DEVELOPMENT ECONOMICS
DEVELOPMENT ECONOMICS THEORY
To better understand economic development, economists focus on developing models that help us understand production and long-term growth.
Scroll down or use the menu to the right to learn more about development economics theory.
Factors of production
How do we understand economic growth?
What is Development Economics?
Development economics is the study of economic transformations and their effects on well-being (human condition).
Development economics considers factors such as health, education, working conditions, domestic and international policies, and market conditions, with a focus on improving living standards in the world’s poorest countries.
How do we measure development?
There are numerous measures we can use to assess development:
GDP Per Capita
Consumption Per Capita
Population Growth
Infrastructure
Urbanization
Social Conditions
How much do your citizens make?
A standard measurement of development is a country’s GDP per capita – the country’s total economic output divided by its population. Measured in US dollars, this provides a standard measure across countries.
Data Source
Look up GDP per capita for your country here.
Development is a country increasing its productive capacity to meet citizens’ basic needs
What is a Production Possibility Frontier (PPF)?
- A country’s ability to meet its citizens’ basic needs is a function of how many goods and services its economy can produce – its Production Possibility Frontier (PPF).
- The Production Possibility Frontier shows the combination of goods that a country is capable of producing given its limited available resources.
In a basic model, we think of a country’s production as result of two main factors of production:
Labor
Capital
A graphical representation of the PPF helps us understand how we can increase growth
The blue curve shows Country A’s PPF of manufactured products and agricultural products.
We assume agriculture is a labor-intensive sector and manufacturing is a capital-intensive sector.
In general, increasing a country’s input factors will lead to greater potential growth
This graph shows a country that has increased the amount of both potential factors: labor and capital.
Note: More raw materials could also increase potential growth. This could arise from free trade agreements – See Module 2 on International Trade.
Increasing labor will increase potential growth, but favor agricultural products
Increased labor could arise from increased birth rates, decreased mortality, and/or increased immigration.
Increasing labor will increase the production of labor-intensive goods and services. In our example, this is agriculture.
Increasing capital will increase potential growth, but favor manufacturing
Increased investments in buildings and equipment could arise from savings, borrowing, and/or foreign direct investment.
Increasing capital will increase the production capital-intensive goods and services. In our example, this is manufactured products.
Long-Term Growth Models
How do countries sustain growth in the long-term?
Growth is more complex than a simple accumulation of factors of production
Economists use the Solow Model to simulate a more robust economic growth that considers the following two factors:
Interaction of Factors of Production
Labor and capital do not produce linear returns to scale – diminishing returns. How these factors are employed jointly affects their overall productivity.
Long-term Growth
Growth is a process that happens over time. Growth rates are affected by the initial endowment of capital or labor for a particular country and how quickly these factors are added.
The Solow Model acknowledges diminishing marginal returns for additional capital or labor
Diminishing Marginal Returns
Adding more capital to fixed labor and technology can increase output, but in smaller increments, indicating that there are diminishing returns to a single factor.
Note: The graph to the left shows decreasing incremental output for each additional unit of capital.
The Solow Model also helps us focus on output per worker as key to growth
Output per Worker
Conversely, adding more labor, while holding technology and K constant: Due to diminishing returns, adding labor to fixed K and productivity would imply a reduction in output per worker.
Note: The orange line to the left shows decreasing output per worker when additional labor is added.
In the long-term, the Solow Model states that growth will reach a steady state
What is Steady State Growth?
- Growth takes place as the capital stock per worker expands, enabling each worker to become more productive by having more capital to work with.
- Since growth from additional capital occurs at a slowing rate, additional capital will eventually reach a point where the cost of depreciation equals the rate of investment – growth will stop.
How do countries sustain growth in the long-term?
Long-term growth is dependent on improvements in technology.
Our previous conceptions of output per worker made technology constant and did not account for improvements in technical capability – or multifactor productivity.
- Multifactor productivity can increase output while holding labor and capital constant.
- Productivity increases from technology and efficiency are not subject to diminishing returns.
Research & Development
While not the only measure of technology, a country’s % of GDP spent on Research & Development (R&D) is an important measure of long-term growth potential.
Data Source
Look up R&D in your country here.
We will examine more specific drivers of growth more closely in the next section.
Learn more about Development Economics
