Chapter 37 / 19 Economic Growth and Development

Chapter Objectives
After you have read and studied this chapter, you should be able to describe the processes of economic growth and development; discuss the special hurdles to development faced in poor countries; and discuss the pros and cons of the "trap of underdevelopment" argument.

Chapter Review: Key Points

1. Economic growth refers to quantitative changes in the capacity to produce goods and services in a country. It occurs through expanding capital or labor resources, discoveries of new sources of raw materials, or development of more productive technologies. Economic development refers to improving the qualitative aspects of economic growth, including changes in the quality of life. 2. The Rule of 72 is a rule of thumb for estimating how long it takes for a variable to double in value given some percentage growth rate. Simply divide 72 by the growth rate. For example, if growth in GDP is occurring at 6 percent per year, GDP will double in approximately 12 years (72/6 = 12). 3. Diminishing returns because of the fixity of land cause output to grow more slowly, even if labor and capital increase in fixed proportions. 4. Reverend Thomas Malthus and other nineteenth-century economists were convinced that population growth is almost uncontrollable, and theorized that equilibrium is attained only when bare subsistence is common to all. 5. Population growth tends to slow as a country develops. The least developed countries of the world tend to have the highest rates of population growth. 6. Capital formation requires high saving rates. If voluntary saving is used to finance development, greater incomes, higher interest rates paid to savers, and (perhaps) less equal income distributions will lead to higher rates of investment. Involuntary saving may be used to free investment resources through confiscation, taxation, or inflation.

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7. Capital widening occurs when the capital stock and labor force grow at the same rates. Capital deepening requires the capital stock to grow faster than the labor force. 8. Technological advances occur when given amounts of resources acquire greater productive capacity.

9. Rapid development requires a strong social infrastructure--education, communications, transportation, and other networks that facilitate production.

Matching Key Terms and Concepts

Set I ___ 1. international credit ___ 2. involuntary saving ___ 3. Rule of "72" ___ 4. economic development ___ 5. economic growth ___ 6. communism ___ 7. capital deepening ___ 8. capital to labor ratio (K/L) ___ 9. high birth rates ___10. voluntary saving a. According to Karl Marx, follows the dictatorship of the proletariat and then the withering away of the state. b. Boosts investment beyond domestic capabilities. c. Expansion of productive capacity. d. Individual choice between present and future consumption. e. Investment is proportionally greater than population growth. f. A quick way of estimating "doubling" times. g. Qualitative expansion. h. Associated with underdevelopment. i. Accomplished by taxes or inflation. j. A crucial determinant of labor productivity.

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Set II ___ 1. technological advance ___ 2. infrastructure ___ 3. "Trap of underdevelopment" ___ 4. high voluntary saving rate ___ 5. Malthusian equilibrium ___ 6. "takeoff" ___ 7. Labor Force Participation Rate ___ 8. surplus value ___ 9. capital widening ___10. low birth rates a. Percentage of a population in the work force. b. A stage in Rostow's growth theory. c. Net investment and population growth are proportional. d. A factor temporarily expanding LFPRs. e. Difference between wage paid and total value produced by a worker. f. Inhibits Keynesian Aggregate Spending but facilitates economic growth. g. The edge of starvation. h. Producing more from given resources. i. Low income inhibits capital accumulation. j. An integral part of economic development.

True/False Questions
___ 1. The labor force as a percentage of the population is known as the capital to labor ratio. ___ 2. An important determinant of the size of the labor force relative to the size of the population is the rate of population growth. ___ 3. Increases in the labor force generally result in an increase in potential real output. ____4. Net investment represents net new capital formation during a given time period. ___ 5. Capital widening increases real per capita income. ___ 6. A government can rapidly increase potential Aggregate Supply by pursuing appropriate demandmanagement policies. ___ 7. An increase in the interest rate received by savers increases the price of present consumption relative to future consumption. ___ 8. Widespread poverty inhibits saving and capital accumulation. ___ 9. Higher interest rates charged investors and lower payments to savers will lead to larger capital stocks over time. ___10. Any smoothly functioning economy needs a sophisticated and efficient financial system.

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Standard Multiple Choice

There is one best answer for each question. ___ 1. The number of years that it takes some variable to double is approximately its annual percentage growth rate divided into: a. its current value. b. 72. c. 76. d. 82. e. None of the above. ___ 2. Economic development in a primitive society would NOT be fostered by: a. an increase in the population growth rate. b. expanded investment in capital embodying new technology. c. improvements in the education of the work force. d. better transportation, communications, and banking networks. e. adoption of advanced agricultural technology. ___ 3. Output per capita would probably rise, but output per worker would probably fall if: a. capital deepening occurred rapidly. b. the labor force participation rate of a given population rose. c. technical education of the work force increased. d. involuntary saving was increased. e. income were distributed equally. ___ 4. In Karl Marx's theory of economic development: a. a takeoff stage precedes the dictatorship of the proletariat. b. feudalism comes just before a withering away of the state. c. communism immediately follows the overthrow of capitalism. d. capitalism is succeeded by a dictatorship of the proletariat. e. high savings rates launch a takeoff into high mass consumption. ___ 5. Voluntary saving is enhanced by higher: a. tax rates and inflation. b. surplus values and more central planning. c. interest rates and income. d. confiscation and inflation. e. degrees of equality in the distribution of income. ___ 6. According to Karl Marx, which event immediately precedes pure communism? a. The "withering away of the state." b. Feudalism. c. A "dictatorship of the proletariat." d. Distribution "from each according to need, to each according to ability." e. A non-sexist, non-racist, nonexploitative Utopia.

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___ 7. A problem NOT part of "Trap of Underdevelopment" theory is: a. high birth rates. b. low per capita income. c. a low capital to labor ratio. d. low productivity. e. high pollution from dirty technology. ___ 8. Voluntary saving will most likely increase if: a. tax rates are increased. b. income decreases. c. interest rates rise. d. the distribution of income becomes more unequal. e. the rate of inflation increases.

___ 9. An economist who argued that population adjusts to a biological subsistence level given available resources was: a. David Ricardo. b. Karl Marx. c. W. W. Rostow. d. Thomas Carlyle. e. Rev. Thomas Malthus. ___10. Which of the following would NOT tend to cause economic growth? a. Improvement in technology. b. Increased labor force participation. c. Increased training and education. d. Increased marginal propensities to consume e. An improved social infrastructure.

Chapter Review (Fill-In Questions)

1. Economic _______________ occurs when an economy's capacity expands; economic __________________ entails qualitative improvements in economic conditions. 2. The time required for doubling any variable is approximated through calculations using the ________________________. Dividing the percentage annual change in a variable into ______ yields the number of years required for the variable to double its value. 3. Economic growth is the long-run process of expanding the limits to _______________. Increased availability of __________________ for production is one source of growth. 4. Per capita income tends to rise when the workforce increases through rising _____________ __________ rates, although less than proportionally because of declining _______________ ratios, assuming investment does not also rise. Productive capacity may also rise if _____________ grows, but _________________ income is likely to fall because of growing numbers of mouths to feed. 5. Many early economists, accepting the analyses of the Rev. _______________, argued that population would always tend towards the maximum sustainable with given resources, so that people would, on the average, live only at _________________ levels. This led critics of the day to term economics "the dismal science." Malthus believed population has a natural tendency to grow, in his terms, ____________________, while food supplies grow only ____________________.

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6. High levels of education, investment, and research and development expenditures create improvements in _______________ and/or physical capital resources in a society. Economywide technological changes occur with the development of social overhead capital, also known as _______________. This road to economic development entails a well organized ______________________________, efficient __________________________, and _____________________ networks, and an educated and disciplined _________________.

Unlimited Multiple Choice

Each question has from zero to four correct responses. ___ 1. Economic growth: a. is synonymous with economic development. b. refers to qualitative change experienced by an economic system. c. occurs when an economic system acquires greater productive capacity. d. always results in increased real per capita output or income. ___ 2. An increase in the capital to labor ratio: a. increases the productive capacity of an economy. b. tends to increase real per capita income. c. increases labor productivity more in a less developed country than in a developed country. d. generally results in economic growth and development. ___ 3. Saving: a. enables production of new capital. b. is necessary for the accumulation of capital. c. is voluntary when individuals decide on their own to defer consumption to some future date. d. is determined by national income, according to the classical model. ___ 4. Potential Aggregate Supply is: a. determined partially by the state of technology. b. potentially increased if government uses highly inflationary policies and secures large tax revenues. c. determined strictly by Aggregate Demand. d. determined by the qualities and quantities of available resources. ___ 5. Capital deepening: a. is an increase in the ratio of labor to capital. b. tends to increase real per capita output and income. c. is less likely to be effective in fostering growth in rich countries than in poor countries. d. can occur when saving rates are zero.

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Problems
Problem 1 This figure shows production possibility frontiers confronting Urbana and Ruritania. Ao denotes the original production possibility frontiers for both countries and A1 denotes the new ones. Each economy begins at point a. Use this information to answer the following True/False questions.

___ a. Rates of capital accumulation in Urbana exceeds those in Ruritania. ___ b. Ruritania has experienced economic growth. ___ c. Urbana must be experiencing economic development. ___ d. Urbana has experienced economic growth. ___ e. The PPF for Ruritania has shifted outward the most because of the relatively large amount of net investment that was made at point a. ___ f. Net additions of real capital in Urbana are probably better suited to produce investment goods than to the production of consumption goods.

___ g. Ruritanian consumers prefer present consumption over future consumption relative to consumers in Urbana. ___ h. Consumers in Urbana (relative to Ruritania) prefer to defer present consumption to some future date. ___ i. Technological advancement may best explain the relative economic growth that Ruritania has experienced. ___ j. Households in Urbana save more of their incomes than do Ruritanians.

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Problem 2 Use the "Rule of 72" to answer the following True/False questions. ___ a. A country's population will double in 72 years if annual population growth is 1 percent. ___ b. Financial investments will double in value in 18 years if the compounded annual interest rate is 4 percent. ___ c. Financial investments will double in 7.2 years if the annual interest rate is 15 percent. ___ d. A population that grows at an annual rate of 7.2 percent will double in 10 years. ___ e. If the annual rate of inflation in consumer prices is 2 percent, it will take 36 years for the CPI to double. ___ f. If an economy experiences an annual increase of 3.6 percent in real output, it will take 20 years for the economy to double its production of output. ___ g. Financial investments will double in 30 years if the annual interest rate is 2.4 percent. ___ h. Financial investments will double in 7 years if the annual interest rate is 10.28 percent. ___ i. A country's population will double in 60 years if population growth is 1.2 percent annually. ___ j. A country's population will double in 40 years if population growth is 1.8 percent annually.

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Problem 3 This figure contains the supply and demand curves for the market for financial capital. Use this information to answer the following True/False questions. ___ a. The supply of saving is a positive function of the rate of interest. ___ b. There is a shortage of financial capital at interest rate i0 this market. ___ c. The capital stock increases as the nominal interest rate increases from i0 to i1. ___ d. The real interest rate remains constant as the nominal interest rate increases from i0 to i1, if there is no inflation. ___ e. The quantity demanded of financial capital increases as the nominal interest rate increases from i0 to i1. ___ f. In this market, the demand for financial capital is positively related to the nominal interest rate, while the supply of financial capital is negatively related to the nominal interest rate. ___ g. The relative price of present consumption would rise if the nominal interest rate declined from i1 to i0. ___ h. The relative price of future consumption decreases as the nominal interest rate increases from i0 to i1. ___ i. The rate of saving is greater at i1 than it is at i0. ___ j. The rate of present consumption is greater at i0 than it is at i1.

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Problem 4 You have retained your job as chief economic advisor based on your fine performance in chapter 35 / 17. However, the president, once again, lacks confidence in your competence. You have just told him that fixed land and other resource constraints make it impossible to have continual radial expansions of the PPF without encountering diminishing returns. The initial situation involves 2,000 units of labor and 2,000 units of capital and allows the economy to produce up to 100 tons of wheat or 100 military airplanes. a. Graph this situation in the figure. Label the curve PPF1. b. Illustrate an increase of 2,000 units of labor and 2,000 units of capital if the productivity of labor never diminishes. Label this curve PPF2. c. Illustrate a scenario where an additional 2,000 units of labor and capital are added to the production process. This time, however, the additional inputs are constrained by the amount of land in the production process. This constraint is particularly severe in the production of grain, where you are only able to get half as much grain output per additional unit of input as before. On the defense side you encounter no similar constraint. Label this curve PPF3. Problem 5 Use the Rule of 72 to answer the following questions about how long it will take: a. your savings account to double, if the bank pays annual interest of 4%? __________ b. GDP to double, if economic growth proceeds at 2% annually? _______ c. housing prices to double, if they grow by 6% annually? ________ d. population to double, if the annual population growth rate is 1.5 %? __________ e. for the value of money to fall by one-half if the annual inflation rate is 2%? ________ If it is 12%? ________ If it is 24%? ________ f. for the CPI to move from 100 to 400 if inflation is 1% annually? __________

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ANSWERS
Matching Set I Set II 1. b 1. h 2. i 2. j 3. f 3. i 4. g 4. f 5. c 5. g 6. a 6. b 7. e 7. a 8. j 8. e 9. h 9. c 10. d 10. d True/False 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. F T T T F F T T F T Multiple Choice 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. b a b d c c e c e d Unlimited MC 1. 2. 3. 4. 5. c abcd abc ad bc

Chapter Review (Fill-In Questions) 1. 2. 3. 4. 5. 6. growth; development Rule of 72; 72 production; resources labor force participation; capital to labor; population; per capita income Thomas Malthus; subsistence; geometrically; arithmetically human; infrastructure; financial system; communications; transportation; labor force

Problem 1 a. b. c. d. e. f. g. h. i. j. T T F T F T T T T T

Problem 2 a. b. c. d. e. f. g. h. i. j. T T F T T T T T T T

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Problem 3 a. b. c. d. e. f. g. h. i. j. T T T F F F F T T T

Problem 4 See figure.

Problem 5 a. b. c. d. e. f. 18 years 36 years 12 years 48 years 36 years; 6 years; 3 years. 144 years.

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