Economic development problem set
UA 323 Development Economics Problem Set 3 Due: March 5 • Remember to include your name on your independently written-up solutions. • You should feel free to work with classmates (and use readings/slides/etc. for help), just please write the names of who you worked with • Submit your solutions to the Brightspace before class starts. No need to bring a hard copy. • Show your work. Include brief and precise explanations of intuition and derivations as appropriate. You do not need to include your code (unless the question explicitly asks for you for the code). But you should save your script. • This is the the most difficult problem set of the semester. Good luck! First, a quick R question, to get you warmed up 1. How quickly will a country, growing at 3% a year, double its income? What about a country growing at 6% per year? How would that compare with a country growing at alternating rates of 0% and 6% per year? (in other words, which country grew faster, a steady 3% per year, or the “unstable” growth country, after 20 years). Please include your R code in addition to your answers.1 An iconic development article that we didn’t have time to discuss in class is Lucas, R. E. (1990). Why doesn’t capital flow from rich to poor countries?. The American Economic Review, 80(2), 92-96.2 The question that is raised in the paper is often called the “Lucas puzzle”. Briefly answer the following questions: 2. What does the simple economic theory predict? Shortly explain this prediction in your own words. 3. What counter example to the theory is given in the text? Can you think of a historical example for a time and place when the theory didn’t get it wrong? 4. Explain the first candidate answer Lucas raises for the question. (Hint: “. . . each American or Canadian worker was estimated to be productive equivalent to about five Indians or Ghanians”). How does he refute this answer? 5. Choose another candidate answer from the next two in the text and briefly explain it, in your own words. 6. After reading this paper and hopefully thinking about this puzzle a bit, give your opinion – why doesn’t capital flow from rich to poor countries? Another iconic model of economics development was written by John Harris and Michael Todaro (who was a professor at NYU). (it’s here, though you don’t need to read it for this assignment) 7. In Todaroland, workers can either work in agriculture or for multinationals (“industry”). Wary of bad international press, the multi-nationals are unwilling to pay their workers less than $10/day (they also won’t pay more, but that isn’t relevant for the problem set). There is linear production in agriculture, and each worker produces $3/day. There are 100 total workers, and multinationals won’t hire more than 30 workers 1 I am sorry – I suspect that you can do this with pencil and paper way faster than you could with R. 2 You should be able to get the article if you are on NYU internet.There are many copies floating around online if you aren’t on campus. 1 (and for this particular question, everyone is employed in one of the two sectors). Given this set-up, what is the equilibrium wages and number of workers in agriculture (LA ) and multinationals (LM )? 8. In the equilibrium of question 7, there are many unhappy workers. What they choose to do is camp outside of the factory in the hopes of finding a job. The multinational does not care about the identity of who they hire, so everyone camping outside the factory has an equal probability of getting a job. Workers who camp outside of the multinational, but who are unlucky, (and don’t get a job) produce nothing. Workers only care about their expected wage (the probability that they get a job times its wage). Given this set-up, what is the equilibrium wages and number of workers in agriculture and multinationals? 9. Now instead of the multinational wage being $10/day, it’s $x/day. In a well-labeled graph, plot GDP (total production in agriculture + total wages in industry) as a function of x.3 10. A friend who has taken one fewer than the correct number of economics classes comes to you and says “forcing multinationals to pay living wages (a) increases unemployment and (b) lowers GDP.” What is your response? 11. Suppose that instead of constant returns to scale in agriculture, there were decreasing returns to scale. How would your answer to 9 change? Plot it. Note that I am not telling you what way to assume decreasing returns to scale – there is no right answer, but there are definitely some approaches that are easier than others. Please let us know what you assumed for decreasing returns to scale, and include a well-labeled graph. 12. You collect a bunch of data, and discover that there are actually increasing returns to scale: Produc7 tion in agriculture is LA5 . Now what are the equilibrium wages and number of workers in agriculture and multinationals? If you find that there are multiple equilibria (which you should), describe what might make a society end up in the “bad” equilibrium instead of the “good” one. 13. We’ve discussed several times in class that models without distortions or frictions are efficient – there is no policy that could make everyone better off. What’s the inefficiency in this model that creates a scope for policy? 3 I would create a variable in R that takes every value from 3.01, 3.02, 3.03… up to a number that makes the graph look good and helps you answer the next question, and then, after having done some algebra, a variable for GDP given that wage) 2
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