Chapter 3: Theories of Economic Growth

1, Resources endowment and economic growth models

1.1 Household utility maximization model
Children as “consumer goods” or “investment goods”
Demand for children in developing countries

Where
Cd is the demand for surviving children
Y is the level of household income
Pc is the “net” price of children
Px is price of all other goods
tx is the tastes for goods relative to children
Assumptions:
(i) having children involve both U (future income/consumer good/investment good) and D
(costs and discomfort relating to raising up children);
(ii) husband and wife share the same utility function relating to U from children,
(iii) both U and D can be qunatified and compared,
(iv) parents have full power in deciding No of children,
(v) saving and social welfare can be substitutes to children,
(vi) income levels or income opportunity can affect decision to have children
Explanations:
(i) optimum no children would be decided by the cutting point between downward sloping
MU and upward sloping MD (why?);
(ii) any changes in MU or MD would change the optimum no. of children (give examples)
Policy implication:
i. Women’s education, role and status: (i) more qualified workers  higher opp. cost of
having children,
ii. Female nonagricultural wage employment:  higher opp. cost of having children
iii. Rise in family income levels: supplying substitutes for children
iv. Reduction in infant mortality rate  reduce the need of having more children to offset
for unfortunate children.
v. Development of old-age and social security: supplying substitutes for children
 vi. Expanded schooling opportunities: (i) more qualified workers  higher opp. cost of
having children, (ii) each can take care of parents more  fewer children would be
needed
1.2 The Dutch disease
Longer term negative impacts:
- Large inflows of the revenue of natural resource export in foreign currency 
domestic currency appreciation  lower competitiveness of tradables from agricultural
and industrial sectors  declines in these sectors
- Reallocation of labour from agricultural and industrial sectors to the natural
resource sector faces time-lag and limited due the capital-intensity of the natural
resource-exploiting sector  unemployment
- Increases in revenue from the booming sector is not sufficient to offset for decreases
in the revenues in the contracted sectors.
Policy implication
 Slowing down the appreciation of the exchange rate
 Increasing the competitiveness of other sectors (manufacturing)

3, Harrod-Domar eco. growth model

BASIC HARROD-DOMAR FUNCTION

g = s/k
where:
 g = ΔYt+1/Yt
 s = St/Yt
 k = ΔKt+1/ΔYt+1 (incremental capital – output ratio - ICOR)
 assumption: St= It+1 = ΔKt+1
 g = ΔYt+1/Yt = (ΔYt+1/Yt)*(St/ΔKt+1) = St/Yt/ΔYt+1/ΔKt+1 = s/k

ICOR is a metric that assesses the marginal amount of investment capital necessary for a
country or other entity to generate the next unit of production.

4, Low-equilibrium trap