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Zymon Andrei D. Ordas, 2023-01286
Midterms Lessons Coverage In ACOT102
LESSON 1: Rostow’s Five Stages of
Economic Development (1960) Rosario C.
Felix, DBA
Took a historical approach in suggesting that
developed countries have tended to pass through
5 Stages to reach their current degree of
Economic Development.
Stage 1: Traditional Safety
• Characterized by a subsistent, agricultural-
based economy, with intensive use of labor.
• Low levels of trading (barter)
• Resource allocation is determined largely by
tradition and customs.
• Communal regional outlook
• Political power is in the hands of landowners
or a central authority.
• The size of the capital stock is limited and of
low quality resulting in very low labor
productivity and little surplus output left to sell
in domestic and overseas markets.
Stage 2: Transitional Stage (preconditions for
takeoff)
• Agricultural revolution; increased
specialization, production of surplus for trading.
• Increased investment in transportation and
emergent manufacturing sector.
• A new class of businessmen emerges.
• Agriculture becomes more mechanized and
more output is traded.
• Savings and investments grow although they
are still a small percentage of national income
(GDP)
• Some external funding is required – for
example in the form of overseas aid or perhaps
remittance incomes from migrant workers
living overseas.
Stage 3: Take Off
• A short period of intensive growth (2-3
decades)
• Industrialization begins and radical changes in
production techniques occur.
• Workers and institutions become concentrated
around a new industry, entrepreneurship
increases savings and investment, and
banks/capital market.
• The growth is self-sustaining as investment
levels increase which in turn generates more
savings to finance further investment.
• The manufacturing industry assumes greater
importance, although the number of industries
remains small. Political and social institutions
start to develop – external finance may still be
required. Savings and investments grow, perhaps
to 15% of GDP.
Rostow’s Five Stages of
Economic Development (1960)
• Agriculture assumes lesser importance in
relative terms although the majority of people
may remain employed in the farming sector.
• There is often a dual economy apparent with
rising productivity and wealth in manufacturing
and other industries contrasted with stubbornly
low productivity and real incomes in rural
agriculture.
Stage 4: Drive to Maturity
• Takes place over a long period of time, as
standards of living rise and the national
economy grows and diversifies.
• Technological innovation is providing a
diverse range of investment opportunities.
• The economy is producing a wide range of
goods and services and there is less reliance on
imports – self-sustaining.
• Industry becomes more diverse.
• Growth should spread to different parts of the
country as the state of technology improves –
the economy moves from being dependent on
factor inputs for growth towards making better
use of innovation to bring about increases in real
per capita incomes.
Stage 5: High Mass Consumption
• The economy is geared towards mass
production and consumerism.
• Consumer durable industries flourish.

• The service sector has become increasingly
dominant.
• Output level grows, enabling increased
consumer expenditure.
• There is a shift towards tertiary sector activity
and the growth is sustained by the expansion of
a middle class of consumers.
LESSON 2: The Harrod-Domar Growth
Model: Mathematical Equation, Rosario C.
Felix, DBA
The Harrod-Domar Model
➣ One of the principal development strategies is
the mobilization of domestic and foreign savings
in order to generate sufficient investment to
accelerate economic growth.
➣ The economic mechanism by which more
investment leads to more growth can be
described in terms of the Harrod-Domar growth
model, often referred to as the AK model.
➣ Every economy must save a certain
proportion of the national income if only to
replace worn-out or impaired capital goods
(buildings, equipment, and materials)
➣ In order to grow, new investments
representing net additions to the capital stock are
necessary.
➣ If we assume that there is some direct
economic relationship between the size of the
total capital stock, K, and total GNP, Y – for
For example, if $3 of capital is always necessary
to produce a $1 stream of GNP – it follows that
any net additions to the capital stock in the
forms of new investment will bring about
corresponding increases in the flow of national
output, GNP.
➣ This relationship is known as the ‘capital-
output ratio’ and is represented as ‘k’ in the
above case ‘k’ is roughly 3:1.
The Harrod-Domar Model,
more specifically says that in the
absence of government.
✧ The growth rate of national income will be
directly or positively related to the savings ratio.
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✧ The more an economy can save and invest
out of a given GNP, the greater the growth of
that GNP will be.
✧ The Harrod-Domar Model further states that
the growth rate of national income will be
inversely or negatively related to the economic
capital-output ratio.
✧ The higher k is, the lower the rate of GNP
growth will be.
LESSON 3: (Refer to the other handout)
LESSON 4: Contemporary Theories of
Economic Development, Rosario C. Felix,
DBA
1. Underdevelopment as a coordination
failure
 Emphasis on complementarities between
various conditions necessary for successful
development.
 Complementarity: when an action taken by
one firm or individual increases the
incentives of (makes it more profitable or
less costly for) other economic agents to
take similar actions (this action does not
have to be a good thing)
 Examples: corruption, not throwing garbage
on the street, using Windows, etc.
Complementarities
 Complementarities involve positive
externalities across agents (the more people
do something, the cheaper and better for
others to do the same)
 A positive externality is a good thing that
happens to someone because of something
someone else did, but they don't have to pay
for it. Example: If your neighbor plants
beautiful flowers in their front yard, your
street looks nicer even though you didn't pay
for the flowers. [studysmarter.co.uk]
 Positive externalities can create status quo
bias – being stuck in a possibly bad situation
(e.g. most people are using Windows today

because DOS was very successful early on).
Very hard to make people switch.
 In contrast, when we have negative
externalities (e.g. congestion), doing more
of something makes it harder/more
expensive to do the same (e.g. traffic on two
bridges) – everyone wants to do the opposite
(not the same) action (e.g. take the other
bridge).
Coordination Failure
 A state of affairs in which agents’ inability
to coordinate their behavior (choices) leads
to a stable outcome (equilibrium) in which
they are all worse off than in an alternative
situation (also equilibrium).
 It may happen even when all agents are fully
aware the other equilibrium exists, it is just
individuality suboptimal to deviate from the
current ‘bad’ equilibrium (e.g. corruption;
entering the train before people get off)
 Each individual agent is better off to wait
someone else to make the first move.
 Thus, the only way is a coordinated switch
to new equilibrium (e.g. driving direction
change in Sweden). But this is very hard to
do.
Applications to Development
Complementarities often involve investments
whose return depends on other investments
being made by other agents (“network
effects/externalities”)
Example 1: The presence of firms using
specialized skills and the availability of workers
with those skills (firms will not move into an
area without such skills, and workers in an area
won’t acquire skills if not sure they’ll be
employed)
 The above coordination problem can leave
the economy in a bad equilibrium (no skilled
workers and no highly productive firms) vs.
having both – another equilibrium.
 Basically, A CHICKEN AND EGG problem
on what comes first. The skills or the
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demand for skills? Most often, both can
happen at the same time.
(idk why ma’am’s ppt doesn’t have example 2)
Example 3: modernization of agriculture – a
farmer will specialize in a crop (more efficient
and productive than each farmer growing
everything) only if he is sure that he can trade it
for another crop – requires good access to
markets; contrast enforcement quality control (a
middleman), etc. Again: one, ‘bad’ equilibrium
is everyone in subsistence agriculture, another,
‘good’ is specialization in crops and trade.
Especially problematic if there’s a lag between
making an investment and realizing the return
on it.
THE “BIG PUSH” MODEL of Rosenstein-
Rodan (RR)
 Perhaps the most famous model of
coordination failure as an obstacle for
development.
 RR asks how a country industrializes. If a
single firm (shoe factory in his original
example) adopts modern technology and
everyone in the country is very poor, who’ll
buy the goods? Even if the firm pays its
workers well, they can’t be sufficient to
support the demand for modern goods. The
single modernizing firm will be making a
loss.
 But if another firm, in a different sector (e.g.
clothes) also modernizes then each firm
creates demand for the other firm’s product;
so if enough firms modernize at the same
time, those spillovers may be enough to
make them all profitable!
 The coordination problem arises because no
single firm wants to modernize first and
suffer losses; only if all (or sufficiently
many) coordinate and modernize
simultaneously, will all make profits.
 RR thus suggests that a “big push”
industrialization policy that modernizes all
sectors at the same time would make
everyone better off.
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Structural-Change Models
Structural-change theory focuses on the 3.2 The Solow Neoclassical Growth Model
mechanism by which underdeveloped economies
transform their domestic economic structures The Solow neoclassical growth model, for which
from a heavy emphasis on traditional subsistence Robert Solow of the Massachusetts Institute of
agriculture to a more modern, more urbanized, Technology received the Nobel Prize, is
and more industrially diverse manufacturing and probably the best-known model of economic
service economy. It employs the tools of growth. Although in some respects Solow's
neoclassical price and resource allocation theory model describes a developed economy better
and modern econometrics to describe how this than a developing one, it remains a basic
transformation process takes place. Two well- reference point for the literature on growth and
known representative examples of the structural- development. It implies that economies will
change approach are the "two-sector surplus conditionally converge to the same level of
labor" theoretical model of W. Arthur Lewis and income if they have the same rates of savings,
the "patterns of development" empirical analysis depreciation, labor force growth, and
of Hollis B. Chenery and his coauthors. productivity growth. Thus, the Solow model is
the basic framework for the study of
convergence across countries (see Chapter 2). In
3.1 The Lewis Theory of Economic this appendix, we consider this model in further
Development detail.
The key modification from the Harrod-Domar
Basic Model One of the best-known early (or AK) growth model, considered in this
theoretical models of development that focused chapter, is that the Solow model allows for
on the structural transformation of a primarily substitution between capital and labor. In the
subsistence economy was that formulated by process, it assumes that there are diminishing
Nobel laureate W. Arthur Lewis in the mid- returns to the use of these inputs.
1950s and later modified, formalized, and
extended by John Fei and Gustav Ranis.5 The
Lewis two-sector model became the general
theory of the development process in surplus-
labor developing nations during most of the
1960s and early 1970s, and it is sometimes still
applied, particularly to study the recent growth
experience in China and labor markets in other
developing countries.
In the Lewis model, the underdeveloped
economy consists of two sectors: a traditional,
overpopulated, rural subsistence sector
characterized by zero marginal labor
productivity—a situation that permits Lewis to
classify this as surplus labor in the sense that it
can be withdrawn from the traditional
agricultural sector without any loss of output—
and a high-productivity modern, urban industrial
sector into which labor from the subsistence
sector is gradually transferred. The primary
focus of the model is on both the process of
labor transfer and the growth of output and
employment in the modern sector. (The modern
sector could include modern agriculture, but we
will call the sector "industrial" as a shorthand).
Both labor transfer and modernsector
employment growth are brought about by output
expansion in that sector. The speed with which
this expansion occurs is determined by the
rate…