StudySheetfortheFirstMidterm

Economics115B
ThefirstmidtermexamwillbeheldinclassonThursday,January29thandwillcover
thematerialpresentedinthelectureandindiscussionsectionsincethebeginningof
thequarter.BelowisalistofpossibletopicsthatcouldbeontheexamandthedetailsI
findthemostimportant.Itisnotacomprehensivelistofeverythingthatcouldbeon
theexambutisagoodrepresentationof
thetypesofthingsyoushouldknow.Anythinginthebookorthereadingsthatwasnot
mentionedinlectureordiscussionsectionwillnotbeontheexam.However,I
recommendthatyoureadtheportionsofthebookcoveredinthelecturesandin
sectioninordertogetasolidunderstandingofthematerial.

1.Indicatorsofdevelopment.
a.Whatarethecomponentsofgrossnationalincome?Whatisthedifferencebetween
grossnationalincomeandgrossdomesticincome?

SoisGDPandGNIthesame?No,gniwouldincludeanamericancompany'sexports
eveniftheamericancompanywasincanada.Yeahbasically.

GDP:Consumption,Governmentspending,InvestmentandNetexports.
GrossDomesticProduct(GDP)ismeasuredinsidethebordersofanation,Gross
NationalIncome(GNI)accountsforincomeofcitizensofthenation(includingthoseliving
abroad)anddoesnotincludeincomeofforeignerslivingwithinthenation.
b.Whatisthedifferencebetweennominalincomeandrealincome?Whatis
purchasingpowerparity?
Nominalincomeistheamountincurrencythatapersonreceives,realincomeishow
muchtheycanbuywiththatmoney(measuredinrelationtoagood)
Nominalincomeisincomethatisnotadjustedforinflation,realincomeisadjustedfor
inflation
PurchasingPowerParity:CalculationofGNIusingacommonsetofinternational
pricesforallgoodsandservices(asdefinedintextbook).usedtodeterminetherelativevalue
ofdifferentcurrencies.
c.WhydoweoftenusePPPinsteadofexchangerateastheconversionfactorto
comparecountries'incomes?
Exchangeratemethodtendstogeneratesmallerestimateofincome,dueto
differencesincostsofnontradeablegoods(resultingfromdifferentlevelsofsupply
anddemandindifferentcountries).
Exchangeratedoesntaccuratelycomparewhatacertainamountofcurrencycould
purchaseindifferentcountries
d.WhatarethecomponentsofNHDI(NewHumanDevelopmentIndex)?Pleaseexplain
whatdoeseachcomponentmeasure.
Health,Education,andIncome

Healthcomponentcalculatedwithlifeexpectancyatbirthindex,whichtakesavalue
between20yrsand83.57years
Educationmeasuresmeanyearsofschoolingandexpectedyearsof

schooling(weekonepowerpoint)
IncomemeasuresGNIpercapita
e.HowistheNHDIcalculated?Howisthegeometricmeanbetterthanthearithmetic
mean?
TheNHDIequalsthecubedrootofHealthtimesEducationtimesIncome(H*E*I)^().
allowsimperfectsubstitutability.
Arithmeticmeanallowsthevariablestobesubstitutesforeachother(ifoneislacking,
doingwellinanothersectorwouldmakeupforit),butinrealitytheyarenotsubstitutes
f.ThethreecomponentsofNHDIarecalculatedusingdimensionindex,butweapply
thenaturalloginthecalculationofincome,why?

Incomehasdiminishingmarginalutility
(can someone expand a bit on this please?)
Anexampleofthiswouldbe:personAhas$20intheiraccountandpersonB
has$200,000.Ifyougiveeachperson$5,personAwillrecievemoreutility
(happiness)fromtheincreaseinmoneythanpersonBthemoremoneyyouhave,
thelesshappinessyoureceivefromfromanadditionaldollar=diminishingmarginal
utilityonincome:)
g.Namesomeofthecommonalitiesofdevelopingcountries.
1.Lowerlevelsoflivingandproductivity
2.Lowerlevelsofhumancapital(health,education,skill)
3.Higherlevelsofinequalityandabsolutepoverty
4.Higherpopulationgrowthrates
5.Greatersocialfractionalization
6.Largerruralpopulationsbutrapidruraltourbanmigration
7.Lowerlevelsofindustrializationandmanufacturedexports
8.Adversegeographyresourceendowments
9.Underdevelopedfinancialandothermarketsimperfectmarkets,incomplete
information
10.ColonialLegacyandExternalDependence(Lingeringcolonialimpactssuchas
poorinstitutionsandoftenexternaldependence)institutions,privateproperty,
personaltaxation

2.DevelopmentTheories
a.Whyistheproductionpossibilityfrontierconcave?
MostofthePPFcurvesareconcaveduetotheinadaptabilityoftheresources.Thelawof
increasingopportunitycoststates:astheproductionofonegoodrises,theopportunitycostof
producingthatgoodincreases.


b.Solowgrowthmodel:knowwhatthekeyrelationshipbetweensavingsrate,
populationgrowth,anddepreciationrate.Whatdoesdifferentsavingsrateimplythe
incomepercapita?Youalsoneedtoknowwhatisthe"steadystate"capitalpercapita.
Explaintheconvergenceprocessofcapitalperworker?

https://www.youtube.com/watch?v=l_Vq9pyrakg

Impliesthateconomieswillconditionallyconvergetothesamelevelofincomeiftheyhavethe
sameratesofsavings,depreciation,laborforcegrowth,andproductivitygrowth.Outputper
workerisafunctionthatdependsontheamountofcapitalperworker.Themorecapitalwith
whicheachworkerhastowork,themoreoutputthatworkercanproduce.Thelaborforce
growsatratenperyear,say,andlaborproductivitygrowth,therateatwhichthevalueofAin
theproductionfunctionincreases,occursatratelambda.Thetotalcapitalstockgrowswhen
savingsaregreaterthandepreciation,butcapitalperworkergrowswhensavingsarealso
greaterthanwhatisneededtoequipnewworkerswiththesameamountofcapitalexisting
workershave.Whenoutputandcapitalperworkerarenolongerchangingthisiscalledthe
steadystate.IfkishigherorlowerthanK*theeconomywillreturntothesteadystate.

changek=sf(k)(depreciation+n)k
steadystate:astateinwhichoutputandcapitalperworkerarenolongerchanging
sf(k*)=(depreciation+n)k*
convergence:ifkishigherorlowerthank*,theeconomywillreturntoitthus,k*isastable
equilibrium

c.Linearstagestheories:Rostow'sstagesofgrowth:knowwhatarethestages
HarrodDomargrowthmodel:knowthemainrelationshipthemodelpresents,andthe
criticismsofthemodel.
Rostow:
1.Traditionalsociety
2.Preconditionsfortakeoffintoselfsustaininggrowth
3.Thetakeoff
4.Thedrivetomaturity
5.Theageofhighmassconsumption

HarrodDomar:
underlyingassumption:growthismainlydeterminedbycapitalaccumulation
Moreinvestmentleadstomoregrowth
economygrowsatsavings/consumption
Criticisms:savingsandinvestmentarenecessarybutnotsufficientconditionsto
economicgrowth

d.Structuralchangemodel:Lewismodel:knowhowthewagesinagriculturalsectoris

determined,thedifferenceoftheproductionfunctionsintwosectors,criticismsofthe
model.

Agriculturewageisdeterminedbyaverageproductoflabor.
Productionfunctionsdifferbecausecapitalintheagsectorisfixed.
Criticisms:
Rateoflabortransferandemploymentcreationmaynotbeproportionaltorateof
modernsectorcapitalaccumulation,laborsavingdevice?(graph)
Surpluslaborinruralareas(b/citisnotfoundinallcountries)
Institutionalfactorsthatdrivesupurbanwages?
Assumptionofdiminishingreturnsinmodernindustrialsector

e.Namesomeoftheinternationaldependencemodels,whataresomeofthecriticisms
oftheinternationaldependencemodels.
Theneocolonialdependencemodel
Legacyofcolonialism,Unequalpower,Coreperiphery
Thefalseparadigmmodel
Pitfallsofusingexpertforeignadvisorswhomisapplydevelopedcountrymodels
(EndangeredSpeciesAct)
Thedualisticdevelopmentthesis
Superiorandinferiorelementscancoexist
7Criticismsandlimitations
Doeslittletoshowhowtoachievedevelopmentinapositivesenseaccumulating
counterexamples

f.Whatisthemainargumentsandcriticismsofthemarketfundamentalism
(neoclassicalmodel)?Usesupplyanddemanddiagramtoshowthemarketfailureif
thereisnogovernmentintervention.
MSC=accountformarginalsocialcost.WeSHOULDbeproducinglessandpayinga
higher
price

g.WhatisthemainargumentofRomer'sendogenousgrowthmodel?Whydrivesthe
economicgrowthundertheendogenousgrowthmodel
mainargument:Becauseoftechnologyspillover,therecanbeeconomicgrowtheven
withouttechnologybreakthroughs
drivenby:technologyspillover
h.Contemporarydevelopmenttheoriesusuallyinvolvescoordinationfailure,usea
diagramtoshowthemultipleequilibriamodel,andexplainwhatarethestableand
unstableequilibria.Whatshouldagovernmentdoiftheeconomyistrappedinaless
desirablestableequilibrium?
firstandlastequilibriuminthemodelarethestableones.whentheindividual
investmentlevelishigherthantheaverage.
govt.canincreaseinvestmentofwholeindustry

govcangivetaxbreaktoincreaseinvestment
i.BeabletoexplainhowaneconomycanbeadvancedfromPt.AtoPt.BintheBig
Pushdiagram.
graphonpage179.
Hiringmoreworkersandatthesametimepayingthemmore.competition?
atPointAfirmsarelessproductive,butenjoyingpayingalowwagetoworkers
atPointB,throughgovernmentinterventionandindustrialization,companiesaremuch
moreproductivebutpayingahigherwagebecausetheydemandmorelabor(thinkoflabor
supplygraph,asdemandforlaborincreasesthenwageincreasestoo)

Explainwhytheideaofsuperentrepreneurmaynotsolvetheproblemofcoordination
failure.

capitalmarketfailures.Theaggregatecapitalmarketwillfail.Oneindividualorpolicycannot
sufficientlyguaranteethatthemarketwillnotfail
costofmonitoringmanagersistoodauntingofataskorirrational,thistiesinwiththeideaof
asymmetricinformation,(economicactorsvsmanagers)
communicationfailure

Thereisnodatafrompreviousstudiesthatsuggestasuperentrepreneurcanpreventthe
problemofcoordinationthatisassociatedwiththeaboveissues.Ithasnotbeendoneyetand
cannotbeconsideredasignificantsolutiontotheissue.

3.AbsoluteandComparativeAdvantage
a.KnowtheassumptionsoftheAbsoluteAdvantageandRicardianmodel.
Absoluteadvantageiswhenthecountrycanproducebothgoodcheaper(lesslabor)thanthe
othercountry.
Assumptions:2countries,2goods,onefactor(labor).Technologyiswhatcausesabsolute
advantage,andinturncomparativeadvantage.
b.Why,accordingtothesemodels,istradeagoodthing?

Bothsidesproducewhattheyhaveacomparativeadvantagein(specialization),thisshiftsout
theirPPFsandshiftsouttheirindifferencecurves>increasesutility.
c.Beabletorecognizewhohasabsoluteadvantageandcomparativeadvantageina
numerical,twocountryexample.
Absoluteadvantageiswhocanproducethegoodscheaper
Comparativeadvantageiswhocanproducethegoodwithloweropportunitycost
d.Beabletocomputetheopportunitycostofacountryinanexampleinordertoshow
whyonecountrywouldhavethecomparativeadvantageintheproductionofagood.
Beabletocomputeapossiblepricethatthetwocountrieswouldsetintheirtrading
relationship.

MPLw

MPLc

Labor

Home

50

Foreign

100

Opportunitycostofwheatathome=2/3
Opportunitycostofclothathome=3/2
Opportunitycostofwheatandclothinforeign=1
Sohomewouldhavecomparativeadvantageinwheat(andproduceit),andforeignwould
haveacomparativeadvantageincloth(andproduceit.)
Ininternationaltradeequilibriumtherelativepriceofclothwouldbebetween1and3/2.

e.HowdoesthismodelofcomparativeadvantageapplytoDevelopingcountriesin
general?

Ingeneral,developingcountrieswillexportagriculture(traditional)goodsandimport
moderngoods.
f.WhatwouldthismodelofcomparativeadvantageadviseanLDCtodo,why?(Would
weimaginethattheywouldcompletelyspecializeinonegoodoranother?)
...
Theywouldcompletelyspecializeinonegoodoranother

4.HeckscherOhlinModelofInternationalTrade
a.KnowtheassumptionsoftheHOmodel.
2goods[ag.product(useslaborintensively)andmanufacture(usescapitalintensively)]
2countries
2factors.1countryhasabundanceinlabor,otherhasabundanceincapital.
countrythatislaborabundantproducesmoreag.product
countrythatiscapitalabundantproducesmoremanufacturingproduct
b.Why,accordingtothismodel,istradeagoodthing?(Dontforgettomentionthat
factorpricestendtoequalize)
Indifferencecurveisfartheroutafterfreetrade.countriesspecialize.Countriesbothconsume
moreofbothgoodswithtradecomparedtoautarky.

worldoutputincreasesfromtrade

abundantfactorusedintensivelyintradewillbebetteroff.factorpriceequalizationwillbe
reached
factorpriceequalization:Intradethewageinlaborabundantcountry(home)wagegoesup
andrentgoesdown.andincapitalabundantcountry(foreign)wagegoesdownandrental
rategoesup
Isthisbecausethelaborabundantcountrieswanttoshifttheirfocustolaborintensive
productstherefore,encouragepeopletoworkbyincreasingwages?Thedemandfor
workersincreases,whichmeansahigherwage.Basically,thereismoredemandfor
capitalinthecapitalabundantcountryandmoredemandforlaborinthelabor
abundantcountry.Theraiseindemandcauseswagesandrenttoincreasebecause
supplyhasstayedthesame.
c.Beabletoidentify,ingeneral,whichcountrywillspecializeinwhichgoodinatwo
country,twogoodexample.
countrythatislaborabundantproducesmoreag.product
countrythatiscapitalabundantproducesmoremanufacturingproduct
d.Beabletographtheproductionpossibilitiesfrontierofacountryinautarkyandthen
withtrade.
http://faculty.washington.edu/danby/bls324/trade/hos3.gif

e.Howdoesthismodelapplytodevelopingcountriesingeneral?Wouldweimagine
thattheywouldcompletelyspecializeinonegoodoranother?
Developingcountrieswouldwanttobeinvolvedintradeastheirconsumptionwouldgoup.
Thisthehelpthesectorinthatcountrytheyareabundantin(labororlandprobably.)Inthis

modelcountriesdonotcompletelyspecializeinonegoodoranother.
f.Whatarethedifferencesbetweenthemodelofcomparativeadvantageandthe
HeckscherOhlinmodelintermsoftheimpactofopeningadevelopingcountryto
internationaltraderelationships?
ThecomparativeadvantagemodelonlyaccountsforlaborwhileHOtakesintoaccountfor
laborandcapital.AlsoHOdoesnotresultincompletespecialization,soitmightbebetterin
thefactthatthedevelopingcountriesdontbecometoodependentoncertainimportsand
exports.
g.HowdoyouusetheHOmodeltoexplainPrebischSingerhypothesis?(Needto
knowwhatisPrebischSingerhypothesis)
PrebischSingerhypothesis:theyarguedcommodityexportpricesfallovertime,so
developingcountriesloserevenueunlesstheycancontinuallyincreaseexportvolumes.they
concludedthatdevelopingcountriesneedtoavoiddependenceonprimaryexports
inHOmodelthiswouldbeseenbyafallinthetradeprice(linewithnewtradeequilibrium
willcontinuouslyfalltowardsautarky)

5.Governmentinvolvementintrade
a.Beabletodiscussthecritiquesontrademodels.
toomanyfixedfactors/assumptions.(fixedresources,fullemployment,internationalfactor
immobility,fixedfreelyavailabletechnology)
assumingalllaboristhesame.ignoreslowskillvs.highskilllabor.makesithardtohave
completemobilitywhichisassumed
assumegovt.isnotinvolved
tradegainsdon'tnecessarilygotothecountry.
moreonslides

b.Becomfortablewiththedefinitionsoftariff,quotas,subsidies,preferentialfixed
exchangeratesandindustrialpolicy.
Tariff
:Ataximposedonimportedgoodsandservices.Tariffsareusedtorestricttrade,as
theyincreasethepriceofimportedgoodsandservices,makingthemmoreexpensiveto
consumers.
Quotas
:governmentimposedtraderestrictionthatlimitsthenumber,orincertaincasesthe
value,ofgoodsandservicesthatcanbeimportedorexportedduringaparticulartimeperiod.
Subsidies:
moneygiventohomesupplier.lowerscost,shiftsoutsupplycurve.allowshome
producertoproducemore.thereisadeadweightlossassociatedwiththisaswell.
Preferentialfixedexchangerates:
tomakeproductmorecompetitivebydropping???
fixedexchangerateishavingacurrencysvaluefixedtoanothercountryscurrency/a
basketofothercountriescurrencies.isthisrelatedtothat?cananyonepleasehelpexplain
thisone?
Keepsacountryscurrencyvaluebetweenanarrowrangebytyingittoanothercountrys
currencyortothepriceofgoldsoitincreasestradebetweencountries(sincethecountries
arentafraidoftoomuchpricefluctuations)

Fixedexchangerates:makeyourexportproductmorecompetitiveasthepriceofthe
productsarecheaper.
Industrialpolicy:
importsubstitution.encouragelocalproductionandlocalconsumptionrather
thanhighdemandforforeignexchange,localproductionincreaseslocalemployment,
encouragesinnovation,selfrelianceonprimarygoodssuchasfood,advancedtechnology,
defense
exportpromotion:strategiesdesignedtoattractmorefirmsintoexportingbyofferinghelpin
productandmarketidentificationanddevelopment,settinguppreshipmentand
postshipmentfinancing,tradefairs,trademarkets,increasingpresenceinforeignmarkets
c.Beabletographatariffandquotaanddiscussthenumbersassignedtovarious
pointsonthegraph.
Tariff:
http://upload.wikimedia.org/wikipedia/commons/thumb/4/4d/EffectOfTariff.svg/2000pxEffectO
fTariff.svg.pngQuota:looksthesamebutnowtheinterventionisbyrestrictingquantityinstead
ofprice
d.UnderstandandbepreparedtodiscussthedefinitionoftheImportSubstitution
Strategy.
Governmentstrategythatencourageslocalproductionforlocalconsumption,ratherthan
producingforexportmarkets.Importsubstitutesaremeanttogenerateemployment,reduce
foreignexchangedemand,stimulateinnovation,andmakethecountryselfreliantincritical
areassuchasfood,defense,andadvancedtechnology
e.UnderstandandbepreparedtodiscussthedefinitionoftheExportPromotion
Strategy.
Strategiesdesignedtoattractmorefirmsintoexportingbyofferinghelpinproductandmarket
identificationanddevelopment,preshipmentandpostshipmentfinancing,training,payment
guarantyschemes,tradefairs,tradevisits,foreignrepresentation,etc

6.Applicationsofthematerial
a.BepreparedtodiscussDornbuschsarticle.Heoutlinesexamplesofsuccessin
bothexportpromotionandimportsubstitutionforparticulardeveloping
countries.Whataretheconditionsthatareimportanttothissuccess?(totheextent
thatit
wasdiscussedinclassanddiscussion)
argumentstillvalidevenafter23years.afterww2manycountriesbeganopeningbackupto
trade
turkey..
IsMexicotheexampleofexportpromotion(b/cendresultofsettingupopentradew/
USAandCanada)whileKoreaisanexampleofimportsubstitution(b/ctheyincreasedlocal
productionofcarsandlocalconsumptionofthosecars)andonlysettraderestrictiononthese
primarycommodities?
conditions:
exchangeratepolicydesignedtoavoidovervaluation
externalcreditplayingkeyroleaswellasforeigninvestment+technology

traderegimesufficientlyselectivesothatintermediategoodsandcapitalgoodsnot
excluded
focusontargetedliberalizationthatdoesnotinterferew/nurturinginfantindustries
b.BepreparedtodiscussRodriksconcernsregardingtherealitybehindpolicyreform
indevelopingcountriesinthe1980s.(totheextentthatitwasdiscussedinclassand
discussion)
liberaltradeisencouragedbutitisnotacureall

Cansomeonepleasepostsomemorecomprehensivenotesthathewantsustofocusonfor
thetwoarticles?Manythanks.
sure:)thesearefromthepowerpointnotes.Imhoping
thisisallweneedtoknowsinceitsaystotheextentthepaperswerecoveredinclass
anddiscussion

Dornbusch(1992)
Duringthe30sProtectionbecamethemodelformostdevelopingcountries.
AfterWWII,industrialcountriescontinuedw/highlyrestrictivetradepolicies,whilemany
developingcountriesdidnotfaceforexproblems.Butthissoonchangedasthecommodity
pricescollapsed.
Turkey:
Tradeliberalizationstartedinearly1980,quotaswereeliminated,exchangerate
depreciated,foreignexchangeregimewasliberated.
Korea:
Tradeliberalizationsince70s.
By1983,some10,000productclasses,19.6percentstillcontainedimportrestrictions.
By1989,thefractiondeclinedtoonly5.3percentandmostofthesewereprimary
commodities.
Only46industrialproductswimportlicensingorprohibition.Avgtariffdownfrom24to11
percent,lessthan5by1993.
Selectiveonproducttobeliberalized.

Tradeliberalizationwasapartofwiderstrategyofachievingstabilityandefficientresource
allocation.
Althoughmodernizationandgrowthcannotattributeduniquelytotradepolicy,liberalized
tradehassofundamentallyshakenuptheproductionstructure,thatmoreliberaltradeis
invariablycreditedwithgoodshareoftheperformance.

Thestrategyworksbestwhenusedselectively.
Thecountrywillnotdevoteresourcestoaccomplishingtheimpossibleandasaresultlower
productivityeconomywide.

Rodrik(1992)

Liberaltraderegimesisgoodforeconomicdevelopmentinthelongrun.
Butitisnotawonderdrug.Needtounderstandtheroleplayedbytradereform.
Importanceofpolicyconsistency.
Policyconsistencyisthemostimportant.
Enhancingcredibility.
(isthissothatothercountrieswilltrustthatcountryandagreetotrade
withthem?sortoflikefixedexchangedrate?)
Importanceofsoundfiscalandexchangerate
stancecannotbeunderestimated.Tradeliberalizationisacentralcomponentofthepackage.

Tradereformisnotacureallsolutionforeconomicproblems.