Economy

1. Introduction to Development Policy
Spring 2023
Problem Set 2
Due: March 31, 2023
Name: Mithun kumer Das, ID:202312102
Part 1. Conceptual problems (limit your answer to 5 lines)
1. How does the Solow growth model specify the role of productivity growth vs. factor deepening in explaining
output growth? How do you use the model to measure the role of technological change (TFP growth) in explaining
part of theobserved growth rate?
Answer:
According to the Solow growth model, the marginal contribution of each factor to output growth declines as the
use of each factor increases. It may be assumed that technology is international public goods which explain the
long-term growth in per capita income. By observing the economy at two points in time, and calculating
∆Y/Y,∆K/K, ∆L/L, wl, wk, and it can be used the difference to measure the role of TFP and the equation illustrate
as ∆A/A=∆Y/Y-Wk*∆K/K-Wl*∆L/L.
2. The Solow model predicts convergence in per capita GDP between less developed countries (LDCs) and more
developed countries (MDCs). Do the empirical facts fit the theoretical prediction? What assumptions are necessary
toreach this prediction? Do you think these assumptions are credible?
Answer:
Solow assumes that countries are using the same production function with equal access to technology as
international public goods to which all countries have access and equal absorptive capacity to attain long-term
growth & per capita GDP convergence. I think the empirical facts do not fit the theoretical prediction. It is not
credible since countries may diffuse technology differently due to different capacities of adoption and adaptation.
3. How can promoting big businesses contribute to economic growth? Find arelevant theoretical framework
to give your answer.
Answer: One relevant theoretical framework is the theory of endogenous growth, which is not solely determined
by exogenous factors such as population growth or technological progress but is also influenced by factors that are
endogenous to the economy, promoting big businesses can contribute to economic growth by enabling to innovation,
achieve economies of scale, and generate spillover effects that benefit other firms and industries in the economy.

2. 4. How does agricultural development affect industrialization? Use the theories that explain the structural change.
Answer:
Using the dualism model, agriculture supplies labor for industry and lowers the price of goods to lower the nominal
wage and the cost of labor for industry. Lewis’s model explains, surplus labor in agriculture can be transferred to
industry, where it can be absorbed without increasing wages, leading to industrialization without sacrificing
agricultural productivity.
5. Consider the sharecropping model. Does adding a fixed compensation, ratherthan increasing the share of the
tenant, solve the incentive problem?
Answer:
Adding a fixed compensation would provide a safety net for the tenant but the incentive problem will not totally
be solved by adding this to the sharecropping model. First and foremost, the tenant will have little incentive to
work harder than is required to earn the fixed compensation. Furthermore, by including a fixed compensation,
the tenant will be less willing to bear the risk because they will be paid regardless of crop yield.
6. Why do people cooperate even without the possibility of meeting each otheragain? Explain your answer.
Answer:
The Game Theory explains why people will choose to cooperate even without the possibility of meeting each other
again. This is based on the mutual benefits for the parties, their reputation, and the fact that the other party possesses
a skill or expertise that is in high demand, as well as the fact that it reduces transition costs.
7. Discuss benefits and risks of maintaining long-term business relationships.
Answer:
Maintaining long-term business relationships can provide numerous benefits for businesses, including increased
trust between business partners, stability, may reduce information asymmetry problem and increased efficiency,
reduced transaction costs, and shared knowledge. However, there are also risks associated with long-term
relationships, such as reduced flexibility, complacency, dependence, and increased reliance on a single partner.
This can also limit their negotiating power.

3. Part 2. Empirical exercise
The Excel file solow.xlsx gives you data for GDP growth (𝛥Y/Y), employment growth(𝛥L/L), capital stock growth
(𝛥K/K), and the labor share (𝑊𝐿) and capital share (𝑊𝐾) for two countries (South Korea and Taiwan), for three
decades (1960-70, 1970-80, and 1980-90). In both countries, the GDP growth rate was consistently very high
through the three decades, yet the relative roles of labor deepening, capital deepening, and TFP growth in
accounting for growth were quite different. And TFP growth (stressed by theSolow model) and factor deepening
(stressed by the Harrod-Domar model) were not equally important in the two countries.
1. Using the following growth accounting equation in the Solow model,
𝛥𝑌/𝑌 = 𝛥𝐴/𝐴 + 𝑊𝐾𝛥𝐾/𝐾 + 𝑊𝐿𝛥𝐿/𝐿
calculate the rate of total factor productivity (TFP) growth (denoted by 𝛥𝐴/𝐴) foreach period. (Fill out
the numbers in the Excel sheet.)
Solow model for South Korea (Alwyn Young, QJE 1995)
Economy-Excluding agriculture
Output Labor Capital Employment Capital stock TFP
growth share share growth growth (A index)
DY/Y WL WK DL/L DK/K DA/A
1960-70 0.111 0.690 0.310 0.088 0.132 0.00936
1970-80 0.095 0.678 0.323 0.054 0.148 0.01058
1980-90 0.096 0.734 0.266 0.060 0.104 0.02430
Solow model for Taiwan
Economy-Excluding agriculture
Output Labor Capital Employment Capital stock TFP
growth share share growth growth (A index)
DY/Y WL WK DL/L DK/K DA/A
1966-70 0.111 0.739 0.261 0.044 0.171 0.03385
1970-80 0.103 0.739 0.261 0.068 0.144 0.01516
1980-90 0.078 0.749 0.251 0.032 0.083 0.03320

4. 2. For each period, calculate the percentage shares of observed growth that can beattributed to labor
deepening, capital deepening, TFP (technological change) contribution. (Fill out the numbers in the
Excel sheet.)
Labor Capital TFP
GDP growth deepening deepening contribution
100 54.7 36.9 8.43243
100 38.5 50.3 11.14105
100 45.9 28.8 25.30833
Percentage contributions to growth (Korea)
Labor Capital TFP
GDP growth deepening deepening contribution
100 29.3 40.2 30.49820
100 48.8 36.5 14.72233
100 30.7 26.7 42.56282
Percentage contributions to growth (Taiwan)

5. 3. Which country was more dependent on factor deepening or on TFP growth for itseconomic boom?
Answer:
Factor Deepening (Labor)
Year Labor Deepening Growth Discussion
Korea Taiwan
1966-70 54.7 29.3
Over the three decades, Factor deepening
(Labor) growth of Korea is more than
Taiwan. Therefore, Korea was more
dependent on factor deepening (Labor) for its
economic boom.
1970-80 38.5 48.8
1980-90 45.9 30.7
Factor Deepening (Capital)
Year Capital Deepening Discussion
Korea Taiwan
1966-70 36.9 40.2 Over the three decades, Factor deepening
(Capital) growth of Korea is more than
Taiwan. Therefore, Korea was more
dependent on factor deepening (Capital)
for its economic boom.
1970-80 50.3 36.5
1980-90 28.8 26.7

6. Therefore, Over the three decades, Factor deepening (Labor & Capital) growth of Korea is more than Taiwan.
Therefore, Korea was more dependent on factor deepening (Labor & Capital) for its economic boom. TFP growth
of Taiwan is more than Korea.Hence, Taiwan was more dependent on TFP growth for its economic boom.
TFP Growth
Year Discussion
Taiwan Korea
1966-70 30.49820 8.43243 Over the three decades, TFP growth of
Taiwan is more than Korea. Therefore,
Taiwan was more dependent on TFP
growth for its economic boom.
1970-80 14.72233 11.14105
1980-90 42.56282 25.30833