Growth and Development Economics Quiz 3B

Lahore School of Economics

Spring Semester, 2013

Development and Growth Economics

BSc IV Section C

Quiz 3B Total Points: 45 Suggested Solutions

Instructions: Answer all questions in the spaces provided. For full marks, make sure you write
all relevant points and formulate coherent and concrete answers. Pencils, pens, rulers, etc.
cannot be shared and cell phones cannot be used during the session.

Question 1

Describe the rationale behind Kuznetss Inverted-U hypothesis. Why do you think its
relevant (or not relevant) to a country like Pakistan? (10 points)

Inverted-U hypothesis is a graph reflecting the

relationship between a countrys income per
capita and its equality of income distribution.

Inequality might worsen during early stages of

economic growth before eventually improving.
This is because of the nature of structural
change. Early growth as per Lewis two stage
model is concentrated in modern, industrial
sector, where employment is limited but wages
and productivity are high. Modern sector enlargement tends to increase rich-poor income gap.
But as supply of workers and education access (and other indicators of economic development)
increase, economic growth is complemented by more equal resource distribution. Although
Kuznets did not specify the mechanism through which inverted U hypothesis was supposed to
occur, it was in principle consistent with sequential process of economic development.
However, it has been observed that modern sector enlargement or enrichment tends to
increase income inequality or has an ambiguous effect on it. Hence, the empirical evidence of a
smooth Inverted-U shaped income distribution curve is mixed. (For example, in most of East
Asia, the upward sloping portion is not seen at all while in Latin America, both portions can be
observed). Pakistan is typically spotted as an example of growth without development.
Inequality has thus increased with higher income per capita. Owing to the character of
economic growth, which for Pakistan includes skewed distribution of assets like land,
education, health, credit access and other resources, economic development has not taken

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 Growth and Development Economics Quiz 3B

place. Hence, at least till this point in time, the Inverted-U hypothesis is not relevant to a
country like Pakistan, although the upward sloping portion of the curve seems applicable. And if
economic development and trickle-down economics happen or pro-poor policies are
implemented over time, we may miraculously see higher economic growth and lower inequality
(the downward sloping portion of the curve). But this seems difficult because inclination of
policymakers towards pro-poor policies and well implemented inequality-reducing policies is
hardly seen.

Question 2

Briefly describe the policy options that can address poverty directly. (10 points)

Students should state and explain briefly the following policies:

Eliminate factor price distortions: more expensive capital labor-intensive technique

more employment and less poverty
Structural change in asset ownership
Progressive taxes and transfers of income or services such as education, health, etc
Social security safety nets (such as BISP)

Question 3

According to Microeconomic Theory of Fertility, how would a higher food-inflation level

change the budget line and indifference curve? (In other words, assume P X and PC both
increase). Explain in theory and diagrammatically. (10 points)

If Pc and PX both increase, then people would purchase less of both goods. The budget line
will change accordingly:

It would tilt inwards. If the increase in

PC > PX, the new budget line would be
in red and if PX > PC, the new line
would be the one in green. If both
increase proportionately, then it
would shift inwards in a parallel
fashion (not shown here). If the cost
of having children increase, be it
opportunity cost, expensive schooling,
taxes on higher number of children, or
if they are not seen as old age
financial and economic security assets, then the new C, demand for children, would be lower

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 Growth and Development Economics Quiz 3B

than before. If PX increases, that is, if price of all other goods rise relative to the price of
children, demand for children would increase. We dont know the final effect this combination
of events would bring. Students can draw the new indifference curve on any of the red or green
lines. Both ways, households are worse off (lower indifference curve) and most likely, demand
for children will fall.

Question 4

How can child labor issue be represented as multiple equilibria problem? State the
options/policies that can address child labor. (10 points)

As wage level falls, households start

sending their children to work at
school going age. Parents respond
more at lower level of wages than at
relatively higher levels of wages. If
wages are high enough, such as wH,
no children would work but if wages
keep on falling, parents start sending
their children to work (at an
increasing rate). The difference
between A and T is purely supply of
child labor. E2 is a stable bad
equilibrium and E1 is a stable good
equilibrium. If all households coordinate and decide to not send their children for work, we can
automatically reach E1 from E2 as at E2, excess demand of labor would push wages up. Since
coordination is difficult, government intervention (such as a policy on banning child labor) is
important.

A stringent policy measure could be a ban on child labor but it may prove to be more costly for
the family (there will be obvious reduction in income/poverty). Hence following policies could
be helpful:

Consider child labor an expression of poverty, so emphasize ending poverty generally (a

traditional World Bank approach)
Get more children into school (as in Millennium Development Goals),
If child labor is inevitable in the short run, regulate it to prevent abuse and provide support
services for working children (UNICEF approach)
Ban child labor in its most abusive forms (ILO strategy; Worst Forms of Child Labor
Convention)

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Activist approach: trade sanctions. Concerns: could backfire when children shift to informal
sector; and if modern sector growth slows

Question 5

Why do you think closing educational gender gap is important? (5 points)

Closing the educational gender gap is important because,

The rate of return on womens education is higher than that of men in developing countries
(education of mother has inverse relationship with child mortality)
It increases productivity, social status and role of woman in a household unit and thus
lowers fertility
Educated mothers have a multiplier impact on many generations
It can break the vicious cycle of poverty and inadequate schooling for women

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