Some comments on the way of answering the exam of

Development economics on Dec. 12th, 2006

Questions 1-6 were worth 1 point each. Questions 7 and 8 are worth 6 points each.

Many of these questions covered the part of the material that was only in the class
reading, not in the notes. Option that is underlined below was

1. If Ruth drives safely on a highway,

a) there is a positive complementarity between her actions and the actions of other
drivers.
b) there is an externality and a complementarity.
c) her behavior has a positive externality on other drivers.
d) her behavior has a positive externality only if other drivers choose to drive safely
too.

2. Which of the following is true

a) it is never possible to summarize inequality by a single number, which can be used
to rank income distributions.
b) The range is a measure of inequality, but it fails to satisfy the Dalton principle.
c) If two Lorenz curves cross, the Lorenz criterion holds.
d) Kuznets suggested the inequality is initially reduced with economic progress, but
later on the inequalities increase.

3. Which of the following is not true of informal sectors in developing countries

a) Informal sector usually does not adhere to norms of minimum wages or
unemployment compensations.
b) Informal sector consists of usually small organizations.
c) The activities of informal sector are strictly illegal. Typical informal sector
activities involve corruption, bribery and activities like drug trade.
d) Informal sector often grows in urban areas as a consequence of migration from the
rural areas.

4. Which of the following is not true of Harris-Todaro model.

a) the model explains rural-urban migration
b) the urban formal sector pays deliberately wages that are higher than elsewhere, so
there is an excess supply of labor in that sector.
c) expansion of formal employment would be an effective policy to reduce urban
unemployment.
5. Which of the following statements is not true
a) reduced child mortality typically does not lead to reduced fertility rates very
quickly.
b) reduced mortality causes typically the population growth to increase.
c) women’s low wages contribute to keeping birth rates high.
d) life expectancy at birth is increasing at a much slower pace in the developing
countries than it did in the now developed countries.

6. Which of the following is not true

a) There is some evidence, by Alesina and Rodrik, that there is a positive relationship
between initial inequality and subsequent growth.
b) The people who are out of poverty but not very rich are likely to be saving large
fractions of their incomes because of their aspirations for a better economic life.
c) Inequality tends to lead to inefficiencies because it prevents people at the lower end
of wealth or income scale to fully exploit their capabilities.
d) Large inequalities may persist if the credit market access is constrained by lack of
adequate collateral.

7. Read the story of the Grameen Phone on the attached sheet. It is a copy from
the Grameen Foundation webpages. Analyze both the potential for success of this
project in furthering development and the potential risks involved. (Hint: Think
of everything you have learned in this class and use that to evaluate this project
as realistically as possible. In addition, feel free to use whatever other knowledge
you have. That can give you bonus points).

There is no one right answer to this question. It was interesting to read the various
answers and analysis that people wrote here. What I did not reward at all was
repeating the sentences or ideas from the Grameen sheet of paper. What I was
expecting was discussion of the possibilities of this type of project to further
development in general based on the material covered in class. You could think of the
feasibility of this kind of business idea in a developing country environment. Can it
further development through empowering women (eg. fertility, children’s education,
employment, increasing the voice and mobility of them), creating cultural change?
What are the market failures that this project may tackle, like lack of functioning
credit markets, lack of collaterals because of poverty, moral hazard, asymmetric
information, monitoring. General features of microcredit, like group lending, and how
it may help in solving some of the critical problems why poor do not get credit to start
even a small business. What are the potential externalities/linkages in the society? In
class we discussed the various ways in which poverty affects people and their
surroundings, and what kind of effects the increased income typically creates. What
does the research say about these issues, based on what we learned? Is there evidence
that there is impact? What is the evidence? What do we know, and what don’t we
know.
You could also discuss, like many did, the importance of communication
infrastructure, risks of administration costs of small loans or technical problems
becoming too big. Or possibility that the cultural restrictions on women are too big to
make this succeed, perhaps leading to violent opposition.
In the morning of the exam Helsingin Sanomat (local newspaper) wrote about this
project. Some had read the morning paper, and new the project was success enough
for the owners to fight for the proceeds.

8. Answer ONLY ONE of the following questions, 8 a) OR 8b).

8 a) Describe the various ways in which economists have modeled technological

change in order to understand economic growth.

Here I was expecting discussion on the economists have modeled technological

progress and why. E.g. the way Solow’s model addresses technological progress
exogenously, and how it is the only driving force in this kind of model to create
sustained growth. How is the level of GDP per capital formed as opposed to the
growth rate, and why is technological progress needed (because of diminishing
marginal product of capital)? You could discuss the role of human capital, and skills
and learning-by-going. What is the role of technology in Harrod-Domar model?
How the more recent endogenous growth models move from perfect to imperfect
competition as imperfect competition is required to make investment in technological
innovation profitable. You could discuss the attempt to model the production of
technology ie the increase in A by making it depend on the number of people working
in R&D, fishing-out effects, externalities of capital accumulation. The role of property
rights and patents was discussed in class as well. Here a verbal essay was better than
even trying to derive the technicalities of the models.

8 b) Shocks to an economy, such as wars, famines, or the unification of two

economies, often generate large one-time flows of workers across borders. What
are the short-run and long-run effects on an economy of a one-time permanent
increase in the stock of labor? Examine this question in the context of the Solow
model with no technological growth (g=0) and n >0. Show what happens in the
short-run and the long-run either graphically or/and analytically. Define
variables you use and include intuition (it is not sufficient to just write down the
right solution).
Use the Solow model version as presented in class where you have the following
production function and the capital accumulation equation (notation as
presented in class):

Y = K α ( AL)1−α
•
K = sY − dK
~ K Y
Hint: In class, we denoted the transformed variables by k ≡ and ~y ≡ .
AL AL

This question was bit more challenging. Most people mixed up the increase in L and
n. A permanent increase in labor force shows as a permanent increase in L, not as a
permanent increase in n, the population growth rate. In terms of Solow diagram this
means that neither of the curves shift themselves but rather the increase in L just
lowers the value of k initially in the short run reducing output per capita. In the long
run k returns to the original long run equilibrium as the capital stock, K, increases
over time correspondingly to the increased L. You could have shown this in the Solow
diagram. I was expecting that you would have realized the increase in the level of L
alone would not affect the long-run K/L – ratio.

In questions 7 and 8a an essay type of discussion was expected, in 8b a shorter

response graphically would have sufficed with some explanations.