ECON315 Final Exam Notes Stefania Scandizzo University of Maryland 1 29 ECONOMIC DEVELOPMENT Key Concepts o Growth o Development o Inequality o Poverty Growth a change in income Positive Why are things this way Normative What can we do about it Development how does that fit in Human Development process of enlarging peoples choices providing Poverty pronounced deprivation in well being opportunities Challenge of development to improve the quality of life MEASURING GROWTH DEVELOPMENT Track progress over time and make cross country comparisons Growth rise in real national income per capita Development broad improvement in quality of life GDP sum of the value of finished goods and services produced within a country in a given year at market prices GND produced by nationals Difference between GDP and GNP o Remittances ex make money in U S and sending money back to Mexico GDP but not GNP o Multinationals included Problems using GDP GNP as measure of growth o Calculated at market prices so if activity is not on the market it is not o Large agricultural sector where farmers grow crops and eat them themselves They are not sold on the market so not counted o Non market activities not included in GDP When included might appear as a large jump in growth but this is not the case Household production childcare Farmers agriculture Economic Bads Non traded goods Pollution crime illegal goods Housekeeping taxis public transportation nails UN International Comparison Program o Gives a set of international prices in common currency GDP PPP purchasing power parity o Trading with currency at same prices GDP per capita GDP Population Growth rate g GDP1 GDP0 GDP0 Doubling time amount of time needed to double income 70 g 2 3 MEASURING ECONOMIC GROWTH Growth rise in real income per capita o g GDP pop income per capita standard of living Doubling times o Given average annual growth rate of years required to double income o g GDP g pop Economic growth is NECESSARY but NOT SUFFICIENT for development Economic growth is NECESSARY redistribution is not enough But not sufficient for increase in standard of living and quality of life of majority of a country s population Why 1 2 Government may not pursue growth to increase welfare but seek political power Inequality and glory 3 y consumption investment Human Development Indicator HDI 0 1 3 dimensions of development 1 Long healthy life life expectancy 2 Knowledge years of schooling for children 3 Standard of living g GNP pop a Average years of schooling required by adults and expected 2 5 MILLENIUM DEVELOPMENT GOALS Goals 1 Eradicate extreme poverty and hunger 2 Achieve universal primary education 3 Promote gender equality and empower women 4 Reduce child mortality 5 6 Combat HIV AIDS and other diseases malaria 7 Environmental sustainability 8 Improve maternal health International cooperation Develop a global partnership for development Criticisms 1 MDGs not ambitious enough 2 Goals aren t prioritized 3 Targets are treated individually w o consideration for COMPLMENTARIES between them 4 Why 2015 5 Goal 1 doesn t take into account intensity of poverty 6 Other goals should be included Is Economic Growth really desirable Environmental degradation Increase in consumerism and materialism Westernization of world cultures Destruction of traditional societies Loss of values o Surveys of life satisfaction and happiness Gallup Result In general rich countries are happier than poor countries BUT it really only holds at lower levels of income Family relationships Community and friends Personal freedoms Values and beliefs Work Health o People care about how they fare relative to others Economic growth still essential for poorer countries o For increasing opportunities o Increasing personal choices o To improve quality of life 2 7 DETERMINANTS OF ECONOMIC GROWTH Economic production o Resources L K o Technology Economic growth increase in production o Factor accumulation o Increases in productivity Technological advance innovation Increase in efficiency ex distribution of labor or organization of a firm Factor accumulation movement along the production function Productivity increases technological advance shift of production function What determines factor accumulation and increases in productivity GROWTH ACCOUNTING Objective decompose economic growth into its major components o Y F K L A where A total factor productivity TFP o gy wkgk wLgL a where a solow residual Characteristics of high growth economies Barro Characteristics that favor investment and or ensure that investment is favorable 1 Macroeconomics political stability Macrostability fiscal and exchange rate policy Political stability poverty increases civil conflict increases poverty increases 2 Investment in health education Health growth Education growth Health Education 3 Effective governance institutions Governance Act of governing Institutions Rules of the Game Corruption a b a b c a b c a 4 Favorable environment for private enterprise Cost of doing business World Bank taxes red tape 5 Favorable geography Landlocked countries a 6 Trade openness a i ii iii Models of Economic Growth Basic assumptions Trade Competitiveness Productivity International transfers of capital Two factors of production L K One product 5 basic equations 1 Production function Y F K L Next 3 equations deal w capital accumulation 2 Total savings S sY where savings is fixed proportion of income Y C I G T trade balance Y C I 3 S I 4 5 where d depreciation rate K I d K L nL where n rate of growth of population labor accumulation Harrod Domar Model The 5 basic assumptions Main assumption fixed coefficient production function o There is only 1 way to combine K L to produce output E g 1K 2L 1 unit of output constant returns to scale 2K 4L 2 units of output o output is a linear function of K no diminishing returns Constant returns to scale 2nd under main assumptions Output and income are used interchangeably 1 measure of productivity of K capital output ratio K Y Incremental Capital Output Ratio ICOR Marginal amount of K needed to produce 1 more unit of output Pro s In our case marginal average ICOR Simplicity Focus on savings On the absence of Economic shocks works pretty well Con s 1 Focus on savings o Savings Investment necessary but not sufficient for growth Savings need to translate into good investments HD makes it seem that savings are sufficient 2 L Y constant n g s d n Knife Edge Equilibrium n g then unemployment increases n g then idle