Classical Theories
Linear-Stages
 Rostow’s Stages of Growth
 Harrod-Domar Model
Rostow’s Stages of Growth
Traditional Society
 A society with low technology and
relies on agriculture for
production.
Preconditions to take-off
 Increase in terms of commercial
activities and development of
infrastructure. Export activities
are also beginning to take place,
although much of the products
being exported are primary
goods.
Take-off
 The economy is becoming self-
sustaining, and the manufacturing
sector is now developing.
Urbanization is also increasing
along with the development of
social and economic institutions.
Drive to maturity
 Domestic production is increasing
along with the diversification of
investments. Growing practices of
import substitution.
High mass consumption
 International trade focused on
exploiting comparative advantage
as high level of infrastructure
supports economic growth. High
demand for wide variety of goods
and services.
Harrod-Domar Model
Growth is dependent in level of income
and capital-output ratio or the
productivity of capital investments.
Basically, the model argues that change
in income of an economy results from
change in savings since the capital-
output ratio is constant.
High capital-output ratio means that an
economy can produce a lot from high
amount of output while low capital-
output ratio means that an economy can
produce a lot from low amount of output.
Assumptions of the model
 Savings lead to investments.
 Investments leads to change in
capital stock.
 Capital output ratio is constant.
Savings lead to investments
From income, the amount allotted to
savings (S) are used for investments (I)
S=I
Investments leads to change in
capital stock
Capital stock is the total capital in an
economy. Whenever investments occur,
it causes the capital stock to change.
I=∆ K
Capital output ratio is constant
Capital-output ratio (r) is always
constant. The productivity of capital
stock remains the same, which means
that whenever there is change in capital
stock, it will cause a change in its
productivity.
Capital-output ratio is denoted by:
This represents ratio on how much
capital (K) is needed to produce an
output (Y). Since the ratio is constant, a
change in capital, will also change the
output or income as denoted below:
∆K
∆Y
Harrod-Domar Model
As a growth model since capital output
∆K
ratio is r =
∆Y
Then income can be determined through
the assumptions of the model. We can
multiply both sides by that will result to *
r = ∆ Y . By dividing both sides by ∆ Y r,
we can ∆ K now derive the income
function of the model:
Since ∆ K I, therefore we can cay that
growth is equals to investments over
capital ratio. This model shows that
increasing the capital stock results to
economic growth.
Structural Change Model
 Lewis Model
 Patterns of Development
Lewis Model (Two-Factor Model)
There are two sectors in an economy
which is the traditional and modern
society.
The traditional society is the
agricultural sector of the economy.
Modern society is the manufacturing
sector of the economy.
The focus of the study is the transfer of
labor from traditional to modern society
to eliminate labor surplus, thus
increasing income.
Assumptions of the Model
There is surplus labor in the agricultural
sector and full employment in
manufacturing sector.
 Since there is labor surplus in the
agricultural sector, there is zero
marginal productivity and income
is low.
 Since the manufacturing sector
needs labor, the income is higher
and labor from traditional
societies should transfer to
modern societies.
Savings are reinvested for expansion.
 The assumes that capitalists
reinvest all of their savings for
expansion to create more labor
demand in the modern sector that
will accommodate the transfer of
labor from agricultural to
manufacturing sector.
 The transfer of labor eliminates
labor surplus and increasing the
income for agricultural sector.
Criticisms of the Model
 Labor surplus in agricultural
sector and the full employment in
manufacturing sector is false.
 Rate of labor transfer and
employment creation may not be
proportional to rate of modern-
sector capital accumulation.
 Capitalists do not invest all of
their savings, which is why the
modern societies may not be able
to accommodate the transfer of
labor.
Patterns of Development
 Focuses on the process of
transformation of how
underdeveloped economies
replace traditional agricultural
production with industrial
production.
 Involves structural changes such
as change in production,
consumer demands, participation
in international trade,
urbanization, and population.
International-Dependence Revolution
 Neocolonial Dependence Model
 False Paradigm
 Dualistic Development Thesis
Neocolonial Dependence Model
Underdevelopments exist because of
the exploitative relationship between rich
and poor countries.
There is unequal power relationships
between the rich countries (identified as
center countries) and developing
countries (identified as peripheries)
The rich countries exploits poor
countries to support the development of
centers, creating poverty in developing
countries through the policies of the
former and their extensions in the latter
in the form of the elites, who are
identified as comprador groups.
False Paradigm
Underdevelopment continues to exist
because of the incorrect development
strategies being implemented by
developing countries.
These strategies and models of
development are taught by developed
countries in their attempt to help
underdeveloped countries to achieve
economic development.
Dualistic Development Thesis
The existence of substantial and
increasing gap between rich and poor
countries.
The coexistence of rich and poor
countries is not temporary and the gap
between the two has an inherent
tendency to increase as the rich
countries may not be doing enough to
help poor countries, and in some cases,
the former may actually be exploiting the
latter.
NEOCLASSICAL
COUNTERREVOLUTION: MARKET
FUNDAMENTALISM
Statist Model
 Central Planning Governments
 Participation of governments to
market activities and highly
regulated industries
Neoclassical Counterrevolution
 The resurgence of free market as
opposed to state intervention.
 Interventionist policies leads to
poor allocation of resources due
to its improper pricing and too
much regulation.
Free Markets
 Market activities free from
government intervention
  An economic system operates
better when free from
government intervention.
Public-Choice Theory
 Governments are inefficient.
 Individual behavior is guided by
self-interest.
Market-Friendly Approach
 Governments should create an
environment in which markets
can operate efficiently.
 Governments should only
intervene only when markets are
inefficient due to market failures,
such as, presence of monopoly,
managing externalities, etc.
Solow Growth Model
 There are diminishing returns to
factors of production but results
to constant returns to scale to
both factors jointly.
 Solow introduced the exogenous
variable for growth, which is
technological progress.
 Output is a product of increases
in labor quantity and quality,
capital, and improvements in
technology.
STATES AND MARKETS
Free-Market System
 Allocation of resources through
markets
 Private individuals controls
factors of production.
Market Failures
 Industry Concentration
 Externalities
 Failure in Economic Structure
 Macroeconomic Imbalances
Industry Concentration
 Lack of competition due to
presence of monopoly power
 May be caused by barriers to
entry or integration activities in
the market.
Externalities
Negative Externalities
 Uncompensated effects of market
activities that brings harm to its
environment and other markets.
 Quantity demand and supply are
more than the ideal quantity that
causes no harm other parties
Positive Externalities
 Benefits of market activities to its
environment and other markets
 There is less quantity demand or
supply than the ideal quantity that
will benefit other parties.
Managing Externalities
Corrective Taxes
 Corrective taxes are designed to
make market forces take into
account the costs that arise from
negative externalities.
 Serve as payment for external
cost brought about by excessive
market activity in a particular
market.
Subsidies
 Subsidies are designed to
encourage more market activities
in order to maximize social
benefits.
Failure in Economic Structure
 Infant Industry
Governments temporarily support new
industries until they have grown strong
enough to meet international
competition.
Developing countries have a potential
comparative advantage in
manufacturing, but new manufacturing
industries in developing countries
cannot initially compete with well-
established manufacturing in developed
countries.
 Import-Substituting
Industrialization
A policy pursued by many less-
developed countries, wherein domestic
industries are created under the
protection of tariffs or import quotas.
Macroeconomic Imbalances
Government controls money supply as
countermeasures to economic failures
such as inflation.
The Washington Consensus
 Fiscal Discipline
 Reordering public expenditure
and priorities.
 Tax Reform
 Liberalize interest rates
 Promote competitive exchange
rates
 Trade Liberalization
 Liberalization of Foreign Direct
Investment (FDI)
 Privatization
 Deregulation
 Secure Property Rights in the
private sector
International Monetary Fund
Stabilization Programs
 Reducing government budget
deficit via higher taxes, reduce
spending, and financing by
borrowing which crowds out
private investment.
 Restrictions on central credit-
control of money supply.
 Adjust exchange rate via
devaluation to stimulate exports.
 Remove price controls on
consumer goods including food
prices.
 Restrain wage increases.
World Bank Structural Adjustment
Program
 Trade reform
 Adjusting prices
 Promoting market competition
 Fostering privatization
 Creating market support
institutions