt heequat i on r epr esent i ngt hemoneymar ket . Fr om t heI SLM t oAggr egat edemandCur ve • Wehav ebeenusi ngt heI S–LM modelt oexpl ai nnat i onali ncomei nt heshor t r unwhent hepr i cel ev eli sf i xed.Toseehow t heI S–LM modelf i t si nt ot he modelofaggr egat esuppl yandaggr egat edemand,wenow exami newhat happensi nt heI S–LM modeli ft hepr i cel eveli sal l owedt ochange.Forany gi v enmoneysuppl yM,ahi gherpr i cel ev elPr educest hesuppl yofr ealmoney bal ancesM/ P.A l owersuppl yofr ealmoneybal ancesshi f t st he LM cur v e upwar d(t ot hel ef t ) ,whi chr ai sest heequi l i br i um i nt er estr at eandl ower st he equi l i br i um l ev el ofi ncome, asshowni npanel ( a) . • Her et hepr i cel ev elr i sesf r om P1 t oP2,andi ncomef al l sf r om Y1 t oY2. The aggr egat edemandcur v ei npanel( b)pl ot st hi snegat i v er el at i onshi pbet ween nat i onal i ncomeandt hepr i cel ev el .I not herwor ds, t heaggr egat edemandcur v e showst hesetofequi l i br i um poi nt st hatar i sei nt heI S–LM modelaswevar yt he pr i cel ev el andseewhathappenst oi ncome. CHAPTER-FOUR AGGREGATEDEMANDI NTHEOPENECONOMY 26 I nt er nat i onal Fl owsofCapi t alandGoods • I nt hepr ev i ouschapt er ,wesi mpl i f i edouranal y si sbyassumi ngacl osed economy . • I nact ual i t y , howev er , mosteconomi esar eopen: – t heyexpor tgoodsandser v i cesabr oad – t heyi mpor tgoodsandser v i cesf r om abr oad, and – t heybor r owandl endi nwor l df i nanci al mar ket s. OpenVer susCl osedEconomi es • Acl osedeconomy i sonet hatdoesnoti nt er actwi t hot hereconomi esi nt he wor l d. Ther ear enoexpor t s, noi mpor t s, andnocapi t alf l ows. • Anopeneconomyi sonet hati nt er act sf r eel ywi t hot hereconomi esar ound t hewor l d. Anopeneconomyi nt er act swi t hot hercount r i esi nt woway s: I tbuy sandsel l sgoodsandser vi cesi nwor l dpr oductmar ket s. I tbuy sandsel l scapi t alasset si nwor l df i nanci al mar ket s. I nt er nat i onalFl owsofGoods:( Expor t s, I mpor t s, andNetExpor t s) • Consi dert heexpendi t ur eonanopeneconomy ’ sout putofgoodsandser v i ces, whi chcanbedi v i dedi nt of ourcomponent s: Cd, consumpt i onofdomest i cgoodsandser v i ces, d , i nv est menti ndomest i cgoodsandser v i ces, I Gd, gov er nmentpur chasesofdomest i cgoodsandser v i ces, EX, expor t sofdomest i cgoodsandser v i ces. • Thedi v i si onofexpendi t ur ei nt ot hesecomponent si sexpr essedi nt hei dent i t y , d Y =Cd +I +Gd +EX • Not et hatdomest i cspendi ngonal l goodsandser v i cesi st hesum of domest i cspendi ngondomest i cgoodsandser v i cesandonf or ei gngoods andser v i ces.Ther ef or e, f d C =Cd +CfI=I +I G =Gd +Gf • Wesubst i t ut et heset hr eeequat i onsi nt ot hei dent i t yabove:andr ear r angi ng d Y =Cd +I +Gd +EX, f )+GI ICf)+( Gf +EX • Y =( C- 27 f Cf +I • Y =C +I+G +EX( +Gf) I M • Y =C +I+G +EX- Thenat i onali ncomei dent i t yi nanopeneconomyi st her ef or e: Y =C +I+G +Nx Or , Nx=Y( C +I+G) NetExpor t s=Out put−Domest i cSpendi ng • I tshowst hati nanopeneconomy , domest i cspendi ngneednotequal t heout put ofgoodsandser v i ces. • I fout putexceedsdomest i cspendi ng( consumpt i on) ,weexpor tt hedi f f er ence: netexpor t sar eposi t i ve. • I fout putf al l s shor tofdomest i c spendi ng ( consumpt i on) ,we i mpor tt he di f f er ence: netexpor t sar enegat i ve. I tshowst hati nanopeneconomy , domest i c spendi ngneednotequal t heout putofgoodsandser v i ces. • Expor t s: ar edomest i cal l ypr oducedgoodsandser v i cest hatar esol dabr oad. • I mpor t s:ar ef or ei gnpr oducedgoodsandser v i cest hatar esol ddomest i cal l y . • Netexpor t s( NX) : al so cal l ed t he t r adebal ance:r ef er st ot hev al uesofa nat i on’ sexpor t smi nust hev al ueofi t si mpor t s. I nt er nat i onalCapi t al Fl ows • Netf or ei gni nvest ment / Netcapi t alout f l ow/ -r ef er st ot hepur chaseoff or ei gn asset s bydomest i cr esi dent s mi nus t he pur chase ofdomest i c asset s by f or ei gner s. • Fori nst ance, t heEt hi opi anr esi dentbuy sst ocki nt heChi nesecor por at i onanda Chi nesebuy sst ocki nt heEt hi opi ancor por at i on. WhenEt hi opi anr esi dentbuy s st ocki nTel mex, t heMexi canphonecompany , t hepur chaser ai sest heEt hi opi an netf or ei gni nv est ment . • WhenaJapaneser esi dentbuy sabondi ssuedbyt heEt hi opi angov er nment , t he pur chaser educest heEt hi opi annetf or ei gni nv est ment . • Fi nanci al / Capi t almar ket sandgoodsmar ket sar ecl osel yr el at ed. • Begi nwi t ht hei dent i t y:Y =C +I +G +NX. Subt r actCandGf r om bot hsi dest oobt ai n: Y -C -G =I +NX Not e:Y -C -G i snat i onalsavi ngS,t hesum ofpr i vat esavi ng,Y -T -C,and publ i csavi ng, T -G. 28 • Ther ef or e, S =I +NX. • Subt r act i ng If r om bot hsi desoft heequat i on,wecanwr i t et henat i onali ncome account si dent i t yas S -I =NX⟹ t r adebal ance = netcapi t alout f l ow) ( • Thi si dent i t yshowst hataneconomy’ snetexpor t smustal waysequalt he di f f er encebet weeni t ssavi ngandi t si nvest ment . , • S-I i st er medasnetcapi t alout f l ow/ netf or ei gni nvest ment( domest i csavi ng l essdomest i ci nvest ment ) . • I fnetcapi t alout f l ow i sposi t i ve,oursavi ngexceedsouri nvest ment ,and wear el endi ngt heexcesst of or ei gner s/ I . e. ,WhenS >I,t hecount r yi sa netl ender / • I ft henetcapi t alout f l ow i snegat i ve,ouri nvest mentexceedsoursavi ng, andwear ef i nanci ngt hi sext r ai nvest mentbybor r owi ngf r om abr oad/I . e. , WhenS <I,t hecount r yi sanetbor r ower / . • Thus,netcapi t aloutf l ow equal st heamountt hatdomest i cr esi dent sar e l endi ngabr oadmi nust heamountt hatf or ei gner sar el endi ngt ous. • Thenat i onali ncomeaccount si dent i t yshowst hatt hei nt er nat i onalf l ow of f undst of i nancecapi t alaccumul at i onandt hei nt er nat i onalf l ow ofgoodsand ser v i cesar et wosi desoft hesamecoi n. • Ont heonehand,i foursav i ngexceedsouri nv est ment ,t hesav i ngt hati snot i nv est eddomest i cal l yi susedt omakel oanst of or ei gner s.For ei gner sr equi r e t hesel oansbecausewear epr ov i di ngt hem wi t hmor egoodsandser v i cest han t heyar epr ov i di ngus.Thati s, wear er unni ngat r adesur pl us. • Ont heot herhand,i fouri nv est mentexceedsoursav i ng,t heext r ai nv est ment mustbef i nancedbybor r owi ngf r om abr oad.Thesef or ei gnl oansenabl eust o i mpor tmor egoodsandser v i cest hanweexpor t .Thati s, wear er unni ngat r ade def i ci t . Fact or st hatI nf l uenceNetFor ei gnI nv est ment : • Ther eal i nt er estr at esbei ngpai donf or ei gnasset s. • Ther eal i nt er estr at esbei ngpai dondomest i casset s. • Theper cei v edeconomi candpol i t i cal r i sksofhol di ngasset sabr oad. • Thegov er nmentpol i ci est hataf f ectf or ei gnowner shi pofdomest i casset s. 29 Savi ngandi nvest menti nasmal lopeneconomy Basi cAssumpt i ons: • Smal lopeneconomyi ti st omeant hatt heeconomyi sasmal lpar toft hewor l d mar ketandt hus,byi t sel f ,canhaveonl yanegl i gi bl eef f ectont hewor l di nt er est r at e. • Per f ectcapi t almobi l i t y-r esi dent soft hecount r yhav ef ul laccesst o wor l d f i nanci almar ket s.Meani ng t he gov er nmentdoes noti mpede i nt er nat i onal bor r owi ng/l endi ng. • Owi ngt ot heabov eassumpt i ons,t hei nt er estr at er ,mustequalt he wor l d i nt er estr at er* ( t her eali nt er estr at epr ev ai l i ngi nwor l d f i nanci almar ket s) : r =r* • Resi dent soft hesmal lopeneconomyneednev erbor r ow atanyi nt er estr at e abov er * ,becauset heycan al way sgetal oan atr *f r om abr oad.Si mi l ar l y , r esi dent soft hi seconomyneednev erl endatanyi nt er estr at ebel owr*because t heycan al way s ear n r*byl endi ng abr oad.Thus,t he wor l di nt er estr at e det er mi nest hei nt er estr at ei noursmal lopeneconomy. Whatdet er mi nest hewor l dr eali nt er estr at e? • Theequi l i br i um ofwor l dsav i ngandwor l di nv est mentdet er mi nest hewor l d i nt er estr at e. • Oursmal lopeneconomyhasanegl i gi bl eef f ectont hewor l dr eali nt er estr at e because,bei ngasmal lpar toft hewor l d,i thasanegl i gi bl eef f ectonwor l d sav i ngandwor l di nv est ment . • Hence,oursmal lopeneconomyt akest hewor l di nt er estr at easexogenousl y gi ven. • TheModel :Tobui l dt hemodeloft hesmal lopeneconomy ,wemaket hr ee assumpt i ons, • ̅ ̅̅ Pr oduct i onf unct i on: Y =Y =F(K, ’ s out putYi s L) :Theeconomy f i xedbyt hef act or sofpr oduct i on. YT) Consumpt i onf unct i on: C =C( I nvest mentf unct i on: I=I ( r ) • Wecannowr et ur nt ot heaccount i ngi dent i t yandwr i t ei tas Nx=( Y -C -G)-I 30 Nx=S -I • Subst i t ut i ngourt hr eeassumpt i onsandt hecondi t i ont hatt hei nt er estr at e equal st hewor l di nt er estr at e, weobt ai n ̅ ̅ Nx=[ ( r* ) Y -C(Y -T) -G] -I ̅ Nx=S -I ( r* ) • Thi sequat i onshowswhatdet er mi nessavi ngSandi nvest mentI ,andt hust he t r adebal ance. Nx • Sav i ngdependsonf i scalpol i cy:l owergover nmentpur chasesGorhi ghert axes Tr ai senat i onalsavi ng.I nvest mentdependsont hewor l dr eali nt er estr at er * : hi ghi nt er estr at esmakesomei nvest mentpr oj ect sunpr of i t abl e.Ther ef or e,t he t r ade bal ance depends on t hese var i abl es as wel l . The t r ade bal ance i s det er mi ned byt he di f f er ence bet ween sav i ng and i nv est mentatt he wor l d i nt er estr at e.( pl easer ef ert ot hegr aph) • I nacl osedeconomy ,t her eali nt er estr at eadj ust st oequi l i br at esav i ngand i nv est ment . But ,i nasmal lopeneconomy,t hei nt er estr at ei sdet er mi nedi nwor l d f i nanci almar ket s.Thedi f f er encebet weensav i ngandi nv est mentdet er mi nest he t r adebal ance.Her et her ei sat r adesur pl us,becauseatt hewor l di nt er estr at e, savi ngexceedsi nvest ment . HowPol i ci esI nf l uencet heTr adeBal ance • Supposet hatt heeconomybegi nsi naposi t i onofbal ancedt r ade.Thati s, att he S, wor l di nt er estr at e, i nv est mentIequalsav i ng, andnetexpor t sNxequalzer o. Let ’ suseourmodelt opr edi ctt heef f ect sofgover nmentpol i ci esathomeand abr oad. Fi scalPol i cyatHome: • Whathappenst ot hesmal lopeneconomyi ft hegov er nmentexpandsdomest i c spendi ng byi ncr easi ng gov er nmentpur chases?Thei ncr easei nG r educes nat i onalsav i ng, becauseS =Y -C -G.Wi t hanunchangedwor l dr eali nt er est r at e,i nvest mentr emai nst hesame.Ther ef or e,sav i ngf al l sbel ow i nv est ment , and some i nv est mentmustnow be f i nanced by bor r owi ng f r om abr oad. BecauseNX =S -I ,t hef al li n Si mpl i esaf al li nNx.Theeconomynowr unsa t r adedef i ci t .( pl easer ef ert ot hegr aph) • BecauseNx i st hedi st ancebet weent hesav i ngschedul eandt hei nv est ment 31 schedul eatt hewor l di nt er estr at e,t hi sshi f tr educesNx.Hence,st ar t i ngf r om bal ancedt r ade,achangei nf i scalpol i cyt hatr educesnat i onalsavi ngl eadst o at r adedef i ci t . Fi scalPol i cyAbr oad • Whathappenst oasmal lopeneconomywhenf or ei gngov er nment si ncr ease t hei rgov er nmentpur chases?Assumi ngt hesef or ei gncount r i esar eal ar ge par toft hewor l deconomy ,andt hust hei ri ncr easei ngov er nmentpur chases r educeswor l dsav i ngandcausest hewor l di nt er estr at et or i se. • Thei ncr easei nt hewor l di nt er estr at er ai sest hecostofbor r owi ngand,t hus, r educesi nv est menti noursmal l openeconomy . Shi f t si nI nv est mentDemand • Whathappenst ooursmal lopeneconomyi fi t si nv est mentschedul eshi f t s out war d—t hati s,i ft hedemandf ori nv est mentgoodsatev er yi nt er estr at e i ncr eases? • Anout war dshi f ti nt hei nv est mentschedul ef r om I ( r 1)t o( I ( r 2)i ncr easest he amountofi nv est mentatt hewor l di nt er estr at er * . • Asar esul t ,i nvest mentnow exceedssavi ng,whi chmeanst heeconomyi s bor r owi ngf r om abr oadandr unni ngat r adedef i ci t . ExchangeRat es • Hav i ngexami nedt hei nt er nat i onalf l owsofcapi t alandofgoodsandser v i ces, we now ext end t he anal y si s by consi der i ng t he pr i ces t hatappl yt ot hese t r ansact i ons. Theexchanger at e( E)i st her at eatwhi chonecur r encyexchanges f oranot her . • Onemayv i ewt heex changer at easi ndi cat i v eoft her el at i v epr i ceofgoodsand ser v i cesdenomi nat edi nt hecur r enci esoft het wocount r i esconcer ned.Ther e ar et woconvent i onsf ormeasur i ngt heexchanger at e,t hedi st i nct i onbet ween whi chcanbet hesour ceofser i ousconf usi on: 32 1)Domest i ccur r encyuni t speruni toff or ei gncur r ency • Forexampl e,i ft hebi r ri st hehomecur r encyandt hedol l ar( $)i st hef or ei gn Cur r ency ,and 20 bi r rexchangesf or$1,t hent heexchanger at ei s20.The domest i ccur r encyi sont henumer at oroft her at i o. • Her e, wheneverEr i sest hehomecur r encyget sweaker ; i tdepr eci at es. • Forex ampl e,ar i sef r om 20t o21meanst hat21bi r rexchangedf or$1,l esst han bef or e. • Conv er sel y , whenEf al l s, t hedomest i ccur r encyget sst r onger , i tappr eci at es. 2)For ei gncur r encyuni t speruni tofdomest i ccur r ency • Thi si sexact l yt heconv er seoft hef i r stconv ent i on. • Thedomest i ccur r encyi sont hedenomi nat or .When20bi r ri sexchangedf or$1, t heexchanger at ei s0. 05. I fEr i ses,t hehomecur r encyget sst r onger ,andvi ce ver sa. RealandNomi nal ExchangeRat es • The Nomi nalExchangeRat e( e)i st her el at i v epr i ceoft hecur r encyoft wo count r i es. • Forexampl e, i ft heexchanger at ebet weent heEt hi opi anbi r randt heU. Sdol l ari s 20bi r rperdol l ar ,t heny oucanexchangeonedol l arf or20bi r ri nt hewor l d mar ket sf orf or ei gncur r ency . TheRealExchangeRat ei st her el at i v epr i ceoft he goodsoft wocount r i es. • Thati s,t her ealexchanger at et el l sust her at eatwhi chwecant r adet hegoods ofonecount r yf ort hegoodsofanot her . I tmeasur esacount r y ’ scompet i t i v eness i nt hei nt er nat i onal t r ade. • Ther eal exchanger at eR, i susual l ydef i nedas R =e. P Pf/ • Wher ePandPfar et hepr i cel ev el sher eandabr oad, r espect i v el yandei st hebi r r pr i ceoff or ei gnexchange( t henomi nalexchanger at e) .Ther at eatwhi chwe exchangef or ei gnanddomest i cgoodsdependsont hepr i cesoft hegoodsi nt he l ocalcur r enci esandont her at eatwhi cht hecur r enci esar eexchanged. I ft her eal exchanger at eequal s1,cur r enci esar eatpur chasi ngpowerpar i t y( PPP) . Ar eal exchanger at eabove1means, t hatgoodsabr oadar emor eexpensi vet hangoods athome. • Ot hert hi ngsequal ,t hi si mpl i est hatpeopl e-bot hathomeandabr oad-ar el i kel y 33 t oswi t chsomeoft hei rspendi ngt ogoodspr oducedathome.Thi si sof t en descr i bedasani ncr easei nt hecompet i t i v enessofourpr oduct s.Asl ongasRi s gr eat ert han1,weex pectt her el at i v edemandf ordomest i cal l ypr oducedgoods t or i se. Exchanger at eDet er mi nat i on/ Fi xedv er susFl exi bl eExchanger at eRegi mes/ Fl exi bl eExchangeRat es: • Undert hi ssy st em t heexchanger at ei scompl et el ymar ket -det er mi ned,wi t hout anyi nt er f er encef r om gov er nmentaut hor i t i es( t hecent r al bank) . • Thebal anceofpayment sbal ances:sur pl usesar eel i mi nat edv i aexchanger at es appr eci at i on; def i ci t sar ecur edbyexchanger at edepr eci at i on. • I not herwor ds, bal anceofpayment sdi sequi l i br i aar esel f cor r ect i ng. Fi xedExchangeRat es: • Her et her at eofexchangei sapol i cypar amet erf i xedbyt heaut hor i t i es. • Theyhav et omeetexcessdemandf oraf or ei gncur r ency( notf i nancedbysal es i nt hatf or ei gncount r y )f r om t hei rr eser vesoff or ei gncur r ency. • Neti nf l owsoff or ei gncur r encyswel lt hedomest i cmoneysuppl y ,aspr i v at e economi cagent swhodon’ tusei tt opur chasegoodsabr oadconv er tf or ei gn cur r encyt odomest i cmoneyatt hef i xedr at eofexchange. • Ther e i s no sel f cor r ect i ng mechani sm t o bal ance of payment s di sequi l i br i a. Bet ween t wo ext r emes we hav e:Managed f l oat( consi dert he Et hi opi ancase) . Depr eci at i onver susAppr eci at i ons • Acur r encyi ssai dt obedepr eci at ewhenunderf l oat i ngr at esi tbecomesl ess expensi v ei nt er msoff or ei gncur r ency .Bycont r ast ,cur r encyappr eci at eswhen i tbecomesmor eex pensi v ei nt er msoff or ei gnmoney . Deval uat i onVer susReval uat i on • Dev al uat i on t akes pl ace when t he pr i ce off or ei gn cur r enci es underf i x ed exchange r at er egi me i si ncr eased byof f i ci al .To pr omot e expor t er s and di scour agei mpor t er s. • Dev al uat i ont husmeanst hatf or ei gner spayl essf ordev al uedcur r encyandt hat r esi dent s oft he dev al ui ng count r y pay mor ef orf or ei gn cur r enci es.The opposi t eofdev al uat i oni sr ev al uat i on. 34 TheMundel l Fl emi ngModel • Themodeldev el opedi nt hi schapt er , cal l edt heMundel l –Fl emi ngmodel , i san S–LM model openeconomyv er si onoft heI . Thi smodelowesi t sor i gi nst o paper spubl i shed byJamesFl emmi ng ( 1962)and Rober tMundel l( 1962, 1963) . • Thei rmaj orcont r i but i onwast oi ncor por at ei nt er nat i onalcapi t almovement s i nt of or mal macr oeconomi cmodel sbasedont heKey nesi anI SLM f r amewor k. • Thei rpaper sl edt osomedr amat i ci mpl i cat i onsconcer ni ngt heef f ect i v eness off i scal andmonet ar ypol i cyonnat i onal i ncome. • TheMundel l –Fl emi ngmodelmakesonei mpor t antandext r emeassumpt i on: i tassumest hatt heeconomybei ngst udi edi sasmal lopeneconomywi t h per f ectcapi t al mobi l i t y . • Thati s,t heeconomycanbor r ow orl endasmuchasi twant si nwor l d f i nanci almar ket sand,asar esul t ,t heeconomy ’ si nt er estr at ei sdet er mi ned byt hewor l di nt er estr at e. • Onev i r t ueoft hi sassumpt i oni st hati tsi mpl i f i est heanal y si s:oncet he i nt er estr at ei sdet er mi ned, wecanconcent r at eourat t ent i onont her ol eoft he exchanger at e. • I nt hi ssect i on,wewi l lbui l dt heMundel l–Fl emi ngmodel ,anduset hemodel t o exami net hei mpactofvar i ouspol i ci est o di scer n how t heeconomy oper at esunderf l oat i ngandf i xedexchanger at er egi mesandnot i cewhet hera f l oat i ngorf i xedexchanger at ei sbet t er . Smal lOpenEconomywi t hPer f ectCapi t al Mobi l i t y • ri sdet er mi nedbyt hewor l di nt er estr at er* t hesmal lopeneconomybei ng r =r* underconsi der at i ondonotaf f ectwor l di nt er estr at e.Mat hemat i cal l y : • Ther =r*equat i onr epr esent st heassumpt i ont hatt hei nt er nat i onalf l owof capi t ali sr api denought okeept hedomest i ci nt er estr at eequalt ot hewor l d i nt er estr at e. • Si nceri sf i xed,f i scalandmonet ar ypol i ci eswi l laf f ectt heI SandLM cur v es t hr ought heexchanger at es. TheGoodsMar ketandt heI S*Cur ve • TheMundel l –Fl emi ngmodeldescr i best hemar ketf orgoodsandser vi ces muchast heI S–LM modeldoes, buti taddsanewt er mf ornetexpor t s. 35 • I npar t i cul ar , t hegoodsmar keti sr epr esent edwi t ht hef ol l owi ngequat i on: Y =C( Y -T) +I ( r* ) +G +Nx( e) • Thenetexpor t sdependont her ealexchanger at e. • TheMundel l Fl emi ngmodel ,howev er ,assumest hatt hepr i cel evel sathome andabr oadar ef i xed,sot her ealandnomi nalexchanger at esar epr opor t i onal ( R=e* pf / pd) • Whent henomi nalexchanger at eappr eci at esf or ei gngoodsbecomecheaper compar edt odomest i cgoods,andt hi scausesexpor t st of al landi mpor t st o r i se, andl ower st heaggr egat ei ncome.( seef i gur ebel ow) . S*cur • Ther el at i onoft heexchanger at eandaggr egat ei ncomei scal l edt heI ve. Fi gur e: TheNet Expor t sFunct i on e1)t Ani ncr easei nt heexchanger at ef r om e1t oe2l ower snetexpor t sf r om Nx( o e2) Nx( Howchangesi nt heexchanger at edoaf f ecti ncome? Fi gur e:TheKeynesi anCr oss ( Pl easeRef ert opl annedexpendi t ur eFi gur e! ) • A decr ease i n netexpor t sf r om Nx( e1) t o Nx( e2)shi f t st he pl annedexpendi t ur eschedul edownwar dandr educesi ncomef r om Y1t o Y2as i ndi cat edabov e. • TheI S*cur vesummar i zi ngt hi sr el at i onshi pbet weent heexchanger at eand i ncome:t hehi ghert heexchanger at e, t hel owert hel evelofi ncome. Fi gur e: The I ve S*Cur 36 TheMoneyMar ketandt heLM*Cur ve • LM cur v ei sder i v edf r om M/ P =L( r , Y) • ThemodelassumesM asf i xedpol i cyv ar i abl echosenbycent r albanksandPi s al sof i xedi nt heshor t r un,andt husLM cur v edr awscombi nat i onsofrandY sat i sf y i ngt heequat i onwr i t t enabov e.Si nceri sf i xedbyt hewor l di nt er estr at e i nanopeneconomy , t heequat i onf i ndsaf i xedamountofi ncomeY,i . e.t osay Yi snotaf f ect edbyt heexchanger at e. • Hence,t he LM cur ve,whi ch dr awst he r el at i on oft he exchange r at e and aggr egat ei ncome, i sver t i cal . • ( Pl easeRef ert ot heLM Fi gur e! ) TheEqui l i br i um/ Combi ni ngt heI S*andLM*Cur ves Monet ar yandFi scal Pol i cyAnal y si si nanOpenEconomywi t hPer f ectCapi t alMobi l i t y TheSmal lOpenEconomyunderFl oat i ngExchangeRat es Fi scalPol i cyunderFl oat i ngExchangeRat es Suppose t hat t he gov er nment st i mul at es domest i c spendi ng by i ncr easi ng gov er nmentpur chasesorbycut t i ngt axes.Becausesuchexpansi onar yf i scalpol i cy i ncr easespl annedexpendi t ur e, i tshi f t st heI S*cur v et ot her i ght , asi nFi gur ebel ow. Asar esul t ,t heexchanger at eappr eci at es,wher east hel ev elofi ncomer emai nst he same. ( Pl easeRef ert ot heFi gur e! ) Not et hemechani sm: • Wheni ncomer i sesi nasmal l openeconomy , duet ot hef i scal expansi on, t he i nt er estr at et r i est or i sebutcapi t al i nf l owsf r om abr oadputdownwar dpr essur e ont hei nt er estr at e.Thi si nf l owcausesani ncr easei nt hedemandf ort he domest i ccur r encypushi ngupi t sv al ue( t hecur r encyappr eci at es) .The appr eci at i onoft heexchanger at emakesdomest i cgoodsexpensi v ef or f or ei gner s, andt hi sr educesnetexpor t s. Thef al li nnetexpor t sof f set st he ef f ect soft heexpansi onar yf i scalpol i cyoni ncome. • Ani ncr easei ngover nmentpur chasesoradecr easei nt axesshi f t st heI S*cur ve t ot her i ght .Thi sr ai sest heexchanger at ebuthasnoef f ectoni ncome. ( Fi scal 37 pol i cyi nt hi scasei si nef f ect i veher e) AFi scalExpansi onUnderFl oat i ngExchangeRat es( Pl easeRef ert ot heFi gur e! ) Monet ar yPol i cyunderFl oat i ngExchangeRat es • Supposenowt hatt hecent r al banki ncr easest hemoneysuppl y. • Becauset hepr i cel ev eli sassumedt obef i xed,t hei ncr easei nt hemoney suppl ymeansani ncr easei nr eal bal ances. • Thei ncr easei nr ealbal ancesshi f t st heLM*cur v et ot her i ght ,asi nFi gur e bel ow. • Hence,an i ncr ease i nt he moneysuppl yr ai ses i ncome and l ower st he exchanger at e. • ( Pl easeRef ert ot heFi gur e! ) Not et hemechani sm: • Wheni ncr easei nt hemoneysuppl yput sdownwar dpr essur eont he domest i ci nt er estr at e.Hence, capi t alf l owsoutoft heeconomyas i nvest or sseekahi gherr et ur nel sewher e.Thi scapi t alout f l owpr event s t hedomest i ci nt er estr at ef r om f al l i ng. • I naddi t i on,becauset hecapi t alout f l ow i ncr easest hesuppl yoft he domest i ccur r encyi nt he mar ketf orf or ei gncur r encyexchange,t he exchanger at edepr eci at es. • Thef al li nt heexchanger at emakesdomest i cgoodscheapr el at i vet o f or ei gngoodsand, t her eby, st i mul at esnetexpor t s. • Hence, i nasmal lopeneconomy,monet ar ypol i cyi nf l uencesi ncomeby al t er i ngt heexchanger at e. • Ani ncr easei nt hemoneysuppl yshi f t st heLM*cur vet ot her i ght , l ower i ngt heexchanger at eandr ai si ngi ncome.( MPi sef f ect i vei nt hi s case) . TheSmal lOpenEconomyunderFi xedExchangeRat es • Underaf i xedexchanger at e,t hecent r albankannouncesav al uef ort he exchanger at eandst andsr eadyt obuyandsel lt hedomest i ccur r encyata pr edet er mi nedpr i cet okeept heexchanger at eati t sannouncedl ev el . • i . e. ,t hesol eobj ect i veofmonet ar ypol i cyi st okeept heexchanger at eatt he announcedl evel . 38 HowaFi xedExchangeRat eSyst em Wor ks • Supposet hatt heEt hi opi annat i onalbankannouncest hati ti sgoi ngt of i xt he exchanger at eat32bi r rperdol l ar( I . e. , $0. 03125perbi r r ) . • I twoul dt henst andr eadyt ogi v e32bi r ri nexchangef or$1ort ogi v e$1i n exchangef or32bi r r . • Hence,t heNBwoul dneedar eser v eofbi r r( whi chi tcanpr i nt )andar eser v e ofdol l ar s( whi chmusthav ebeenpur chasedpr ev i ousl y ) • Suppose i nt he cur r entequi l i br i um wi t ht he cur r entmoney suppl y ,t he exchanger at ei s20bi r rperdol l ar( $0. 05perbi r r )t hati shi ghert han32bi r r perdol l ardet er mi nedbyt hecent r al bank. • Ar bi t r ageur s use t hei rbi r rt o buy f or ei gn cur r ency i nf or ei gnexchange mar ket sandsel l i tt ot hedomest i cnat i onal bankf orapr of i t . • Thi spr ocessaut omat i cal l yi ncr easest hemoneysuppl y( t hebasemoney) - shi f t i ngt heLM * cur vet ot her i ghtandl ower st heexchanger at east het abl e bel owpr esent s. Fi gur e:Whent heequi l i br i um exchanger at ei sgr eat ert hant hef i xedexchange r at e ( Rev er si ng) • Supposet heequi l i br i um exchanger at ei sl owert hant hef i xedexchanger at e. • Ar bi t r ageur swi l lbuybi r ri nf or ei gnexchangemar ket sanduset hem t obuy f or ei gncur r encyf r om nat i onal bankofEt hi opi a. • Thi spr ocessaut omat i cal l yr educest hemoneysuppl y , shi f t i ngt heLM *cur v e t ot hel ef tandr ai sest heexchanger at easf i gur e, pr esent s. Whent heequi l i br i um exchanger at ei sl esst hant hef i xedexchanger at e • ( Pl easeRef ert ot heFi gur e! ) Fi scalPol i cyunderFi xedExchangeRat es • Supposet hatt hegov er nmentst i mul at esdomest i cspendi ngbyi ncr easi ng gov er nmentpur chasesorbycut t i ngt axes. 39 • Thi spol i cyshi f t st heI S*cur v et ot her i ght ,asi nFi gur e,put t i ngupwar d pr essur eont heexchanger at e. • Butbecauset hecent r albankst andsr eadyt ot r adef or ei gnanddomest i c cur r encyatt hef i xedexchanger at e, ar bi t r ageur squi ckl yr espondt ot her i si ng exchanger at ebysel l i ngf or ei gncur r encyt ot hecent r albank,l eadi ngt o anaut omat i cmonet ar yexpansi on. Ther i sei nt hemoneysuppl y( i nt hebase money )shi f t st heLM *cur v et ot her i ght .Thus, underaf i xedexchanger at e, a f i scal expansi onr ai sesaggr egat ei ncome.( PFi sef f ect i v ei nt hi scase) . • Af i scalexpansi onshi f t st heI S*cur vet ot her i ght . • Tomai nt ai nt hef i xedexchanger at e,t hecent r albankmusti ncr easet he moneysuppl y, t her ebyshi f t i ngt heLM*cur vet ot her i ght . • Hence,i n cont r astt ot he case off l oat i ng exchange r at es,underf i xed exchanger at esaf i scalexpansi onr ai sesi ncome. Monet ar yPol i cyunderFi xedExchangeRat es • I magi net hatacent r albankoper at i ngwi t haf i xedexchanger at ewer et ot r y t oi ncr easet hemoneysuppl y—f orexampl e,bybuy i ngbondsf r om t hepubl i c. What woul dhappen?Thei ni t i ali mpactoft hi spol i cyi st oshi f tt heLM*cur v e t ot her i ght , l ower i ngt heexchanger at e, asi nFi gur ebel ow. • Hence, monet ar ypol i cyi si nef f ect ualunderaf i xedexchanger at e.Byagr eei ng t of i xt heexchanger at e,t hecent r albankgi vesupi t scont r olovert hemoney suppl y. • ( Pl easeRef ert ot heFi gur e! ) • I ft heNat i onalbankt r i est oi ncr easet hemoneysuppl yf orexampl e, bybuyi ng bondsf r om t hepubl i c—i twi l lputdownwar dpr essur eont heexchanger at e. • Tomai nt ai nt hef i xedexchanger at e,t hemoneysuppl yandt heLM*cur ve mustr et ur nt ot hei ri ni t i alposi t i ons.Hence,underf i xed exchanger at es, monet ar ypol i cyi si nef f ect ual . 40 TheMundel l Fl emi ngModelwi t haChangi ngPr i ceLevel * * S• TheI i sconst r uct edf orf i x edpr i cel ev el . LM model • Howev er ,achangei nt hepr i cel ev elshi f t st heLM * cur v eandchangest he equi l i br i um i ncome. • Consi derr educt i oni nt hepr i cel evel .Whent hepr i cel ev elf al l s, t heLM*cur v e shi f t st ot her i ght .Theequi l i br i um l ev el ofi ncomer i ses. TheShor t RunandLongRun Equi l i br i ai naSmal lOpenEconomy • Nowl et ’ scompar et heshor t r unandt hel ongr unequi l i br i um oft heeconomy usi ngt heI egat edemandaggr egat esuppl ymodel s. S*LM *andaggr • Poi ntKi nbot hpanel sshowst heequi l i br i um undert heKey nesi anassumpt i on t hatt hepr i cel ev el i sf i xedatP1. • Poi ntCi nbot hpanel sshowst heequi l i br i um undert hecl assi calassumpt i on ̅ t hatt hepr i cel ev el adj ust st omai nt ai ni ncomeati t snat ur al r at e Y. CHAPTERFI VE:AGGREGATESUPPLY 5. 1Th eCl assi calappr oacht oaggr egat esuppl y • I npr ev i oussect i onwehav eanal y zedt hedemandsi deoft heeconomyt aki ng t hepr i cel ev elpasexogenousl ydet er mi ned.Thi ssect i ondev el opst hesuppl y si deofmacr oeconomy . • Byequat i ngSSandDDi nt heeconomyweobt ai nendogenousl ydet er mi ned equi l i br i um v al ues ofout putand t he pr i ce l ev el .we f ocus on di f f er ent aggr egat esuppl ymodel s. 41 • Aggr egat esuppl yi st her el at i onshi pbet weenquant i t yofgoodsandser vi ces suppl i edandt hepr i cel evel . • Weneedt odi scusst wodi f f er entaggr egat esuppl ycur v es: • l ongr unaggr egat esuppl ycur v eLRAS( t hecl assi cal suppl ycur v e)and • shor t r unaggr egat esuppl ycur v eSRAS( t heKey nesi ansuppl ycur v e) • Fi nal l yanat t emptwi l lbemadet opr esentf ourpr omi nentmodel sofshor t r un aggr egat esuppl ycur v e. TheLongRun:t heVer t i cal Aggr egat eSuppl yCur v e Cl assi calmodeldescr i beshowt heeconomybehav esi nt hel ongr un; weder i v e t hel ongr unaggr egat esuppl ycur v ef r om t hecl assi calmodel . Thecl assi cal aggr egat esuppl ycur v ei sv er t i cal , i ti si ndi cat i ng t hatt he same amountofgoods wi l lbe suppl i ed what ev ert hepr i cel ev el or out putdoesnotdependont hepr i cel ev el Thecl assi cal suppl ycur v ei sbasedont heassumpt i on l abormar keti si nequi l i br i um wi t hf ul l empl oy mentofl abor I ft heaggr egat esuppl ycur v ei sv er t i cal ,t henchangesi naggr egat edemand af f ectpr i cesbutnotout put .Forexampl e,i ft hemoneysuppl yf al l s,t he aggr egat edemandcur v eshi f t sdownwar ds.Theeconomymov esf r om poi ntA t opoi ntB. I fi ti sani ncr easei nmoneysuppl y ,t heeconomymov esf r om At oC. Theshi f t i naggr egat edemandaf f ect sonl ypr i ces. 42 Thecl assi calmodelandt hev er t i calaggr egat esuppl ycur v eappl yonl yi nt he l ongr un. I nt heshor tr un,somepr i cesar est i ckyand,t her ef or e,do notadj ustt o changesi ndemand. Becauseoft hi spr i cest i cki ness,shor tr unaggr egat esuppl ycur v ei snot v er t i cal Thi si swhatwecal l t heKey nesi anaggr egat esuppl ycur v e. I nt heext r emeKey nesi ancaseAggr egat esuppl ycur vei shor i zont al . Thei deaunder l y i ngt heKey nesi anaggr egat esuppl ycur v ei st hatbecause t her ei sunempl oy ment ,f i r mscanobt ai nasmuchl aborast heywantatt he cur r entwage. Thei rav er agecost sofpr oduct i ont her ef or ear eassumednott ochangeas t hei rout putl ev el s change.The shor tr un equi l i br i um oft he economyi s obt ai nedatt hei nt er sect i onoft heAD cur v eandt hehor i zont alAScur v e. Supposecent r albankr educest hemoneysuppl yandaggr egat edemandcur v e shi f t sdownwar d. I nt heshor tr un, pr i cesar est i cky , sot heeconomymov esf r om poi ntAt opoi nt B. 43 Out putand empl oy mentf al lbel ow t hei rnat ur all ev el s,whi ch means t he economy ,i si nr ecessi on.Ov ert i me,i nr esponset ot hel ow demand,wages andpr i cesf al l . Thegr adualr educt i oni nt hepr i cel ev elmov est heeconomydownwar dal ong t heaggr egat edemandcur v et opi ntC,whi chi st henewl ongr unequi l i br i um. 5. 2Th eKeynesi anappr oacht oaggr egat esuppl y 5. 2. 1TheFourModel sofAggr egat eSuppl y I nt hepr ev i oussect i ont heI SLM modelshowshowchangesi nmonet ar yand f i scal pol i cyt ot hemoneyandgoodsmar ketshi f tt heaggr egat edemandcur v e. I nt hel ongr un, pr i cesar ef l exi bl e, andt heaggr egat esuppl ycur v ei sv er t i cal . Whent heaggr egat esuppl ycur v ei sv er t i cal ,shi f t si nt heaggr egat edemand cur v eaf f ect st hepr i cel ev el , butout putr emai nsunchanged. I nt heshor tr un, pr i cesar est i cky , andt heaggr egat esuppl ycur v ei snotv er t i cal . I nt hi scase, shi f t si nt heaggr egat edemanddocausef l uct uat i onsi nout put . I nt hi ssect i onwest udyf ourmodel sofshor t r unAScur v e. Al t hought hesemodel sdi f f eri nsomesi gni f i cantdet ai l s,butwi t hcommon concl usi ont hatshor t r unaggr egat esuppl ycur v ei supwar dsl opi ng. Aggr egat esuppl yequat i onoft hef or m: Wher eYi sout put , i st henat ur alr at eofout put , pi st hepr i cel ev el , andpei s t heexpect edpr i cel ev el . Thi sequat i onst at est hatout putdev i at esf r om i t snat ur alr at ewhent hepr i ce l ev el dev i at esf r om t heexpect edpr i cel ev el . Thepar amet erαi ndi cat eshowmuchout putr espondst ounexpect edchanges i nt hepr i cel ev el . Eachoft hesemodel st el l sdi f f er entst or yaboutwhatl i esbehi ndt hi sshor t r un aggr egat esuppl yequat i on. 44 Di f f er entmodel sofaggr egat esuppl y : TheSt i cky–Pr i ceModel TheI mper f ectI nf or mat i on Model TheSt i cky -WageModel The wor ker smi sper cept i onmodel Cour seTi t l e:Macr oeconomi csI I Cour seCode:Econ1032 Cour seObj ect i v e: Thi s cour se has t he obj ect i v e of pr ov i di ng st udent s wi t h t he basi cs of macr oeconomi canal y si s.Thecour sei st hussupposedt ol etst udent sunder st and t hef undament al soft hei nt er act i onsofeconomi cagent satt heaggr egat el ev el .Wi t h t hi sper spect i v e,st udent sar eexpect edt oacqui r eatl eastt hef r amewor kt of ur t her anal y zet heaggr egat ei nt er act i onsamongeconomi cagent st hemsel v esandt he out comes t hatt hese i nt er act i ons gener at ei nt he economy atsome l ev elof aggr egat i on.Thi si sf undament al l ybasedont heweal t hofmacr oeconomi ct heor i es t hatcanbeascr i bedt ot hecl assi cal andKey nesi anschool soft hought . Chapt erOne Behav i our alFoundat i ons:Theor i esofConsumpt i on Topi csunderdi scussi on: JohnMay nar dKey nesandt heConsumpt i onFunct i on I r v i ngFi sherandI nt er t empor al Choi ce Fr ancoModi gl i ani andt hel i f ecy cl eHy pot hesi s Mi l t onFr i edmanandt hePer manent I ncomeHy pot hesi s Rober tHal l andt heRandomWal kHy pot hesi s Thi schapt erpr esent st hevi ewsoff i vepr omi nenteconomi st st oshowt hedi ver se appr oachest oexpl ai ni ngconsumpt i on. JohnMay nar dKey nesandt heConsumpt i onFunct i on Theconsumpt i onf unct i onexhi bi t st hr eepr oper t i est hatKey nesconj ect ur ed. Themar gi nal pr opensi t yt oconsumeci sbet weenzer oandone. b/ c,whenaper sonear nsanext r adol l ar ,het y pi cal l yspendssomeofi t andsav essomeofi t. 45 Theav er agepr opensi t yt oconsumef al l sasi ncomer i ses. Hebel i ev edt hatsav i ngwasal uxur y ,soheexpect edt her i cht osav ea hi gherpr opor t i onoft hei ri ncomet hant hepoor Consumpt i oni sdet er mi nedbycur r enti ncome. i ncomei st hepr i mar ydet er mi nantofconsumpt i on Key nesi anconsumpt i onf unct i oni sof t enwr i t t enas: wher eCi sconsumpt i on,Yi sdi sposabl ei ncome,Ci saconst ant ,andci st he mar gi nal pr opensi t yt oconsume. Thi sconsumpt i onf unct i on, showni nFi gur e1. 1, i sgr aphedasast r ai ghtl i ne. Not i ce t hatt hi s consumpt i on f unct i on exhi bi t st he t hr ee pr oper t i es t hat Key nesposi t ed. I tsat i sf i es1stpr oper t yb/ ct heMPCi sbet weenzer oandone, sot hathi gheri ncomel eadst ohi gherconsumpt i onandal sot ohi gher sav i ng I tsat i sf i es2ndpr oper t yb/ ct heAPCi s AsYr i ses, C/ Yf al l s, andsot heAPCi . e.C/ Yf al l s.And Fi nal l y , t hi sconsumpt i onf unct i onsat i sf i es3rd pr oper t yb/ c t hei nt er estr at ei snoti ncl udedi nt hi sequat i on TheEar l yEmpi r i calSuccesses Soonaf t erKey neseconomi st sbegancol l ect i ngandexami ni ngdat at ot est hi sconj ect ur es. Theear l i estst udi esi ndi cat edt hatt heKey nesi anconsumpt i onf unct i onwasa goodappr oxi mat i onofhowconsumer sbehav e. Theyf oundt hatHHswi t hhi gheri ncomeconsumedmor e, whi chconf i r ms t hatt heMPCi sgr eat ert hanzer o. Theyal sof oundt hatHHswi t hhi gheri ncomesav edmor e, whi chconf i r ms t hatt heMPCi sl esst hanone. I naddi t i on,t heyf oundt hathi gher i ncomeHHssav edal ar gerf r act i onof t hei ri ncome, whi chconf i r mst hatt heAPCf al l sasi ncomer i ses. Thus,t hesedat av er i f i edKey nes’ sconj ect ur esaboutt hemar gi nalandav er age 46 pr opensi t i est oconsume. I not herst udi es,r esear cher sexami nedaggr egat edat aonconsumpt i onand i ncomef ort heper i odbet weent het wowor l dwar s. Thesedat aal sosuppor t edt heKey nesi anconsumpt i onf unct i on. I ny ear swheni ncomewasunusual l yl ow,suchasdur i ngt hedept hsoft he Gr eatDepr essi on, bot hconsumpt i onandsav i ngwer el ow, i ndi cat i ngt hatt heMPCi sbet weenzer oandone. I naddi t i on, dur i ngt hosey ear sofl owi ncome, t her at i oofconsumpt i ont oi ncomewashi gh,conf i r mi ng2nd conj ect ur e. Fi nal l y ,becauset hecor r el at i onbet weeni ncomeandconsumpt i onwasso st r ong, noot herv ar i abl eappear edt obei mpor t antf orexpl ai ni ngconsumpt i on. Ther ef or e, i tconf i r medKeynes’ st hi r dconj ect ur et hati ncomei st hepr i mar y det er mi nantofhowmuchpeopl echooset oconsume. Secul arSt agnat i on, Si monKuznet s, andt heConsumpt i onPuzzl e Al t hought heKey nesi anconsumpt i onf unct i onmetwi t hear l ysuccesses,t wo anomal i essoonar ose. Bot hconcer nKey nes’ sconj ect ur et hatt heAPCf al l sasi ncomer i ses. Thef i r stanomal y someeconomi st smadeer r oneous—pr edi ct i ondur i ngWor l d WarI I . Theyr easonedt hat : as i ncomes i nt he economy gr ew ov ert i me,househol ds woul d consumeasmal l erandsmal l erf r act i onoft hei ri ncomes. Theyf ear ed t hatt her emi ghtnotbeenough pr of i t abl ei nv est ment pr oj ect st oabsor bal l t hi ssav i ng. Af t ert heendofWor l dWarI Ii ncomeswer emuchhi gheraf t ert hewart han bef or e,t hesehi gheri ncomesdi dnotl eadt ol ar gei ncr easesi nt her at eof sav i ng. Keynes’ sconj ect ur et hatt heaver agepr opensi t yt oconsumewoul df al lasi ncome r oseappear ednott ohol d. Thesecondanomal yar osewheneconomi stSi monKuznet di scov er edt hatt her at i o 47 ofconsumpt i ont oi ncomewasr emar kabl yst abl ef r om decadet odecade,despi t e l ar gei ncr easesi ni ncomeov ert heper i odhest udi ed. Agai n, Key nes’ sconj ect ur et hatt heav er agepr opensi t yt oconsumewoul df al l asi ncomer oseappear ednott ohol d. Thef ai l ur eoft hesecul ar st agnat i onhy pot hesi sandt hef i ndi ngsofKuznet s bot hi ndi cat edt hatt heaver agepr opensi t yt oconsumei sf ai r l yconst ant overl ongper i odsoft i me. Concl usi on,t woconsumpt i onf unct i ons: Theshor tt i meser i es,t heKey nesi anconsumpt i onf unct i onappear edt o wor kwel l . Yetf ort hel ongt i meser i es, t heconsumpt i onf unct i onappear edt oexhi bi t aconst antav er agepr opensi t yt oconsume. Theset wor / psb/ nconsumpt i onandi ncomear ecal l edt heshor t r unandl ong r unconsumpt i onf unct i ons. Economi st sneededt oexpl ai nhow t heset woconsumpt i onf unct i onscoul d beconsi st entwi t heachot her . I nt he 1950s,Fr anco Modi gl i aniand Mi l t on Fr i edman each pr oposed expl anat i onsoft heseseemi ngl ycont r adi ct or yf i ndi ngs. I r vi ngFi sherandI nt er t empor alChoi ce Theconsumpt i onf unct i oni nt r oducedbyKey nesr el at escur r entconsumpt i on t ocur r enti ncome. Thi sr el at i onshi p, howev er , i si ncompl et eatbest . Whenpeopl edeci dehow mucht oconsumeandhow mucht osav e,t hey consi derbot ht hepr esentandt hef ut ur e. Themor econsumpt i ont heyenj oyt oday ,t hel esst heywi l lbeabl et oenj oy t omor r ow. I nmaki ngt hi st r adeof f ,HHsmustl ookaheadt ot hei ncomet heyexpectt o r ecei v ei nt hef ut ur eandt ot heconsumpt i onofgoodsandser v i cest hey hopet obeabl et oaf f or d. Theeconomi stI r v i ngFi sherdev el opedt hemodelwi t hwhi checonomi st s anal y ze how r at i onal ,f or war dl ooki ng consumer s make i nt er t empor al choi ces—t hati s, choi cesi nv ol v i ngdi f f er entper i odsoft i me. 48 Fi sher ’ smodeli l l umi nat es t heconst r ai nt sconsumer sf ace,t hepr ef er encest heyhave,and how t heseconst r ai nt sandpr ef er encest oget herdet er mi net hei r choi cesaboutconsumpt i onandsav i ng 1. 1. 1 TheI nt er t empor alBudgetConst r ai nt Mostpeopl ewoul dpr ef ert oi ncr easet hequant i t yorqual i t yoft hegoodsand ser v i cest heyconsumet owearni cercl ot hes,eatatbet t err est aur ant s,orsee mor emov i es. Ther easonpeopl econsumel esst hant heydesi r ei st hat t hei rconsumpt i oni s const r ai nedbyt hei ri ncome, cal l edabudgetconst r ai nt . Ourf i r stst epi ndev el opi ngFi sher ’ smodeli st oexami net hi sconst r ai nti n somedet ai l . Tokeept hi ngssi mpl e, weexami net hedeci si onf aci ngaconsumerwhol i v es f ort woper i ods. Per i odoner epr esent st heconsumer ’ sy out h, and per i odt wor epr esent st heconsumer ’ sol dage Theconsumerear nsi ncomeY1andconsumesC1i nper i odone,andear ns i ncomeY2andconsumesC2i nper i odt wo. ( Al lvar i abl esar er eal —t hati s, adj ust edf ori nf l at i on. ) Becauset heconsumerhast heoppor t uni t yt obor r owandsav e,consumpt i on i nanysi ngl eper i odcanbeei t hergr eat erorl esst hani ncomei nt hatper i od. Consi der how t he consumer ’ si ncome i nt he t wo per i ods const r ai ns consumpt i oni nt het woper i ods. I nt hef i r stper i od, savi ngequal si ncomemi nusconsumpt i on.Thati s, wher eSi ssavi ng. 1 I nt hesecondper i od,consumpt i onequal st heaccumul at edsavi ng,i ncl udi ng t hei nt er estear nedont hatsav i ng, pl ussecondper i odi ncome. Thati s, 2 Forex ampl e, i ft her eali nt er estr at ei s5per cent , t henf orev er y$1ofsav i ngi n per i odone, t heconsumerenj oy sanext r a$1. 05ofconsumpt i oni nper i odt wo. Becauset her ei snot hi r dper i od,t heconsumerdoesnotsav ei nt hesecond 49 per i od. Not et hatt hev ar i abl eScanr epr esentei t hersav i ngorbor r owi ng. I ff i r st per i odconsumpt i oni sl esst hanf i r st per i odi ncome,t heconsumeri s sav i ng, andSi sgr eat ert hanzer o. I ff i r st per i od consumpt i on exceedsf i r st per i od i ncome,t he consumeri s bor r owi ng, andSi sl esst hanzer o. Forsi mpl i ci t y , weassumet hatt hei nt er estr at ef or ( bor r owi ng=sav i ng) . Toder i vet hebudgetconst r ai nt , combi net het woequat i ons. Subst i t ut et he1stequat i onf orSi nt ot he2ndequat i ont oobt ai n C2=( 1+r ) ( Y1−C1)+Y2 Tomaket heequat i oneasi ert oi nt er pr et , wemustr ear r anget er ms. Topl aceal lt heconsumpt i ont er mst oget her ,br i ng( 1+r ) C1f r om t her i ght handsi det ot hel ef t handsi deoft heequat i ont oobt ai n( 1+r ) C1+C2=( 1+ r ) Y1+Y2. Nowdi v i debot hsi desby1+rt oobt ai n Thi sequat i onr el at esconsumpt i oni nt het woper i odst oi ncomei nt het wo per i ods. I ti st hest andar dwayofexpr essi ngt heconsumer ’ si nt er t empor albudget const r ai nt .1. 3. 2ConsumerPr ef er ences Theconsumer ’ spr ef er encesr egar di ngconsumpt i oni nt het woper i odscanbe r epr esent edbyi ndi f f er encecur ves. Ani ndi f f er encecur v eshowst hecombi nat i onsof1st per i odand2ndper i od consumpt i ont hatmaket heconsumerequal l yhappy . Theconsumeri si ndi f f er entamongcombi nat i onsW,X,andY,becauset hey ar eal l ont hesamecur v e. i ft heconsumer ’ sf i r st per i odconsumpt i oni sr educed,sayf r om poi ntW t o poi ntX, secondper i odconsumpt i onmusti ncr easet okeephi m equal l yhappy . Theconsumeri sequal l yhappyatal lpoi nt sonagi v eni ndi f f er encecur v e, but hepr ef er ssomei ndi f f er encecur v est oot her s. Because he pr ef er s mor e consumpt i on t ol ess,he pr ef er s hi gher i ndi f f er encecur v est ol owerones. Thesetofi ndi f f er encecur v esgi v esacompl et er anki ngoft heconsumer ’ s pr ef er ences. 50 I tt el l sust hatt heconsumerpr ef er spoi ntZt opoi ntW, butt hatshoul d beobv i ousbecausepoi ntZhasmor econsumpt i oni nbot hper i ods. 1. 1. 2 Opt i mi zat i on Theconsumerwoul dl i ket o end up wi t ht hebestpossi bl ecombi nat i on of consumpt i oni nt het woper i ods—t hati s,ont hehi ghestpossi bl ei ndi f f er ence cur v e. Thehi ghesti ndi f f er encecur v et hatt heconsumercanobt ai nwi t houtv i ol at i ngt he budgetconst r ai nti st hei ndi f f er encecur v et hatj ustbar el yt ouchest hebudget l i ne, whi chi scur v eI C3i nt hef i gur e. Thepoi ntatwhi cht hecur veandl i net ouch—poi ntO,f or“ opt i mum” —i st hebest combi nat i onofconsumpt i oni nt het woper i odst hatt heconsumercanaf f or d. Not i cet hat ,att heopt i mum,t hesl opeoft hei ndi f f er encecur v eequal st hesl ope oft hebudgetl i ne. Thei ndi f f er encecur vei st angentt ot hebudgetl i ne. Thesl opeoft hei ndi f f er encecur v ei st hemar gi nalr at eofsubst i t ut i onMRS,and t hesl opeoft hebudgetl i nei s1pl ust her eal i nt er estr at e. Weconcl udet hatatpoi ntO MRS=1+r . Theconsumerchoosesconsumpt i oni nt het woper i odssucht hatt hemar gi nal r at eofsubst i t ut i onequal s1pl ust her eal i nt er estr at e. Fr ancoModi gl i aniandt hel i f ecycl eHypot hesi s I nt he1950’ s,Fr ancoModi gl i ani ,AndoandBr umber gusedFi sher ’ smodelof consumerbehav i ort ost udyt heconsumpt i onf unct i on. Oneoft hei rgoal swast ost udyt heconsumpt i onpuzzl e. Accor di ngt oFi sher ’ smodel ,consumpt i ondependsonaper son’ sl i f et i me i ncome. Modi gl i aniemphasi zedt hat i ncomev ar i essy st emat i cal l yov erpeopl e’ sl i v es andsav i ngal l owsconsumer st omov ei ncomef r om t hoset i mesi nl i f ewhen i ncomei shi ght ot hoset i meswheni ncomei sl ow. 51 TheHy pot hesi s Mostpeopl epl ant ost opwor ki ngataboutage65,andt heyexpectt hei r i ncomest of al lwhent heyr et i r e,butdon’ twantadr opi nst andar dofl i v i ng char act er i zedbyconsumpt i on. Supposeaconsumerexpect st ol i v eanot herT y ear s, hasweal t hofW andexpect st oear ni ncomeYunt i lsher et i r esRy ear s f r om now. Whatl ev elofconsumpt i onwi l lt heconsumerchooset o hav easmoot h consumpt i onov erherl i f e? TheLi f ecy cl eConsumpt i onFunct i on TheLi f et i mer esour cesofconsumerf orTy ear sar eweal t hW andl i f et i me ear ni ngsofRxY( assumi ngi nt er estr at et obezer o) . Tohav esmoot hestconsumpt i onov erl i f et i me, shedi v i dessucht hat C=( W +RY)/T or C=( 1/T) W +( R/T) Y I fsheexpect sT=50andR=30, t hent heconsumpt i onf unct i onwi l l be C=1/50W +30/ 50Y or C=0. 02W +0. 6Y Thi sequat i onsay st hatconsumpt i ondependsonbot hi ncomeandweal t h. Anext r a$1ofi ncomepery earr ai sesconsumpt i onby$0. 60per y ear , andanext r a$1ofweal t hr ai sesconsumpt i onby$0. 02per y ear . Gener al i zi ngf orAggr egat eConsumpt i onf unct i onoft heeconomy : C=αW +βY Wher e, α=MPCoutofWeal t h β=MPCoutofI ncome Thel i f ecy cl emodelsay st hatconsumpt i ondependsonweal t haswel las i ncome. Asar esul t , t hei nt er ceptoft heconsumpt i onf unct i onαW dependsonweal t h. Accor di ngt oLi f ecy cl econsumpt i onf unct i on, APC=C/ Y=α( W/ Y)+β Because,i nshor tper i ods, weal t hdoesnotv ar ypr opor t i onat el ywi t hi ncomes, Hi ghi ncomescor r espondst oLowAPC. Butov erl ongerper i ods, weal t h and i ncomes gr ow t oget her ,r esul t i ng i n 52 const antW/ Yr at i oandhenceaconst antAPC. Mi l t onFr i edmanandt hePer manent I ncomeHypot hesi s I n1957,Mi l t onFr i edmanpr oposed t he per manent i ncomehypot hesi st o expl ai nconsumerbehav i or . I t sessencei st hatcur r entconsumpt i oni spr opor t i onal t oper manenti ncome. Fr i edman’ s per manent i ncome hy pot hesi s compl ement s Modi gl i ani ’ sl i f ecy cl ehy pot hesi s: bot huseFi sher ’ st heor yofconsumpt i onshoul dnotdependoncur r ent i ncomeal one. Butunl i ket hel i f ecy cl ehy pot hesi s, whi chemphasi zest hati ncomef ol l owsar egul arpat t er nov eraper son’ s l i f et i me, per manent i ncomehy pot hesi semphasi zest hatpeopl eexper i encer andom andt empor ar ychangesi nt hei ri ncomesf r om y eart oy ear . Fr i edmansuggest edt hatcur r enti ncomeYast hesum oft wocomponent s, per manenti ncomeYPandt r ansi t or yi ncomeYT. Y=YP +YT Per manentI ncomei st hepar tofi ncomet hatpeopl eexpectt oper si sti nt he f ut ur e. Tr ansi t or yi ncomei st hepar tofi ncomet hatpeopl edonotexpectt oper si st . Fr i edmanr easonedt hatconsumpt i onshoul ddependpr i mar i l yonper manent i ncome b/ c consumer s use sav i ngs and bor r owi ngs t o smoot h consumpt i on i n r esponset ot r ansi t or ychangesi ni ncome. Fr i edmanappr oxi mat i onofconsumpt i onf unct i oni s: C=αYP Whi l eAv er agepr opensi t yt oconsumei s: APC=C/ Y=αYP/ Y, WhenY>YP, APCFal l s, WhenY<YP, APCr i ses Rober tHal landt heRandomWal kHypot hesi s Rober tHal lwasf i r stt oder i v et hei mpl i cat i onsofr at i onalexpect at i onsf or consumpt i on. 53 He showed t hati ft he per manent i ncome hy pot hesi si s cor r ect ,and i f consumer shav er at i onalexpect at i ons,t henchangesi nconsumpt i onov er t i meshoul dbeunpr edi ct abl e. Whenchangesi nav ar i abl ear eunpr edi ct abl e,t hev ar i abl ei ssai dt of ol l owa r andom wal k. Accor di ng t o Hal l ,t he combi nat i on oft he per manent i ncome hy pot hesi s andr at i onal expect at i onsi mpl i est hatconsumpt i onf ol l owsar andom wal k. CHAPTERTWO I NVESTMENTTHEORY I nv est menti st hemostv ol at i l ecomponentofGDP. Whenexpendi t ur eongoodsandser v i cesf al ldur i ngar ecessi on, muchoft he decl i nei susual l yduet oadr opi ni nv est mentspendi ng. Themodel sofGDP, suchasI SLM model , wer ebasedonasi mpl ei nv est ment f unct i onr el at i ngi nv est mentt or eal i nt er estr at e: I=I ( r ) Thatf unct i on st at es t hatan i ncr ease i nt he r eali nt er estr at er educes I nvest ment . Her ewel ookmor ecl osel yatt het heor ybehi ndt hi si nv est mentf unct i on. Thr eet y pesofI nv est mentSpendi ng 1)Busi ness f i xed i nv est ment :i ncl udes t he equi pmentand st r uct ur es t hat busi nessesbuyt ousei npr oduct i on. 2)Resi dent i ali nv est ment :i ncl udest henew housi ngt hatpeopl ebuyt ol i v ei n andt hatl andl or dsbuyt or entout . 3)I nv ent or yi nv est ment :i ncl udest hosegoodst hatbusi nessesputasi dei n st or age,i ncl udi ng mat er i al sand suppl i es,wor ki n pr ogr ess,and f i ni shed goods. Weshal l bui l dmodel sofeacht y peofi nv est mentt oexpl ai nt hef l uct uat i onsi n t heeconomy . Al sot hesemodel swi l l shedl i ghtont hequest i onssuchas: Whyi nv est menti snegat i v el yr el at edt ot hei nt er estr at e? Whatcausesi nv est mentf unct i ont oshi f t ? Whydoesi nv est mentr i sedur i ngboomsandf al l dur i ngr ecessi ons? 2. 1. 1Busi nessFi xedI nv est ment Thel ar gestpi eceofi nv est mentspendi ng( about¾oft ot al )i sbusi nessf i x ed 54 i nv est ment . Busi ness:t hesei nv est mentgoodsar eboughtbyf i r msf orusei nf ut ur e pr oduct i on. Busi ness Fi xed i nv est ment i ncl udes ev er y t hi ng f r om f ax machi nes t o f act or i es, comput er st ocompanycar s. Thest andar dmodel ofbusi nessf i xedi nv est menti scal l edt heneocl assi cal modelofi nvest ment . I texami nest hebenef i t sandcost sofowni ngcapi t al goods. Her e ar e t hr ee v ar i abl es t hat shi f ti nv est ment : or t he l ev el of i nv est ment / t headdi t i ont ot hest ockofcapi t al r el at edt o: mar gi nal pr oductofcapi t al i nt er estr at e t axr ul esaf f ect i ngf i r ms To dev el op t hemodel ,i magi net hatt her ear et wo ki ndsoff i r msi nt he economy : pr oduct i onf i r mst hatpr oducegoodsandser v i cesusi ngt hecapi t alt hat t heyr ent Rent alf i r mst hatmakeal lt hei nv est ment si nt heeconomy .t heybuy capi t al andr enti toutt ot hepr oduct i onf i r ms. i . TheRent al Pr i ceofCapi t al At y pi cal pr oduct i onf i r m deci deshowmuchcapi t al t or entbycompar i ngt he costandbenef i tofeachuni tofcapi t al . Thef i r mr ent sCapi t al atar ent al r at eRandsel l si t sout putatapr i ceP Ther ealcostofauni tofcapi t al t ot hepr oduct i onf i r mi sR/ P Ther ealbenef i tofauni tofcapi t al i st hemar gi nal pr oductofcapi t al , MPK ( t heext r aout putpr oducedwi t honemor euni tofcapi t al ) MPKf al l sast heamountofcapi t al r i ses. Tomaxi mi zepr of i t , t hef i r mr ent scapi t al unt i l t hemar gi nal pr oductofcapi t al f al l st oequal t her eal r ent al pr i ce. ( seef i gur ebel ow) MPK=R/ P HenceMPKdet er mi nest hedownwar dsl opi ngdemandcur v ef orcapi t al f ora f i r m Whi l eatpoi nti nt i me, t heamountofcapi t al i naneconomyi sf i xed, sosuppl y 55 cur v ei sf i xed. So, t omaxi mi zepr of i t , t hef i r mr ent scapi t al unt i l t heMPKf al l st o: Ther ealr ent alpr i ceofcapi t al adj ust st oequi l i br at et hedemandf orcapi t al ( det er mi nedbyt hemar gi nal pr oductofcapi t al )andt hef i xedsuppl y . TheCobbDougl aspr oduct i onf unct i onser v esasagoodappr oxi mat i onofhow t heact ual economyt ur nscapi t al andl abori nt ogoodsandser v i ces TheCobbDougl aspr oduct i onf unct i oni s: wher e Y Þi sout put ,KÞcapi t al , LÞl abor A Þapar amet ermeasur i ngt hel ev el oft echnol ogy αÞapar amet erbet ween0and1t hatmeasur escapi t al ’ sshar eofout put . Themar gi nal pr oductofcapi t al ( MPK)f ort heCobbDougl aspr oduct i on f unct i oni s: 1α MPK=αA( L/ K) Becauset her eal r ent al pr i ce( R/ P)equal sMPKi nequi l i br i um, wecanwr i t e: 1α R/ P=αA( L/ K) Thi sexpr essi oni dent i f i est hev ar i abl est hatdet er mi net her eal r ent al pr i ce.I t showst hef ol l owi ng: Thel owert hest ockofcapi t al , t hehi ghert her eal r ent al pr i ceofcapi t al Thegr eat ert heamountofl aborempl oy ed, t hehi ghert her eal r ent al pr i ceof capi t al s Thebet t ert het echnol ogy , t hehi ghert her eal r ent al pr i ceofcapi t al . Ev ent st hatr educet hecapi t al st ock, orr ai seempl oy ment , ori mpr ov et he t echnol ogy , r ai set heequi l i br i um r eal r ent al pr i ceofcapi t al . i . TheCostofCapi t al TheRent alf i r ms,j ustl i kecarr ent alf i r msmer el ybuycapi t algoodsandr ent t hem out . Let ’ sconsi dert hebenef i tandcostofowni ngcapi t al . Thebenef i tofowni ngcapi t ali st her ealr ent alpr i ceofcapi t alR/ Pf oreachuni t ofcapi t al i townsandr ent sout . Foreachper i odoft i met hataf i r mr ent soutauni tofcapi t al ,t her ent alf i r m bear st hr eecost s: 56 I nt er estont hei rl oans,whi chequal st hepur chasepr i ceofauni tofcapi t alPK t i mest hei nt er estr at e, i , soi PK Thecostoft hel ossorgai nont hepr i ceofcapi t al denot edasDPK Themi nussi gni sher ebecausewear emeasur i ngcost s, notbenef i t s. Depr eci at i onddef i nedast hef r act i onofv al uel ostperper i odbecauseoft he wearandt ear , sodPK Tot al costofcapi t al =i PK-DPK+dPK =PK( i -DPK/ PK+d) Thecostofcapi t aldependsupont hepr i ceofcapi t al ,t hei nt er estr at e,r at eof changeofcapi t al pr i cesandt hedepr eci at i onr at e. Exampl e: ACarr ent al company Buy scar sf or$1, 000, 000eachandr ent st hem outt oot herbusi nesses I fi tf acesani nt er estr at ei of10%pery ear ,sot hei nt er estcost , i Pk= $100, 000pery earf oreachcart hecompanyowns. Carpr i cesar er i si ngat6%pery ear , soexcl udi ngmai nt enancecost st hef i r m get sacapi t al gai n, DPk=$60, 000pery ear Car sdepr eci at eat20%pery earso, l ossduet owearandt ear , dPk=$200, 000 So, Tot al costofcapi t al =i PK-DPK+dPK =100, 000–60, 000+200, 000 =$240, 000 Thecostt ot hecar r ent al companyofkeepi ngacari ni t scapi t al st ocki s $2, 400/y ear . Tomaket heexpr essi onf ort hecostofcapi t al si mpl erandeasi ert oi nt er pr et , weassumet hatt hepr i ceofcapi t al goodsr i seswi t ht hepr i cesofot hergoods. I nt hi scase, DPK/ PKequal st heover al lr at eofi nf l at i onp.Becausei πequal s t her eal i nt er estr at er , wecanwr i t et hecostofcapi t alas CostofCapi t al =PK( r+d) . Thi sequat i onst at est hatt hecostofcapi t al dependsont he pr i ceofcapi t al , t her eal i nt er estr at e, and t hedepr eci at i onr at e. Fi nal l y , wewantt oexpr esst hecostofcapi t al r el at i v et oot hergoodsi nt he 57 economy . Ther ealcostofcapi t al —t hecostofbuy i ngandr ent i ngoutauni tofcapi t al measur edi nuni t soft heeconomy ’ sout put —i s RealCostofCapi t al=( PK/ P) ( r+d) . Thi sequat i onst at est hatt her eal costofcapi t al dependsont her el at i v epr i ce ofacapi t al goodPK/ P, t her eali nt er estr at er , andt hedepr eci at i onr at ed. TheDet er mi nant sofI nv est ment Nowconsi derar ent alf i r m’ sdeci si onaboutwhet hert oi ncr easeordecr ease i t scapi t al st ock. Foreachuni tofcapi t al ,t hef i r m ear nsr ealr ev enueR/ Pandbear st her eal cost( PK/ P) ( r +d) . Ther eal pr of i tperuni tofcapi t al i s Pr of i tr at e=Rev enue–Cost=R/ P -( PK/ P)( r +d) Becauser ealr ent alpr i ceequal st hemar gi nalpr oductofcapi t al , wecanwr i t e t hepr of i tr at eas: Pr of i tr at e=MPK-( PK/P) ( r+d) Thechangei nt hecapi t al st ock, cal l edneti nv est mentdependsont he di f f er encebet weent heMPKandt hecostofcapi t al . I ft heMPKexceedst hecostofcapi t al , f i r mswi l l addt ot hei rcapi t al st ock. I ft heMPKf al l sshor toft hecostofcapi t al , t heyl ett hei rcapi t al st ock shr i nk. Thus: DK=I n[ MPK-( PK/P) ( r+d) ] wher eI n()i st hef unct i onshowi nghowmuchneti nv est mentr espondst o t hei ncent i v et oi nv est . Wecannowder i v et hei nv est mentf unct i oni nt heneocl assi cal model of i nv est ment . Tot al spendi ngonbusi nessf i xedi nv est menti st hesum ofneti nv est ment andt her epl acementofdepr eci at edcapi t al . Thi s model shows 58 why i nv est mentdependsont her eal i nt er estr at e. Adecr easei nt her eali nt er estr at el ower st hecostofcapi t al .I tt her ef or e r ai sest he amountofpr of i tf r om owni ng t he capi t aland i ncr easest he i ncent i v et oaccumul at emor ecapi t al . Si mi l ar l yani ncr easei nr eali nt er estr at er ai sescostofcapi t alandl eadst he f i r mst or educet hei ri nv est ment . TheSt ockMar ketand Tobi n’ sq Thet er m st ockr ef er st ot heshar esi nt heowner shi pofcor por at i ons Thest ockmar keti st hemar keti nwhi cht heseshar esar et r aded. TheNobel Pr i zewi nni ngeconomi stJamesTobi npr oposedt hatf i r msbaset hei r i nv est mentdeci si onsont hef ol l owi ngr at i o, whi chi snowcal l edTobi n’ sq: Thenumer at orofTobi n’ sqi st hev al ueoft heeconomy ’ scapi t al asdet er mi ned byt hest ockmar ket . Thedenomi nat ori st hepr i ceofcapi t al asi fi twer epur chasedt oday . Tobi nconv ey edt hatneti nv est mentshoul ddependonwhet herqi sgr eat eror l esst han1. I fqi sgr eat ert han1,t hent hest ockmar ketval uesi nst al l edcapi t alat mor et hani t sr epl acementcost ,t hef i r msr ai set hev al ueoft hei rst ock byi ncr easi ngcapi t al . I fqi sl esst han1,t he st ockmar ketv al uescapi t alatl esst hani t s r epl acementcost .I nt hi scase,manager swi l lnotr epl acecapi t alasi t wear sout . Resi dent i alI nvest ment Wewi l l nowconsi dert hedet er mi nant sofr esi dent i al i nv est mentbyl ooki ngata si mpl emodel oft hehousi ngmar ket . Resi dent i al i nv est menti ncl udest hepur chaseofnewhousi ngbot hbypeopl e whopl ant ol i v ei ni tt hemsel v esandbyl andl or dswhopl ant or enti tt oot her s. Tokeept hi ngssi mpl e, weshal l assumet hatal l housi ngi sowner occupi ed. Ther ear et wopar t st ot hemodel : 1)Themar ketf ort heexi st i ngst ockofhousesdet er mi nest heequi l i br i um 59 housi ngpr i ce 2)Thehousi ngpr i cedet er mi nest hef l owofr esi dent i al i nv est ment Ther el at i v epr i ceofhousi ngadj ust st oequi l i br at esuppl yanddemandf ort he exi st i ngst ockofhousi ngcapi t al . Const r uct i onf i r msbuymat er i al sandhi r el abort obui l dt hehousesandt hensel l t hem atmar ketpr i ce. Thei rcost sdependont heov er al lpr i cel ev elPwhi l et hei rr ev enuedependson t hepr i ceofhousesPH.TheHi ghert hePH, t hegr eat eri ncent i v et obui l dhouse. Thi smodelofr esi dent i ali nv est menti smuchsi mi l art oqt heor yofbusi ness f i xedi nv est ment ,whi chst at est hatbusi nessf i xedi nv est mentdependsont he mar ketpr i ceofi nst al l edcapi t alr el at i v et oi t sr epl acementcost ,whi chi nt ur n dependsonexpect edpr of i t sf r om owni ngi nst al l edcapi t al Ther esi dent i ali nv est mentdependsont her el at i v epr i ceofhousi ng,whi chi n t ur n dependson demand f orhousi ng,dependi ng on t hei mput ed r entt hat i ndi v i dual sexpectt or ecei v ef r om t hei rhousi ng Whent hedemandf orhousi ngshi f t s,t heequi l i br i um pr i ceofhousi ngchanges, andt hi schangei nt ur naf f ect sr esi dent i ali nv est ment .Ani ncr easei nhousi ng demand,per hapsduet oaf al li nt hei nt er estr at e,r ai seshousi ngpr i cesand r esi dent i al i nv est ment . 2. 3I nvent or yI nvest ment • I nv ent or yi nv est ment , t hegoodst hatbusi nessesputasi dei nst or age, i satt he samet i menegl i gi bl eandofgr eatsi gni f i cance. • I ti soneoft hesmal l estcomponent sofspendi ng, y eti t sv ol at i l i t ymakesi t cr i t i cal i nt hest udyofeconomi cf l uct uat i ons. • I nr ecessi on, f i r msst opr epl eni shi ngt hei ri nv ent or yasgoodsar esol d, and i nv ent or yi nv est mentbecomesnegat i v e Reasonsf orHol di ngI nv ent or i es pr oduct i onsmoot hi ng st ockoutavoi dance i nvent or i esasaf act orof wor ki npr ocess pr oduct i on TheAccel er at orModelofI nv ent or i es Theaccel er at ormodelassumest hatf i r mshol dast ockofi nv ent or i est hati s pr opor t i onal t ot hef i r m’ sl ev el ofout put . 60 Whenout puti shi gh,manuf act ur i ngf i r msneedmor emat er i al sandsuppl i es onhand, andmor egoodsi npr ocessofcompl et i on. WhenEconomyi sboomi ng,r et ai lf i r mswantt ohav emor emer chandi seon t hei rshel v est oshowcust omer s. Thus, i fNi st heeconomy ’ sst ockofi nv ent or i esandYi sout put , t hen N=bY Wher e, bi sapar amet err ef l ect i nghowmuchi nv ent or yf i r mswi sht ohol dasa pr opor t i onofout put . I nv ent or yi nv est mentIi st hechangei nt hest ockofi nv ent or i esDN. Ther ef or e, I=DN=bDY Theaccel er at ormodelpr edi ct st hati nv ent or yi nv est menti spr opor t i onalt o t hechangei nout put Whenout putr i ses, f i r mswantt ohol dal ar gerst ockofi nv ent or y , soi nv ent or y i nv est menti shi gh Whenout putf al l s,f i r mswantt ohol dasmal l erst ockofi nv ent or y ,sot hey al l owt hei ri nv ent or yt or undown, andi nv ent or yi nv est menti snegat i v e. Themodelsay st hati nv ent or yi nv est mentdependsonwhet hert heeconomy i sspeedi nguporsl owi ngdown. Chapt er3:MoneyDemandandMoneySuppl y 3. 1Ba nks’ r ol ei nt heMoneySuppl y Themoneysuppl yequal scur r encypl usdemand( checki ngaccount )deposi t s: M=C+D Si ncet hemoneysuppl yi ncl udesdemanddeposi t s, t hebanki ngsy st em pl ay san i mpor t antr ol e. Af ewpr el i mi nar i es: Reser v es( R) :t hepor t i onofdeposi t st hatbankshav enotl ent . Abank’ sl i abi l i t i esi ncl udedeposi t s, asset si ncl uder eser v esandout st andi ng l oans. 100per cent r eser v ebanki ng:asy st em i nwhi chbankshol dal ldeposi t sas r eser v es. Fr act i onal r eser v ebanki ng: asy st em i nwhi chbankshol daf r act i onoft hei r deposi t sasr eser v es. Tounder st andt her ol eofbanks, wewi l lconsi dert hr eescenar i os: 61 a)Nobanks b)100per centr eser v ebanki ng( bankshol dal l deposi t sasr eser v es) c)Fr act i onal r eser v ebanki ng( bankshol daf r act i onofdeposi t sasr eser v es, use t her estt omakel oans) I neachscenar i o, weassumeC=$1000. SCENARI O1:Nobankswi t hnobanks, 62 D=0 and M =C=$1000. 63 Thr eei nst r ument sofmonet ar ypol i cy 1)Openmar ketoper at i ons 2)Reser v er equi r ement s 3)Thedi scountr at e Openmar ketoper at i ons 64 Def i ni t i on: Thepur chaseorsal eofgov er nmentbondsbyt heFeder al Reser v e. howi twor ks: I fFedbuy sbondsf r om t hepubl i c,i tpay swi t hnewdol l ar s,i ncr easi ngB and t her ef or eM. Reser v er equi r ement s Def i ni t i on: Fedr egul at i onst hatr equi r ebankst ohol dami ni mum r eser v edeposi tr at i o. howi twor ks: Reser v er equi r ement saf f ectr randm:I fFedr educesr eser v er equi r ement s, t henbankscanmakemor el oansand“ cr eat e”mor emoneyf r om each deposi t . Thedi scountr at e Def i ni t i on: Thei nt er estr at et hatt heFedchar gesonl oansi tmakest obanks. howi twor ks: Whenbanksbor r owf r om t heFed, t hei rr eser v esi ncr ease, al l owi ngt hem t o makemor el oansand“ cr eat e”mor emoney .TheFedcani ncr easeB by l ower i ngt hedi scountr at et oi nducebankst obor r owmor er eser v esf r om t he Fed. Whi chi nst r umenti susedmostof t en? Openmar ketoper at i ons: mostf r equent l yused. Changesi nr eser v er equi r ement s: l eastf r equent l yused. Changesi nt hedi scountr at e: l ar gel ysy mbol i c. TheFedi sa“ l enderofl astr esor t , ”doesnotusual l ymakel oanst obankson demand. NewI nst r ument sofMonet ar yPol i cy Fi nanci al Cr i si sl edFedt ouseNewTool s Ter m Auct i onFaci l i t y : Al l owsbankst obor r owr eser v est hr oughanauct i onmechani sm. Af f ect st hemonet ar ybasej ustl i kebor r owi ngt hr ought hedi scount wi ndow. Pay i ngI nt er estonReser v es: 65 Hi gheri nt er estr at eonr eser v eshel dondeposi tatt heFedl eads bankst ohol dmor er eser v es. Af f ect st her eser v edeposi tr at i oand, i nt ur n, t hemoneymul t i pl i er . MoneyDemand Twot y pesoft heor i es Por t f ol i ot heor i es emphasi ze“ st or eofv al ue”f unct i on r el ev antf orM2, M3 notr el ev antf orM1.( Asast or eofv al ue, M1i sdomi nat edbyot her asset s. ) Tr ansact i onst heor i es emphasi ze“ medi um ofexchange”f unct i on al sor el ev antf orM1 Asi mpl epor t f ol i ot heor y wher e r xpect edr eal r et ur nonst ocks s=e r xpect edr eal r et ur nonbonds b=e πe=expect edi nf l at i onr at e W=r eal weal t h TheBaumol Tobi nModel at r ansact i onst heor yofmoneydemand not at i on: Y=t ot al spendi ng, donegr adual l yov ert hey ear i =i nt er estr at eonsav i ngsaccount N=numberoft r i psconsumermakest ot hebankt owi t hdr awmoneyf r om sav i ngs account F=costofat r i pt ot hebank( e. g. , i fat r i pt akes15mi nut esandconsumer ’ swage =$12/ hour , t henF=$3) . Chapt er4:TheLabourMar ket Chapt erObj ect i v es: Att heendoft hi schapt ery ouwi l lbeabl et o: 66 El abor at ehowpeopl emakechoi cesbet weenl ei sur eandhour sofwor k I dent i f yt hei ncomeandsubst i t ut i onef f ect sofawagei ncr easeonl abour suppl y Ment i onanddi scusst hedet er mi nant sofl abourdemand Show how t hei nt er act i onb/ nsuppl yofanddemandf orl abourdet er mi nes wager at eandempl oy menti nt heneocl assi cal model ofl abourmar ket Di st i ngui shbet weent heNeocl assi cal , Key nesi anandNewKey nesi anv i ewof t hel abourmar ketandt hei ri mpl i cat i ons Ment i onandexpl ai nt hecausesofunempl oy ment Di scuss how gov er nmentpol i cy i nt er v ent i ons & f i r ms deci si on af f ect s empl oy ment 4. 1I nt r oduct i on We hav el ear ntaboutt wo maj orcomponent s ofGDP,consumpt i on and i nv est ment .Wedi scussedt heexpor t s, andi mpor t si nt hef i r sthal foft hecour se. Anot herwayofmeasur i ngGDPi st hr ought hei ncomeappr oach,whi chi nv ol v es f act or sofpr oduct i on. Labormar keti s wher e an i mpor t antf act orofpr oduct i on i st r aded wi t h i mpl i cat i onsf ort hel ev el ofout putpr oduced. I nt hi ssect i on, t her ef or e, wewi l lat t emptt ol ear nhowt hel abormar ketwor ksby l ooki ngatneocl assi calmi cr oeconomi csmodelandt heNew Key nesi anv i ew of t hel abourmar ket . Neocl assi calMi cr oeconomi csModelOfTheLabourMar ket TheNeocl assi calTheor yofLaborSuppl y Tohol dapai dj ob, y oumustf i r sthav edeci dedt odoso.Thi si st hest ar t i ngpoi ntof t hesocal l ed‘ ‘ Neocl assi cal ’ ’t heor yofl aboursuppl y .I tposi t st hateachi ndi v i dual di sposesofal i mi t edamountoft i me,whi chs/ hechoosest oal l ocat ebet weenpai d wor kandl ei sur e. Assuch,t heNeocl assi calt heor yofl aboursuppl yi sbasedonamodelofa consumermaki ngachoi cebet weenconsumi nggoodsandl ei sur e. Choi ceBet weenConsumpt i onandLei sur e I ti sassumedt hatconsumerder i vesut i l i t yf r om t wosour ces: Thequant i t yofconsumergoods( aggr egat edt oCwi t hpr i cenor mal i zedt ouni t y) and 67 t heamountofl ei sur e( t i medevot edt oot heract i vi t i est hanwor k, denot edbyL) Twokeyassumpt i onsusedbyt hemodel : i .Peopl eactt omaxi mi zet hei rwel f ar e, orut i l i t y( i . e.peopl edot hebestt heycanwi t h whatt heyhav e) . i i .Peopl eexper i encedi mi ni shi ngmar gi nalbenef i tt oconsumi ngext r aconsumpt i on goodsorext r al ei sur e( i . e.t hei rwel f ar egoesupbutatadi mi ni shi ngr at e) . Weassumet hatawor kerwant st oachi ev et hemi xofr eali ncomeandl ei sur et hati s mostsat i sf act or yt ohi m orher .Todev el opt hel aboursuppl ymodel ,weuset he mi cr oeconomi csmodelofconsumerbehav i orwher et heconsumermaxi mi zesut i l i t y subj ectt ohi s/ herbudgetconst r ai nt . A.Consumer ’ sPr ef er ences The t r adeof fb/ n consumpt i on and l ei sur e can be depi ct ed by t he hel p of i ndi f f er encecur v eanal y si sofaut i l i t yf unct i on,U( C,L) ,wher eCandLdesi gnat e, r espect i vel yt heconsumpt i onofgoodsandt heconsumpt i onofl ei sur e. Thesl opeoft hei ndi f f er encecur v eatagi v enpoi ntdef i nest hemar gi nalr at eof MRSCL) subst i t ut i onb/ nconsumpt i onandl ei sur e( . I tr epr esent st hehour sofl ei sur ewhi chaconsumermustgi veupi nexchangef oran hourofwor korconsumpt i ongoods,f orhi s/ herl evelofsat i sf act i ont or emai n unchanged. B.Consumer ’ sBudgetConst r ai nt Nowl et ’ sconsi deral lt her esour cesav ai l abl et oaper son.Theconsumerhasnon l abori ncome( R)and24hour sadaywhi chs/ hecanuset owor kandgeti ncome ( wher ewT i st hewagei ncomef r om wor ki ngal lt hepossi bl ehour sav ai l abl e) . Peopl ecant henuset hi si ncomet obuyconsumpt i ongoods( C)orl ei sur ehour s ( .Thi sgi v esusabudgetconst r ai ntoft hef or m: wL) C +wL =wT +R Thi s equat i on st at es t hata per son can use hi s/ heri ncome t o ei t herbuy consumpt i ongoods,ort o“ buy ”l ei sur et i me.Her et hepr i ceoft hel ei sur et i mewe “ buy ”i st heoppor t uni t ycostoft hatt i me,whi chsi mpl yequal st hewagei ncomewe di dnotear n, butcoul dhav e. C.Consumer ’ sChoi ceOpt i malAl l ocat i onOfTi meb/ nWor kandLei sur e Sof ar , wehav edev el opedt heconsumer ’ sconsumpt i onl ei sur epr ef er encecur v eand t he Consumer ’ s Consumpt i onLei sur e BudgetLi ne.Now,l et ’ s def i ne consumer 68 equi l i br i um. D.Ef f ectofWageI ncr easeonLaborSuppl y Nowconsi derwhathappenst ol aborsuppl ywhent hewager at er i ses.Achangei n Wager at ecausest woef f ect s: 1.Subst i t ut i onEf f ect —ast hepr i ceofl ei sur ei ncr eases,t heamountofl ei sur e consumedgoesdown,andt heamountofl aborser v i cessuppl i edi ncr eases, hol di ngut i l i t yconst ant . 2.I ncomeEf f ect —aspeopl e’ si ncomei ncr eases,t heamountofl ei sur econsumed i ncr eases,andt heamountofl aborser v i cessuppl i eddecr eases.Wecanshow t heset woef f ect sgr aphi cal l yasf ol l ow: Summar y:Thenetef f ect sofawagei ncr easeonl aboursuppl y: Hi gherwage wi l li ncr ease l aboursuppl y( decr ease demand f orl ei sur e)i f subst i t ut i onef f ecti sst r ongert hani ncomeef f ect : Hi gherwagewi l ldecr easel aboursuppl y( i ncr easedemandf orl ei sur e)i fi ncome ef f ecti sst r ongert hansubst i t ut i onef f ect : i . LaborDemandi nt heNeocl assi calModel Sof ar ,wehav econsi der edt hesuppl ysi deoft hel abormar keti nt heneocl assi cal cont ext .Now, l et ’ sconsi dert heot herpar toft hel abourmar ket ( I . e. , Labordemand)t oaddt ooursuppl yf unct i onoft hel abourmar ket . Twokeyassumpt i onsusedbyt hemodel : 1.Fi r msactt omaxi mi set hei rpr of i t s. 2.Ther eexi stdi mi ni shi ngmar gi nalbenef i t st oempl oy i ngext r ar esour ces ( i . e.out putgoesupbutatadi mi ni shi ngr at e) . Thepr obl em t husf aci ngf i r msi st odeci dehowmuchofeachi nputt oempl oyt o maxi mi zepr of i t ssubj ectt ot het echnol ogi est heyhav eandpr i cest heyf ace. Thedemandf orl abouri sademandf orf act or sofpr oduct i onder i vedf r om demandf orf i nalgoods.Fi r msi naper f ect l ycompet i t i v emar ketuseashor tr un pr oduct i onf unct i on( wi t hpr edet er mi nedcapi t alst ockandgi v ent echnol ogy ) t o maxi mi zepr of i t s: Y =AF( L, K) A t Wher eY–r ealout put , K–gi vencapi t alst ock, L–amountofl abourempl oyed,– echnol ogy. w =MPL 69 WhatDet er mi nesLabourDemand( ? LD) ↑)=f ↑) ↑) w( ,A( ,K( ↓) [ ] Fr om t heabovemat hexpr essi onwecancl ai mt hat : . LD( 0) i .Ani ncr easei nr ealwager educesdemandf orl abour( Si nceFLL < . I ft he r ealwage r at ei ncr eases t hen t hi s means t he MC t o empl oy i ng l abour i ncr eases.I ft hef i r m wasi nequi l i br i um bef or et hewagei ncr ease,i twi l lnow be maki ngl ossesont hel astuni t sofl abouri templ oy sast hei rMBwi l lbel owert han t hei rMC. Thi st el l sust hatt her ei sanegat i v er el at i onshi pb/ nt her ealwageandt hequant i t y ofl abourempl oy edandcanbechar act er i zedast henor maldownwar dsl opi ng l abourdemandcur v e, andi nf actt hel abourdemandcur v ei sj ustt heMPL. a. Ani ncr easei ncapi t alst ocki ncr easesdemandf orl abour( Si nce FLK >0) 0) b.Ani mpr ovementi nt echnol ogyi ncr easesdemandf orl abour ( Si nceFL > Howchangesi ncapi t alst ockandt echnol ogyaf f ectdemandf orl abour ? I fki ncr easesorpr oduct i ont echnol ogyget sbet t ert hent heMPL i ncr eases,t hati s, eachuni tofl abourempl oy edbecomesmor epr oduct i v e.Thi si sshowngr aphi cal l y byanout war dshi f toft heMPL schedul e,( orequi v al ent l y ,byout war dshi f toft he l abourdemandcur v e) . TheNeocl assi calLaborMar ket Thedemandf orl abouri sadecr easi ngf unct i onoft her ealwager at e( i ndi cat i ng t hati ti sbyr educi ngt her ealwager at et hatmor ewor ker scanbeempl oy ed) . Cont r ar yt ot hi s,t hesuppl yofl abouri sani ncr easi ngf unct i onoft her ealwage r at e( showi ngt hati ti sbyi ncr easi ngt her ealwager at et hatmor ewor ker scanbe empl oy ed) . I ngener al ,t hef or cesi nt hi smar ketactt odet er mi nebot ht heamountofl abour t r adedandt hel ev eloft her ealwage.I ti sal sowor t hnot i ngt hatt her ei sno i nvol unt ar yunempl oymenti nt hi smodel .Peopl emaybe“ unempl oyed” ,buti ti s onl ybecauset heychoosenott owor katt hegoi ngr ealwage. Accor di ngt ot hi smodel ,f ul lempl oymenti sanor malsi t uat i onandanydevi at i on f r om t hi sr egar dedassomet hi ngabnor mal ,andt het endencyoft heeconomi c syst em i st oaut omat i cal l ypr ovi def ul lempl oymenti nt hel abormar ket . 70 Unempl oy menti nt heNeocl assi cal Model Recal l t hatNeocl assi cal l abourmar keti schar act er i zedby : o Per f ectcompet i t i onandPer f ecti nf or mat i on o Mar ketcl ear i ng, f l exi bl ewages o Homogenouswor ker s o Noi nv ol unt ar yunempl oy ment I st heNeocl assi calmodelenought oexpl ai nt heper f or manceoft hel abormar ket t oday? Possi bl eExpl anat i onsf orUnempl oyment oIfwagesdon’tclearthemarket,sothatthereexistunemployment,whydon’tthey f al l ? Wager i gi di t y( especi al l ydownwar d) –mi ni mum wagel egi sl at i on Ef f i ci encywages–i tmaybepr of i t abl ef orf i r mst opayhi gherwaget han mar ket cl ear i ngwage. Bar gai ni ngpowerofl aboruni ons Het er ogenei t yofwor ker sandj obs–sear chf orj obsandmat chi ngawor ker wi t hsui t abl ej obi scost l yandt akest i me. Unempl oymentmayr esul tf r om t her i gi di t yi nt hewagest r uct ur eandi nt er f er encei n t hewor ki ngoff r eemar ketsyst em i nt hef or m ofl aboruni on,mi ni mum wage l egi sl at i onet c. Keynesi anvi ewsoft heLaborMar ket I twasKey nest hatf i r stacknowl edgest heexi st enceofdi sequi l i br i ai nt hel abor mar ket .He emphasi zes t he possi bi l i t yofdownwar d nomi nalwage st i cki ness. Howev er ,concer ni ngt hecapaci t yofnomi nalwagesr educt i onsi nr est or i ngf ul l empl oy ment , Key nesdi dnotbel i ev et hatnomi nalwager i gi di t ywast hemai nsour ce ofunempl oy ment .Asaconsequence,heasser t edt hatnomi nalwagecut swer enot t hepr opercur ef orunempl oy ment . Asar esul t ,Key nesadv ocat edt hemai nt enanceofast abl el ev elofnomi nalwages andt hataut hor i t i es/ gov er nment swoul dt akeposi t i v eact i oni nor dert or est or ef ul l empl oy ment . Thei mpl i cat i oni st hatgover nmentt hr oughmonet ar yandf i scalpol i ci escanal t er aggr egat edemand,andt her ebyempl oyment . Consi dert heI SLM modelofKey nes 71 t ounder st andhowt hi swor ks. I S( I nvest ment Savi ng) :Y =C( YT( ↓) )+I ( r ( ↓) ) ( ↑)+G( ↑) M( ↑) =L( r , Y) ( ↓) P LM ( Li qui di t yPr ef er encesMoneySuppl y) : Not e:Ar r owsi ndi cat eexpansi onar ypol i ci es. Expansi onar ypol i ci esshi f t sI SandLM cur v est ot her i ghtwhatpr ov okesashi f ti n t hesamedi r ect i onoft heaggr egat edemandf i xi nganewandhi gherl ev elofout put and empl oy mentata gi v en pr i ce l ev el .The f ol l owi ng di agr am pr esent s how expansi onar y pol i ci es i nf l uences aggr egat e demand whi ch t hen det er mi nes empl oy ment . a.NewKeynesi anVi ewoft heLaborMar ket New Key nesi an Economi st s( NKE)whi ch obt ai ns t hei ri nspi r at i on f r om Key nes accept edt heexi st enceofwagesandpr i cer i gi di t y .Howev er ,unl i keKey nes,NKE ar guedt hatwager i gi di t ycanbet hesour ceofunempl oy ment .Asar esul t ,f orNKE f l ex i bl ewageswoul dal l owt heeconomyt omai nt ai nf ul l empl oy ment . Thus,NKEat t empt st opr ov i demi cr of oundat i onsf ort hephenomenaofwagesand pr i cessl uggi shadj ust ment s.Fori nst ance,NKEdev el oped ef f i ci encywagesand i nsi der out si dert heor i est oexpl ai nwhyf i r msdonotcutwageswhent her ear e unempl oy edwor ker s. i .Ef f i ci encywages:NewKeynesi aneconomi st sof t ent ur nt ot heor i esofwhatt hey cal lef f i ci encywagest oexpl ai nwhyl abourmar ket cl ear i ngmechani sm mayf ai l . I n an asy mmet r i ci nf or mat i on f r amewor k,ef f i ci ency wage model s descr i be sev er alr easons f orwhi ch cut t i ng a wage adv er sel y af f ectt he qual i t y or pr oduct i v i t yofl aborandi ncr easeatt heendt hef i r m’ scost . Theset heor i eshol dt hathi ghwagesmakewor ker smor epr oduct i v e.Hence,t he i nf l uenceofwagesonwor keref f i ci encymayexpl ai nt hef ai l ur eoff i r mst ocut wagesdespi t eanexcesssuppl yofl abor . i i .I nsi der Out si derTheor y:i nt hi st heor y ,i ti sar guedt hatt hei nsi der s( empl oy ed wor ker s)hav esomepoweri ndet er mi ni ngf i r m’ swageandempl oy mentdeci si on duet ot hepr esenceoft ur nov ercost s.Si ncef oraf i r mi ti scost l yt oexchange i nsi der sf orout si der s( unempl oy edwor ker s) ,t hei nsi der scanext r actashar eof t heeconomi cr entgener at edbysucht ur nov ercost s. b.Labour Mar ketSear chandUnempl oyment 72 Empi r i calev i dence has shown t hatt he l abourmar keti n many count r i es i s char act er i zed by huge gr oss f l ows of wor ker sl eav i ng a j ob and ent er i ng unempl oy mentandv i cev er sa.I nt hi ssect i on,wedevel opasi mpl emodelofl abor - f or cedynami cst hatshowswhatdet er mi nest henat ur alr at eofunempl oyment . Becauseev er y wor keri sei t herempl oy edorunempl oy ed,t hel aborf or cei st hesum oft heempl oyedandt heunempl oyed: i . e. , L =E +U 3. 5. TypesandCausesofUnempl oyment I .JobSe ar chandFr i ct i onalUnempl oyment Oner easonf orunempl oy menti st hati tt akest i met omat chwor ker sandj obs. Asa mat t eroff act ,wor ker shav edi f f er entpr ef er encesand abi l i t i es,and j obshav e di f f er entat t r i but es.Fur t her mor e,t hef l ow ofi nf or mat i onaboutj obcandi dat esand j ob v acanci es i si mper f ect ,and t he geogr aphi c mobi l i t y of wor ker si s not i nst ant aneous. Theunempl oymentcausedbyt het i mei tt akeswor ker st osear chf oraj obi scal l ed f r i ct i onalunempl oyment . Economi st scal lachangei nt hecomposi t i onofdemandamongi ndust r i esorr egi ons asect or alshi f t .Becausesect or alshi f t sar eal way soccur r i ng,andbecausei tt akes t i mef orwor ker st ochangesect or s, t her ei sal way sf r i ct i onalunempl oyment . I I .Cycl i calUnempl oyment I ti st heunempl oy mentt hataccompani esf l uct uat i onsi nr ealGDPandsomet i mes cal l ed“ Demanddef i ci entunempl oyment ” . Ref l ect sbusi nesscy cl econdi t i ons Whent her ei sagener aldownt ur ni nbusi nessact i v i t y ,cy cl i calunempl oy ment r i ses. I I I .SeasonalUnempl oyment Apr oductofr egul ar ,r ecur r i ngchangesi nt hehi r i ngneedsofcer t ai ni ndust r i eson amont hl yorseasonal basi s. I V. Real WageRi gi di t yandSt r uct ur alUnempl oyment Wager i gi di t yr ef er st ot hef ai l ur eofwagest oadj ustunt i ll aborsuppl yequal sl abor demand.The unempl oy mentr esul t i ng f r om wage r i gi di t yi s cal l ed st r uct ur al unempl oy ment .Mi ni mumWageLaws 73 The gov er nmentcauses wage r i gi di t ywhen i tpr ev ent s wages f r om f al l i ng t o equi l i br i um l ev el s.Mi ni mumwagel awssetal egalmi ni mum ont hewagest hatf i r ms payt hei rempl oy ees.Formostwor ker s,t hi smi ni mum wagei snotbi ndi ng,because t heyear nwel labov et hemi ni mum.Yetf orsomewor ker s,especi al l yt eenager sand unski l l ed wor ker s, mi ni mumwage l aws hav e si gni f i cantunempl oy menti mpact s si ncei tr ai sest hei rwageabov ePol i cyOpt i onst oSol veUnempl oymentcaused byMi ni mum wageLaws i .Taxcr edi t s:Mi ni mum wagei ncr easesar edesi gnedt ohel pt hewor ki ngpoor . Howev er , i tcausesunempl oy ment . i i .Subsi di zi ngunski l l edl abor :t hegov er nmentbysubsi di zi ngunski l l edl aborcoul d pusht hel abordemandupsot hatempl oy mentwoul dbebet t er . i i i . The gover nment can di r ect l y empl oy some unski l l ed wor ker s at t he goi ngmi ni mum wage.Agai n,t hedemandf orunski l l edl aborshi f t st ot her i ght andunempl oy menti sr educed. N. B:Foral lt het hr eeopt i onsdi scussedabove,t her ei sar evenuer equi r ement ont hepar toft hegover nment . A.Pr ovi si on oft r ai ni ng t o unski l l ed wor ker s by t he gover nment :By maki ng unski l l edl abormor epr oduct i v e,i ti spossi bl et ost i mul at et hedemandf ort hose wor ker sandempl oy ment . B.Uni onsandCol l ect i veBar gai ni ng Anot hercauseofwager i gi di t yi st hemonopol ypowerofuni ons.I nSweden84 per centofwor ker s,andi nt heUni t edSt at es,onl y18per centofwor ker sbel ongt o uni ons.Of t en,uni oncont r act ssetwagesabov et heequi l i br i um l ev elandal l ow t he f i r mt odeci dehowmanywor ker st oempl oy . C.Ef f i ci encyWages Ef f i ci ency wage t heor i es pr opose a t hi r d cause ofwage r i gi di t yi n addi t i on t o mi ni mumwagel awsanduni oni zat i on.Theset heor i eshol dt hathi ghwagesmake wor ker smor epr oduct i v e.Thei nf l uenceofwagesonwor keref f i ci encymayexpl ai n t hef ai l ur eoff i r mst ocutwagesdespi t eanexcesssuppl yofl abor .Event hougha wage r educt i on woul dl owera f i r m’ s wage bi l l ,i twoul d al so l owerwor ker pr oduct i v i t yandt hef i r m’ spr of i t s. Economi st shavepr oposedvar i ousr easonst oexpl ai nhowwagesaf f ect 74 wor kerpr oduct i vi t y 1.Wagesi nf l uencenut r i t i on( whi chi sappl i edmost l yt opoor ercount r i es) 2.Hi ghwagesr educel abort ur nover 3.Theaver agequal i t yofaf i r m’ swor kf or cedependsont hewagei tpaysi t s empl oyees 4.Hi ghwagei mpr oveswor keref f or t CHAPTERFI VE Macr oeconomi cPol i cyDebat es:St abi l i zat i onPol i cy I nt hi schapt erweaskt woquest i onst hatar i sei nt hi sdebat e. Fi r st ,shoul d monet ar yand f i scalpol i cyt akean act i v er ol ei nt r y i ng t o st abi l i zet heeconomy , orshoul dpol i cyr emai npassi v e? Second,shoul dpol i cy maker sbef r eet ouset hei rdi scr et i oni nr espondi ngt o changi ngeconomi ccondi t i ons,orshoul dt heybecommi t t edt oaf i xedpol i cy r ul e? Quest i on1: Shoul dpol i cybeact i veorpassi ve? Ar gument sf oract i v epol i cy Recessi onscauseeconomi char dshi pf ormi l l i onsofpeopl e. Themodelofaggr egat edemandandsuppl yshowshowf i scalandmonet ar y pol i cycanr espondt oshocksandst abi l i zet heeconomy . I nt heabsenceofanact i v egov er nmentr ol ei nt heeconomy , ev ent sl i ke t heGr eatDepr essi oncoul doccurr egul ar l y . I tal soshowshow monet ar yandf i scalpol i cycanpr eventr ecessi onsby r espondi ngt ot heseshocks. Ar gument sagai nstact i v epol i cy Ot hereconomi st scr i t i csar guest hatgov er nmentshoul dt akeahandsof f appr oacht omacr oeconomi cpol i cy . Pol i ci esactwi t hl ong&v ar i abl el ags, i ncl udi ng: i nsi del ag:t het i mebet weent heshockandt hepol i cyr esponse. t akest i met or ecogni zeshock t akest i met oi mpl ementpol i cy , especi al l yf i scal pol i cy out si del ag: t het i mei tt akesf orpol i cyt o af f ecteconomy . i . e Monet ar ypol i cy 75 I fcondi t i onschangebef or epol i cy ’ si mpacti sf el t ,t hepol i cymay dest abi l i zet heeconomy . Aut omat i cst abi l i zer s Somepol i ci es,cal l edaut omat i cst abi l i zer s,ar edesi gnedt or educet hel ags associ at edwi t hst abi l i zat i onpol i cy . Aut omat i cst abi l i zer sar epol i ci est hatst i mul at eordepr esst heeconomywhen necessar y wi t houtany del i ber at e pol i cy change.Exampl es:i ncome t ax , unempl oy menti nsur ance/Wel f ar e Whyt hei ncomet axi sanaut omat i cst abi l i z er : Eachper son’ st axbi l ldepends onheri ncome.I n r ecessi on, av er agei ncomesf al l , sot heav er ageper sonpay s f ewert axes. Whyunempl oy menti nsur ance/ wel f ar ei sanaut omat i cst abi l i zer For ecast i ngt hemacr oeconomy Becausepol i ci esactwi t hl ags, pol i cy maker smustpr edi ctf ut ur econdi t i ons. Twoway seconomi st sgener at ef or ecast s: Leadi ngeconomi ci ndi cat or s:dat aser i est hatf l uct uat ei nadv anceoft he economy Macr oeconomet r i c model s: Lar gescal e model s wi t h est i mat ed par amet er st hatcanbeusedt of or ecastt her esponseofendogenous v ar i abl est oshocksandpol i ci es TheLucascr i t i que Duet oRober tLucaswhowonNobel Pr i zei n1995f orr at i onal expect at i ons. For ecast i ngt heef f ect sofpol i cychangeshasof t enbeendoneusi ngmodel s est i mat edwi t hhi st or i cal dat a. Lucaspoi nt edoutt hatsuchpr edi ct i onswoul dnotbev al i di ft hepol i cy change al t er s expect at i ons i n a way t hat changes t he f undament al r el at i onshi psbet weenv ar i abl es. Anexampl eoft heLucascr i t i que Pr edi ct i on( basedonpastexper i ence) : Ani ncr easei nt hemoneygr owt hr at ewi l l r educeunempl oy ment . TheLucascr i t i quepoi nt soutt hati ncr easi ngt hemoneygr owt hr at emayr ai se expect edi nf l at i on, i nwhi chcaseunempl oy mentwoul dnotnecessar i l yf al l . An i ncr easei n moneygr owt h and i nf l at i on onl yr educesunempl oy menti f 76 expect edi nf l at i onr emai nsunchanged.Per hapst hatwast hecasei nt hepast . But now,i ft he money gr owt hi ncr ease causes peopl et or ai se t hei r expect at i onsofi nf l at i on, t henunempl oy mentwon’ tf al l . Quest i on2:Shoul dpol i cybeconduct edbyr ul eordi scr et i on? Rul esanddi scr et i on:Basi cconcept s Pol i cyconduct edbyr ul e:Pol i cy maker sannouncei nadv ancehowpol i cywi l l r espondi nv ar i oussi t uat i ons, andcommi tt hemsel v est of ol l owi ngt hr ough. Pol i cyconduct edbydi scr et i on:Asev ent soccurandci r cumst anceschange, pol i cy maker s use t hei rj udgment and appl y what ev er pol i ci es seem appr opr i at eatt het i me. Ar gument sf orr ul es: 1. Di st r ustofpol i cy maker sandt hepol i t i cal pr ocess mi si nf or medpol i t i ci ans pol i t i ci ans’ i nt er est ssomet i mesnott hesameast hei nt er est sof soci et y : pol i t i cal busi nesscy cl e? 2.Thet i mei nconsi st encyofdi scr et i onar ypol i cy Def :Ascenar i oi nwhi chpol i cy maker shav eani ncent i v et or enegeona pr ev i ousl yannouncedpol i cyonceot her shav eact edont hatannouncement . Dest r oy spol i cy maker s’ cr edi bi l i t y , t her ebyr educi ngef f ect i v enessoft hei r pol i ci es. Monet ar ypol i cyr ul es a. Const antmoneysuppl ygr owt hr at e b. Tar getgr owt hr at eofnomi nal GDP Aut omat i cal l yi ncr easemoneygr owt hwhenev ernomi nal GDPgr owssl ower t hant ar get ed. Decr easemoneygr owt hwhennomi nal GDPgr owt hexceedst ar get . c. Tar gett hei nf l at i onr at e Aut omat i cal l yr educemoneygr owt hwhenev eri nf l at i onr i sesabov et het ar get r at e. Manycount r i es’ cent r al banksnowpr act i cei nf l at i ont ar get i ng, butal l ow t hemsel v esal i t t l edi scr et i on. Cent r albanki ndependence Apol i cyr ul eannouncedbycent r albankwi l lwor konl yi ft heannouncementi s 77 cr edi bl e. Cr edi bi l i t ydependsi npar tondegr eeofi ndependenceofcent r al bank. Chapt erSi x Model sofMacr oeconomi cGr owt h TheneoKey nesi anHar r od–Domarmodel TheSol ow–Swanneocl assi cal model ; and TheRomer –Lucasi nspi r edendogenousgr owt hmodel s TheHar r od-DomarGr owt hModel Har r od( 1939,1948)andEv sey Domar( 1946,1947)i ndependent l ydev el oped t heor i est hatr el at eaneconomy ’ sr at eofgr owt ht oi t scapi t al st ock. Themodelassumes: anexogenousr at eofl abourf or cegr owt h( n)agi v en t echnol ogyexhi bi t i ngf i xedf act orpr opor t i ons i . e.-const antcapi t al –l abour r at i o, K/ L)andaf i xedcapi t al –out putr at i o( K/ Y) . Assumi ngat wosect oreconomy( househol dsandf i r ms) wecanwr i t et he si mpl enat i onal i ncomeequat i onas: Yt=Ct+St6. 1 wher eYt=GDP, Ct=consumpt i onandSt=savi ng. Equi l i br i um i nt hi ssi mpl eeconomyr equi r es: I t=St6. 2 Subst i t ut i ng( 6. 2)i nt o( 6. 1)y i el ds( 6. 3) : Yt=Ct+I t6. 3 Wi t hi nt heHar r od–Domarf r amewor kt hegr owt hofr eal GDPi sassumedt obe pr opor t i onal t ot heshar eofi nv est mentspendi ng( I )i nGDPandf oran economyt ogr ow, netaddi t i onst ot hecapi t al st ockar er equi r ed. Thecapi t al st ockov ert i mei sgi v eni nequat i onas Kt +1=( 1−δ) Kt+I t6. 4 wher eδi st her at eofdepr eci at i onoft hecapi t al st ock. Ther el at i onshi pbet weent hesi zeoft het ot al capi t al st ock( K)andt ot alGDP( Y) i sknownast hecapi t al –out putr at i o( K/ Y=v)andi sassumedf i xed. Gi v ent hatwehav edef i nedv=K/ Y, i tal sof ol l owst hatv=ΔK/ ΔY Assumet hatt ot al sav i ngi ssomepr opor t i on( s)ofGDP( Y) St=sYt6. 5 Si nceK=v YandI t=St , i tf ol l owst hatwecanr ewr i t eequat i on( 6. 4)asequat i on 78 vYt +1=( 1−δ) vYt+sYt6. 6 Di v i di ngbyv , andsubt r act i ngYt f r om bot hsi desofequat i on( 6. 6)y i el dsequat i on ( 6. 7) : Yt +1−Yt=[ s/ v−δ] Yt6. 7 Di v i di ngt hr oughbyYtgi v esusequat i on: [ Yt +1−Yt] / Yt=( s/ v )−δ6. 8 Her e[ Yt+1–Yt ] / Yti st hegr owt hr at eofGDP.Let t i ngG=[ Yt+1–Yt ] / Yt , Wecanwr i t et heHar r od–Domargr owt hequat i onas: G=s/ v−δ6. 9 NB:Thi ssi mpl yst at est hatt hegr owt hr at e( G)ofGDPi sj oi nt l ydet er mi nedby t hesav i ngsr at i o( s)di vi dedbyt hecapi t al –out putr at i o( v) Thehi ghert hesavi ngsr at i oandt hel owert hecapi t al –out putr at i oand depr eci at i onr at e, t hef ast erwi l l aneconomygr ow. Byi gnor i ngdepr eci at i onr at eHar r od–Domarmodel as G=s/ v6. 10 Forexampl e, i fadev el opi ngcount r ydesi r edt oachi ev eagr owt hr at eofper capi t ai ncomeof2percentperannum andpopul at i oni sest i mat edt obe gr owi ngat2percent , t heneconomi cpl anner swoul dneedt osetat ar getr at e ofGDPgr owt h( G* )equal t o4percent . G/pop%=Per capi t ai ncome 4%/ 2%=2% I fv=4, t hi si mpl i est hatG*canonl ybeachi ev edwi t hadesi r edsav i ngsr at i o ( s* )of0. 16, or16percentofGDP. I fs*>s, t her ei sa‘ sav i ngsgap’ , andpl anner sneededt odev i sepol i ci esf or pl uggi ngt hi sgap. Si ncet her at eofgr owt hi nt heHar r od–Domarmodel i sposi t i vel yr el at edt ot hesavi ngsr at i o I fdomest i csour cesoff i nancewer ei nadequat et oachi ev et hedesi r edgr owt h t ar get , t henf or ei gnai dcoul df i l lt he‘ savi ngsgap’ Ai dr equi r ement s( Ar )woul dsi mpl ybecal cul at edas: s*–s=Ar TheSol owNeocl assi cal Gr owt hModel I nSol owmodel : capi t al , l abor , andt echnol ogyar ekeydet er mi nant sof pr oduct i onofgoods&ser v i ces. 79 Wedev el opedt heSol owmodel t oshow: howchangesi ncapi t al( t hr oughSandI ) &changesi nt hel aborf or ce( pongr owt h)af f ecteconomy ’ sout put Wear enowr eadyt oaddt het hi r dsour ceofgr owt hchangesi nt echnol ogy—t o t hemi x. TheSol owmodel doesnotexpl ai nt echnol ogi cal pr ogr essbut , i nst ead, t akesi tasexogenousl ygi v enand showshowi ti nt er act swi t hot herv ar i abl esi nt hepr ocessofeconomi c gr owt h TheSol ow gr owt hmodeli sdesi gnedt oshow how gr owt hi nt hecapi t alst ock, gr owt hi nt hel aborf or ce,andadv ancesi nt echnol ogyaf f ectanat i on’ st ot alout put ofgoodsandser v i ces. Ourf i r stst epi st oexami nehow t hesuppl yanddemandf orgoodsdet er mi nest he accumul at i onofcapi t al . I nt hi sf i r stst ep, weassumet hat ( t hel aborf or ceandt echnol ogyar ef i xed) . Wet henr el axt heseassumpt i onsbyi nt r oduci ngchangesi nt hel aborf or ce l at eri nt hi schapt erandbyi nt r oduci ngchangesi nt echnol ogyi nt henext . Thesuppl yofgoodsi nt heSol owmodel i sbasedont hepr oduct i onf unct i on, whi chst at est hatout putdependsoncapi t alst ockandl aborf or ce: Y=F( K, L) TheSol owgr owt hmodel assumest hatt hepr oduct i onf unct i on hasconst antr et ur nst oscal e.zY=F( zK, zL) Pr oduct i onf unct i onswi t hconst antr et ur nst oscal eal l owust oanal y zeal l quant i t i esi nt heeconomyr el at i v et ot hesi zeoft hel aborf or ce. Toseet hatt hi si st r ue, setz=1/ Li nt hepr ecedi ngequat i ont oobt ai n Y/ L=F( K/ L, 1) Thi sequat i onshowst hatt heamountofout putperwor kerY/ L i saf unct i onoft heamountofcapi t al perwor kerK/ L. ( Thenumber1i sconst antandt huscanbei gnor ed. ) Theassumpt i onofconst antr et ur nst oscal ei mpl i est hat t hesi zeoft heeconomyasmeasur edbyt henumberofwor ker sdoes notaf f ectt her el at i onshi pbet weenout putperwor kerandcapi t alper wor ker y=Y/ Li sout putperwor ker , andk=K/ Li scapi t alperwor ker . 80 Wecant henwr i t et hepr oduct i onf unct i onas, y=f( k) t hepr oduct i onf unct i onbecomesf l at t er ,i ndi cat i ngt hatt hepr oduct i on f unct i onexhi bi t sdi mi ni shi ngmar gi nalpr oductofcapi t al . Whenki sl ow, t heaver agewor kerhasonl yal i t t l ecapi t al t owor kwi t h, soan ext r auni tofcapi t al i sv er yusef ul andpr oducesal otofaddi t i onal out put . Whenki shi gh, t heaver agewor kerhasal otofcapi t alal r eady , soanext r auni t i ncr easespr oduct i ononl ysl i ght l y .( Ref ert ot hef i gur e! ) TheDemandf orGoodsandt heConsumpt i onFunct i on Thedemandf orgoodsi nt heSol owmodel comesf r om consumpt i onand i nvest ment . I not herwor ds, out putperwor keryi sdi vi dedbet weenconsumpt i onper wor kercandi nvest mentperwor keri : y=c+i TheSol owmodel assumest hateachy earpeopl esav eaf r act i onsoft hei r i ncomeandconsumeaf r act i on( 1–s) Wecanexpr esst hi si deawi t ht hef ol l owi ngconsumpt i onf unct i on: c=( 1−s) y wher es, t hesavi ngr at e Toseewhatt hi sconsumpt i onf unct i oni mpl i esf ori nv est ment , subst i t ut e( 1–s) yf orci nt henat i onal i ncomeaccount si dent i t y : y=( 1−s) y +i Rear r anget het er mst oobt ai n i=sy Foranygi v encapi t al st ockk, t hepr oduct i onf unct i ony=f ( k) det er mi neshowmuchout putt heeconomypr oduces, and Thesav i ngr at esdet er mi nest heal l ocat i onoft hatout putbet ween consumpt i onandi nv est ment . Gr owt hi nt heCapi t alSt ockandt heSt eadySt at e Atanymoment , t hecapi t al st ocki sakeydet er mi nantoft heeconomy ’ s out put , butt hecapi t al st ockcanchangeov ert i me, andt hosechangescan l eadt oeconomi cgr owt h I npar t i cul ar , t wof or cesi nf l uencet hecapi t alst ock:i nvest mentand depr eci at i on. I nvest menti sexpendi t ur eonnewpl antandequi pment , andi tcausest he capi t alst ockt or i se. 81 Depr eci at i oni st hewear i ngoutofol dcapi t al , andi tcausest hecapi t alst ock t of al l . Thi sequat i onr el at est heexi st i ngst ockofcapi t al kt ot heaccumul at i onofnew capi t al i . Thepr oduct i onf unct i onf ( k) , andt heal l ocat i onoft hatout putbet ween consumpt i onandsav i ngwhi chi sdet er mi nedbyt hesavi ngr at es . Toi ncor por at edepr eci at i oni nt ot hemodel , weassumet hatacer t ai nf r act i ond oft hecapi t al st ockwear souteachy ear . Forexampl e, i fcapi t all ast sanaver ageof25year s, t hent hedepr eci at i onr at ei s 4per centpery ear( d=0. 04) . Theamountofcapi t al t hatdepr eci at eseachy eari sdk. Changei nCapi t al St ock=I nv est ment−Depr eci at i on Dk=i −dk wher eDki st hechangei nt hecapi t alst ockbet weenoneyearandt henext . Becausei nv est menti equal ssf ( k) , wecanwr i t et hi sasDk=sf( k)−dk. Let ’ sconsi dereachoft hesef or cesi nt ur n.Aswehav eal r eadynot ed, i nv est mentperwor keri equal ssy. Bysubst i t ut i ngt hepr oduct i onf unct i onf ory , wecanexpr essi nvest mentper wor kerasaf unct i onoft hecapi t al st ockperwor ker : i=sf ( k) . Regar dl essoft hel evelofcapi t al wi t hwhi cht heeconomybegi ns, i tendsup wi t ht hest eadyst at el evelofcapi t al . Toseewhyaneconomyal way sendsupatt hest eadyst at e, supposet hatt he economyst ar t swi t hl esst hant hest eady st at el ev elofcapi t al ,suchasl ev elk1 i nFi gur e6. 2. I nt hi scase, t hel ev el ofi nv est mentexceedst heamountofdepr eci at i on. Ov ert i me, t hecapi t alst ockwi l lr i seandwi l lcont i nuet or i se-al ongwi t h out putf ( k) —unt i li tappr oachest hest eadyst at ek* . Si mi l ar l y ,supposet hatt heeconomyst ar t swi t hmor et hant hest eady st at e l ev elofcapi t al ,such as l ev elk2.I nt hi s case,i nvest menti sl ess t han depr eci at i on:capi t al i swear i ngoutf ast ert hani ti sbei ngr epl aced.Thecapi t al st ockwi l l f al l , agai nappr oachi ngt hest eady st at el ev el . Once t he capi t alst ock r eaches t he st eady st at e,i nv est ment equal s 82 depr eci at i on,andt her ei snopr essur ef ort hecapi t alst ockt oei t heri ncr ease ordecr ease. Thehi ghert hecapi t alst ock, t hegr eat ert heamount sofout putandi nv est ment . Yett hehi ghert hecapi t al st ock, t hegr eat eral sot heamountofdepr eci at i on. I ft heeconomyf i ndsi t sel fatt hi sl ev eloft hecapi t alst ock,t hecapi t alst ockwi l l notchangebecauset het wof or cesact i ngoni t i nv est mentanddepr eci at i onj ust bal ance. Thati s,atk* ,Dk=0,sot hecapi t alst ockkandout putf ( k)ar est eadyovert i me ( r at hert hangr owi ngorshr i nki ng) . Wet her ef or ecal l k*t hest eadyst at el evelofcapi t al . ( Ref ert oFi gur e6. 2) TheSol owmodel showst hatt hesav i ngr at ei sakeydet er mi nantoft hest eady st at ecapi t al st ock. I ft hesavi ngr at ei shi gh, t heeconomywi l lhaveal ar gecapi t alst ockandahi gh l evelofout puti nt hest eadyst at e. I ft hesavi ngr at ei sl ow, t heeconomywi l lhaveasmal lcapi t alst ockandal ow l evelofout puti nt hest eadyst at e. TheGol denRul eLevelofCapi t al Sof ar ,wehav eusedt heSol ow modelt oexami nehow aneconomy ’ sr at eof sav i ngandi nv est mentdet er mi nesi t sst eady st at el ev el sofcapi t al andi ncome. Yetsupposeanat i onhadasav i ngr at eof100per cent .Thatwoul dl eadt ot he l ar gestpossi bl ecapi t al st ockandt hel ar gestpossi bl ei ncome. Buti fal loft hi si ncomei ssavedandnonei severconsumed, whatgoodi si t ? Thi ssect i onusest heSol ow modelt odi scusst heopt i malamountofcapi t al accumul at i onf r om t hest andpoi ntofeconomi cwel l bei ng. So, howdowef i ndt hesandk*t hatmaxi mi zec*? K*golden= t he Gol den Rul el ev elofcapi t al , t he st eadyst at ev al ue ofkt hat maxi mi zesconsumpt i on. Tof i ndi t , f i r stexpr essc*i nt er msofk*: * c*= y*i * = f( k*) i =f( k*) dk* I ngener al : i=Dk+dk I nt hest eadyst at e: 83 * i = dk*becauseDk=0. ( Ref ert ot hef i gur e! ) Popul at i onGr owt h Assumet hatt hepopul at i onandl aborf or ce-gr owatr at en. ( ni s exogenous) EX:SupposeL=1000i ny ear1andt hepopul at i oni sgr owi ngat2%/ y ear ( n=0. 02) . Then DL=nL=0. 02´1000=20, soL=1020i ny ear2. Br eakev eni nv est ment ( d+n) k=br eakev eni nv est ment ,t heamountofi nv est mentnecessar yt o keepkconst ant . Wi t hpopul at i ongr owt h, t heequat i onofmot i onf orki s Dk=sf ( k) ( d+n)k Act ual i nv esment br eakev eni nv est ment TheEf f ect sofPopul at i onGr owt h Ani ncr easei nn=br eakev eni nv est ment , l eadi ngt oal owerst eady st at el ev el ofk. * Hi ghernÞl owerk*.Andsi ncey=f ( k),l owerk*Þl owery . Thus, Sol owmodel pr edi ct st hatcount r i eswi t hhi gherpopngr owt hwi l l hav e l owerl ev el sofcapi t al andi ncomeperwor keri nt hel ongr un. ( Ref ert ot hef i gur e! ) TheGol denRul ewi t hPopul at i onGr owt h Tof i ndt heGol denRul ecapi t al st ock, weagai nexpr essc*i nt er msofk*: * c*= y*i =f ( k*) ( d+n)k* c*i smaxi mi zedwhen MPK=d+norequi v al ent l y , MPKd=n Technol ogi calPr ogr essi nSol owModel Pr ev i ousl y ,i nt heSol ow model t hepr oduct i ont echnol ogywashel dconst ant i ncome percapi t awasconst anti nt hest eadyst at e. Tech.pr ogr essi nt heSol owmodel 84 Anewv ar i abl e:E=l aboref f i ci ency Assume: Technol ogi calpr ogr essi sl abor augment i ng: i ti ncr easesl abor ef f i ci encyatt heexogenousr at eg: Wenowwr i t et hepr oduct i onf unct i onas wher eL´ E=t henumberofef f ect i vewor ker s Hence,i ncr eases i nl aboref f i ci ency hav et he same ef f ecton out putas i ncr easesi nt hel aborf or ce. Not at i on: y=Y/ LE =out putperef f ect i v ewor ker k=K/ LE =capi t al peref f ect i v ewor ker Pr oduct i onf unct i onperef f ect i v ewor ker : y=f ( k) Sav i ngandi nv est mentperef f ect i v ewor ker : sy=sf ( k) ( d+n +g) k=br eakev eni nv est ment : Theamountofi nv est mentnecessar yt okeepkconst ant .Consi st sof : dkt or epl acedepr eci at i ngcapi t al nkt opr ov i decapi t al f ornewwor ker s gk t o pr ov i de capi t alf ort he new “ ef f ect i v e”wor ker s cr eat ed by t echnol ogi cal pr ogr ess Pol i ci est opr omot egr owt h Fourpol i cyquest i ons: Ar ewesav i ngenough?Toomuch? Whatpol i ci esmi ghtchanget hesav i ng r at e? How shoul dweal l ocat eouri nv est mentbet weenpr i v at el yownedphy si cal capi t al , publ i ci nf r ast r uct ur e, and“ humancapi t al ” ? Whatpol i ci esmi ghtencour age f ast ert echnol ogi cal pr ogr ess? Ev al uat i ngt heRat eofSav i ng Uset heGol denRul et odet er mi newhet heroursav i ngr at eandcapi t al st ockar e t oohi gh, t ool ow, oraboutr i ght .Todot hi s, weneedt ocompar e( MPKd)t o( n +g) . Toest i mat e( MPKd) , weuset hr eef act saboutaneconomy ; 1. k=2. 5y Thecapi t al st ocki sabout2. 5t i mesoney ear ’ sGDP. 2. dk=0. 1y About10%ofGDPi susedt or epl acedepr eci at i ngcapi t al . 3. MPK´ k=0. 3y Capi t al i ncomei sabout30%ofGDP 1.k=2. 5y 2. dk=0. 1y 3. MPK´ k=0. 3y Todet er mi ned, di v i ded2by1: 85 Todet er mi neMPK, di v i ded3by1: Hence, MPKd=0. 12-0. 04=0. 08 Fr om t hel astsl i de:MPKd=0. 08, Real GDPgr owsanav er ageof3%/ y ear , so n+g =0. 03.Thus, i nt hi seconomy ,MPKd=0. 08>0. 03=n+g Concl usi on: Theeconomyi sbel owt heGol denRul est eadyst at e:i fwei ncr easesav i ngr at eof t hi seconomy , t heeconomywi l l hav ef ast ergr owt hunt i l i tr eachest oanew st eadyst at ewi t hhi gherconsumpt i onpercapi t a. EndogenousGr owt hTheor y Sol owmodel : Sust ai nedgr owt hi nl i v i ngst andar dsi sduet ot echpr ogr ess, t her at eof t echpr ogr essi sexogenous. Endogenousgr owt ht heor y : asetofmodel si nwhi cht hegr owt hr at eofpr oduct i v i t yandl i v i ng st andar dsi sendogenous Abasi cmodel Pr oduct i onf unct i on:Y =AK wher e, Yi sOut put,Ki st hecapi t alst ock, Ameasur est heamount ofout putpr oducedf oreachuni tofcapi t al ( Ai sexogenous& const ant ) Keydi f f er encebet weent hi smodel &Sol ow:MPKi sconst anther e, di mi ni shes i nSol ow I nv est ment :sY Depr eci at i on: dK 86 Equat i onofmot i onf ort ot al capi t al : ΔK =sYdK ΔK =sYdK Di v i det hr oughbyK anduseY =AK, get : Chapt er7:Macr oeconomi cTheor i esandAf r i canEconomi es Macr oeconomi cTheor i esandAf r i canEconomi es:Anover vi ew 7. 1TheAppl i cabi l i t yofConv ent i onal Theor i est oAf r i canEconomi es 7. 1. 1I nt r oduct i on Ther ewer eal somuchmor edebat eont heappl i cabi l i t yofconv ent i onalmacr omodelt o Af r i caneconomi esi npar t i cul aranddev el opi ngcount r i esi ngener al .Butt hemaj or v i ewscanbecat egor i zedi nt ot wo: a)TheOr t hodoxVi ew Accor di ngt ot hi sv i ewsuchmacr omodel sar eappl i cabl eel sewher ebei tdev el opedor dev el opi ngcount r i es.Thesol ut i onf or war dedbyt hi sv i ew i st hatt ol ett hemar kett o al l ocat er esour cesandl i mi tgov er nmenti nt er v ent i on.Thegui di ngpr i nci pl eofeconomi c deci si oni s“ pr i ceandmar ketsyst em i sr i ght ” . b)TheSt r uct ur al i stVi ew Thest r uct ur al i stv i ewcanbecl assi f i edas: Ear l yVi ew:i tar guest hatt hest r uct ur eofdev el opi ngcount r i esi sdi f f er entf r om t hatof dev el oped count r i es.Thi s schooli st he pr oponentofi nf anti ndust r yar gumentwhi ch f ocusesonpr ot ect i ngt hei ndust r i esandoni mpor tsubst i t ut i onst r at egy . TheRecentVi ew:t hi sv i ew f ocusesonshor tt er m adj ust ment s.Fort hi sschoolmonet ar y and f i scalpol i cypr escr i pt i onst hatmaybeappl i cabl et o dev el oped count r i esar enot r el ev antf ordev el opi ngcount r i es. Remov i ngst r uct ur alr i gi di t i es, cr eat i ngwel l f unct i oni ngandi nt egr at edmar ket st oel i mi nat e suppl ysi der i gi di t i esshoul dt her ef or ebei nt hepr i or i t i esofdev el opmentst r at egi es. 7. 1. 2Char act er i st i csofDev el opi ngCount r i es Thesechar act er i st i csi ncl udet henat ur eofopennesst ot r adewi t ht her estoft hewor l di nbot h commodi t i es and asset s,t he pr oper t i es oft he economy ’ sl ongr un and shor t r un suppl y f unct i ons,t henat ur eoff i nanci almar ket s,t hechar act er i st i csoft hegov er nment ’ sbudgetand t hei ri mpl i cat i onf orf i scal pol i cy , et c. Dev el opi ngcount r i est endt obemor eopenandhav el i t t l econt r olov ert hepr i cesoft he 87 goodst heyexpor tand i mpor t .Hencet heconv ent i onalcl osed economymodeli snot appl i cabl e. I ncont r astt ot hemaj ori ndust r i alcount r i es,t hev astmaj or i t yofdev el opi ngcount r i eshav e notadopt edf l exi bl eex changer at es. Dev el opi ngcount r i est endt obecapi t ali mpor t er s,andt heser v i ci ngofext er naldebti sa cent r al pol i cyi ssuei nmanyoft hem. Theext entofext er nalt r adei nasset st endst obemor el i mi t edi ndev el opi ngcount r i est han i ni ndust r i al ones. Theaggr egat edemandcur v ei sdownwar dsl opi ngj ustl i kedev el opedcount r i esbutmuch st eeper . 7. 1. 3Dev al uat i onandDev el opi ngCount r i es Thedi f f er encebet weent heMDCandLDCmodel sar eper hapsmostev i dentwhenconsi der i ng dev al uat i on. I nt heMDC,dev al uat i oni mpr ov est hebal anceoft r adeshi f t i ngt heI Sandt he aggr egat edemandcur v es( YD)t ot her i ght ,r esul t i ngi nani ncr easei nbot hout putandt hepr i ce l ev el ;r est r i ct i v emonet ar yandf i scalpol i cyar el i kel yt obet heappr opr i at est abi l i zat i onpol i ci es t oaccompanydev al uat i on. 7. 1. 4Rest r i ct i v eMonet ar ypol i cyandDev el opi ngCount r i es Ani ncr easei nt her eser v er at i o, r educi ngt hemoneysuppl y , hasal ar gei mpactont heLM cur v e ( f oragi v enpr i cel ev el )becauseoft hei nt er estel ast i ci t yofmoneydemand.Thedecr easei nt he av ai l abi l i t yofl ow i nt er estcommer ci albankl oansal sor educesr et ai nedear ni ngsomewhat shi f t i ngt heI Scur v edown. 7. 1. 5Rest r i ct i v eFi scal pol i cyandDev el opi ngCount r i es Whi l er est r i ct i v emonet ar ypol i cyi sl i kel yt oi ncr easebot hunempl oy mentandi nf l at i oni nt he LDCi nt heshor tr un, r est r i ct i v ef i scalpol i cyi sl i kel yt obemor esuccessf uli nr educi ngt hepr i ce l ev el wi t houtt hecost sofamaj orr ecessi on. 7. 1. 6I ncomepol i cyandDev el opi ngCount r i es Ani ncomepol i cyt hatl ower st henomi nalwageaf f ect st hest andar dLDC economi esi na numberofway s. Shi f t st heI Scur v et ot hel ef t( si ncegov er nmentspendi ngi sdecr easi ng) TheLM cur v eshi f t st ot her i ghtduet oadecr easei nmoneydemand I tdecr easesbot hwageandi nt er estcost sshi f t i ngaggr egat esuppl ydown END 88 DEVELOPMENTECONOMI CSMODULE DEVELOPMENTECONOMI CSI CHAPTERONE Economi csofdevel opment :concept sandappr oaches Dev el opmenteconomi csdeal swi t hdev el opmentpr obl emsofdev el opi ngcount r i es.I n ot herwor ds,i ti saboutt hecausesandcur esofmasspov er t yi nt hel essdev el oped nat i ons.Att heout set ,t her ef or e,weshoul dbeawar eoft her el ev antconcept sand measur i ngmet hodsofdev el opmentdev i sedbydi f f er enti nst i t ut i onsandper sons.Thus, t hedi scussi onoft hehi st or i calev ol ut i onoft heconceptdev el opmentandt hemet hods empl oy ed i n measur i ng dev el opmentar ev i t al .Dearst udent s,we wi l lbegi n our di scussi on dev el opmenteconomi csbydef i ni ng t heconcept sofdev el opmentand economi cgr owt h. Themeani ngofeconomi cgr owt hi sunambi guous. Al mostal leconomi st swoul d acceptt hei ncr easei nt heout putofgoodsandser v i cesofacount r yperuni tt i meas i t sdef i ni t i on. Out puti smeasur ed byt hegr ossnat i onalpr oduct( GNP)orgr oss domest i cpr oduct( GDP) .Gr owt hi nGNP/ GDPcanbecal cul at edei t heratmar ketpr i ce orf act orcost .I nor dert omeasur et heef f ectofgr owt hont hest andar dofl i v i ngoft he popul at i on, t heGNP/ GDPpercapi t al i st aken, whi chi sal soknownaspercapi t al i ncome. Percapi t ali ncomecanbemeasur edi nt er msofhomecur r encyandf ori nt er nat i onal compar i sonsi nt er msofUSdol l ar .Howev er ,t heUSdol l arhasdi f f er entpur chasi ng poweri nt hemar ketofdi f f er entcount r i esespeci al l yf ornont r adedgoods. Ot hert r i edt oexpl ai ndev el opmenti nt er msoft hepr ocessofst r uct ur alt r ansf or mat i on oft heeconomy .Thusi t ’ st hepl annedal t er at i onoft hest r uct ur eofpr oduct i onand empl oy ment .Lat eronconcer nar eaccor dedt opov er t y ,unempl oy ment ,i nequal i t i esof i ncome,andot hereconomi c,i nst i t ut i onal ,soci alandpol i t i calf act or sowi ngt ot he f ai l ur eofdev el opi ngcount r i est oi mpr ov et hest andar dofl i v i ngoft hepoor . 89 Dudl eySeer sar guesont heneedofl ooki ngonwhathasbeenhappeni ngt opov er t y , unempl oy ment ,and i nequal i t yasa det er mi nantofdev el opmentr at hert han mer e gr owt hofpercapi t ai ncome.Af t erhi mI naddi t i ont ot hesei ssues, dev el opmenthast o i ncor por at eot hereconomi candnoneconomi cf act or s.Aconceptofdev el opmenti n gener ali sr equi r edwhi chembr acest hemaj oreconomi candsoci alobj ect i v esand v al uest hatsoci et i esst r i v ef or . Cur r ent l y ,byPodar o dev el opmenti s“ concei ved as a mul t idi mensi onalpr ocess i nvol vi ng maj or changes i n soci alst r uct ur es,popul ar at t i t udes,and nat i onal i nst i t ut i ons,as wel las t he accel er at i on ofeconomi c gr owt h,t he r educt i on of i nequal i t y( andunempl oyment ) ,andt heer adi cat i onofabsol ut epover t y” .Deni sGoul et di st i ngui shes t hr ee basi c component s orcor ev al ues i nt hi s wi dermeani ng of dev el opment .Li f esust enance:i sconcer nedwi t ht hepr ov i si onofbasi cneeds.No count r ycanber egar dedasf ul l ydev el opedi fi tcannotpr ov i dei t sent i r epeopl ewi t h suchbasi cneedsashousi ng, cl ot hi ng, f oodandmi ni mum educat i on.Amaj orobj ect i v e ofdev el opmentmustbet or ai sepeopl eoutofpr i mar ypov er t yandt opr ov i debasi c needssi mul t aneousl ywi t houtwhi ch t her ei sabsol ut e underdev el opment .Hence, economi cdev el opmenti sanecessar ycondi t i on( butnotsuf f i ci entcondi t i on)f ort he i mpr ov ementoft hequal i t yofl i f ei npr ov i di ngt hesel i f esust enanceneedsandbr i ngi ng dev el opment . Sel f Est eem: sel f est eem i s concer ned wi t h t he f eel i ng of sel f r espect and i ndependence.I tmeanst obeaper son,asenseofwor t handsel f r espect ,ofnotbei ng usedasat oolbyot her sf ort hei rownends.Ev er ysoci et yori ndi v i dualst r i v est owar ds sel f est eem.Wi t houtdev el opmentt hepr i deoft hepeopl esoft hedev el opi ngcount r i es ont hei rcul t ur ali dent i t yanddi gni t yar ebei nger oded.Nocount r ycanber egar dedas f ul l ydev el opedi fi ti sexpl oi t edbyot her sanddoesnothav et hepowerandi nf l uencet o conductr el at i onsonequalt er ms.Nowday s, economi cweal t handt echnol ogi calpower hav e become al most uni v er salmeasur es of wor t h.Dev el opi ng count r i es seek dev el opmentf orsel f est eem;t oer adi cat et hef eel i ngofdomi nanceanddependence whi chi sassoci at edwi t hi nf er i oreconomi cst at us. Fr eedom f r om ser v i t ude:Fr eedom i sabi l i t yofpeopl et odet er mi net hei rdest i ny .I t i nv ol v esanexpandedr angeofchoi cesf orsoci et i esandt hei rmember st oget herwi t ha mi ni mi zat i onofext er nalconst r ai nt si nt hepur sui tofdev ol v ement .Nomani sf r eei f 90 s/ hecannotchoose; i fs/ hei si mpr i sonedbyl i v i ngont hemar gi nofsubsi st encewi t hno educat i onandnoski l l s. Economi cpr osper i t yexpandst her angeofchoi cest hatpeopl emayhav e.I tenabl est o gai ngr eat ercont r olov ernat ur eandphy si calenv i r onment .I tgi v est hef r eedom t o choosegr eat erl ei sur e,t o hav emor egoodsandser v i cesordenymat er i alwant s. Ther ef or e,dev el opmenti s har dl ypossi bl e wi t houtgr owt h,butgr owt hi s possi bl e wi t houtdev el opment .Di f f er entmet hods ofmeasur i ng dev el opmentand maki ng i nt er nat i onal compar i sonshav esof arbeendev i sed.Amongt hese: 1. 1. Conv ent i onalMeasur esofDev el opment : The domi nantconv ent i onalmeasur es ofgr owt h and dev el opmentar et he Gr oss Nat i onalPr oduct( GNP)orGr ossDomest i cPr oduct( GDP)andt hei rcor r espondi ngper capi t alv al ues.GNPi scal cul at edast het ot aldomest i candf or ei gnv al ueaddedcl ai med byacount r y ’ sr esi dent swi t houtmaki ngdeduct i onsf ordepr eci at i onoft hedomest i c capi t al st ock. 1. 2. Al t er nat i v edev el opmenti ndi cat or s: Asi def r om t heaf or ement i oneddef i ci enci esencount er edi nmeasur i ngi ncomei t sel f , t hi ssear chhasbeenpr ompt edbyt hef ol l owi ngconsi der at i ons: i . Thef ai l ur eoft heGNP/ GDPmeasur est or ef l ectt hei mpactofgr owt hont he pat t er nofi ncomedi st r i but i on i i . Thei nabi l i t yoft heGNP/ GDPmeasur est or ef l ectt hewel f ar ei mpactoft hegoods andser v i cespr oducedaswel last hel i kel ycost st osoci et yofcer t ai npat t er nsof gr owt h. i i i . Thei nv al i di t yoft heGNP/ GDPi ndi cat orasameasur eofwel lbei ngi nsi t uat i ons wher egr owt hhasact ual l ydeepenedpov er t yandi ncomei nequal i t i es,i ncr eased unempl oy mentandaf f ect edt heenv i r onmentadv er sel y . Ther ef or e, t hemosti mpor t antf act ori nf l uenci ngt hesear chf oral t er nat i v ei ndi ct or shas beent hemar kedshi f ti nt hi nki ngamongdev el opmenteconomi st s,or gani zat i onsand pr act i t i oner ssi ncet hebegi nni ngoft he1970saboutt hemeani ngofdev el opmentand t hepr ocessesl eadi ngt oi t .Amongt hedev el opedal t er nat i v ei ndi cat or st hemaj orar e t he phy si calqual i t yofl i f ei ndex ( PQLI )dev el oped byMor r i s( 1979) ,t he Human 91 Dev el opmentI ndex( HDI )dev el opedbyUNDP, andt heHumanPov er t yI ndex.Thesear e t obedi scussedonebyonebel ow: PQLI=Li f eexpec.i ndex+i nf antmor t .i ndex+l i t er acyi ndex 3 ThePQLIi ndi r ect l yr ef l ect st heef f ect sonhumandev el opmentofi nv est menti nheal t h ser v i ce,wat erandsewagesy st ems,qual i t yoff oodandnut r i t i on,educat i on,housi ng, andchangesi ni ncomedi st r i but i on.Oneposi t i v easpectoft hePQLIi s, t her ef or e, t hati t hel pedr edi r ect i ngat t ent i onawayf r om gr owt h,t owar dabr oaderconceptofhuman dev el opment . Howev er ,t hePQLIhasbeencr i t i ci zedasani ndi cat orofsoci aldev el opmenti nr el at i on t o bot ht he choi ce ofi ndi cat or saswel last he wei ghtassi gned t ot he di f f er ent i ndi cat or s. I ti shandi cappedbyt hel i mi t eddat aav ai l abi l i t y I tgi v esdi spr opor t i onat ewei ghtt ol ongev i t yast wooft het hr eei ndi cat or s, i nf antmor t al i t yandl i f eexpect ancyar er el at edt oi t . I tgi v esequal wei ghtt oeachi ndi cat orar bi t r ar i l ywi t houtobv i ousr at i onal e I tt r eat seconomi candsoci al i ndi ct or ssepar at el y , i nst eadofcombi ni ngt hem i nacomposi t ei ndex . HDIi sr anki ngv ar i ouscount r i esaccor di ngt ot her el at i v esuccesst heyhav ehadwi t h t hehumandev el opmentoft hei rpopul at i on.UNDPi sof f er i ngt heHDIasanal t er nat i v e t ot heGNPf ormeasur i ngt her el at i v esoci oeconomi cpr ogr essofnat i ons.HDIhas al soat t empt edt ot akeaccountofsomeoft hel i mi t at i onsoft hePQLI .HDIi sbasedon t hr eev ar i abl es: l ongev i t y : -asmeasur edbyl i f eexpect ancyatbi r t h educat i onalat t ai nment : -asmeasur edbyacondi t i onofadul tl i t er acy( t wo t hi r d wei ght )and a combi ned pr i mar y ,secondar y ,and t er t i ar y school enr ol l mentr at i os( onet hi r dwei ght ) St andar dofl i v i ngmeasur edbyr ealpercapi t ai ncomeatPPP.Themar gi nal v al ueofmoneyi ncomeabov et hewor l dav er aget hr eshol dof$5120r eal GDP percapi t ai sassumedt ober api dl ydi mi ni shi ng Foranycomponentoft heHDI , t hei ndi v i duali ndi cescanbecomput edaccor di ngt ot he 92 gener al f or mul aof : I ndex=Act ual v al ue–Mi ni mum v al ue Maxi mum v al ue–Mi ni mum v al ue Li f eExpect ancyI ndex= Educat i onI ndex= Adul tLi t er acyI ndex( ALI )= Gr ossEnr ol mentI ndex( GEI )= GDPI ndex= Wher e:LE: Li f eexpect ance CGER: Combi nedgr ossenr ol mentr at i o ALR: Adul tl i t er acyr at e GDPpc: GDPpercapi t aatPPPi nUSD Thei ndext husr angesf r om 0t o1.I ft heact ualv al uei sequalt omaxi mum t hei ndexi s one.TheHDIr ankscount r i esi nt ot hr eegr oups:l owhumandev el opment( 0. 0t o0. 49) , medi um humandev el opment( 0. 50t o0. 79)andhi ghhumandev el opment( 0. 80t o1. 00) . Foranygi v eny ear , HDImeasur esr el at i v enotabsol ut el ev elofhumandev el opmentand t hati t sf ocusi sont heendsofdev el opment( l ongev i t y ,educat i onalachi ev ementand st andar dofl i v i ng) . TheUni t edNat i onshasconst r uct edhumanpov er t yi ndi cesf ordev el opi ngcount r i es. The composi t e measur ef ocuses on di mensi ons of depr i v at i ons.The HPIf or dev el opi ngcount r i esi sbasedont hr eemai ni ndi ces: Theper cent ageoft hepopul at i onnotexpect edt osur v i v et ot heageof40( P1) Theadul ti l l i t er acyr at e( P2) Adepr i v at i oni ndexbasedonanav er ageoft hr eev ar i abl es:t heper cent ageoft he popul at i onwi t houtaccesst o saf ewat er ;t heper cent ageofpopul at i onwi t hout accesst oheal t hser v i ce;andt heper cent ageoft heunder wei ghtchi l dr enunderf i v e y ear sol d( P3) .Thef or mul ai sgi v enby : HPI=[ 1/ 3( P13+P23+P33) ]1/3 93 Quest i on1. 1.Whyi sast r i ct l yeconomi cdef i ni t i onofdev el opmenti nadequat e?Use empi r i calev i dences as exampl es ofcount r i es dev el opi ng economi cal l y butar e under dev el oped. Chapt ert wo St r uct ur alf eat ur esandcommonchar act er i st i csofdev el opi ngcount r i es Thi schapt erpor t r ay st hest r uct ur al di v er si t yofdev el opi ngnat i ons.Wi t ht hi si nt ent i on wewi l l makeanexami nat i onofei ghtcr i t i cal component s.Thesear e: Thesi zeoft hecount r y( geogr aphi car ea, si zeofpopul at i on, andi ncomel ev el s) Ev i dent l y , economi cpot ent i alofacount r yi ssi gni f i cant l ydet er mi nedbyi t sphy si caland popul at i onsi ze,andi t sl ev elofnat i onali ncomepercapi t a. Thesear eal somaj or f act or sdi f f er ent i at i ngonedev el opi ngcount r yf r om anot her .Thi ssi zepr ov i desbot h adv ant agesanddi sadv ant ages. Lar gesi zeusual l ypr esent sadv ant agesofdi v er se r esour ce endowment ,l ar ge pot ent i almar ket s,and l esserdependence on f or ei gn sour cesofmat er i al sandpr oduct s. Buti tal socr eat espr obl emsofadmi ni st r at i v e cont r ol , nat i onal cohesi on, andr egi onal i mbal ances. Howev er , i ti st obebor nt hatt her ei snonecessar yr el at i onshi pamongacount r y ’ ssi ze, i t sl ev elofpercapi t ai ncome, andt hedegr eeofequal i t yori nequal i t yi nt hedi st r i but i on oft hati ncome.Forexampl e,ascompar edt oEt hi opi a,t henei ghbor i ngcount r y ,Keny a i ssmal l eri ngeogr aphi candpopul at i onsi ze. ButKeny ahasabout3t i mest heper capi t ai ncomeofEt hi opi aatof f i ci alexchanger at e.ButKeny ahasal sol esserpercapi t a i ncomet hanBr azi l andsomeot herl ar gerdev el opi ngcount r i es. I t shi st or i calandeconomi calbackgr ound Theot hersour cesofdi v er si t yamongt hedev el opi ngcount r i esar et hei rt r adi t i onaland col oni alher i t ages.Appar ent l y ,count r i eshav et hei rowndi f f er entcul t ur albackgr ound accumul at ed i nt hei rhi st or ymaki ng t hem t o hav e di f f er entsoci aland economi c i nst i t ut i ons.Mor eov er ,dev el opi ng nat i ons wer e atone t i me orot hercol oni es of West er nEur opeancount r i es.TheEur opeancol oni alpower shadadr amat i candl ongl ast i ngi mpactont heeconomi es,pol i t i calandi nst i t ut i onalst r uct ur esoft hei rAf r i can and Asi an col oni es. The economi cst r uct ur esoft hese nat i ons,aswel last hei r 94 educat i onalandsoci ali nst i t ut i onshav et y pi cal l ybeenmodel edont hoseoft hei rf or mer economi cr ul er s. Hence,t he di v er si t yi n col oni alher i t age t oget her wi t ht he i ndi genous cul t ur al di f f er enceshav er esul t eddi f f er entst r uct ur al pr obl emsi nt hesecount r i es.Dependi ngon t hei rcol oni alher i t aget her ef or et hecount r i esar er equi r edt ot akedi f f er entmeasur es. Count r i esl i ket hosei nAf r i cat hatonl yr ecent l ygai nedt hei ri ndependencear el i kel yt o bemor econcer nedwi t hconsol i dat i ngandev ol v i ngt hei rownnat i onaleconomi cand pol i t i cal st r uct ur est hanwi t hsi mpl ypr omot i ngr api deconomi cdev el opment . Thei rpol i ci esmayconsequent l y ,r ef l ectagr eat eri nt er esti nt hesei mmedi at epol i t i cal i ssues.Lat i nAmer i cancount r i eshav eal ongerhi st or yofpol i t i cali ndependencepl usa mor eshar edcol oni alher i t age. Ther ef or e,i nspi t eofgeogr aphi canddemogr aphi c di v er si t yt he count r i es possess r el at i v el y si mi l areconomi c,soci al ,and cul t ur al i nst i t ut i onsandf acesi mi l arpr obl ems. I nAsi a,ont heot herhand,di f f er entcol oni al her i t agesandt hedi v er secul t ur alt r adi t i onsoft hei ndi genouspeopl eshav ecombi ned t ocr eat edi f f er enti nst i t ut i onal andsoci al pat t er ns. I tendowment sofphysi calandunmanr esour ces Endowment sofphy si calandhumanr esour cesar eot hersour cesofdi spar i t i esi n economi cgr owt hpot ent i aloft hecount i es.I fwest ar twi t ht hephy si calr esour ce endowment s,ont heonehandt her ear ecount r i eswhi char eext r emel yandf av or abl y endowedi nr esour cessuchasmi ner al s,r aw mat er i al s,andf er t i l el and.Ont heot her hand,t her ear eal sopoor l yendowednat i onswher eendowment sofr awmat er i al sand mi ner al sandev enf er t i l el andar er el at i v el ymi ni mal . Mor eov er ,geogr aphyandcl i mat ecanal sopl ayani mpor t antr ol ei nt hesuccessor f ai l ur e ofdev el opmentef f or t s. Ot hert hi ngs bei ng equal ,i ti s sai dt hati sl and economi esseem t odobet t ert hanl andl ockedeconomi es.Wi t hr espectt ocl i mat eal so t emper at ezonecount r i esdobet t ert hant r opi calzonenat i ons.Dev el opi ngcount r i es ar eal sodi st i ngui shedonef r om t heot heri nt hei rhumanr esour ceendowment s.The humanr esour ceendowment si ncl udesnotonl yt henumberofpeopl eandt hei rski l l l ev el sbutsoal sot hei rcul t ur alout l ooks,at t i t udest owar dwor k,accesst oi nf or mat i on, wi l l i ngnesst oi nnov at e, anddesi r ef orsel f i mpr ov ement . I t set hni candr el i gi ouscomposi t i on 95 Et hni ci t yandr el i gi onof t enpl ayamaj orr ol ei nt hesuccessorf ai l ur eofdev el opment ef f or t s.Ev i dent l y ,t hegr eat ert heet hni candr el i gi ousdi v er si t yofacount r yt hemor e l i kel yi ti st hatt her e wi l lbe i nt er nalst r i f e and pol i t i cali nst abi l i t y .Ther ei s al so di st i nct i oni net hni candr el i gi ouscomposi t i onamongnat i ons. Pr esent l ymor et han40%oft hewor l d’ snat i onshav emor et hanf i v esi gni f i cantet hni c popul at i ons.I nmostcases,oneormor eoft hesegr oupsf aceser i ouspr obl emsof di scr i mi nat i on. Ov erhal foft he wor l d’ sl ess dev el oped count r i es hav er ecent l y exper i encedsomef or m ofi nt er et hni cconf l i ct .Justi nt hef i r sthal foft he1990s, et hni c andr el i gi ousconf l i ct sl eadi ngt owi despr eaddeat handdi st i nct i ont ookpl acei nmany Af r i cancount r i esandsomecount r i esofot herr egi ons. Butnei t herov er tphy si calconf l i ctnorwi despr eadv i ol encei snecessar yt odi sr uptan economyorcausepol i t i cali nst abi l i t y .I fdev el opmenti sabouti mpr ov i nghumanl i v es andpr ov i di ngawi deni ngr angeofchoi cet oal lpeopl es,r aci al ,et hni c,orr el i gi ous di scr i mi nat i onscanbeequal l ydest r uct i v e.Forexampl et hr oughoutLat i nAmer i ca, i ndi genouspopul at i onshav esi gni f i cant l yl aggedbehi ndot hergr oupsonal mostev er y measur eofeconomi candsoci alpr ogr ess.I nt hesecount r i es,bei ngi ndi genousmakes i tmuchmor el i kel yt hatani ndi v i dualwi l lbel esseducat ed,i npoor erheal t h,andi na l owersoci o economi c st r uct ur et han ot herci t i zens. Thi si s par t i cul ar l yt r ue f or i ndi genouswomen.Et hni candr el i gi ousdi v er si t yneednot , howev er , necessar i l yl eadt o i nequal i t y , t ur moi l , ori nst abi l i t y . Ther el at i v ei mpor t anceofi t spubl i candpr i v at esect or Mostdev el opi ngcount r i eshav emi xedeconomi csy st ems,f eat ur i ngbot hpubl i cand pr i v at eowner shi panduseofr esour ces.Thedi v i si onbet weent het woandt hei rr el at i v e i mpor t ancear emost l ydet er mi nedbyt hehi st or i calandpol i t i calci r cumst ancesoft he count r i es.Thus,i ngener al ,Lat i nAmer i canandSout hEastAsi annat i onshav el ar ger pr i v at esect or st hanSout hAsi aandAf r i cannat i ons. Thedegr eeoff or ei gnowner shi pont hepr i v at esect ori sanot heri mpor t antv ar i abl et o consi derwhendi f f er ent i at i ngamongl essdev el opedcount r i es.Al ar gef or ei gnowned pr i v at esect orusual l ycr eat eseconomi candpol i t i caloppor t uni t i esaswel laspr obl ems notf oundi ncount r i eswher ef or ei gni nv est or sar el esspr ev al ent . Economi cpol i ci es, suchast hosedesi gnedt opr omot emor eempl oy ment , wi l lnat ur al l y bedi f f er entf orcount r i eswi t hl ar gepubl i csect or sandoneswi t hsi zeabl epr i v at e sect or s.Di r ectgov er nmenti nv est mentpr oj ect sandl ar ger ur al wor kpr ogr amsmayt ake 96 pr ecedencei neconomi esdomi nat edbyt hepubl i csect or s. I nt hepr i v at eor i ent ed economi es, howev er , speci alt axal l owancesdesi gnedt oi nducepr i v at ebusi nessest hat canempl oymor ewor ker smi ghtbemor ecommon.Ther ef or e, al t hought hepr obl em t o besol v edmaybesi mi l ar , t hesol ut i oncandi f f eri ncount r i eswi t hsi gni f i cantdi f f er ences i nt her el at i v ei mpor t anceoft hepubl i candpr i v at esect or s. Thenat ur eofi t si ndust r i al st r uct ur e Dev el opi ng count r i es ar e pr edomi nant l yagr ar i an i n economi c,soci al ,and cul t ur al out l ook.Labourf or ce i n mostoft hese count r i es i s ov er whel mi ngl y engaged i n agr i cul t ur e.Theagr i cul t ur alsect orcont r i but essi gni f i cant l yal sot ot heGDPofmanyof t hepoornat i ons.Far mi ngi snotmer el yanoccupat i onbutawayofl i f ef ormostpeopl e i nAsi a,Af r i ca,andLat i nAmer i ca. Nev er t hel ess,t her ear egr eatdi f f er encesbet ween t hest r uct ur eofagr ar i ansy st emsandpat t er nsofl andowner shi pi nLat i nAmer i caand Af r i ca.Asi aagr ar i ansy st emsar esl i ght l ycl osert ot hoseofLat i nAmer i cai nt er msof pat t er nsofl andowner shi p.Butev ent hent hesi mi l ar i t i esar el essenedbysubst ant i alby cul t ur al di f f er ences. I ti si nt her el at i v ei mpor t anceofbot ht hemanuf act ur i ngandser v i cesect or st hatwe f i ndt hewi destv ar i at i onamongdev el opi ngnat i ons. MostLat i nAmer i cancount r i es possessmor eadv ancedi ndust r i alsect or s.Buti nt he1970sand1980scount r i esl i ke Tai wan, Sout hKor ea, andSi ngapor ear er api dl ybecomi ngi ndust r i al i zedst at es. I t sdegr eeofdependenceonext er nal economi candpol i t i calf or ces Thedegr eet owhi chacount r yi sdependentonf or ei gneconomi c,soci al ,andpol i t i cal f or cesi sr el at edt oi t ssi ze,r esour cesendowment ,andpol i t i calhi st or y . Formost dev el opi ngcount r i es, t hi sdependencei ssubst ant i al .I nsomecases, i tt ouchesal most ev er yf acetofl i f e. Mostsmal lnat i onsar ehi ghl ydependentonf or ei gnt r adewi t ht he dev el opedwor l d.Al mostal lsmal lnat i onsar edependentont hei mpor t at i onoff or ei gn and of t en i nappr opr i at et echnol ogi es of pr oduct i on.Thi sf actal one exer t s an ext r aor di nar yi nf l uenceont hechar act eroft hegr owt hpr ocessi nt hesedependent nat i ons. Acount r y ’ sabi l i t yt ochar ti t sowneconomi candsoci aldest i nyi ssi gni f i cant l yaf f ect ed byi t sdegr eeofdependenceont heseandot herext er nal f or ces Thedi st r i but i onofpowerandt hei nst i t ut i onal andpol i t i calst r uct ur ewi t hi nt henat i on. I nt hef i nalanal y si s,i ti sof t ennott hecor r ect nessofeconomi cpol i ci esal onet hat det er mi nest heout comeofnat i onalappr oachest ocr i t i caldev el opmentpr obl ems.The 97 pol i t i calst r uct ur eandt hev est edi nt er est sandal l egi ancesofr ul i ngel i t es( e. g. ,l ar ge l andowner s,ur bani ndust r i al i st s,banker s,f or ei gnmanuf act ur er s,t hemi l i t ar y ,andt r ade uni oni st s)wi l lt y pi cal l ydet er mi newhatst r at egi esar epossi bl eandwher et hemai n bar r i er st oef f ect i v eeconomi candsoci al changemayl i e. Theconcent r at i onofi nt er est sandpoweramongdi f f er entsegment soft hepopul at i ons ofmostdev el opi ngcount r i esi si t sel ft her esul toft hei reconomi c,soci al ,andpol i t i cal hi st or i esandi sl i kel yt odi f f erf r om onecount r yt ot henext .Nev er t hel ess, what ev ert he speci f i cdi st r i but i on ofpoweramong t hemi l i t ar y ,t hei ndust r i al i st s,and t hel ar ge l andowner sofLat i nAmer i ca; t hepol i t i ci ansandhi ghl ev elci v i lser v ant si nAf r i ca; t heoi l Shei ksandf i nanci almogul soft heMi ddl eEast ;ort hel andl or ds,moneyl ender s,and weal t hyi ndust r i al i st sofAsi a–mostdev el opi ngcount r i esar er ul eddi r ect l yori ndi r ect l y bysmal l andpower f ul el i t est oagr eat erext entt hant hedev el opednat i onsar e. Ef f ect i v esoci alandeconomi cchangest husr equi r eei t hert hatt hesuppor tofel i t e gr oupsbeenl i st edort hatt hepoweroft heel i t ebeof f setbymor epower f uldemocr at i c f or ces.Ei t herwayeconomi candsoci aldev el opmentwi l lof t enbei mpossi bl ewi t hout cor r espondi ngchangesi nt hesoci al ,pol i t i cal ,andeconomi ci nst i t ut i onsofanat i on. Suchi nst i t ut i onalchangesmayi ncl ude:l andt enur esy st ems,f or msofgov er nance, educat i onalst r uct ur es,l abourmar ketr el at i onshi ps,pr oper t yr i ght s,t hedi st r i but i onand cont r olofphy si calf i nanci alasset ,l awsoft ax at i onandi nher i t anceandpr ov i si onof cr edi t . CommonChar act er i st i csofDevel opi ngCount r i es Thef or egoi ngdi scussi onshav edemonst r at edwhyi ti ssomet i mesr i skyt ogener al i ze t oo much aboutsuch a di v er se setofnat i ons.Nev er t hel ess common economi c f eat ur esofdev el opi ngcount r i esper mi tust ov i ewt hem i nabr oadl ysi mi l arf r amewor k. Thi ssect i onpor t r ay sv ar i ousdi mensi onsoft hedev el opmentgapbet weenr i chand poorcount r i esandsi mi l ar i t i esofpoornat i ons.Thesei ncl udel ev elandgr owt hr at eof i ncome,unempl oy mentand under empl oy ment ,popul at i on gr owt hr at e,economi c st r uct ur e, pol i t i cal andi nst i t ut i onal f act or s, anddegr eeofdependence.Forconv eni ence, wecancl assi f yt hesecommonchar act er i st i csi nt osev enbr oadcat egor i es. Lowl ev el sofl i v i ng, char act er i zedbyl owi ncome, i nequal i t y , poorheal t h, andi nadequat e educat i on I ndev el opi ngnat i ons, gener all ev el sofl i v i ngt endt obev er yl owf ort hev astmaj or i t yof 98 peopl e.Thi si st r uenotonl yi nr el at i ont ot hei rcount er par t si nr i chnat i onsbutof t en al soi nr el at i ont osmal lel i t egr oupswi t hi nt hei rownsoci et i es.Thesel ow l ev el sof l i v i ngar emani f est edquant i t at i v el yandqual i t at i v el yi nt hef or m ofl owi ncome( pov er t y ) , i nadequat ehousi ng,poorheal t h,l i mi t edornoeducat i on,hi ghi nf antmor t al i t y ,l owl i f e andwor kexpect anci es, andi nmanycaseagener al senseofmal ai seandhopel essness. PerCapi t aNat i onalI ncome:Asy ouhav eseeni ti nchapt erone,t heGNPpercapi t ai s of t enusedassummar yi ndexoft her el at i v eeconomi cwel l bei ngofpeopl ei ndi f f er ent nat i ons.Onecommondi st i ngui shi ngf eat ur eofdev el opi ngcount r i esascompar edt o dev el opednat i onsi st heext r emel yl ow l ev elofi ncome.Thedi f f er encei ni ncome bet ween r i ch and poornat i ons wi l lbe appar entwhen one t akes accountoft he di st r i but i onofwor l dpopul at i on.I nt heset er ms,t hi smeanst hatal most80% oft he wor l d’ si ncomei spr oducedi nt heeconomi cal l ydev el opedr egi onsby20%oft hewor l d’ s peopl e.Thust her emai ni ngf our f i f t hsoft hewor l d’ spopul at i oni spr oduci ngonl yonef i f t hoft ot al wor l dout put . Gr owt hRat esofI ncome:Manydev el opi ngcount r i esnotonl yhav emuchl owerl ev el sof percapi t ai ncomebutal sohav eexper i encesl owerGNPgr owt ht hant hedev el oped nat i ons Di st r i but i on ofNat i onalI ncome:t he gr owi ng gap i n percapi t ai ncomes bet weenr i chandpoornat i onsi snott heonl ymani f est at i onoft hewi deni ngeconomi c di spar i t ybet weent hewor l d' sr i chandpoor .Toappr eci at et hebr eadt handdept hof Thi r dWor l dpov er t y ,i ti sal sonecessar yt ol ookatt hegr owi nggapbet weenr i chand poorwi t hi ni ndi v i dualLDCs.Al lnat i onsoft hewor l dshow somedegr eeofi ncome i nequal i t y .Ther ear el ar gedi spar i t i esbet weent hei ncomeoft her i chandoft hepoori n bot hdev el opedandunder dev el opedcount r i es.Nev er t hel ess,t hegapbet weenr i chand poori sgener al l ygr eat eri nl essdev el opednat i onst hani ndev el opednat i ons. Ext entofPov er t y :Themagni t udeandext entofpov er t yi nanycount r ydependont wo f act or s:t he av er age l ev elofnat i onali ncome and t he degr ee ofi nequal i t yi ni t s di st r i but i on.Buthowi sonet omeasur epov er t yi nanymeani ngf ul quant i t at i v esense? Heal t h:i naddi t i ont ost r uggl i ngonl owi ncome, manypeopl ei ndev el opi ngnat i onsf i ght aconst antbat t l eagai nstmal nut r i t i on, di sease, andi l l heal t h. I nt he mi d1970s,mor et han 1 bi l ¬l i on peopl e,al mosthal ft hepopul at i on oft he dev el opi ngwor l d( excl udi ngChi na) ,wer el i v i ngondi et sdef i ci enti nessent i alcal or i es. Onet hi r doft hem wer echi l dr enunder2y ear sofage.I nbot hAsi aandAf r i ca, ov er60% 99 oft hepopul at i onbar el ymetmi ni mum cal or i cr equi r ement snecessar yt omai nt ai n adequat eheal t h.Tomakemat t er swor se,number sofdoct or s,medi calf aci l i t i esar e concent r at edi nur banar easwher eonl y25% oft hepopul at i onr esi des;t hewoef ul l y i nadequat epr ov i si onofheal t hcar et ot hemassesofpoorpeopl ebecomesst r i ki ngl y cl ear .Mostpr obabl yt hesev i ct i ms66%oft hem wer er esi di ngi nAf r i cawhi l eAsi aand Lat i nAmer i cahad21%and4. 3%r espect i v el y . Educat i on:t hespr eadofeducat i onaloppor t uni t i esi st hef i nali ndi cat oroft hev er yl ow l ev el sofl i v i ngt hati sper v asi v ei ndev el op¬i ngnat i ons.Theat t emptt opr o¬v i depr i mar y schooleducat i onaloppor t uni t i eshaspr obabl ybeent hemostsi gni f ¬i cantofal lLDC dev el opmentef f or t s.I n mostcount r i es,educat i on t akes si gni f i cantshar e oft he gov er nment s’ budget . Yeti nspi t eofsomei mpr essi v equant i t a¬t i v eadv ancesi nschoolenr ol l ment s,l i t er acy l ev el sr emai nst r i ki ngl yl owcom¬par edwi t ht hedev el opednat i ons.Forexampl e, among t hel eastdev el opedcoun¬t r i es, l i t er acyr at esav er ageonl y45%oft hepopul at i on. Lowl evelofpr oduct i vi t y I naddi t i ont ol owl ev elofl i v i ng,LDCsar echar act er i zedbyr el at i v el yl owl ev elofl abor pr oduct i v i t y .Si ncepr oduct i onf unct i ondescr i best hewayi nwhi chsoci et i esgoabout pr ov i di ngf ort hei rmat er i alneeds.Thr oughoutt hedev el opi ngwor l d,l ev el sofl abor pr oduct i v i t yar eext r emel yl owcompar edwi t ht hosei ndev el opedcount r i es.Thi scanbe expl ai nedbypr i nci pl eofdi mi ni shi ngmar gi nalpr oduct i v i t yt hati fi ncr easi ngamount sof av ar i abl ef act or( l abor )ar eappl i edt of i xedamount sofot herf act or s( e. g. , capi t al , l and, mat er i al s) , t heext r aormar gi nalpr oductoft hev ar i abl ef act ordecl i nesbey ondacer t ai n number . Low l ev el sofl aborpr oduct i v i t ycant her ef or ebeexpl ai nedbyt heabsenceorsev er e l ack of" compl ement ar y "f ac¬t ori nput s such as phy si calcapi t alorexper i enced management .Tor ai sepr oduct i v i t y ,accor di ngt ot hi sar gument ,domest i csav i ngsand f or ei gnf i nancemustbemobi l i zed.Thi si st ogener at enew i nv est menti nphy si cal capi t algoodsandbui l dupt hest ockofhumancapi t al( e. g. ,manager i alski l l s)t hr ough i nv est ¬menti neducat i onandt r ai ni ng. Popul at i onGr owt handDependencyBur dens 100 St at i st i csondemogr aphi cev ol ut i onbycount r yshowt hatt hepr esentr hy t hm ofgl obal popul at i ongr owt hi sl ar gel yt her esul toft heaccel er at i onofgr owt hi nt hedev el opi ng r egi ons.The cr ude bi r t hr at ei s pr obabl y one of t he mostef f i ¬ci entway s of di st i ngui shi ngt hel essdev el opedf r om t hedev el opedcount r i es.Deat hr at es( t hey ear l y numberofdeat hsper1, 000popul at i ons)i nThi r dWor l dcount r i esar eal sohi ghr el at i v e t ot hedev el opednat i ons. Howev er ,t hesepoornat i onshav ebenef i t edf r om t hepr ogr essofmedi ci nef ort he massesandt hecampai gnsagai nstendemi cdi sease.Thi swasf ol l owedbyf al li n mor t al i t y .Hence,t hedi f f er encesi ndeat hr at ebet weendev el opi ng and dev el oped count r i esar esubst ant i al l ysmal l ert hant hecor r espondi ngdi f f er encesi nbi r t hr at es. Thusi nmostdev el opi ngcount r i es,t heact i v el aborf or cehast osuppor tpr opor t i onal l y al mostt wi ceasmanychi l dr enasi tdoesi nr i chercount r i es. Wemayconcl ude,t her ef or e,t hatnotonl yar eThi r dWor l dcount r i eschar act er ¬i zedby hi gherr at esofpopul at i ongr owt h, butt heymustal socont endwi t hgr eat erdependency bur denst hanr i chnat i ons. Hi ghUnempl oymentandUnder empl oyment Oneoft hepr i nci palmani f est at i onsofandcont r i but or st ot hel ow l ev el sofl i v i ngi n dev el opi ngnat i onsi st hei rr el at i v el yi nadequat eori nef f i ci entut i l i zat i onofl abori n compar i sonwi t ht hedev el opednat i ons.Unempl oy menti ncr easedasar esul toft hef act t hatempl oy menthasbeengr owi ngdur i ngt hepastatar at ewhi chi smuchsl owert han t her at eofgr owt hoft hel abourf or ce;st agnat i ngeconomi cgr owt handal sohi ghr ur al t our banmi gr at i on.Theunempl oy edexhi bi tt woi mpor t antchar act er i st i cs,namel yt hei r y out hf ul nessandt hei rhi ghl ev elofeducat i on.Andal socr eepi ngupt heeducat i on l adder Subst ant i alDependenceonAgr i cul t ur alPr oduct i onandPr i mar yPr oductExpor t s Thev astmaj or i t i esofpeopl ei nLDCsl i v eandwor ki nr ur alar eas.Ov er65%ar er ur al l y based,compar edt ol esst han27%i neconomi cal l ydev el opedcount r i es.Si mi l ar l y ,58% oft hel aborf or cei sengagedi nagr i cul t ur e,compar edt oonl y5%i ndev el opednat i ons. Agr i cul t ur econt r i but esabout14%oft heGNPofdev el opi ngnat i onsbutonl y3%oft he GNPofdev el opednat i ons. Ther ei s st r i ki ng di f f er ence bet ween t he pr opor t i onat e si ze of t he agr i cul t ur al 101 pop¬ul at i oni nAf r i ca,whi chconst i t ut es( 68%)andSout hAsi a( 64%)v er susNor t h Amer i ca( 3%) .Butt heav er agepr oduct i v i t yofagr i cul t ur all abori sal most35t i mes gr eat eri nNor t hAmer i cat hani nAsi aandAf r i cacombi ned.Agr i cul t ur alpr oduct i v i t yi s l ow notonl ybecauseoft hel ar genumber sofpeopl ei nr el at i ont oav ai l abl el andbut al sobecauseLDC agr i cul t ur ei sof t enchar act er i zedbypr i mi t i v et echnol ogi es,poor or gani zat i on, andl i mi t edphy si cal andhumancapi t al i nput s. Mosteconomi esofl essdev el opedcount r i esar eor i ent edt owar dt hepr oduct i onof pr i mar ypr oduct s.Thesepr i mar ycommodi t i esf or mt hei rmai nexpor t s.Andal somost poorcount r i esneedt oobt ai nf or ei gnexchangei naddi t i ont odomest i csav i ngsi nor der t of i nancepr i or i t ydev el op¬mentpr oj ect s. I mper f ectMar ket sandI ncompl et eI nf or mat i on St ar t i ng f r om t he 1980s al mostev er y dev el opi ng count r yi s mov i ng t owar dt he est abl i shmentofamar keteconomyf ormanyr easons.Ther eseemedt obeagr owi ng consensust hatt her ehadbeent oomuchgov er nmenti nt er v ent i oni nt hewor ki ngsof Thi r dWor l deconomi es.Thi sgov er nmenti nt er v ent i oni ssi ght edbymanyast hemaj or cause oft he pr obl ems i nt he poornat i ons.Hence,f r ee mar ketand unf et t er ed compet i t i onar econsi der edast hekeyt or api deconomi cgr owt h. Domi nance, Dependence, andVul ner abi l i t yi nI nt er nat i onalRel at i ons FormanyLDCs, af i nalsi gni f i cantf act orcont r i but i ngt ot heper si st enceofl owl ev el sof l i v i ng,r i si ng unempl oy ment ,and gr owi ng i ncome i nequal i t yi st he hi ghl yunequal di st r i but i onofeconomi candpol i t i calpowerbet weenr i chandpoornat i ons.These unequalst r engt hsar emani f est ed economi cal l yand noneconomi caspect soft he r el at i onshi p.Economi cal l yt hedomi nantpower sofr i chnat i onscont r olt hepat t er nof i nt er nat i onalt r ade.Theyhav eal sot heabi l i t yt odi ct at et het er mswher ebyt echnol ogy , f or ei gnai d, andpr i v at ecapi t al ar et r ansf er r edt odev el opi ngcoun¬t r i es. Fi nal l y ,t hepenet r at i onofr i chcount r yat t i t udes,v al ues,andst andar dsal socont r i but es t oapr obl em wi del yr ecogni zedandr ef er r edt oast hei nt er nat i onal br ai ndr ai n( mi gr at i on ofpr of essi onal andski l l edper sonnel ) . Quest i on2. 1.Di scusst hechar act er i st i csofEt hi opi at hatmakei tt obecat egor i zed asoneoft hedevel opi ngcount r i esbyt aki ngact ualf i gur eswhenappr opr i at e. 102 CHAPTERTHREE Gr owt hModel sandTheor i esofDev el opment I nt hepr evi ouschapt er ,wehavedi scussedt hedi mensi onsoft hepr obl emsof devel opi ng count r i es, whi ch may be cal l ed t hei r di ver si t i es and common char act er i st i cs.Gener al l y ,wehavet r i edt omakeanassessmentoft hef act or st hat maket hesecount r i est obecat egor i zedaspoorcount r i es.Wehaveal soassessed t hedi f f er encesamongt hem t hatshoul dbeobser vedi nf or mul at i ngdevel opment pol i ci esandst r at egi es. Now i ti st i me t ol ook atsome oft he avai l abl et ool s usef uli n expl ai ni ng devel opment pr obl ems and f or mul at i ng r el evant devel opment pol i ci es and st r at egi es.These hel pf uli nst r ument s ar et he gr owt h model s and devel opment t heor i es.Ther ear edi f f er entt heor i esexpl ai ni ngt hedi ver sedevel opmentpr obl ems ofcount r i esatdi f f er entsoci al ,economi c,pol i t i cal ,andi nst i t ut i onalci r cumst ances. Chapt erdi vi ded i nt wo maj orpar t st hese ar e gr owt h modeland devel opment t heor i es. Gr owt hModel s TheHar r odDomarGr owt hModel Thegr owt hmodelt hatwaspar t i cul ar l ypopul arwi t heconomi cpl anner sj ustaf t er Wor l dWarI Icamet obeknownast heHar r odDomarmodel ,si ncei twasbasedon i ndependent l ypubl i shedar t i cl esbyRoyHar r odandEvseyDomar .Thef actt hatt he t woaut hor si ndependent l ypr oducedi dent i calmodel swasnotsur pr i si ng. Thei r model s wer e si mpl e ext ensi ons of John May nar d Key nes’ s wel l known macr oeconomi c model ,whi ch domi nat ed economi ct hi nki ng i nt he 1940s.The Har r odDomarmodelmakessi mi l arassumpt i onst ot heKey nesi anmacr oeconomi c model : o Unl i mi t edamountofunempl oy edl abour ,out putcanbei ncr easedwi t hout t r i gger i ngpr i cei ncr eases. o Duet of i r stassumpt i onmar gi nalpr oductofcapi t al( capi t alout putr at i o) . o Duet o second assumpt i on out putgr owt hi sdi r ect l ypr opor t i onalt o new i nvest menti nnewcapi t al . 103 o Pr oduct i vei nvest menti sal way sequalt osavi ng. Har r odsmodeldy nami cext ensi onofkey nes'st at i cequi l i br i um anal y si s.Fi r st l yi n Key ens' Gener alTheor y ,t hecondi t i onf ori ncomeandout putt obei nequi l i br i um ( i n acl osedeconomy )i st hatpl anst oi nvestequal spl anst osave.Hence, Har r odasked i fchangesi ni ncomei nducei nvest ment ,whatmustbet her at eofgr owt hofi ncome f orpl anst oi nvestt oequalpl anst osavei nor dert oensur eamovi ngequi l i br i um i n agr owi ngeconomyt hr ought i me? Secondl y ,i nst at i cKey nesi ant heor y ,i fequi l i br i um bet weensav i ngandi nv est menti s di st ur bed,t he economycor r ect si t sel fand a new equi l i br i um i sachi ev ed v i at he mul t i pl i erpr ocess.Thent hesecondquest i oni si fgr owt hequi l i br i um i sdi st ur bed, wi l li t besel f cor r ect i ngorsel f aggr av at i ng?Andl ast l y ,wi l lt hi sequi l i br i um r at ebeequalt o t hemaxi mum r at eofgr owt ht hatt heeconomyi sabl et osust ai ngi v ent her at eof gr owt hofpr oduct i v ecapaci t y ?I fnotwhatwi l l happen? Toexpl ai nt hi scondi t i on, Har r oddi st i ngui shedt hr eedi f f er entgr owt hr at es.Thesear e Act ual gr owt hr at e( g)def i nedas G=s/ c1 Wher eass=t her at i oofsav i ngt oi ncome( S/ Y) , c=act uali nv est mentcapi t alout putr at i o, t hati st her at i oofext r acapi t al accumul at i onori nv est mentt ot hegr owt hofout put ( K/ Y=I / Y) g=s/ c=( S/ Y) /( I / Y) =( S/ Y)( Y/ I ) =Y/ Y( r at eofgr owt hofout put ) , gi v enS=I War r ant edgr owt hr at e( gw) :r at eofgr owt hwhi ch,i fi toccur s,wi l ll eav eal lpar t i es sat i sf i ed.Att hi sr at epr oducer shav epr oducednei t hermor enorl esst hant her i ght amount .I ti sdet er mi nedas:pl anst osav eatanyt i mear egi v enbyt heKey nesi an sav i ngf unct i on S=sY2 104 Thedemandf ori nv est menti sgi v enbyt heaccel er at i onpr i nci pl e.Thi si swher ecri st he accel er at orcoef f i ci entmeasur edast her equi r edamountofext r acapi t alori nv est ment t opr oduceauni tf l owofout putatagi v enr at eofi nt er est ,det er mi nedbyt echnol ogi cal condi t i on.Thus Cr=Kr / Y=I / Y I=Cr Y3 Forpl annedsav i ngst oequal pl annedi nv est mentt her ef or e, wehav e sY=Cr Y4 Andt her equi r edr at eofgr owt hf oramov i ngequi l i br i um t hr ought i mei s Y/ Y=s/ cr=gw5 Thi si st hewar r ant edr at eofgr owt hs( gw) .Fordy nami cequi l i br i um,out putmustgr ow att hi sr at e.Thecondi t i onf orequi l i br i um i st hat g=gw Fr om e5andel , t hi smeans gc=gwcr ( g/ gw=cr / c) Supposet her ei sdi sequi l i br i um g>gwt henc<cri mpl i esi nv est mentf al lbel owt hel ev el r equi r edt omeett hei ncr easei nout put .Ther ewi l lbeashor t ageofequi pment ,a depl et i onofst ocksandani ncent i v et oi nv estmor e.Theact ualgr owt hr at ewi l lt hen depar tev enf ur t herf r om t hewar r ant edr at e.Ther i v er st r uef orsur pl usofgoodsand i nv est mentwi l l bedi scour aged, causi ngt heact ual gr owt hr at et of al l ev enf ur t herbel ow t heequi l i br i um r at e.Thus, asHar r odpoi nt sout , i nt hedy nami cf i el dwehav eacondi t i on opposi t et ot hati nst at i cf i el d. Nat ur al gr owt hr at e( go) : der i v edf r om t hei dent i t y Fi nal l y ,t her ei snol i mi tt ohow muchgr owt hcanbehad!Al t hought heHar r odDomar modelwasi ni t i al l ycr eat edt ohel panal y zet hebusi nesscy cl e,i twasl at eradapt edt o expl ai neconomi cgr owt h.I t si mpl i cat i onswer et hatgr owt hdependsont hequant i t yof l aborandcapi t al ;mor ei nv est mentl eadst ocapi t alaccumul at i on,whi chgener at es 105 economi cgr owt h.Themodelal sohadi mpl i cat i onf orl esseconomi cal l ydev el oped count r i es;l abori si npl ent i f ulsuppl yi nt hesecount r i esbutphy si calcapi t ali snot , sl owi ngeconomi cpr ogr ess.LDCSdonothav esuf f i ci entav er agei ncomest oenabl e hi gh r at es ofsav i ng,and t her ef or e accumul at i on oft he capi t alst ock t hr ough i nv est menti sl ow. TheSol owModel TheSol ow modeli sbui l tar oundt woequat i ons,apr oduct i onf unct i onandacapi t al accumul at i onequat i on.Thepr oduct i onf unct i ondescr i beshowi nput sar ecombi nedt o pr oduceout put .Tosi mpl i f yt hemodel ,wegr oupt hesei nput si nt ot wocat egor i es, capi t al , K, andl abour , L, anddenot eout putasY.Thepr oduct i onf unct i oni sassumedt o hav et he CobbDougl asf or m andi sgi v enby Y=F( K, L)=KαL1-α…. …. . ( 1) wher eαi ssomenumberbet ween0and1.Not i cet hatt hi spr oduct i onf unct i onexhi bi t s const antr et ur nst oscal e: i fal l oft hei nput sar edoubl ed, out putwi l l exact l ydoubl e-i . e. apr oduct i onf unct i onhasconst antr et ur nst oscal ei f zY=F( zK, zL) f oranyposi t i v enumberz.Thati s,i fwemul t i pl ybot hcapi t alandl abourbyz,weal so mul t i pl yt heamountofout putbyz.I nl i newi t ht heabov est y l i sed f act s,wear e i nt er est edi nexpl ai ni ngout putperwor kerorpercapi t aout put .Wi t ht hi si nt er esti nmi nd, wecanr ewr i t et hepr oduct i onf unct i oni nequat i on[ 1]i nt er msofout putperwor ker , y≡ Y/ L, andcapi t al perwor ker , k≡K/ L-i . e.set t i ngz=1/ L Y/ L=F( K/ L, 1) y =f ( k)wher ef ( k)=F( k, 1) Equat i on[ 1]can, t hus, bewr i t t enas y= α k………. . ( 2) Thi spr oduct i onf unct i oni sgr aphedbel ow.Wi t hmor ecapi t alperwor ker , f i r mspr oduce mor eout putperwor ker .Howev er ,t her ear edi mi ni shi ngr et ur nst ocapi t alperwor ker : eachaddi t i onaluni tofcapi t alwegi v et oasi ngl ewor keri ncr easest heout putoft hat 106 wor kerbyl essandl ess. Theor i esofDevel opment Rost ow’ sSt ageofEconomi cgr owt h Wal tW.Rost ow usest hehi st or i calappr oacht oexpl ai nt hepr ocessofeconomi c dev el opment .I t sessencei st hatl ogi cal l yandpr act i cal l ypossi bl et oi dent i f yst agesof dev el opmentand t o cl assi f ysoci et i es.Accor di ng t o hi m,t her ear ef i v est agesof economi cgr owt h; TheTr adi t i onalSoci et y :t het r adi t i onalsoci et yi sdef i nedasonewhosest r uct ur ei s dev el opedwi t hi nal i mi t edpr oduct i onandbackwar dt echnol ogy .The“ Pr econdi t i onf or Takeof f ” Hecal l st hest agebet weenf eudal i sm andt akeof ft het r ansi t i onst age.Dur i ngt he t r ansi t i onper i odal l t hepr econdi t i onsf orsust ai nedeconomi cdev el opmentar ecr eat ed. I nt hi sst agel ev eloneconomi cf r ont ; i nv est mentr ai sed, sel f sust ai ni nggr owt hensur ed, mai ndi r ect i onofi nv est mentbui l despeci al l yt r anspor t at i onandt el ecommuni cat i on, t echnol ogi calr ev ol ut i oni nagr i cul t ur alsect or ,i mpor texpansi on.Onsoci alf r ont ;new el i t eemer ged,sur pl uschannel edbynew el i t ef r om agr i cul t ur et oi ndust r y .I naddi t i on, pol i t i cal l yef f ect i v emoder ngov er nmenti sv i t al . Takeof f :i sdef i ned byRost ow as“ an i ndust r i alr ev ol ut i on t i ed di r ect l yt or adi cal changesi nt hemet hodsofpr oduct i onhav i ngt hei ri mpactov erashor tper i odoft i me whi chl ast sf ort wodecades. ”I thast hr eenecessar ycondi t i ons:ar i sei nt her at eof pr oduct i v ei nv est ment ,dev el opmentofsubst ant i almanuf act ur i ng sect or ,and t he exi st ence ofpol i t i cal ,soci al ,and i nst i t ut i onalf r amewor ki nf ost er i ng economi c dev el opment . Ther ear et woappr oachesf ort akeof f :Aggr egat eappr oachbasedonHDmodelof gr owt handl eadi ngsect orappr oachesbasedonunbal ancedgr owt ht heor y .Thet akeof fper i odi sdi f f er entf ordi f f er entcount r i es.Thet akeof fst agesf orsomeoft he dev el opedcount r i esar e Dr i v et omat ur i t yst age:aper i odwhenasoci et yhasef f ect i v el yappl i edt her angeof moder nt echnol ogyt odev el opt hebul kofi t sr esour ces.I nt hi sst age,t hr eesi gni f i cant changes t ake pl ace: char act erofwor kf or ce become ski l l ed and or gani zed) , 107 ent r epr eneur shi p, i ndust r i al i zat i on.AgeofHi ghMassConsumpt i ons:dur i ngt hi sst age, t hebal anceofat t ent i onofsoci et yi sshi f t edf r om suppl yt odemandf orgoodsand ser v i cesandf r om pr obl emsofpr oduct i ont oconsumpt i onandwel f ar e. Cr i t i ci sms of Rost ow’ s model :t oo r i gi d,uni v er salappl i cabi l i t y cl ai med,l i near concept i onofhi st or yi nt hest agesofgr owt hi sahi st or i cal . 2. 1. 1.Sur pl usLabourTheor y Pr of .Ar t hurLewi shasdev el opedav er ysy st emat i ct heor yofeconomi cdev el opment wi t hunl i mi t edsuppl yofl abour .I t sf ocuswasst r uct ur alt r ansf or mat i onofapr i mar y subsi st enceeconomy .Themodelst ar t swi t ht heassumpt i onofadualeconomywi t ha moder ni ndust r i al sect orandat r adi t i onal subsi st encesect or . 2. 1. 2.Dual i st i cTheor i es Dual i sm i ndi cat esasi t uat i onwher et y pesofpar al l elphenomenacoexi st .I tr epr esent s t heexi st enceandper si st enceofi ncr easi ngdi v er gencesbet weenr i chandpoornat i ons and r i ch and poorpeopl eson v ar i ousl ev el s.Speci f i cal l y ,t heconceptofdual i sm embr acesf ourkeyel ement ssuchas;super i orandot her si nf er i orcanco¬exi sti na gi v enspace,Thi scoexi st encei schr oni candnotmer el yt r ansi t i onal ,Notonl ydot he degr eesofsuper i or i t yori nf er i or i t yf ai lt oshow anysi gnofdi mi ni shi ng,butt heyev en hav eani nher entt endencyt oi ncr easeandThei nt er r el at i onsbet weent hesuper i orand i nf er i orel ement s Dual i sm hasbeenper cei vedi ndi f f er entway ssuchas:soci al ,t echnol ogi cal( useof di f f er entpr oduct i onf unct i onsi nt headvancedsect orandt het r adi t i onalsect orof t heeconomi esofunder devel opedcount r i es) ,f i nanci al( coexi st enceofdi f f er ent i nt er estr at esi nt heor gani zedandunor gani zedmoneymar ket si nt heLDCs) ,and geogr aphi cdual i sm. CHAPTERFOUR 108 Hi st or i cGr owt handCont empor ar yDev el opment :Lessonand cont r ov er si es Today ,count r i esoft hewor l dar edi v i dedi nt or i ch( dev el oped)count r i esandpoor ( dev el opi ng)count r i es.Ther ei sawi degapbet weent her i chandt hepoorcount r i es. Thest at ementt hat“ t her i chnat i onsgetr i cherandt hepoorcount r i esgetpoor er ”has becomepopul ari nt hel i t er at ur ei nwor l dpov er t y .Butwhatar et heexpl anat i onsf ort he poorper f or manceoft hedev el opi ngcount r i es? Ther ear et woappr oachest oexpl ai n t he det er mi nant s of economi c dev el opment t he t r adi t i onalappr oach and t he i nst i t ut i onal appr oach. 4. 1Tr adi t i onalAppr oach( Economi cFact or s)t oDevel opment The t r adi t i onalappr oach t o dev el opmentassumes t hateconomi c dev el opmenti s det er mi nedbyeconomi cf act or s,l i kenat ur alr esour ces,capi t al ,t echnol ogy ,et c.Let ’ s seeeachoft hemaj oreconomi cf act or s a)Nat ur alResour ces:Thepr i nci pal s’f act oraf f ect i ngt hedev el opmentofaneconomy i st henat ur alr esour cesorl and.“ Land”asusedi neconomi ci ncl udesnat ur alr esour ces suchasf er t i l i t yofl and,i t ssi t uat i onandcomposi t i on,f or estweal t h,mi ner al s,cl i mat e, wat err esour ces,sear esour ces,geogr aphi calpr oxi mi t ywi t hr i chcount r i eset c. For gr owt h, t heexi st enceofnat ur al r esour cesi nabundancei sessent i al .Acount r ywhi chi s def i ci enti nnat ur alr esour ceswi l lnotbei naposi t i ont odev el opr api dl y .Aspoi nt edout byLewi s,“ Ot hert hi ngsbei ngequal ,mencanmakebet t eruseofr i chr esour cest han t heycanofpoor . ” I nLDCsnat ur alr esour cesar eunut i l i zed,under ut i l i zedormut ual i zed.Thesear eoneof t her easonsf ort hei rbackwar dness.Thepr esenceofnat ur alr esour cesi snotsuf f i ci ent f oreconomi cgr owt h.Whati sr equi r edi st hei rpr operexpl oi t at i on. I ti sof t ensai dt hateconomi cgr owt hi spossi bl eev enwhenaneconomi ci sdef i ci enti n nat ur alr esour ces.Aspoi nt edoutbyLewi s, “ Acount r ywhi chi sconsi der edt obepoori n r esour cest odaymaybeconsi der edv er yr i chi nr esour cesatsomel at ert i me, notmer el y because unknown r esour ces ar e di scov er ed,butequal l y because new uses ar e di scov er edf ort heknownr esour ces. ”Japani sonesuchcount r ywhi chi sdef i ci enti n nat ur alr esour cesbuti ti soneoft headv ancedcount r i esoft hewor l dbecausei thas beenabl et odi scov ernewusesf orl i mi t edr esour ces. 109 b)Capi t alAccumul at i on Capi t almeanst hest ockofphy si calr epr oduci bl ef act or sofpr oduct i on.Whencapi t al st ocki ncr easeswi t ht hepassageoft i me,i ti scal l edcapi t alaccumul at i onorcapi t al f or mat i on.Capi t alf or mat i oni si nv est menti ncapi t algoodst hatl eadst oi ncr easei n capi t al st ock, nat i onal out putandi ncome. Capi t alf or mat i oni st hekeyt oeconomi cdev el opment . Ont heonehandi tr ef l ect s ef f ect i v edemandandont heot herhand, i tcr eat espr oduct i v eef f i ci encyf orpr oduct i on. Capi t alf or mat i onpossessesspeci ali mpor t ancet o LDCs. Thepr ocessofcapi t al f or mat i onl eadst ot hei ncr easei nnat i onalout puti nanumberofway s. Capi t al f or mat i oni sessent i alt omeett her equi r ement sofani ncr easi ngpopul at i oni nsuch economi es.I nv est menti n capi t algoods notonl yr ai ses pr oduct i on butal so empl oy mentoppor t uni t i es.I ti scapi t alf or mat i ont hatl eadst ot echnol ogi calpr ogr ess. Technol ogi cali nt ur nl eads t o speci al i zat i on and t he economi es ofl ar ge scal e pr oduct i on. Thepr ov i si onofsoci alandeconomi cov erheads,l i ket r anspor t ,power educat i onet ci nacount r yi spossi bl et hr oughcapi t alf or mat i on. I ti sal socapi t al f or mat i on t hatl eadst ot heexpl oi t at i on ofnat ur alr esour ces,i ndust r i al i zat i on and expansi onofmar ket swhi char eessent i al f oreconomi cpr ogr ess. c)Or gani zat i on Or gani zat i oni sani mpor t antpar toft hegr owt hpr ocess.I tr el at est ot heopt i mum use off act orofpr oduct i oneconomi cact i v i t i es.Or gani zat i oni scompl ementt ocapi t aland l abourandhel psi ni ncr easi ngt hei rpr oductact i v i t i es.I nmoder neconomi cgr owt h, t he ent r epr eneurhasbeenper f or mi ngt het askofanor gani zerandunder t aki ngr i sksand uncer t ai nt i es. Theunder dev el opedcount r i esl ackent r epr eneur i alact i v i t y .Suchf act or sast hesmal l si zeoft hemar ket ,capi t aldef i ci ency ,absenceofpr i v at epr oper t yandcont r act ,l ackof ski l l edandt r ai nedl abour ,nonav ai l abi l i t yofadequat er awmat er i al sandi nf r ast r uct ur al f aci l i t i esl i ket r anspor t ,power ,et ci ncr easer i skanduncer t ai nt i es.Thati swhysuch count r i esl ackent r epr eneur s. d)Technol ogi calPr ogr ess:Technol ogi calchar gesar er egar dedast hemosti mpor t ant f act ori nt hepr ocessofeconomi cgr owt h.Theyar er el at edt ochangesi nt hemet hods ofpr oduct i onwhi char et her esul tofsomenew t echni quesofr esear chori nnov at i on. 110 Changesi nTechnol ogyl eadt oi ncr easei npr oduct i v i t yofl abour ,capi t alandot her f act or sofpr oduct i on. e)Di vi si onofl abourandscal eofpr oduct i on:Speci al i zat i onanddi v i si onofl abourl ead t oi ncr easei npr oduct i v i t y .Theyl eadt oeconomi esofl ar gescal epr oduct i onwhi ch f ur t herhel pi ni ndust r i aldev el opment . Adam Smi t hgav emuchi mpor t ancet ot he di v i si onofl abouri neconomi cdev el opment .Di v i si onofl abourl eadst oi mpr ov ementi n t hepr oduct i v ecapaci t i esofl abour .Ev er yl abor erbecomesmor eef f i ci entt hanbef or e. S/ hesav est i me.S/ hei scapabl eofi nv ent i ngnewmachi nesandpr ocessi npr oduct i on. Ul t i mat el ypr oduct i oni ncr easesmani f ol d.Butdi v i si onofl abourdependsupont hesi ze oft hemar ket .Thesi zeoft hemar ket , i nt ur n, dependsuponeconomi cpr ogr ess, i . e.t he ext entt owhi cht hesi zeofdemand,t hegener all ev elofpr oduct i on,t hemeansof t r anspor tet car edev el oped.Whent hescal eofpr oduct i oni sl ar get her ei sgr eat er speci al i zat i onanddi v i si onofl abour .Asar esul tpr oduct i oni ncr easesandt her at eof economi cpr ogr essi saccel er at ed. Under dev el opedcount r i esar eunabl et ot akeadv ant ageoft heeconomi csofdi v i si onof l abourandl ar gescal epr oduct i onduet ot hepr esenceofmar keti mper f ect i ons, whi chi n t ur nkeept hesi zeoft hemar ketsmal l . 4. 2I nst i t ut i onalAppr oacht oDevel opment Thei nst i t ut i onalappr oacht odev el opmenti sar ecentphenomenon. I tar guest hat expl anat i onsoft hepooreconomi cdev el opmentar ef oundnotonl yi neconomi cf act or s butal sononeconomi cf act or s. I nf actmostoft hesef act or sar eexpl ai nedbynoneconomi cf act or sori nst i t ut i onal f act or s. Thei nst i t ut i onalappr oacht odev el opmentemphasi zesi mpor t anceoft hei nst i t ut i onal f act or smor et hant heeconomi cf act or susi ngt hecaseofamet r opol i t anci t y . The cent r alci t yi n a met r opol i t an ar ea,whi l e gai ni ng some hi ghr i se bui l di ngs,has a st agnantpopul at i onandani ncr easi ngpr opor t i onofpoorpeopl e.Ont heot herhand subur bsar epr osper ousandgr owi ngr api dl y .Toacer t ai ndegr ee, moder neconomi csi s l i kesuchamet r opol i t anar ea.Thet r adi t i onaleconomi csi satt hecent eroft heci t y .At t hesamet i me, t hesubur bsofeconomi csar eexpandi ngr api dl yi nal l di r ect i ons. Thei nst i t ut i onappr oacht odev el opmenti sacasei npoi nt . Forexampl e,consi der shi f t i ngt hef ocusf r om capi t al andot herr esour cest owar dt hequal i t yofgov er nance.I n 111 t hesubur bsofeconomi cs,gov er nancei saf ocus,butnoti nt heci t ycent erwher e capi t ali st hef ocus.Thei nst i t ut i onalf act orf ur t herar guest hatmostoft heeconomi c f act or scanbeobt ai nedi nt hegl obal i zemar ket .Forexampl e, manyMNCsar er eadyt o i nv estasi gni f i cantamountofcapi t ali fcondi t i onsar ef av or abl e.Besi desLDCscanal so bor r owt echnol ogi esf r om DCS. Thei nst i t ut i onal f act or st hatdet er mi neeconomi cper f or mancei ncl ude. a)TypeofGover nment Acount r ywi t hamonar chysy st em i sl essl i kel yt odev el opascompar edwi t hacount r y wi t hademocr at i cgov er nment .Thenat ur eofdemocr acydependsont hel ev elof educat i on, di sci pl i ne, cul t ur eet coft hepeopl e.I nmai nt ai ni ngr ul es, gov er nment scoul d besof torst r ong.Tomai nt ai nr ul esandt her ebypr epar et hegr oundf ordev el opment , gov er nment s need be st r ong.To pr ov i de f ort he enf or cementofcont r act s,t he pr ev ent i onofanar chy ,andt hepr ov i si onofot herpubl i cgood,t hecoer ci v epowerof gov er nmenti snecessar y . Good gov er nance i s anot her i mpor t ant f act or whi ch det er mi nant s economi c per f or mance of count r i es.Accor di ng t o Ol son M. “ Gov er nance i s a deci si v e det er mi nantofeconomi cper f or manceandt hatwi t ht her i ghteconomi cpol i cyand i nst i t ut i ons, poorcount r i escangr owatav er yr api dr at e. ”Goodgov er nancei sr ef l ect ed byl ongt em v i si on, cor r ectpol i ci esandef f ect i v ei mpl ement at i on.Forexampl e, i nJapan t hegov er nmentdeci dedwhatt y peofi ndust r i est odev el opaf t erWor l dWarI I .I tgav e emphasi st ot ext i l e,i r onandst eel ,shi pbui l di nget c.I nr ecenty ear s,t hegov er nment shi f t edt owar dsel ect r oni csi nr esponset oachangei nwor l dmar ket . Anot heraspectofgoodgov er nancei st hedev el opmentofi nf r ast r uct ur e.Count r i esl i ke HongKong, Si ngapor e, Mal ay si a, et cdev el opi nf r ast r uct ur eandat t r actf or ei gncapi t al . b) I nst i t ut i ons:Avai l abi l i t yoft echnol ogyl i ket hecapi t algood,compl ement ar yf act or s l i kei nf r ast r uct ur e,hi ghl yski l l edl abor ,i nnov at i onet car er equi r edf oraneconomyt o gr ow.Tohav esucht echnol ogi calchangesr equi r esagoodi nst i t ut i on.Forexampl e,i n maki ngi nnov at i ons,t her ecoul dber esi st ance.Tocal m suchr esi st ance,gov er nment ef f or ti sr equi r ed.Thus,i nst i t ut i ons t hatencour age t echnol ogi cali nnov at i on and sui t abi l i t yofi nst i t ut i onf orsuccessf uladopt i onofnewi deasi sani mpor t antquest i on. Pol i t i calandcul t ur aldy nami sm hel pi nadopt i onofnew t echnol ogyandt henegat i v e 112 f or ces such as l abouruni on or t hodoxy shoul d be managed pr oper l y by good gov er nance.Spr eadofeducat i on,sci ent i f i ccul t ur ear enecessar yf oradopt i onofnew t echnol ogy Reser vat i on/ Af f i r mat i veAct i on/ .Soci alj ust i cer equi r est hati fsomesect i onsoft he soci et yar edepr i v ed, t heymustbegi v enspeci alat t ent i oni . e.r eser v at i oni sneeded.The suppor t er sofr eser v at i onj ust i f yi t susei nt er msofsoci alj ust i ce,equi t yandt or ect i f y hi st or i cal mi st akes.Howev er , f r om t hepoi ntofv i ewofef f i ci ency , i ti snotj ust i f i ed. c) Soci alSt r uct ur eofPopul at i on:I nsomecount r i es,wegetahomogenoust y peof popul at i on.Homogenei t yoft he popul at i on l eads t ot he dev el opmentofnat i onal f eel i ngs, whi chi shel pf ulf oreconomi cdev el opment–f orexampl eChi na, Japan, Kor ea, Russi a.Ont heot herhand,popul at i onofacount r ycoul dal sobehet er ogeneousdi v i dedont hebasi sofl anguage,r el i gi on,et hni ci t y ,cast eet c.I nsuchsoci et i es,some gr oupspl ayent r epr eneur i al r ol e.Forexampl e, t heJewsi nUSA. d) Human Capi t aland Cul t ur alTr ai t s:Thedi f f er encei npercapi t ai ncomeamong count r i escoul dbeexpl ai nedbyhumancapi t alandcul t ur alt r ai t s.I nt heDCs,human capi t alandcul t ur alt r ai t si nt hef or m ofwor kcul t ur e,di sci pl i ne,goodent r epr eneur shi p et chav epl ay edani mpor t antr ol e.Poorcount r i esar epoorbecauset heyl ackt hese t r ai t s.Thecul t ur alt r ai t st hatper pet uat epov er t yar et her esul tofcent ur i esofsoci al accumul at i onandt heycan’ tbechangedqui ckl y .Cul t ur aladv ancementaccor di ngt oM. Ol sonr esul t si nt wot y pesofhumancapi t al : a)Mar ket abl ehumancapi t al-t hesei ncl udemor eski l l ,pr opensi t yt owor khar der , mor eent r epr eneur i alper sonal i t y-t hesequal i t i esr esul ti ni ncr easei nt hequal i t y andquant i t yofpr oduct i v eout put s. Theser esul t si ni ncr easei ni ncomeof per sons, gr oupsaswel l asofnat i ons. b)Ci v i ccul t ur e.A ci v i ccul t ur el eadst ot heel ect i onofgoodgov er nmentwhi ch adopt sgoodpol i cy .I tal sor esul t si nadi sci pl i nedsoci et y .Cor r upt i onwi l l bel ess. Peopl epayt ax. I ti si mpossi bl et ost udyt heeconomi cgr owt hoft hedevel opi ngcount r i esi nmoder n t i meswi t houtconsi der i ngt hemut uali nt er act i onsbet weent heseeconomi esand t hoseoft headvanced count r i es.When West er n Eur opean Capi t al i sm began t o expand i t s pr oduct i on and t r ade on a wor l dwi de scal e,i tawakened t he l essdevel opedar easoft hewor l dt omoder neconomi cdevel opment .Thi sar t i cl ewi l l 113 t akeupt heAsi anaf ea, i ncl udi ngJapan, asobj ectofexami nat i on.Economi cgr owt h i nt heAsi anar eawasbr oughtaboutbyt heeast war dadvanceofWest er nEur opean capi t al i sm.I nt hi si nt er mi ngl i ngofWest er nEur opeanandAsi aneconomi est he f ol l owi nghi st or i calst agescanbeobser ved. Thef i r stst agei st heper i odwhennat i veAsi ani ndust r ydevel opedasar esul toft he exchangeofnat i veAsi anpr oduct sf orWest er nEur opeani ndust r i alpr oduct s. The second st age i st he per i od when t he nat i ve handi cr af ti ndust r ycr umbl ed because manuf act ur ed consumergoods f l owed i nt ot he Asi an ar ea af t ert he I ndust r i alRevol ut i oni nWest er nEur ope.Thet hi r dst agei st heper i odwhenWest er n Eur opeancapi t alandt echni quesi nf i l t r at edt heAsi anar eaf ort hel ar gescal ei n consequence;t her ewasaconspi cuouschangef r om consumergoodst ocapi t al goodsi nt hei mpor tst r uct ur e. Thesi xt hst agei st heper i odwhenmanuf act ur edgoodsi ngener albegant obe pr oduced by nat i ve i ndust r i es,whet hert he r aw mat er i al s wer e domest i cal l y avai l abl eornot .Thecapi t algoodsr equi r edbyt hesei ndust r i eswer ei mpor t edatt he expenseoft hei nduct i onoff or ei gncapi t alandoft heexpor tofpr i mar ypr oduct s. The sevent h st age i st he per i od when t he i ndust r i al i zat i on oft he devel opi ng count r i esbecamesoadvancedast omakepossi bl et heexpor tofmanuf act ur ed consumergoods,and when t he domest i c pr oduct i on ofsome capi t algoods gr adual l ycamet ot hef or e. CHAPTERFI VE I NEQUALI TY, POVERTYANDDEVELOPMENT The1970,wi t nessedar emar kabl echangei npubl i candpr i v at eper cept i onsaboutt he ul t i mat enat ur eofeconomi cact i v i t y .I nbot hr i chandpoorcount r i es,t her ewasa gr owi ngdi si l l usi onmentwi t ht hei deat hatr el ent l esspur sui tgr owt hwast hepr i nci pal economi cobj ect i v eofsoci et y .I nt hedev el opedcount r i es, t hemaj oremphasi sseemed t oshi f tt owar dmor econcer nf ort hequal i t yofl i f e,aconcer nmani f est edmai nl yi nt he 114 env i r onment al mov ement . I nt hi schapt er , wewi l l exami ne: Whati st heext entofr el at i v ei nequal i t yi nLDCs Whoar et hepoor , andt hei reconomi cchar act er i st i cs? Hatdet er mi net henat ur eofeconomi cgr owt h, t hati swhobenef i t s? Ar er api deconomi cgr owt handmor eequi t abl edi st r i but i onsofi ncome? Whatki ndsofpol i ci esar er equi r edt or educet hemagni t udeandext entof absol ut epov er t y ? I ncomei nequal i t y Bypul l i ngquest i on1and2t oget hersamer ecentev i dencef r om v ar i et yofsour ces;we def i net hedi mensi onsofi ncomedi st r i but i onandpov er t ypr obl emsandi dent i f ysome si mi l ar el ement st hat char act er i ze t he pr obl em i n many dev el opi ng count r i es. Economi st susual l yl i ket o di st i ngui shbet weent wo pr i nci palmeasur esofi ncome di st r i but i onf orbot hanal y t i candquant i t at i v epur poses. 1.Theper sonalorsi zedi st r i but i onofi ncome:i st hemeasur emostcommonl yused byeconomi st s.I tsi mpl ydeal swi t hi ndi v i dualper sonsorhousehol dsandt het ot al i ncomet heyr ecei v e.Economi st sandst at i st i ci ans,t her ef or e,l i ket oar r angeal l i ndi v i dual sbyascendi ngper sonali ncomesandt hendi v i dedt het ot alpopul at i oni n t odi st i nctgr oupsorsi zes.Acommonmet hodi st odi v i det hepopul at i oni nt o successi v equi nt i l es( f i f t hs)ordeci l es( t ent hs)accor di ngt ot heascendi ngi ncome l ev el sandt hendet er mi newhatpr opor t i onoft het ot alnat i onali ncomei sr ecei v ed byeachi ncomegr oup. Lor enzCur v e:Anot hercommonwayt oaper sonali ncomest at i st i csi st oconst r uct whati sknown asaLor enzcur v e.On t hehor i zont alaxi s,t henumberofi ncome r eci pi ent si spl ot t ed,noti nabsol ut et er msbuti ncumul at i v eper cent ages.Thev er t i cal axi sshowst heshar eoft ot ali ncomer ecei v edbyeachper cent ageoft hepopul at i on;i t al soi scumul at i v eupt o100%meani ngt hatbot haxesar eequal l yl ong.Theent i r ef i gur e i sencl osed i n a squar e and t he cur v e showst he act ualquant i t at i v er el at i onshi p 115 bet weent heper cent agesofi ncomer eci pi ent sandt heper cent ageoft heact uali ncome t heydi di nf actr ecei v edur i ng, say , agi v eny ear . Themor et heLor enzl i necur v esi sawayf r om t hedi agonal ( per f ectequal i t y ) , t hegr eat er t hedegr eeofi nequal i t yr epr esent ed.Theext r emecaseofper f ecti nequal i t y(i . e.a si t uat i oni nwhi choneper sonr ecei v esal loft henat i onali ncomewhi l eev erbodyel se r ecei v esnot hi ng)woul dber epr esent edbyt hecongr uenceoft heLor enzcur v ewi t ht he bot t om hor i zont al andr i ghthandv er t i cal axes. Gi niCoef f i ci entorGi niconcent r at i onr at i o:A f i nalandv er yconv eni entshor thand summar ymeasur eoft her el at i v edegr eeofi ncomei nequal i t yi nacount r ycanbe obt ai nedbycal cul at i ngt her at i ooft hear eabet weent hedi agonalandt heLor enzcur v e di v i dedbyt het ot al ar eaoft hehal fsquar ei nwhi cht hecur v el i es.Thi si sshownbel ow. Fi gur e5. 1:Gi nicoef f i ci entcur v e 116 Gi ni ShadedAr eaA Coef f i ci ent Tot al Ar eaBCD 2.Thef unct i onalordi st r i but i v ef act orshar edi st r i but i onofi ncome: The second common measur e ofi ncome di st r i but i on used by economi st s,t he f unct i onalorf act orshar edi st r i but i onsofi ncome, at t empt st oexpl ai nt heshar eoft ot al nat i onali ncome t hateach oft he f act or sofpr oduct i on ( l and,l abourand capi t al ) r ecei v es.I nst ead ofl ooki ng ati ndi v i dual s as separ at e ent i t i es,i nqui r i es i nt ot he per cent aget hatl abourr ecei v esasawhol eandcompar est hi swi t ht heper cent agesof t ot ali ncomedi st r i but edi nt hef or m of r ent , i nt er est , and pr of i t( i . e.t her et ur nt ol and andf i nanci al andphy si cal capi t al ) . I nequal i t yandAbsol utPover t y I nequal i t y :v ar i at i onsamongcount r i es Quest i on5. 1whati st her el at i onshi pbet weenl evel sofpercapi t ai ncomeanddegr eeof i nequal i t y? Ar ehi gheri ncomesassoci at edwi t hgr eat erorl esseri nequal i t yorcanno def i ni t i vest at ementbemade? Absol ut epov er t y :Ext entandmagni t ude Nowl et ' sswi t chourat t ent i onf r om r el at i v ei ncomeshar esofv ar i ousper cent i l egr oups wi t hi nagi v enpopul at i ont ot hemor esi gni f i cantquest i onoft heext entandmagni t ude ofabsol ut epov er t yi ndev el opi ngcount r i es.Absol ut epov er t yi smeantt or epr esenta speci f i cmi ni mum l ev elofi ncomeneededt osat i sf yt hebasi cphy si calneedsoff ood, cl ot hi ngandshel t eri nor dert oensur econt i nuedsur v i v alext entofobsol et epov er t yi s t her ef or et he numberofpeopl ewhoar eunabl et ocommandsuf f i ci entr esour cest o sat i sf ybasi cneeds. A pr obl em,howev er ,ar i seswhenoner ecogni zest hatt hosemi ni mum subsi st ence l ev el s wi l lv ar yf r om count r yt o count r yand r egi on t or egi on,r ef l ect i ng di f f er ent phy si ol ogi calaswel lassoci alandeconomi cr equi r ement s.Economi st shav et her ef or e t ended t o make consul t at i v e est i mat es of wor l d pov er t yi n or der t o av oi d unsubst ant i at ed exagger at i onsoft hepr obl em.Si ncet hei nt er nat i onalpov er t yl i ne knowsnoboundar i es,i si ndependentoft hel ev elofnat i onalpercapi t ai ncome,and t akesi nt oaccountdi f f er i ngpr i cel ev elbymeasur i ngpov er t yasanyonel i v i ngonl ess 117 t han$1adayi nPPPdol l ar s. Quest i on5. 2l et ’ sassumet hatt hepov er t yl i nei ssetat$360.I ft woi ndi v i dual sAandB ear n$350and$300r espect i v el y ,t het woar ebel ow t hepov er t yl i neAr et woequal l y poor Quest i on5. 3" Hi gherpercapi t ai ncomes perse do notguar ant ee t he absence of si gni f i cantnumber sofabsol ut epoor .I ti spossi bl ef oracount r ywi t hahi gherpercapi t a i ncomet ohav eal ar geper cent agel i neandal ar gerpov er t ygapt hanacount r ywi t ha l owerpercapi t ai ncome “ Ar gue on t hi s st at ementby r el at i ng y ouranswer st o quest i on5. 1 Whypov er t yper si sti nLDCs?Theansweri sbasi cal l ybecauseofl ar gei nequal i t yl ev el wi t hi nanat i onandacr osscount r i es.Consi dert hef ol l owi ngf act s:amongf ourpoi nt f ourbi l l i onpeopl el i v ei ndev el opi ngcount r i es.Thr eef i f t hsl ackbasi csani t at i on, al most onet hi r dhav enoaccesst ocl eanwat erandquar t er( 25%)donothav eadequat e housi ng.Twent yper centhav enoaccesst omoder nheal t hser v i ces.I n1997t her i chest f i f t hoft hewor l d’ spopul at i onhad74t i mest hei ncomeoft hepoor estf i f t h.Thet op t hr eebi l l i onai r eshav easset sgr eat ert hant hecombi nedGNPofal ll eastdev el oped count r i esandt hei r600mi l l i onpeopl e. Whyshoul dwebeconcer nedwi t hi nequal i t yamongt hoseabov et hepov er t yl i ne? Ther ear et hr eemaj oranswer st ot hi squest i on.Fi r st ,ext r emei ncomei nequal i t yl eads t oeconomi ci nef f i ci ency .Thi sdi spar i t yunder mi nessoci alst abi l i t yandsol i dar i t y .Hi gh i nequal i t yf aci l i t at esr entseeki ng,i ncl udi ngact i onssuchasexcessi v el obby i ngand br i ber y .Thesecanbegener al l yv i ewedasunf ai r . Gener al l y ,ourassumpt i oni st hat soci alwel f ar edependsposi t i v el yont hel ev elofi ncomepercapi t abutnegat i v el yon pov er t yandnegat i v el yont hel ev el ofi nequal i t y . Fact or sDr i v i ngHi gherI ncomeI nequal i t y Technol ogi cal change: el i mi nat i ng many j obs t hr ough aut omat i on, f i nanci al dev el opmentcoul dbenef i tt her i chi nt heear l yst agesofdev el opment , changesi nl abor mar keti nst i t ut i ons( adecl i nei nt r adeuni onmember shi pcoul dr educet her el at i v e bar gai ni ngpowerofl abor ) ,r edi st r i but i v epol i ci es,f al sePr ogr essi v et axat i on&soci al t r ansf er s. 118 Causesofpov er t yi nt hi r dwor l dcount r i es( LDCs Tr ade:t hi r d wor l d count r i es l ose outt hr ough unf ai rt r ade agr eement s,l ack of t echnol ogyandi nv est ment , andr api dl ychangi ngpr i cesf ort hei rgoods. Wor kandgl obal i sat i on:Bet t ercommuni cat i onsandt r anspor thav el edt oa“ gl obal i sed” economy .Compani esl ookf orl owcostcount r i est oi nv esti n.Thi scanmeant hat , t hought her ear ej obs, t heyar el owpai d. Warorconf l i ct :Whenacount r yi satwar( i ncl udi ngci v i lwar )basi cser v i cesl i ke educat i onar edi sr upt ed.Peopl el eav et hei rhomesasr ef ugees.Cr opsar edest r oy ed Pol i cyOpt i on:Fourbr oadar easofpossi bl egov er nmentpol i cyi nt er v ent i oncanbe i dent i f i ed: 1) Al t er i ngt hef unct i onal di st r i but i ont hr oughandchangi ngr el at i v ef act orpr i ces. I ti sar guedt hatmeasur esdesi gnedt or educet hepr i ceofl aborr el at i v et ocapi t al( e. g. , t hr oughpubl i cwagesubsi di est oempl oy er s)wi l lcauseempl oy er st osubst i t ut el abor f orcapi t ali nt hei rpr oduct i onact i v i t i esSuchf act orsubst i t ut i oni ncr easest heov er al l l ev el ofempl oy mentandul t i mat el yr ai sest hei ncomesoft hepoor . 2)Mi t i gat i ng t he si z e di st r i but i on:t hr ough pr ogr essi v er edi st r i but i on ofasset owner shi p 3)Moder at i ng( r educi ng)t hesi zedi st r i but i onatupperl ev el s:t hr oughpr ogr essi v e t axat i onofper sonali ncomeandweal t h.Pr ogr essi v ei ncomet axi sat axwhose r at ei ncr eases wi t hi ncr easi ng per sonali ncomes.Such t axat i on i ncr eases gov er nmentr ev enuest hatdecr easet heshar eofdi sposabl ei ncomeoft hev er y r i ch 4) Moder at i ng( i ncr easi ng)t hesi zedi st r i but i onatl owerl ev el s:t hr ought r ansf er pay ment sandpubl i cpr ov i si onofgoodsandser v i ces. DEVELOPMENTECONOMI CSI I CHAPTERONE Popul at i onGr owt handt heQual i t yofLi f e Ev er yy earappr oxi mat el y80mi l l i onpeopl ear ebei ngaddedt ot hewor l d’ spopul at i on. 119 Al mostal loft hi snetpopul at i oni ncr ease( 97%)i si ndev el opi ngcount r i es.I ncr easesof suchmagni t udear eunpr ecedent ed.Butt hepr obl em ofpopul at i ongr owt hi snotsi mpl y apr obl em ofnumber s.I ti sapr obl em ofhumanwel f ar eandofdev el opment .Rapi d popul at i ongr owt hcanhav eser i ousconsequencesf ort hewel l bei ngofal lofhumani t y . I fdev el opmentent ai l st hei mpr ov ementi npeopl e’ sl ev el sofl i v i ng,t hent her eal l y i mpor t antquest i on aboutpopul at i on gr owt hi st hi s:How does t he cont empor ar y popul at i onsi t uat i oni nmanydev el opi ngcount r i escont r i but et oordet r actf r om t hei r chancesofr eal i zi ngt hegoal sofdev el opment ,notonl yf ort hecur r entgener at i onbut al so f orf ut ur e gener at i ons?Conv er sel y ,how does dev el opmentaf f ectpopul at i on gr owt h? Amongt hemaj ori ssuesr el at i ngt ot hi sbasi cquest i onar et hef ol l owi ng: Wi l l dev el opi ng count r i esbecapabl eofi mpr ov i ngt hel ev el sofl i v i ngf ort hei rpeopl ewi t ht hecur r ent andant i ci pat edl ev el sofpopul at i ongr owt h?Towhatext entdoesr api dpopul at i on i ncr easemakei tmor edi f f i cul tt opr ov i deessent i alsoci alser v i ces,i ncl udi nghousi ng, t r anspor t , sani t at i on, andsecur i t y ? How wi l lt hedev el opi ngcount r i esbeabl et ocopewi t ht hev asti ncr easesi nt hei r l aborf or cesov ert hecomi ngdecades?Wi l lempl oy mentoppor t uni t i esbepl ent i f ul , orwi l li tbeamaj orachi ev ementj ustt okeepunempl oy mentl ev el sf r om r i si ng? Whatar et hei mpl i cat i onsofhi gherpopul at i ongr owt hr at esamongt hewor l d’ spoor f ort hei rchancesofov er comi ngt hehumanmi ser yofabsol ut epov er t y ?Wi l lwor l d f ood suppl yand i t sdi st r i but i on besuf f i ci entnotonl yt o meett heant i ci pat ed popul at i oni ncr easei nt hecomi ngdecadesbutal sot oi mpr ov enut r i t i onall ev el st o t hepoi ntwher eal l humanscanhav eanadequat edi et ? Gi v ent heant i ci pat edpopul at i ongr owt h,wi l ldev el opi ngcount r i esbeabl et oext end t hecov er ageandi mpr ov et hequal i t yoft hei rheal t handeducat i onal sy st emssot hat ev er y onecanatl easthav et hechancet osecur eadequat eheal t hcar eandabasi c educat i on?Towhatext entar el owl ev el sofl i v i ngani mpor t antf act ori nl i mi t i ngt he f r eedom ofpar ent st ochooseadesi r edf ami l ysi ze?I st her ear el at i onshi pbet ween pov er t yandf ami l ysi ze? Towhatext enti st hegov er ni ngaf f l uenceamongt heeconomi cal l ymor edev el oped 120 nat i onsani mpor t antf act orpr ev ent i ngpoornat i onsf r om accommodat i ngt hei r gr owi ngpopul at i ons?I st hei nev i t abl epur sui tofi ncr easi ngaf f l uenceamongt her i ch mor edet r i ment alt ot hegl obalenv i r onmentandt or i si ngl i v i ngst andar dsamongt he poort hant heabsol ut ei ncr easei nt hei rnumber s?Wewi l lt r yt oexpl or eandexpl ai n t heseandot herpr obl emsi nt hi scour se. Wor l dPopul at i onGr owt ht hr oughHi st or y Gi v encur r entpopul at i ongr owt hr at esi ndi f f er entpar t soft hewor l d,t her egi onal di st r i but i onoft hewor l d’ spopul at i onwi l li nev i t abl ychangeby2050.Byt hatt i me,i ti s l i kel yt hatt her ewi l lbe6. 6bi l l i onmor epeopl eont heear t ht hani n1950and3. 1bi l l i on mor et hani n2000.Af r i cawi l lexper i encet hel ar gestper cent agei ncr ease( 184%) ,and i t spr oj ect edpopul at i onof2. 1bi l l i onwi l lbeal mostt hr eet i mesi t s1998popul at i onand al most10t i mesi t s1950popul at i on. Fer t i l i t yand Mor t al i t yTr ends:t he r at e ofpopul at i on i ncr ease i s quant i t at i v el y measur edast heper cent agey ear l ynetr el at i v ei ncr easei npopul at i onsi zeduet o nat ur ali ncr easeandneti nt er nat i onalmi gr at i on.Nat ur ali ncr easesi mpl ymeasur es t heexcessofbi r t hsov erdeat hsor , i nmor et echni calt er ms, t hedi f f er encebet ween f er t i l i t yandmor t al i t yr at es. Thedi f f er encebet weendev el opi nganddev el opednat i onsi nt er msofr at esof popul at i ongr owt hcanbeexpl ai nedsi mpl ybyt hef actt hebi r t hr at es( f er t i l i t yr at es) i n dev el opi ng count r i esar e gener al l ymuch hi ghert han i nt he r i ch nat i ons.I n Dev el opi ngcount r i es,deat hr at es( mor t al i t yr at es)ar eal sohi gher .Howev er ,t hese deat hr at edi f f er encesar esubst ant i al l ysmal l ert hant hedi f f er encesi nbi r t hr at es. AgeSt r uct ur eanddependencyBur dens:Wor l dpopul at i ont odayi sv er yy out hf ul , par t i cul ar l yi nt hedev el opi ngwor l d.Chi l dr enundert heageof15const i t ut emor e t han31%oft het ot alpopul at i onofdev el opi ngcount r i esbutj ust18%ofdev el oped nat i ons. TheHi ddenMoment um ofPopul at i onGr owt h Per haps t he l eastunder st ood aspectofpopul at i on gr owt hi si t st endencyt o cont i nueev enaf t erbi r t hr at eshav edecl i nedsubst ant i al l y .Popul at i ongr owt hhasa bui l t i nt endencyt ocont i nue, apower f ulmoment um t hat , l i keaspeedi ngaut omobi l e whent hebr akesar eappl i ed, t endst okeepgoi ngf orsomet i mebef or ecomi ngt oa 121 st op.I nt hecaseofpopul at i ongr owt h, t hi smoment um canper si stf ordecadesaf t er bi r t hr at esdr op.Ther ear et wobasi cr easonsf ort hi s.Fi r st , hi ghbi r t hr at escannotbe al t er edsubst ant i al l yov er ni ght .Thesoci al ,economi c,andi nst i t ut i onalf or cest hat hav ei nf l uencedf er t i l i t yr at esov ert hecour seofcent ur i esdonotsi mpl yev apor at eat t heur gi ngofnat i onall eader s.Thesecondandl essobv i ousr easonf ort hehi dden moment um ofpopul at i ongr owt hr at ei sr el at edt ot heagest r uct ur eofLDC. Thecausef orhi ghf er t i l i t yi nLDCs Mal t husi anPopul at i onTr ap Twocent ur i esago,t heRev er endThomasMal t husputf or war dat heor yoft he r el at i onshi p bet ween popul at i on gr owt h and economi c dev el opmentt hatst i l l sur v i v est oday .TheMal t husi anpopul at i ont r appr ov i desat heor yoft her el at i onshi p bet weenpopul at i ongr owt handeconomi cdev el opment .Unf or t unat el y , i ti sbasedon anumberofsi mpl i st i cassumpt i onsandhy pot hesest hatdonotst andt het estof empi r i cal v er i f i cat i on. Wecant husl ar gel yr ej ectt heMal t husi anandneoMal t husi ant heor i esasappl i edt o cont empor ar ydev el opi ngnat i onsont hef ol l owi nggr ounds:f i r stt heydonott ake adequat eaccountoft her ol eandi mpactoft echnol ogi calpr ogr ess.Secondt heyar e basedonahy pot hesi saboutamacr or el at i onshi pbet weenpopul at i ongr owt hand l ev el sofpercapi t ai ncomet hatdoesnotst andupt oempi r i calt est i ng.Thi r dt hey f ocusont hewr ongv ar i abl e,percapi t ai ncome,ast hepr i nci paldet er mi nantof popul at i ongr owt hr at es.Thus,amuchbet t erand mor ev al i d appr oacht ot he quest i onofpopul at i onanddev el opmentcent er sont hemi cr oeconomi csoff ami l y si zedeci si onmaki ngi nwhi chi ndi v i dual ,andnotaggr egat e,l ev el sofl i v i ngbecome t hepr i nci pal det er mi nantofaf ami l y ’ sdeci si ont ohav emor eorf ewerchi l dr en. TheMi cr oeconomi cHousehol dTheor yofFer t i l i t y I nr ecenty ear s,economi st shav ebegunt ol ookmor ecl osel yatt hemi cr oeconomi c det er mi nant soff ami l yf er t i l i t yi nanat t emptt opr ov i deabet t ert heor et i caland empi r i calex pl anat i onf ort heobser v edf al l i ngbi r t hr at esassoci at edwi t hst age3of t he demogr aphi ct r ansi t i on.I n doi ng t hi s,t heyhav e dr awn on t he t r adi t i onal neocl assi calt heor yofhousehol dandconsumerbehav i orf ort hei rbasi canal y t i cal modelandhav eusedt hepr i nci pl esofeconomyandopt i mi zat i ont oexpl ai nf ami l y si zedeci si ons.Speci f i cal l y ,bi r t hr at esamongt hev er ypoorar el i kel yt of al lwher e 122 t her ei s:Ani ncr easei nt heeducat i onofwomenandaconsequentchangei nt hei r r ol eandst at us. Ani ncr easei nf emal enonagr i cul t ur alwageempl oy mentoppor t uni t i es,whi chr ai ses t hepr i ceorcostoft hei rt r adi t i onalchi l dr ear i ngact i v i t i es;ar i sei nf ami l yi ncome l ev el st hr ought hei ncr easeddi r ectempl oy mentandear ni ngsofahusbandandwi f e ort hr ought her edi st r i but i onofi ncomeandasset sf r om r i cht opoor ;ar educt i oni n i nf antmor t al i t yt hr ough expanded publ i cheal t h pr ogr amsand bet t ernut r i t i onal st at usf orbot hmot herandchi l dandbet t ermedi cal car e;t hedev el opmentofol dage andot hersoci alsecur i t ysy st emsout si det heext endedf ami l ynet wor kt ol essent he economi c dependence ofpar ent s,especi al l y women,on t hei rof f spr i ng and Expandedschool i ngoppor t uni t i essopar ent scanbet t ersubst i t ut echi l d“ qual i t y ”f or l ar genumber sofchi l dr en. 1. 1. 1.SomePol i cyAppr oaches I nv i ew oft hesebr oadgoal sandobj ect i v es,whatki ndsofeconomi candsoci al pol i ci es mi ghtt he dev el opi ng count r yand dev el opedcount r ygov er nment s and i nt er nat i onalassi st anceagenci esconsi derbr i ngi ngaboutl ongt er mr educt i onsi n t he ov er al lr at e ofwor l d popul at i on gr owt h?Thr ee ar eas ofpol i cycan hav e i mpor t antdi r ectandi ndi r ecti nf l uencesont hewel l bei ngofpr esentandf ut ur ewor l d popul at i ons: Gener alandspeci f i cpol i ci est hatLDCgov er nment scani ni t i at et oi nf l uenceand per hapsev encont r olt hei rpopul at i ongr owt handdi st r i but i on.Gener alandspeci f i c pol i ci est hatdev el opedcount r ygov er nment scani ni t i at ei nt hei rowncount r i est o l essent hei rdi spr opor t i onat econsumpt i onofl i mi t edwor l dr esour cesandpr omot ea mor eequi t abl edi st r i but i onoft hebenef i t sofgl obal economi cpr ogr ess. Cer t ai ndev el opmentpol i ci esar epar t i cul ar l ycr uci ali nt het r ansi t i onf r om ahi ghgr owt ht oal owgr owt h popul at i on.Thesepol i ci esai m atel i mi nat i ng absol ut e pov er t y ;l esseni ng i ncome i nequal i t i es; expandi ng educat i onal oppor t uni t i es, especi al l yf orwomen;pr ov i di ng i ncr eased j ob oppor t uni t i esf orbot h men and women;br i ngi ng t hebenef i t sofmoder n pr ev ent i v emedi ci neand publ i cheal t h pr ogr ams,especi al l yt hepr ov i si onofcl eanwat erandsani t at i on,t ot her ur aland ur banpoor ; i mpr ov i ngmat er nalandchi l dheal t ht hr oughmor ef ood, bet t erdi et s, and 123 i mpr ov ednut r i t i ont ol oweri nf antmor t al i t y ;andcr eat i ngamor eequi t abl epr ov i si on ofot hersoci al ser v i cest owi desegment soft hepopul at i on. 1. 1. 2.How Dev el oped Count r i es Can Assi stDev el opi ng Count r i es wi t h Thei r Popul at i onPr ogr ams Ther ear eal soanumberofway si nwhi cht hegov er nment sofr i chcount r i esand mul t i l at er aldonoragenci escanhel pt hegov er nment sofdev el opi ngcount r i esachi ev e t hei rpopul at i onpol i cyobj ect i v esi nshor t erper i odsoft i me.Themosti mpor t antof t heseconcer nst hewi l l i ngnessofr i chcount r i est obeofgenui neassi st ancet opoor count r i esi nt hei rdev el opmentef f or t s.Suchgenui nesuppor twoul dconsi stnotonl yof expandedpubl i candpr i v at ef i nanci alassi st ancebutal soofi mpr ov edt r ader el at i ons, suchast ar i f f andquot af r eeaccesst odev el opedcount r ymar ket s,mor eappr opr i at e t echnol ogy t r ansf er s,and assi st ance i n dev el opi ng i ndi genous sci ent i f i cr esear ch capaci t i es, bet t eri nt er nat i onal commodi t y pr i ci ngpol i ci es, andamor eequi t abl eshar i ng oft hewor l d’ sscar cenat ur al r esour ces. Ther ear et woot heract i v i t i esmor edi r ect l yr el at edt of er t i l i t ymoder at i oni nwhi chr i chcount r y gov er nment s,i nt er nat i onaldonoragenci es,and pr i v at e nongov er nment al or gani zat i ons( NGOs)canpl ayani mpor t antassi st i ngr ol e. Thef i r sti st hewhol ear eaofr esear chi nt ot het echnol ogyoff er t i l i t ycont r ol ,t he cont r acept i v epi l l , moder ni nt r aut er i nedev i ces( I UDs) , v ol unt ar yst er i l i zat i onpr ocedur es, and, par t i cul ar l yf orAf r i cai nt heageofAI Ds, ef f ect i v ebar r i ercont r acept i on. Thesecondar eai ncl udesf i nanci alassi st ancef r om dev el opedcount r i esf orf ami l y pl anni ng pr ogr ams,publ i c educat i on,and nat i onalpopul at i on pol i cy r esear ch act i v i t i esi nt hedev el opi ngcount r i es.Thi shast r adi t i onal l ybeent hepr i mar yar eaof dev el opedcount r yassi st ancei nt hef i el dofpopul at i on. UNI T TWO HumanCapi t al :Educat i onandHeal t hi nEconomi cDevel opment I nt he t hi r d uni t ,we exami ne t he r ol es ofeducat i on and heal t hi n economi c dev el opment .Theset wohumancapi t ali ssuesar et r eat edt oget herbecauseoft hei r cl oser el at i onshi p.Weconsi dert her el at i onshi psbet weeni ncomeont heonehand andheal t handeducat i onont heot her . 124 1. 2. Educat i onandHeal t hasJoi ntI nv est ment sf or Dev el opment Heal t handeducat i onar ecl osel yr el at edi neconomi cdev el opment .Ont heonehand, gr eat erheal t hcapi t almayi mpr ov et her et ur nt oi nv est menti neducat i on,i npar t becauseheal t hi san i mpor t antf act ori n schoolat t endanceand i nt hef or mal l ear ni ng pr ocess ofa chi l d.A l ongerl i f er ai ses t he r et ur nt oi nv est ment si n educat i on;bet t erheal t hatanypoi ntdur i ngwor ki ngl i f emayi nef f ectl owert her at e ofdepr eci at i onofeducat i oncapi t al .Ont heot herhand,gr eat ereducat i oncapi t al mayi mpr ov et her et ur nt oi nv est ment si nheal t h, becausemanyheal t hpr ogr amsr el y onbasi cski l l sof t enl ear nedatschool , i ncl udi ngper sonal hy gi eneandsani t at i on, not t oment i onbasi cl i t er acy ;educat i oni sal soneededf ort hef or mat i onandt r ai ni ngof heal t hper sonnel .Fi nal l y ,ani mpr ov ementi npr oduct i v eef f i ci encyf r om i nv est ment s i neducat i onr ai sest her et ur nonal i f esav i ngi nv est menti nheal t h. WhyI ncr easi ngI ncomeI sNotSuf f i ci ent ?Heal t handeducat i onl ev el sar emuch hi gheri nhi ghi ncomecount r i es.Ther ear egoodr easonst obel i ev et hatt hecausal i t y r unsi nbot hdi r ect i ons:Wi t hhi gheri ncome,peopl eandgov er nment scanaf f or dt o spendmor eoneducat i onandheal t h;wi t hgr eat erheal t handeducat i on,hi gher pr oduct i v i t yandi ncomesar epossi bl e.Becauseoft heser el at i onshi ps, dev el opment pol i cyneedst of ocusoni ncome, heal t h, andeducat i onsi mul t aneousl y . Chi l dLabor :Chi l dl abori sawi despr eadpr obl em i ndev el opi ngcount r i es.Whenachi l d underage14wor k,t hei rl abort i medi sr upt st hei rschool i ngandi namaj or i t yofcases pr ev ent st hem f r om at t endi ngschool .Compoundi ngt hi s,t heheal t hofchi l dwor ker si s si gni f i cant l ywor se,ev enaccount i ngf ort hei rpov er t yst at us,t hant hatofchi l dr enwho donotwor k; phy si calst unt i ngamongchi l dl abor er si sv er ycommon.I naddi t i on, al ar ge f r act i onofl abor i ngchi l dr eni ssubj ectt oespeci al l ycr uelandexpl oi t at i v ewor ki ng condi t i onst hatwi l laf f ectt hei rheal t handt hei rpr oduct i v i t ydur i ngt hei rol daget hatwi l l hav edi r ecti mpactont hedev el opmentoft hedev el opi ngcour t i er s. Ther ear ef ourmai nappr oachest ochi l dl aborpol i cycur r ent l yi ndev el opmentpol i cy : 125 Thef i r str ecogni zeschi l dl aborasanexpr essi onofpov er t yand r ecommendsan emphasi sonel i mi nat i ngpov er t yr at hert handi r ect l yaddr essi ngchi l dl abor ; t hi sposi t i on i sgener al l yassoci at edwi t ht heWor l dBank. Thesecondappr oachemphasi zesst r at egi est ogetmor echi l dr eni nt oschool , i ncl udi ng expandedschoolpl aces,suchasnewv i l l ageschool s,andi ncent i v est oi nducepar ent s t osendt hei rchi l dr ent oschool .Thet hi r dappr oachconsi der schi l dl abori nev i t abl e,at l easti nt heshor tr un,andst r essespal l i at i v emeasur essuchasr egul at i ngi tt opr ev ent abuseandt opr ov i desuppor tser v i cesf orwor ki ngchi l dr en.Thef our t happr oachf av or s banni ngchi l dl abor .I ft hi si snotpossi bl e, howev er , andr ecogni zi ngt hatchi l dl abormay notal way sr esul tf r om mul t i pl eequi l i br i a, t hi sappr oachf av or sbanni ngchi l dl abori ni t s mostabusi v ef or ms.Thel at t erappr oachhasr ecei v edmuchat t ent i oni nr ecenty ear s. Fi nal l y ,manyact i v i st si ndev el opedcount r i eshav epr oposedt hei mposi t i onoft r ade sanct i onsagai nstcount r i est hatper mi tchi l dl abororatl eastbanni ngt hegoodson whi chchi l dr enwor k.Thi sappr oachi swel li nt ent i oned, buti ft heobj ect i v ei st hewel f ar e ofchi l dr en,i tneedst obeconsi der edcar ef ul l y ,becausei fchi l dr encannotwor ki nt he expor tsect or ,t heywi l lal mostcer t ai nl ybef or cedt owor ki nt hei nf or malsect or ,wher e wagesandot herwor ki ngcondi t i onsar egener al l ywor se. 1. 3. Pol i ci esf orHeal t h,Educat i on,andI ncome Gener at i on I nt hecomi ngy ear s,t hecl earev i dencet hatheal t handeducat i onar ej oi nti nv est ment smayof f erscopef oramor ei nt egr at edpol i cyappr oach.I tmaybet hat oneoft hemostef f ect i v ei nv est ment swecanmakei neducat i onqual i t yi st o i mpr ov echi l dheal t h.Si mi l ar l y , oneoft hemostef f ect i v ei nv est ment swecoul dmake i nheal t hmaybet oi mpr ov et hequal i t yofeducat i on.I nf act , anumberofpr omi nent pov er t ypr ogr amsi ndev el opi ngcount r i esnowexpl i ci t l yi nt egr at ei ncent i v esf ort he dev el opmentofheal t handeducat i onhumancapi t alamongl ow i ncomef ami l i es. I nt egr at edst r at egi esseekl i nki nghi ghl ysuccessf ulmi cr ocr edi tsy st emswi t hheal t h andeducat i on. I nt egr at i ngpr ogr am oneducat i on,heal t handnut r i t i oni sanot hergoodst r at egyt o r ef ert o.I nt hi si nt egr at edst r at egy , t her ei scasht r ansf ert opoorf ami l y , f ami l ycl i nk 126 v i si t , andot heri nki ndnut r i t i onalsuppl ement , andot herheal t hbenef i t sf orpr egnant andl act at i ngwomenandt hei rchi l dr enunderaspeci f i edage.Someoft hebenef i t s canbemadecondi t i onalonchi l d’ sr egul arschoolat t endance.I nt hi smanneri ti s possi bl et oi nt egr at edheal t h, educat i onandbenef i tpackagest ot hehousehol ds. Chapt ert hr ee Rur al ur bani nt er sect i on, mi gr at i on, andunempl oy ment Af t ercompl et i ngt hi suni t ,y ouwi l lcl ear l yunder st andt hepot ent i alr ol esofci t i est o enhanceeconomi cdev el opmenti nt hecont empor ar ydev el opi ngeconomi esy oube f ami l i arwi t ht hewel l knownt heor et i calmodelofr ur al -ur banmi gr at i on(t heTodar o ModelofMi gr at i on)y ouwi l lbeabl eexami net headv ant agesanddi sadv ant agesoft he i nf or malsect ori nt hemoder nci t i esoft hecont empor ar ydev el opi ngcount r i esy ouwi l l beabl et oev al uat edi f f er entpol i cyopt i onst hatt hecont empor ar ydev el opi ngcount r i es shoul d pur suet o sol v epr obl emsassoci at ed wi t hheav yi nf l ow ofr ur alt o ur ban mi gr at i on 1. 4. Ther ol eci t i es Whatexpl ai nst hest r ongassoci at i onbet weenur bani zat i onanddev el opment ?Toa l ar gedegr ee, ci t i esar ef or medbecauset heypr ov i decostadv ant agest opr oducer sand consumer s t hr ough what ar e cal l ed aggl omer at i on economi es. Aggl omer at i on economi escomei nt wof or ms.Ur bani zat i oneconomi esar eef f ect sassoci at edwi t ht he gener algr owt h ofa concent r at ed geogr aphi cr egi on.Local i zat i on economi es ar e ef f ect scapt ur edbypar t i cul arsect or soft heeconomy ,suchasf i nanceoraut omobi l es, ast heygr owwi t hi nanar ea. 1. 5. TheUr banGi ant i sm Pr obl em I nt hecaseofdev el opi ngcount r i es, t hemai nt r anspor t at i onr out esar eof t enal egacyof col oni al i sm.Theor i st soft hedependencyschoolhav ecompar edcol oni alt r anspor t at i on net wor kst odr ai nagesy st ems,emphasi zi ngeaseofext r act i onoft hecount r y ' snat ur al r esour ces.I nmanycases,t hecapi t alci t ywi l lbel ocat edneart heout l etoft hi ssy st em ont heseacost .Thi st y peoft r anspor t at i onsy st em i sal socal l eda" hubandspoke sy st em, "whi chi sespeci al l yv i si bl ewhent hecapi t alci t yi sl ocat edi nt hei nt er i oroft he count r y . 127 1. 5. 1.CausesofUr banGi ant i sm Whyhav ef i r stci t i es of t en swel l ed t o such a l ar ge mul t i pl e ofsecond ci t i es i n dev el opi ngcount r i es?Ov er al l ,ur bangi ant i sm pr obabl yr esul t sf r om acombi nat i onofa hubandspoket r anspor t at i onsy st em andt hel ocat i onoft hepol i t i calcapi t ali nt he l ar gestci t y ,t hus combi ni ng t he ef f ect s oft he ur ban hi er ar chy modelwi t ht he di f f er ent i at ed pl anemodel .Thi si sf ur t herr ei nf or ced byapol i t i calcul t ur eofr ent seeki ngandt hecapi t almar ketf ai l ur est hatmaket hecr eat i onofnewur bancent er sa t askt hatmar ket scannotcompl et e. TheUr banI nf or malSect or Asdi scussedi nmodul eone,amaj orf ocusofdev el opmentt heor yhasbeenont he dual i st i cnat ur eofdev el opi ngcount r i es' nat i onaleconomi est heexi st enceofamoder n ur bancapi t al i stsect orgear edt owar dcapi t al i nt ensi v e,l ar gescal epr oduct i onanda t r adi t i onal r ur al subsi st ence sect or gear ed t owar d l abor i nt ensi v e, smal l scal e pr oduct i on.Thei nf or malsect orcont i nuest o pl ayani mpor t antr ol ei ndev el opi ng count r i es,despi t edecadesofbeni gnnegl ectatbestandout r i ghthost i l i t yatwor st .I n manydev el opi ngcount r i es,abouthal foft heempl oy edur banpopul at i onwor ksi nt he i nf or mal sect or . Thei nf or malsect ori schar act er i zedbyal ar genumberofsmal l scal epr oduct i onand ser v i ceact i v i t i est hatar ei ndi v i dual l yorf ami l y ownedandusesi mpl e,l abor i nt ensi v e t echnol ogy .Theyt endt ooper at el i kemonopol i st i cal l ycompet i t i v ef i r mswi t heaseof ent r y ,excesscapaci t y ,andcompet i t i ondr i v i ngpr of i t s( i ncomes)downt ot heav er age suppl ypr i ceofl aborofpot ent i al newent r ant s. Mor eov er ,wor ker si nt hei nf or malsect ordo notenj oyt hemeasur eofpr ot ect i on af f or ded by t he f or malmoder n sect ori nt er ms ofj ob secur i t y ,decentwor ki ng condi t i ons,and ol dage pensi ons.Manywor ker s ent er i ng t hi s sect orar er ecent mi gr ant sf r om r ur alar easunabl et of i nd empl oy menti nt he f or malsect or .Thei r mot i v at i on i s of t en t o obt ai n suf f i ci enti ncome f orsur v i v al ,r el y i ng on t hei rown i ndi genous r esour ces t o cr eat e wor k.Si nce manymember s oft he househol d as possi bl ear ei nv ol v edi ni ncomegener at i ngact i v i t i es, i ncl udi ngwomenandchi l dr en, and 128 t heyof t enwor kv er yl onghour s. Al ar gef r act i oni nhabi tshackst hatt heyt hemsel v eshav ebui l ti nsl umsandsquat t er set t l ement s,whi chgener al l yl ackmi ni malpubl i cser v i cessuchasel ect r i ci t y ,wat er , dr ai nage,t r anspor t at i on,andeducat i onalandheal t hser v i ces.Ot her sar eev enl ess f or t unat e.Theyf i ndspor adi ct empor ar yempl oy menti nt hei nf or malsect orasday l abor er sandhawker s,butt hei ri ncomesar ei nsuf f i ci entt opr ov i deev ent hemost r udi ment ar yshel t er . 2. 2. 1.Ar gument si nf av orofUr banI nf or malSect or Ther ear esev er al ar gument st hatar emadei nf av orofpr omot i ngt hei nf or mal sect or : Fi r st ,scat t er edev i dencei ndi cat est hatt hei nf or malsect orgener at essur pl usesev en undert hecur r ent l yhost i l epol i cyenv i r onment , whi chdeni esi taccesst ot headv ant ages of f er edt ot hef or malsect or ,suchascr edi t ,f or ei gnexchange,andt axconcessi ons. Thust hei nf or malsect or ' ssur pl uscoul dpr ov i deani mpet ust ogr owt hi nt heur ban economy . Second, asar esul tofi t sl owcapi t al i nt ensi t y , onl yaf r act i onoft hecapi t al neededi nt he f or malsect ori sr equi r ed t o empl oy a wor keri nt he i nf or malsect or ,of f er i ng consi der abl esav i ngst odev el opi ngcount r i essoof t enpl aguedwi t hcapi t al shor t ages. Thi r d,bypr ov i di ngaccesst ot r ai ni ngandappr ent i ceshi psatsubst ant i al l yl owercost s t hant hatpr ov i dedbyf or mali nst i t ut i onsandt hef or malsect or ;t hei nf or malsect orcan pl ayani mpor t antr ol ei nt hef or mat i onofhumancapi t al . Four t h, t hei nf or malsect orgener at esdemandf orsemi ski l l edandunski l l edl aborwhose suppl yi si ncr easi ngi nbot hr el at i v eandabsol ut et er msandi sunl i kel yt obeabsor bed byt hef or mal sect orwi t hi t si ncr easi ngdemandsf oraski l l edl aborf or ce. Fi f t h, t hei nf or malsect ori smor el i kel yt oadoptappr opr i at et echnol ogi esandmakeuse ofl ocal r esour ces, al l owi ngf oramor eef f i ci ental l ocat i onofr esour ces. Si xt h, t hei nf or malsect orpl ay sani mpor t antr ol ei nr ecy cl i ngwast emat er i al s, engagi ng i nt hecol l ect i onofgoodsr angi ngf r om scr apmet al st oci gar et t ebut t s,manyofwhi ch 129 f i ndt hei rwayt ot hei ndust r i alsect ororpr ov i debasi ccommodi t i esf ort hepoor .Fi nal l y , pr omot i onoft hei nf or malsect orwoul densur eani ncr easeddi st r i but i onoft hebenef i t s ofdev el opmentt ot hepoor ,manyofwhom ar econcent r at edi nt hei nf or malsect or . Pr omot i onoft hei nf or mal sect ori snot , howev er , wi t houti t sdi sadv ant ages. Ur banUnempl oyment One oft he maj orconsequences oft he r api d ur bani zat i on pr ocess has been t he bur geoni ngsuppl yofj obseeker si nt obot ht hemoder n( f or mal )andi nf or malsect or sof t heur baneconomy .I nmanydev el opi ngcount r i es,t hesuppl yofwor ker sf arexceeds t he demand, t he r esul t bei ng ext r emel y hi gh r at es of unempl oy ment and under empl oy menti nur banar eas.Becauseamaj orcont r i but i ngf act ort obot hhi gh r at esofur bangr owt handhi ghr at esofunempl oy mentandunder empl oy menti sr ur al ur banmi gr at i on, i ti sessent i al t oi nv est i gat et hi si ssuei nsomedet ai l . Mi gr at i onandDevel opment Aswehav eseenear l i eri nt heuni t ,r ur al ur banmi gr at i onhasbeendr amat i c,andur ban dev el opmentpl ay sani mpor t antr ol ei neconomi cdev el opment .Rat esofr ur al ur ban mi gr at i oni ndev el opi ngcount r i eshav eexceededr at esofur banj obcr eat i onandt hus sur passedgr eat l yt heabsor pt i oncapaci t yofbot hi ndust r yandur bansoci alser v i ces. Mi gr at i ont oday , par t i cul ar l yt ot hel ar gestLDCci t i es, mustbeseenast hemaj orf act or cont r i but i ng t ot he ubi qui t ous phenomenon ofur ban sur pl us l abor ,a f or ce t hat cont i nuest oexacer bat eal r eadyser i ousur banunempl oy mentpr obl ems. Mi gr at i onwor sensr ur al ur banst r uct ur ali mbal ancesi nt wodi r ectway s.Fi r st ,ont he suppl ysi de, i nt er nalmi gr at i ondi spr opor t i onat el yi ncr easest hegr owt hr at eofur banj ob seeker sr el at i v et our banpopul at i ongr owt h, whi chi t sel fi sathi st or i cal l yunpr ecedent ed l ev el s,becauseoft hehi ghpr opor t i onofwel l educat edy oungpeopl ei nt hemi gr ant sy st em.Thei rpr esencet endst oswel lt heur banl aborsuppl ywhi l edepl et i ngt her ur al count r y si deofv al uabl ehumancapi t al .Second,ont hedemandsi de,ur banj obcr eat i on i sgener al l ymor edi f f i cul tandcost l yt oaccompl i sht hanr ur alj obcr eat i onbecauseof t heneedf orsubst ant i alcompl ement ar yr esour cei nput sf ormostj obsi nt hei ndust r i al sect or .Mor eov er , t hepr essur esofr i si ngur banwagesandcompul sor yempl oy eef r i nge benef i t si n combi nat i on wi t ht heunav ai l abi l i t yofappr opr i at e,mor el abor i nt ensi v e 130 pr oduct i ont echnol ogi esmeanst hatar i si ngshar eofmoder nsect orout putgr owt hi s account edf orbyi ncr easesi nl aborpr oduct i v i t y .Toget hert hi sr api dsuppl yi ncr easeand l aggi ngdemandgr owt ht endt oconv er tashor t r unpr obl em ofr esour cei mbal ances i nt oal ongr unsi t uat i onofchr oni candr i si ngur bansur pl usl abor Towar danEconomi cTheor yofRur al Ur banMi gr at i on Theeconomi cdev el opmentofWest er nEur opeandt heUni t edSt at eswascl osel y associ at edwi t ht hemov ementofl aborf r om r ur alt our banar eas.Fort hemostpar t , wi t har ur alsect ordomi nat edbyagr i cul t ur alact i v i t i esandanur bansect orf ocusi ngon i ndust r i al i zat i on, ov er al leconomi cdev el opmenti nt hesecount r i eswaschar act er i zedby t hegr adualr eal l ocat i onofl aboroutofagr i cul t ur eandi nt oi ndust r yt hr oughr ur al ur ban mi gr at i on,bot hi nt er nalandi nt er nat i onal .Ur bani zat i onandi ndust r i al i zat i onwer ei n essencesy nony mous. Butt heov er whel mi ngev i denceoft hepastsev er aldecades,whendev el opi ngnat i ons wi t nessedamassi v emi gr at i onoft hei rr ur alpopul at i onsi nt our banar easdespi t er i si ng l ev el sofur banunempl oy mentandunder empl oy ment ,l essenst hev al i di t yoft heLewi s t wosect ormodelofdev el opment .Anexpl anat i onoft hephenomenon,aswel las pol i ci est oaddr esst her esul t i ngpr obl emsmustbesoughtel sewher e.Asar esul tt he Todar omi gr at i onmodel wasdev el oped 2. 2. 2.Fi v ePol i cyI mpl i cat i onsoft heModel Al t hought heTodar ot heor ymi ghtatf i r stseem t odev al uet hecr i t i cali mpor t anceof r ur al ur banmi gr at i onbypor t r ay i ngi tasanadj ust mentmechani sm bywhi chwor ker s al l ocat et hemsel v esbet weenr ur alandur banl abormar ket s,i tdoeshav ei mpor t ant pol i cyi mpl i cat i onsf ordev el opmentst r at egywi t hr egar dt owagesandi ncomes,r ur al dev el opment , andi ndust r i al i zat i on. Fi r st ,i mbal ancesi nur banr ur alempl oy mentoppor t uni t i escausedbyt heur banbi as, par t i cul ar l yf i r st ci t y bi as,ofdev el opmentst r at egi es mustbe r educed.Because mi gr ant sar eassumedt or espondt odi f f er ent i al si nexpect edi ncomes,i ti sv i t al l y i mpor t antt hati mbal ancesbet weeneconomi coppor t uni t i esi nr ur alandur bansect or s bemi ni mi zed.Per mi t t i ngur banwager at est or i seatagr eat erpacet hanav er ager ur al 131 i ncomeswi l lst i mul at ef ur t herr ur al ur banmi gr at i oni nspi t eofr i si ngl ev el sofur ban unempl oy ment .Thi sheav yi nf l uxofpeopl ei nt our banar easnotonl ygi v esr i set o soci oeconomi cpr obl emsi nt heci t i esbutmayal soev ent ual l ycr eat epr obl emsofl abor shor t agesi nr ur alar eas,especi al l ydur i ngt hebusyseasons.Thesesoci alcost smay exceedt hepr i v at ebenef i t sofmi gr at i on. Second,ur banj obcr eat i oni sani nsuf f i ci entsol ut i onf ort heur banunempl oy ment pr obl em. Forev er ynew j obcr eat ed,t woort hr eemi gr ant swhower epr oduct i v el y occupi edi nr ur alar easmaycomet ot heci t y .Henceapol i cydesi gnedt or educeur ban unempl oy mentmayl eadnotonl yt ohi gherl ev el sofur banunempl oy mentbutal sot o l owerl ev el s ofagr i cul t ur alout putdue t oi nduced mi gr at i on.Thi r d,i ndi scr i mi nat e educat i onalexpansi onwi l ll eadt of ur t hermi gr at i onandunempl oy ment .Four t h,wage subsi di esandt r adi t i onal scar ci t yf act orpr i ci ngcanbecount er pr oduct i v e. Pol i ci esofr ur aldev el opmentar ecr uci alt ot hi sai m.Manyi nf or medobser v er sagr eeon t hecent r ali mpor t anceofr ur alandagr i cul t ur aldev el opmenti ft heur banunempl oy ment pr obl em i st obesol v ed.Mostpr oposal scal lf ort her est or at i onofapr operbal ance bet weenr ur alandur bani ncomesandf orchangesi ngov er nmentpol i ci est hatcur r ent l y gi v edev el opmentpr ogr amsast r ongbi ast owar dt heur bani ndust r i alsect or( e. g. , pol i ci esi nt hepr ov i si onofheal t h,educat i on,andsoci alser v i ces) .Concept ual l y ,i tmay beusef ult ot hi nkofci t i esandt hei rsur r oundi ngr ur alar easasi nt egr at edsy st ems. Ther ear esi gni f i cantcompl ement ar i t i esbet weent ownandcount r y .Agr i cul t ur aland r awmat er i al sgr ownandext r act edi nr ur al ar easar ei nput sf orur bani ndust r y . Al l i nal l , t heTodar omi gr at i onmodel hasf ourbasi cchar act er i st i cs: Mi gr at i on i s st i mul at ed pr i mar i l y by r at i onaleconomi c consi der at i ons ofr el at i v e benef i t sandcost s, most l yf i nanci al butal sopsy chol ogi cal . Thedeci si ont omi gr at edependsonexpect edr at hert hanact ualur banr ur alr eal wage di f f er ent i al swher et heexpect eddi f f er ent i ali sdet er mi nedbyt hei nt er act i onoft wo v ar i abl es,t heact ualur banr ur alwagedi f f er ent i alandt hepr obabi l i t yofsuccessf ul l y obt ai ni ngempl oy menti nt heur bansect or . UNI TFOUR 132 AGRI CULTUREANDECONOMI CDEVELOPMENT Thi suni ti saboutagr i cul t ur eandeconomi cdev el opment .Agr i cul t ur eanddev el opment ofanat i oni ngener alandr ur aldev el opmenti npar t i cul arar ehi ghl yi nt er connect ed.Wel l ov er3. 3bi l l i onpeopl el i v edi nr ur alar easi n2003.Peopl el i v i ngi nt hecount r y si de compr i seconsi der abl ymor et hanhal ft hepopul at i onofdev el opi ngcount r i es.I nAf r i ca, t her at i osar emuchhi gher , wi t hmostcount r i eshav i ngr ur aldwel l er si nexcessoft hr eequar t er soft het ot alpopul at i on.Ov ert wot hi r dsoft hewor l d’ spoor estpeopl ear eal so l ocat edi nr ur alar easandengagedpr i mar i l yi nsubsi st enceagr i cul t ur e.I ti sest i mat ed t hatmor et han800mi l l i onoft hesepeopl edonothav eenoughf oodt omeett hei rbasi c nut r i t i onal needs.Thei rbehav i ormayhav eof t enseemedi r r at i onal t omanyobser v er s.I f dev el opmenti st ot akepl aceandbecomesel f sust ai ni ng, i twi l lhav et oi ncl udet her ur al ar eai ngener alandt heagr i cul t ur alsect ori npar t i cul ar .Si xmai nquest i ons,t her ef or e, needt o beaskedaboutagr i cul t ur eandr ur aldev el opmentasi tr el at est o ov er al l nat i onal dev el opment : 1.Howcant ot alagr i cul t ur alout putandpr oduct i v i t ypercapi t abei ncr easedi n amannert hatwi l ldi r ect l ybenef i tt heav er agesmal lf ar merandt hel andl ess r ur aldwel l er swhi l epr ov i di ngasuf f i ci entf oodsur pl ust osuppor tagr owi ng ur ban, i ndust r i al sect or ? 2.Whati st hepr ocessbywhi cht r adi t i onal l owpr oduct i v i t ypeasantf ar msar e t r ansf or medi nt ohi ghpr oduct i v i t ycommer ci al ent er pr i ses? 3.Whent r adi t i onalf ami l yf ar mer sandpeasantcul t i v at or sr esi stchange,i s t hei rbehav i orst ubbor nandi r r at i onal ,orar et heyact i ngr at i onal l ywi t hi n t hecont extoft hei rpar t i cul areconomi cenv i r onment ? 4.Ar eeconomi candpr i cei ncent i v essuf f i ci entt o el i ci tout puti ncr eases amongpeasantagr i cul t ur al i st s,orar ei nst i t ut i onalandst r uct ur alchanges i nr ur al f ar mi ngsy st emsal sor equi r ed? 5.I sr ai si ngagr i cul t ur alpr oduct i v i t ysuf f i ci entt oi mpr ov er ur all i f e,ormust t her e be concomi t ant of f f ar m empl oy ment cr eat i on al ong wi t h i mpr ov ement si neducat i onal ,medi cal ,andot hersoci alser v i ces?I not her wor ds,whatdo we mean byr ur aldev el opment ,and how can i tbe 133 achi ev ed? TheSt r uct ur eofAgr ar i anSy st emsi nt heDev el opi ngWor l d Wor l dagr i cul t ur ecompr i sest wodi st i nctt y pesoff ar mi ng:( 1)t hehi ghl yef f i ci ent agr i cul t ur eoft hedev el opedcount r i es,wher esubst ant i alpr oduct i v ecapaci t yand hi ghout putperwor kerper mi tav er ysmal lnumberoff ar mer st of eedent i r enat i ons, and( 2)t hei nef f i ci entandl owpr oduct i v i t yagr i cul t ur eofdev el opi ngcount r i es, wher e i nmanyi nst ancest heagr i cul t ur alsect orcanbar el ysust ai nt hef ar m popul at i on,l et al one t he qui ckl yi ncr easi ng ur ban popul at i on,ev en,ata mi ni mum l ev elof subsi st ence.Thegapbet weent het wot y pesofagr i cul t ur ei si mmense. 4. 1. 1. TheSt r uct ur eofAgr ar i anSy st emsi nLat i nAmer i caandAsi a: Si mi l ar i t i esanddi f f er ences: Bot ht heLat i nAmer i canandAsi anpeasanti sar ur alcul t i v at orwhosepr i meconcer n i ssur v i v al .Ear nssubsi st encei ncomebyt i l l i ngi nadequat epi eceofl andr ent edf r om orpawnedt oal andl or dormoney l ender ,orbysel l i nghi sl abourf orsubst andar d wagest oacommer ci al agr i cul t ur al ent er pr i se.Empl oy st echni quesr at i onal l yscal ed t ohi sl ev el ofdi sposabl ecapi t al : o humanandani mal powerr at hert hanmechani zedequi pment ; o excr ementr at hert hanchemi cal f er t i l i zer s; o t r adi t i onal cr opsandseedsr at hert hanexper i ment al cul t i v at i on 4. 1. 1. 3TheSt r uct ur eofAgr ar i anSy st emsi nAf r i ca Asi nAsi aandLat i nAmer i ca,subsi st encef ar mi ngonsmal lpl ot sofl andi st heway ofl i f ef ort he v astmaj or i t yofAf r i can peopl e.Howev er ,t he or gani zat i on and st r uct ur e ofAf r i can agr i cul t ur alsy st ems di f f ermar kedl yf r om t hose f ound i n cont empor ar yAsi aorLat i nAmer i ca.Thegr eatmaj or i t yoff ar mf ami l i esi nt r opi cal Af r i capl ant hei rout putpr i mar i l yf ort hei rownsubsi st ence.Si ncet hebasi cv ar i abl e i nputi n Af r i can agr i cul t ur ei sf ar m f ami l yand v i l l agel abor ,Af r i can agr i cul t ur e sy st ems ar e domi nat ed byt hr ee maj orchar act er i st i cs:( 1)t he i mpor t ance of subsi st encef ar mi ngi nt hev i l l agecommuni t y ;( 2)t heexi st enceofsome( t hough r api dl ydi mi ni shi ng)l andi nexcessofi mmedi at er equi r ement s,whi chper mi t sa 134 gener al pr act i ceofshi f t i ngcul t i v at i onandr educest hev al ueofl andowner shi pasan i nst r umentofeconomi candpol i t i calpower ;and( 3)t her i ght sofeachf ami l y( bot h nucl earandext ended)i nav i l l aget ohav eaccesst ol andandwat eri nt hei mmedi at e t er r i t or i alv i ci ni t y ,excl udi ngf r om suchaccessusebyf ami l i est hatdonotbel ongt o t hecommuni t yev ent hought heymaybeoft hesamet r i be. Thel owpr oduct i v i t ysubsi st encef ar mi ngchar act er i st i cofmostt r adi t i onalAf r i can agr i cul t ur er esul t sf r om acombi nat i onoft hr eehi st or i calf or cesr est r i ct i ng t he gr owt hofout put : 1. I nspi t eoft heexi st enceofsomeunusedandpot ent i al l ycul t i v abl el and,onl y smal lar eascanbepl ant edandweededbyt hef ar mf ami l yatat i mewheni tuses onl yt r adi t i onal t ool s. 2.Gi v ent hel i mi t edamountofl andt hataf ar mf ami l ycancul t i v at ei nt hecont extof at r adi t i onalt echnol ogyandt heuseofpr i mi t i v et ool s,t hesesmal lar east endt o bei nt ensi v el ycul t i v at ed. 3.Labori sscar cedur i ngt hebusi estpar toft hegr owi ngseason, pl ant i ngand weedi ngt i mes.Atot hert i mes, muchoft hel abori sunder empl oy ed. Thenetr esul toft heset hr eef or ceshadbeenar el at i v el yconst antl ev el ofagr i cul t ur al t ot al out putandl aborpr oduct i v i t yt hr oughoutmuchofAf r i ca. Ofal l t hemaj orr egi onsof t hewor l d, Af r i cahassuf f er edt hemostf r om i t si nabi l i t yt oexpandf oodpr oduct i onata suf f i ci entpacet okeepupwi t hi t sr api dpopul at i ongr owt h. TheEconomi csofAgr i cul t ur al Dev el opment Forexposi t or yconv eni ence,wecani dent i f yt hr eebr oadst agesi nt heev ol ut i onof agr i cul t ur alpr oduct i on.Thef i r standmostpr i mi t i v ei st hepur e,l owpr oduct i v i t y , most l ysubsi st encel ev elpeasantf ar m.Thesecondst agei swhatmi ghtbecal l ed di v er si f i edormi xedf ami l yagr i cul t ur e,wher epar toft hepr oducei sgr ownf or consumpt i onandpar tf orsal et ot hecommer ci alsect or .Thet hi r dst ager epr esent s t hemoder nf ar m,excl usi v el yengagedi nhi ghpr oduct i v i t yspeci al i zedagr i cul t ur e gear edt ot hecommer ci al mar ket . 4. 1. 2.Subs i st enceFar mi ng:Ri skAv er si on, Uncer t ai nt y , andSur v i v al 135 On t he cl assi c peasantsubsi st ence f ar m,mostout puti s pr oduced f orf ami l y consumpt i on,andaf ewst apl ef oods( usual l yi ncl udi ngwheat ,bar l ey ,sor ghum,r i ce,or cor n)ar et hechi efsour cesofnut r i t i on. Out putandpr oduct i v i t yar el ow,andonl yt he si mpl estt r adi t i onalmet hodsandt ool sar eused.Capi t ali nv est menti smi ni mal ;l and andl aborar et hepr i nci palf act or sofpr oduct i on.Thel aw ofdi mi ni shi ngr et ur nsi si n oper at i onasmor el abori sappl i edt oshr i nki ng( orshi f t i ng)par cel sofl and. Thef ai l ur eoft her ai ns,t heappr opr i at i onofhi sl and,andt heappear anceoft he money l endert ocol l ectout st andi ngdebt sar et hebanesoft hepeasant ' sexi st enceand causehi mt of earf orhi ssur v i v al . Labori sunder empl oy edf ormostoft hey ear , al t houghwor ker smaybef ul l yoccupi edatseasonalpeakper i odssuchaspl ant i ngand har v est .Thepeasantusual l ycul t i v at esonl yasmuchl andashi sf ami l ycanmanage wi t houtt heneedf orhi r edl abor ,al t houghmanypeasantf ar mer si nt er mi t t ent l yempl oy oneort wol andl essl abor er s. Theenv i r onmenti shar shandst at i c:Technol ogi call i mi t at i ons, r i gi dsoci ali nst i t ut i ons, andf r agment edmar ket sandcommuni cat i onnet wor ksbet weenr ur alar easandur ban cent er st end t o di scour age hi gherl ev el s ofpr oduct i on.Anycash i ncome t hati s gener at edcomesmost l yf r om nonf ar m wagel abor . TheTr ansi t i ont oMi xedandDi v er si f i edFar mi ng I ti snei t herr eal i st i cnordesi r abl et ot hi nkofi nst ant l yt r ansf or mi ngat r adi t i onal agr ar i ansy st em t hathaspr ev ai l edf ormanygener at i onsi nt oahi ghl yspeci al i zed commer ci alf ar mi ngsy st em.Di v er si f i edormi xedf ar mi ngt her ef or er epr esent sa l ogi cali nt er medi at e st ep,i nt he t r ansi t i on f r om subsi st ence t o speci al i zed pr oduct i on. I nt hi sst age,t hest apl ecr opnol ongerdomi nat esf ar m out put ,andnewcashcr ops suchasf r ui t s,v eget abl es,cof f ee,t ea,andpy r et hr um ar eest abl i shed,t oget herwi t h si mpl eani malhusbandr y .Thesenewact i v i t i escant akeupt henor malsl acki nf ar m wor kl oads, dur i ngt i mesoft hey earwhendi sgui sedunempl oy menti spr ev al ent .Thi s i sespeci al l ydesi r abl ei nmanydev el opi ngnat i onswher er ur all abori sabundant l y av ai l abl ef orbet t erandmor eef f i ci entuse. 136 Thesuccessorf ai l ur eofef f or t st ot r ansf or mt r adi t i onalagr i cul t ur ewi l ldependnot onl yont hef ar mer ' sabi l i t yand ski l li nr ai si ng hi spr oduct i v i t ybut ,ev enmor e i mpor t ant ,ont hesoci al ,commer ci al ,andi nst i t ut i onalcondi t i onsunderwhi chhe mustf unct i on.I fhecanhav er easonabl eandr el i abl eaccesst ocr edi t ,f er t i l i z er , wat er , cr opi nf or mat i on, andmar ket i ngf aci l i t i es; i fher ecei v esaf ai rmar ketpr i cef or hi sout put ;andi fhecanf eelsecur et hatheandhi sf ami l ywi l lbet hepr i mar y benef i ci ar i esofanyi mpr ov ement s, t her ei snor easont oassumet hatt het r adi t i onal f ar merwi l l notr espondt onewoppor t uni t i est oi mpr ov ehi sst andar dofl i v i ng. Ev i dencef r om suchdi v er secount r i esasCol ombi a,Mexi co,Ni ger i a,Ghana,Keny a, I ndi a,Paki st an,Thai l and,andt hePhi l i ppi nesshowst hatunderpr opercondi t i ons, smal lf ar mer sar er esponsi v et opr i cei ncent i v esandeconomi coppor t uni t i esand wi l lmaker adi calchangesi nwhatt heypr oduceandhow t heypr oducei t .Lackof i nnov at i oni nagr i cul t ur e,aswehav eseen,i susual l yduenott opoormot i v at i onor f earofchangebutt oi nadequat eorunpr of i t abl eoppor t uni t i es. Thr oughoutmuchoft hedev el opi ngwor l d,agr i cul t ur ei sst i l li nt hi ssubsi st ence st age.Buti nspi t eoft her el at i v ebackwar dnessofpr oduct i ont echnol ogi esandt he mi sgui dedconv i ct i onsofsomef or ei gner swhoat t r i but et hepeasant s' r esi st ancet o changeasasi gnofi ncompet enceori r r at i onal i t y ,t hef actr emai nst hatgi v ent he st at i cnat ur eoft he Fr om Di v er gencet oSpeci al i zat i on:Moder nCommer ci alFar mi ng Thespeci al i zedf ar mr epr esent st hef i nal andmostadv ancedst ageofi ndi v i dual hol di ng i nami xedmar keteconomy .I ti st hemostpr ev al entt y peoff ar mi ngi nadv anced i ndust r i alnat i ons.I thasev ol v edi nr esponset oandpar al l elwi t hdev el opmenti not her ar easoft henat i onal economy .Gener al r i sesi nl i v i ngst andar ds, bi ol ogi cal andt echni cal pr ogr ess,andt heexpansi onofnat i onalandi nt er nat i onalmar ket shav epr ov i dedt he mai ni mpet usf ori t semer genceandgr owt h. I nspeci al i zedf ar mi ng,pur ecommer ci alpr of i tbecomest hecr i t er i onofsuccess,and maxi mum per hect ar ey i el dsder i v ed f r om sy nt het i c( i r r i gat i on,f er t i l i zer ,pest i ci des, hy br i dseeds, et c. )andnat ur al r esour cesbecomet heobj ectoff ar m act i v i t y .Pr oduct i on, 137 i nshor t ,i sent i r el yf ort hemar ket .Speci al i zedf ar msv ar yi nbot hsi zeandf unct i on. Theyr angef r om i nt ensi v el ycul t i v at edf r ui tandv eget abl ef ar mst ot hev astwheatand cor nf i el dsofNor t hAmer i ca.I nmostcases,sophi st i cat edl abor sav i ngmechani cal equi pment ,r angi ngf r om huget r act or sandcombi nehar v est er st oai r bor nespr ay i ng t echni ques, per mi t sasi ngl ef ami l yt ocul t i v at emanyt housandsofhect ar esofl and. Thecommonf eat ur esofal lspeci al i zedf ar ms,t her ef or e,ar et hei remphasi sont he cul t i v at i onofonepar t i cul arcr op,t hei ruseofcapi t al i nt ensi v eandi nmanycases l abor sav i ngt echni quesofpr oduct i on,andt hei rr el i anceoneconomi esofscal et o r educeuni tcost sandmaxi mi zepr of i t s. Towar daSt r at egyofAgr i cul t ur alandRur alDevel opment :SomeMai n Requi r ement s I ft hemaj orobj ect i v eofagr i cul t ur alandr ur aldev el opmenti ndev el opi ngnat i onsi s t hepr ogr essi v ei mpr ov ementi nr ur all ev el sofl i v i ngachi ev edpr i mar i l yt hr ough i ncr easesi nsmal l f ar mi ncomes,out put ,andpr oduct i v i t y ,i ti si mpor t antt oi dent i f y t hepr i nci palsour cesofagr i cul t ur alpr ogr essandt hebasi ccondi t i onsessent i alt o i t sachi ev ement .Thesear enecessar i l yi nt er r el at ed,butf orpur posesofdescr i pt i on wemaysepar at et hemandf ur t herdi v i deeachi nt ot hr eecomponent s: 4. 1. 3.Sour cesofsmal l scal eagr i cul t ur alpr ogr essi ncl ude: Technol ogi calchangeandi nnov at i onappr opr i at egov er nmenteconomi cpol i ci es Suppor t i v e soci al i nst i t ut i ons Condi t i ons f or Gener al Rur al Adv ancement : Moder ni zi ngf ar m st r uct ur est omeetr i si ngf ooddemandscr eat i nganef f ect i v e suppor t i ngsy st em changi ngt her ur alenv i r onmentt oi mpr ov el ev el sofl i v i ng.Letus l ookateachoft hesesi xi nt er r el at edcomponent s. 4. 2. Technol ogyandI nnov at i on Two maj or sour ces of t echnol ogi cali nnov at i on can i ncr ease f ar m y i el ds. Unf or t unat el y ,bot hhav esomewhatpr obl emat i ci mpl i cat i onsf orLDCagr i cul t ur al dev el opment .Thef i r sti st hei nt r oduct i onofmechani zedagr i cul t ur et or epl acel abor . Thei nt r oduct i onofl aborsav i ngmachi ner ycanhav eadr amat i cef f ectont he 138 v ol umeofout putperwor ker ;especi al l ywher el andi sext ensi v el ycul t i v at edand l abori sscar ce.Forexampl e,onemanoper at i ngahugecombi nehar v est ercan accompl i sh i n a si ngl e hourwhatwoul dr equi r e hundr eds ofwor ker s usi ng t r adi t i onal met hods. Buti nt her ur alar easofmostdev el opi ngnat i ons,wher el andpar cel sar esmal l , capi t ali sscar ce,andl abori sabundant ,t hei nt r oduct i onofheav i l ymechani zed t echni ques i s notonl y of t en i l l sui t ed t ot he phy si calenv i r onmentbut ,mor e i mpor t ant ,of t enal sohast heef f ectofcr eat i ngmor er ur alunempl oy mentwi t hout necessar i l yl ower i ngper uni tcost soff oodpr oduct i on.Thesecondmaj orsour ces ar e bi ol ogi cal( hy br i d seeds) ,wat ercont r ol( i r r i gat i on) ,and chemi cal( f er t i l i zer , pest i ci des, i nsect i ci des, et c. )i nnov at i ons.Theyar el andaugment i ng; CHAPTERFI VE I nt er nat i onalt r adeandeconomi cdev el opment :t het r adepol i cydebat e andi ndust r i al i zat i on Ov ert he pastsev er aldecades,t he economi es oft he wor l d hav e become i ncr easi ngl yl i nked,t hr oughexpandedi nt er nat i onalt r adei nser v i cesaswel las pr i mar y and manuf act ur ed goods, t hr ough por t f ol i o i nv est ment s such as i nt er nat i onall oansandpur chasesofst ock,andt hr oughdi r ectf or ei gni nv est ment , especi al l yont hepar tofl ar gemul t i nat i onalcor por at i ons.Att hesamet i me,f or ei gn ai dhasi ncr easedv er yl i t t l eandi ndeedhasbecomedwar f edbyt henowmuchl ar ger f l owsofpr i v at ecapi t al .Thesel i nkageshav ehadamar kedef f ectont hedev el opi ng wor l d. Tr adeTheor yandDevel opmentExper i ence Basi cQuest i onsaboutTr adeandDev el opment Ourobj ect i v ei nt hi ssect i oni st of ocusont r adi t i onalandmor econt empor ar y t heor i esofi nt er nat i onalt r adei nt hecont extoff i v ebasi ct hemesorquest i onsof par t i cul ari mpor t ancet odev el opi ngnat i ons.( 1) Howdoesi nt er nat i onalt r adeaf f ect t her at e,st r uct ur e,andchar act erofLDC’ seconomi cgr owt h?( 2) How doest r ade 139 al t ert hedi st r i but i onofi ncomeandweal t hwi t hi nacount r yandamongdi f f er ent count r i es?( 3)Howar et hegai nsandl ossesdi st r i but ed, andwhobenef i t s?( 4) Under whatcondi t i onscant r adehel pLDCsachi ev et hei rdev el opmentobj ect i v es?Can LDCsbyt hei rownact i onsdet er mi nehowmucht heyt r ade? ( 5)I nt hel i ghtofpastexper i enceandpr ospect i v ej udgment , shoul dLDCsadoptan out war dl ooki ngpol i cy( f r eert r ade, expandedf l owsofcapi t alandhumanr esour ces, i deasandt echnol ogy , et c. )orani nwar dl ooki ngone( pr ot ect i oni sm i nt hei nt er estof sel f r el i ance) ,orshoul dt heypur suesomecombi nat i onofbot h,f orexampl e,i nt he f or m ofr egi onaleconomi ccooper at i on?Whatar et hear gument sf orandagai nst t heseal t er nat i v et r adest r at egi esf ordev el opment ?Thus,cl ear l yt heanswer sor suggest edanswer st ot hesef i v equest i onswi l lnotbeuni f or m t hr oughoutt he di v er seeconomi esoft hedev el opi ngwor l d. I mpor t anceofExpor t st oDi f f er entDevel opi ngNat i ons Dev el opi ng count r i es ar e gener al l y mor e dependenton t r ade t han dev el oped count r i esar e.Thi si sshowncl ear l yi nt hecaseoft r adi t i onal l yexpor t or i ent edJapan, whoseex por t samountt or oughl y10%ofGDP, wher easLDCswi t hsomewhatl ar ger popul at i onssuchasI ndonesi a, Bangl adesh, andNi ger i aexpor taf arhi ghershar eof out put . Whi l et ot alexpor t sandt heshar eofmanuf act ur esi nmer chandi seexpor t shav e been r i si ng f ormanydev el opi ng count r i es,i ti si mpor t antt o keep t hi sr i sei n per spect i v e.A f ew Newl yI ndust r i al i zed Count r i es st i l lcommand a domi nant posi t i oni ndev el opi ngcount r yex por t s.Forexampl e,i n2000,Sout hKor eaal one expor t edmor et hanal lofSout hAsi aandsubSahar anAf r i cacombi ned.AndSout h Kor eaandTai want oget herexpor t edmor emanuf act ur edgoodsi n2000t hant he ent i r er egi onsofLat i nAmer i ca,t heCar i bbean,t heMi ddl eEast ,Nor t hAf r i ca,Sout h Asi a, andsubSahar anAf r i cacombi ned. 2. 1. 3.TheTr adi t i onal Theor yofI nt er nat i onalTr ade Whatdet er mi neswhi chgoodsar et r adedandwhysomecount r i espr oducesome 140 t hi ngswhi l eot her spr oducedi f f er entt hi ngs?Theanswerl i esi nt hei nt er nat i onal di f f er encesi n cost sofpr oduct i on and pr i cesofdi f f er entpr oduct s.Thus,t he conceptofabsol ut eand/ orr el at i v ecostandpr i cedi f f er encesi sbasi ct ot het heor y ofi nt er nat i onalt r ade.Themai ni deaofAbsol ut e&Compar at i v eadv ant agel i eson t henot i onofspeci al i zat i onandt r ade.I ft hecount r ypr oduceagoodf orwhi chi thas anabsol ut eand/ orcompar at i v eadv ant ageov eranot hercount r yandt r adesi twi t h t heot hercount r y , t het ot al pot ent i al consumpt i oni nbot hcount r i escanbei ncr eased bey ondwhati spossi bl ewi t houtt r ade. TheSmi t h’ st heor yst at edt hatweal t hofnat i onsdependont hegoodsandser v i ces av ai l abl et ot hei rci t i zens, r at hert hant hei rgol dr eser v es. Tr adest i mul at eseconomi cgr owt h:I tenl ar gesacount r y ’ sconsumpt i oncapaci t i es, i ncr easeswor l dout put ,andpr ov i desaccesst oscar cer esour ces.Tr adepr omot es i nt er nat i onalanddomest i cequal i t ybyequal i zi ngf act orpr i ces,r ai si ngr eali ncomes oft r adi ngcount r i es,&maki ngef f i ci entuseofeachnat i on’ sr esour ceendowment s. E. g.Byr ai si ngr el at i v ewagesi nl abor abundantcount r i esandl ower i ngt hem i nl abor scar cecount r i es. 2. 1. 4.Bal anceofPay ment s&Macr oeconomi cst abi l i zat i on Thebal anceofpay ment s( BoP)i sasummar yst at ementi nwhi ch, i npr i nci pl e, al l t he economi ct r ansact i onsoft her esi dent sofanat i onwi t ht her esi dent sofal lot her nat i onsar er ecor deddur i ngapar t i cul arper i odoft i me, usual l yacal endary ear .Thus, BoPi st hef l ow ofgoods,ser v i ces,gi f t s,andasset sbet weent her esi dent sofa nat i onandt her esi dent sofot hernat i onsdur i ngapar t i cul arper i odoft i me, usual l ya cal endary ear .Thet echni quesofr ecor di ngt r ansact i onsunderDebi tandCr edi ti n t hebal anceofpay ment . Anyt r ansact i ont hatsuppl i est hecount r y ’ scur r encyi nt hef or ei gnexchangemar ket ( t hemar keti nwhi chcur r enci esofdi f f er entcount r i esar eexchanged)i sr ecor dedas adebi t .Forexampl e, aU. S.r et ai l erwant st obuyJapaneset el ev i si onset ssot hathe cansel lt hem i nhi sst or esi nt heUni t edSt at es.Heneedt osuppl ydol l art oFX.Any 141 t r ansact i ont hatcr eat esademandf ort hecount r y ’ scur r encyi nt hef or ei gnexchange mar keti sr ecor dedasacr edi t . I nt er nat i onalt r ansact i onsar ecl assi f i edascr edi t sordebi t s.Cr edi tt r ansact i onsar e t hoset hati nv ol v et her ecei ptofpay ment sf r om f or ei gner s.Debi tt r ansact i onsar e t hoset hati nv ol v et hemaki ngofpay ment st of or ei gner s. TheBoPhast hr eemaj oraccount sunderwhi chdi f f er entt r ansact i onsar er ecor ded: 1)Cur r entAccount( CA) :hasmanycomponent s,suchast r adei ngoods,t r adei n ser v i ces,debtser v i cepay ment s,i ncome&netuni l at er alt r ansf er s.Thebal anceof cur r entaccountt el l susi facount r yhasadef i ci torasur pl us.I ft her ei sdef i ci tor sur pl us, doest hatmeant heeconomyi sweakorst r ong?Notnecessar i l y . At r adedef i ci toccur swhenacount r yi mpor t smor et hanexpor t s.Thi scoul dbe i ndi cat i onofl essr ev enuebei nggener at edandhencer esul t i ngi nl ow st andar dof l i v i ngi nagi v eneconomy .I tcoul dal sobeasi gnofeconomi cexpansi on.At r ade sur pl usoccur swhenacount r ysel l smor et hani tbuy sf r om f or ei gnmar ket s. 2)Capi t alAccount : i ncl udesal l pay ment sr el at edt ot hepur chaseandsal eofasset s and t o bor r owi ng and l endi ng act i v i t i es.I t smaj orcomponent sar e out f l ow of domest i ccapi t alandi nf l ow off or ei gncapi t al .Capi t alaccountcl assi f i edi nt ot wo capi t alout f l ow ( domest i cpur chasesoff or ei gnasset s)andcapi t ali nf l ow ( f or ei gn pur chaseofdomest i ccur r ency ) . END 142 143
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