AE 12 Lesson 4 5

LESSON 4:
Contemporary Models
of Development and
Underdevelopment
Overview of the
01 Underdevelopment as a Coordination Failure
02
Lesson
Multiple Equilibria
03 Big Push Model
04 Problem in Multiple Equilibria
05 O-Ring Theory – Michael Kremer’s
06 Economic Developmentas Self-Discovery
07 Hausmann-Rodrik-Velasco Growth Diagnostic Framework

Underdevelopment as a
Coordination Failure
Where-to-meet dilemma
Complementaritie Coordination
s Failure Prisoner’s dilemma
Big Push O-Ring

Model Model
Underdevelopment trap
Middle-income trap
Deep Intervention
Multiple Equilibria
https://www.youtube.com/watch?v=d6oNlgC-i8Q&ab_channel=EconJohn
Multiple Equilibria
Prisoner's Dilemma
Pareto Improvement
- An actor of the economy
can have an improvement
without putting anyone at
risk or worst situation.
Starting Economic Development: The
Big Push
● Sometimes market failures lead to a need for public policy intervention
● The Big Push: A Graphical Model, 6 assumptions
1. One factor of production
2. Two sectors
3. Same production function for each sector
4. Consumers spend an equal amount on each good
5. Closed economy
6. Perfect competition with traditional firms operating, limit pricing monopolist with a
modern firm operating
● A big push may also be necessary when there are:
1. Intertemporal effects
2. Urbanization effects
3. Infrastructure effects
4. Training effects
BIG PUSH THEORY
The Big Push Model is a concept in

development economics or welfare economics
that emphasizes the fact that a firm's decision
whether to industrialize or not depends on the
expectation of what other firms will do.
For example, to move from a large unproductive

agricultural sector to a productive agricultural
economy fertilizer is necessary, amongst other things.
Further Problems of Multiple
Equilibria
1. Inefficient Advantages of Incumbency
2. Behavior and Norms
3. Linkages
4. Inequality, Multiple Equilibria, and Growth
Michael Kremer’s O-Ring Theory of Economic
Development
● The O-Ring Model
○ Production is modeled with strong complementarities among inputs
○ Positive assortative matching in production
● Implications of strong complementarities for economic
development and the distribution of income across countries
The “O-Ring” Theory: A Simple
Illustration of the basic idea
• HR Department has 4 workers- 2 H-types and 2 L-types;
In a simplified model let Q = qiqj
• How to allocate?
{HH, LL}; or {HL, LH}?
• We know that H2 + L2 > 2HL because: (H–L)2 > 0
• So with strong complementarity it always pays to do
assortative matching
Economic Development as Self-
Discovery
• Hausmann and Rodrik: A Problem of Information
• Not enough to say developing countries should produce “labor
intensive products,” because there are thousands of them
• Industrial policy may help to identify true direct and indirect
domestic costs of potential products in which to specialize by:
 Encouraging exploration in the first stage
 Encouraging movement out of inefficient sectors and into more
efficient sectors in the second stage
Economic Development as Self-
Discovery
● Three building blocks of the theory; and case examples of
their reasonableness in practice:
○ Uncertainty about what products can be produced efficiently (evidence:
India’s success in information technology was unexpected; reasons for
Bangladesh’s efficiency in hats vs Pakistan’s in bedsheets is not clear)
○ Need for local adaptation of foreign technology (evidence: seen in cases
such as shipbuilding in South Korea)
○ Imitation can be rapid (e.g. the spread of cut flower exporting in Colombia)
Hausmann-Rodrik-Velasco Growth
Diagnostics Framework
● Focus on a country’s most binding constraints on
economic growth
● No “one size fits all” in development policy
● Requires careful research to determine the most likely
binding constraint
Hausmann-Rodrik-Velasco Growth Diagnostics Decision
Tree
Lesson 5
Poverty, Inequality,
and Development
Measuring Absolute Poverty
1. Size or Personal Distribution of income
i. Lorenz Curve
ii. Gini Coefficients and aggregate
measures of inequality
2. Functional or Distributive factor share
distribution of income
Lorenz Curve of Income
Distribution
● Depicting
the
variance of
the size
distributio
n of
income
GINI COEFFICIENT
 An aggregate numerical
measure of income
inequality
 Measured by dividing the
area between the perfect
equality line and the Lorenz
curve by the total area lying
to the right of the equality
line in a Lorenz diagram
Lorenz Curve and Gini % of Population % of Income
0 0
Coefficient 10 0
Plot the graph of the data and fine the Gini 20 5
coefficient.
30 10
40 15
50 25
60 35
70 45
80 55
90 75
100 100
Lorenz Curve and Gini Coefficient: SW1
Plot the graph of the data and fine the Gini coefficient. .
% of Population % of Income
0 0
10 10
20 20
30 30
40 35
50 45
60 50
70 55
80 70
90 85
100 100
Four Highly Desirable Properties
1. Anonymity principle simply means that our measure of inequality should
not depend on who has the higher income; for
2. example, it should not depend on whether we believe the rich or the poor
to be good or bad people.
3. Scale independence principle means that our measure of inequality
should not depend on the size of the economy or the way we measure its
income
4. Population independence principle it states that the measure of
inequality should not be based on the number of income recipients
5. Transfer principle (sometimes called the Pigou-Dalton principle). it states
that, holding all other incomes constant, if we transfer some income from a
richer person to a poorer person (but not so much that the poorer person is
now richer than the originally rich person), the resulting new income
distribution is more equal.
Funcitonal Income Distribution
• Attempts to explains the share of
total national income that each of the
factors of production receives.
• Functional income dostribution =
Wages as a percentage of Profits
Measuring Absolute Poverty
Headcount Index
Measuring TPG and APG
1. Count the number of population in poverty and
label it as 1.
2. To get the poverty gap depth, use the formula
(poverty line value – Yi)
3. To get the severity of the poverty gap, use the same
formula as depth raise to the second power
2
(poverty line value – Yi)
4. Then get the ∑ summation of the depth and
severity to get the total poverty gap in depth
and severity
5. To get the AVPd =
6. To get the AVPs =
2
Z = 30/mo.
In
Depth Severity
Person Income Poverty
(Z-Yi) (Z–Yi)2
=1
1 8
2 10
3 14
4 20
5 25
6 27
7 35
8 45
9 60
10 100
SW2 Z = 300/mo.
Depth Severity
Person Income In Poverty = 1
(Z-Yi) (Z–Yi)2
1 150
2 200
3 230
4 280
5 300
6 320
7 350
8 450
9 600
10 1000
GROWTH AND POVERTY
● A rapid growth is bad for the poor because they
would be bypassed and marginalized by the
structural changes of modern growth
POLICY OPTIONS ON INCOME
INEQUALITY AND POVERTY: SOME
BASIC CONSIDERATIONS
1. Altering the functional distribution of income through
relative factor prices
2. Modifying the size distribution through increasing assets of
the poor
3. Progressive income and wealth taxes
4. Direct transfer payments and the public provisions of
goods and services

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LESSON 4:

03 Big Push Model

04 Problem in Multiple Equilibria

05 O-Ring Theory – Michael Kremer’s

06 Economic Developmentas Self-Discovery

07 Hausmann-Rodrik-Velasco Growth Diagnostic Framework

Big Push O-Ring

The Big Push Model is a concept in

For example, to move from a large unproductive

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