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ECOS3002 – Development Economics
Section 1. Draw, calculate, interpret
1. (15 points) Inequality analysis. Suppose a neighborhood has 6 households, with
expenditure levels 2, 3, 5, 6, 8 and 10. You can call them HH1, HH2, HH3, HH4, HH5,
and HH6, respectively. Suppose the poverty line is 5.
a. (5 points) Draw the Lorenz curve for this neighborhood.
b. (5 points) Calculate the Gini coefficient for this neighborhood. Please provide
your workings (how you calculated the solution).
c. (5 points) Suppose you could implement a tax redistribution scheme that takes
up to half the income from any household(s), and gives a cash transfer to any
household(s), to reduce the value of the Gini coefficient by 10%. How would
you do so (which household(s) and how much would you take from them, and
which household(s) and how much would you give to them), while minimizing
the total amount transferred? Please provide your workings (how you calculate
the solution and/or succinctly describe the logic you used).
2. (15 points) Addressing negative externalities. One of the challenges with environmental
sustainability is that it often involves market failures – cases where the “free market”
does not necessarily lead to a socially optimal solution. This can occur for a number of
reasons, including negative externalities like pollution. The following figures, adapted
from Figure 15.1 in our textbook, illustrates this situation. While the socially optimal
outcome would be at point B, where the Marginal Social Cost (MSC) of pollution
equals the Marginal Social Benefit (MSB) of the associated production activities, in a
market equilibrium we end up at point C, where MSB = MPC (Marginal Private Cost).
The difference between MSC and MPC is the Marginal Externality Cost (MEC). The
MSC = MPC + MEC
MPC
MEC
Demand = MSB
free market solution effectively ignores the MEC, because the MEC doesn’t directly
affect the decision-makers over production. Moving from point C toward point B
generally requires some kind of market intervention, usually by the government, to
force the decision-makers over production to internalize the MEC.
a. (5 points) Create a figure similar to the figure above, to illustrate one potential
intervention to force relevant decision-makers to internalize the externality.
Only use the minimum information in your figure to illustrate the solution, not
just copying the figure above or the figure in the textbook. However, where you
use the same concepts in the above figure (e.g., B, MPC, q*), you should use the
same labels. You will describe your solution in words in part b.
b. (5 points) Describe in words the figure you created in part a, succinctly
explaining how it illustrates a potential market intervention to create a more
socially-optimal outcome. Make sure you describe the policy and precisely
exposit how it increases social welfare, using objects in the model.
c. (5 points) If you wanted to implement the policy in practice, which entity or
entities would be responsible to implement the policy, and which would be
recipients of the policy (i.e., be directly responsible to comply with it)? What
would likely be the main political economy challenge with implementing the
policy in practice?
Section 2. Interpret an RCT
3. (15 points) Interpret a microfinance RCT. Many of the microfinance RCTs in the
literature focus on the question “what is the impact of microfinance (relative to a
control?,” often finding muted effects. However, these studies, and Rachael Meager’s
meta-analysis of the early microfinance RCTs, suggest that more experienced
microenterprise owners with larger enterprises, while a minority of the general
population, can get a fairly significant boost to their business activities from increasing
their access to finance through microfinance loans.
Suppose you are evaluating an RCT that further delves into this effect in more
experience microenterprise owners running relative large microenterprises. The study
also concerns itself with the “spillover” effect of boosting some business, on their
neighbors/competitors – i.e., if microfinance can boost the income of loan recipients by
10%, but their neighbors/competitors who aren’t recipients lose 10% of income, then
the effect of a loan program on overall economic welfare might be neutral, or even
negative.
The study uses the following design. It identifies a sample of 500 villages in rural Brazil
which have limited prior presence of microfinance programs, and identifies all of the
microenterprises with 3-10 employees (on average, each village 7.2 such businesses).
It randomly allocates:
1. 250 villages to control;
2. 250 villages to treatment. Within these villages, they then randomly allocate
50% of eligible business (3-10 employees) to treatment (being offered a
microfinance loan), and 50% to control (not being offered any loan).
The study only has resources for 1 post-treatment survey, surveying all ~5,000 eligible
businesses (3-10 employees) in the 500 villages. They find that:
• At endline, in the control villages, the average business income is 3200
Brazilian Real per month (1 Real = 0.25 AUD).
• At endline, in the treatment villages,
o Amongst the 50% that were intended for treatment, the average business
income is 3840 Real per month;
o Amongst the 50% that were not intended for treatment, the average
business income is 2880 Real per month.
a. (5 points) What is the estimated effect of microfinance loans on treatment
enterprises? What is the estimated “spillover effect” of microfinance loans?
Succinctly explain your answer (show your calculation, if you have one).
b. (5 points) Interpret these results: what is the net welfare effect of the
microfinance program?
c. (5 points) Provide at least two caveats to the above results and interpretation,
due to information that hasn’t been provided about the data and analysis.
Section 3. Short answer
4. (5 points) Impact evaluation methods. Suppose you are chatting with someone who
works at an international development consultancy, and you learn that they specialize
in monitoring and evaluation. You ask them about how they do the evaluations, and
they tell you that they usually measure the outcomes before an intervention, and after
an intervention, for those targeted to receive the intervention, and then calculate the
change in outcomes over time for the group receiving the intervention. How would you
(diplomatically) explain why this approach doesn’t meet the standards of an impact
evaluation, and what they could do instead?
5. (5 points) Education and development. Succinctly explain two reasons why it might be
rational for individuals in a developing country setting to end their schooling early, i.e.,
to demand less than a high school education.
6. (10 points) Evaluate a quasi-experiment. A strand of the literature on institutions and
culture in economics attempts to understand the historical factors behind modern-day
institutions. A growing literature shows that social and cultural norms can have a
significant impact on modern-day economic behavior and development.
Suppose that you are reviewing a research paper on the effects of religion on economic
outcomes, at the level of regions within countries. The authors motivate their paper by
pointing out that religion can be a key source of social and cultural values, including
virtues like honesty, hard work, and self-discipline. Hence these values and the norms
that come from them can be a key determinant of the quality of informal institutions in
regions within countries (as contrasted to formal institutions, like legal and financial
institutions, that are also studied in some of the recent literature on institutions).
The empirical strategy of the paper is to use instrumental variables analysis, in a two-
stage least squares regression framework:
1. In the first stage, they instrument current religious presence by constructing
historical information on the spread of religious missionary groups in Africa,
Asia, and South America. I.e., their first-stage is a regression like:
, = + ∗ , + ,,
where
• indexes regions-within-countries, and indexes countries.
• is a measure of the extent of community participation
in religion in the present day.
• is a measure of the extent of missionary activity in
the region from 1750-1950.
• , , and are regression parameters ( is the “error term”).
2. In the second stage, they regress current economic outcomes on the projected
value of the variable in the first stage, using a regression
like:
, = + ∗ ,� + ,,
where
• indexes regions-within-countries, and indexes countries.
• is a present-day economic or social outcome, like
regional GDPpc, life expectancy, or a measure of innovation.
• � is the projected value of from the
first stage.
• , , and are regression parameters ( is the “error term”).
This approach addresses the concern of simply running religious presence on economic
outcomes in an OLS regression, since there could easily be reverse causality from
current economic outcomes to current religious intensity.
The authors defend their empirical strategy by arguing that the factors that drove
historical missionary movements are unrelated to the main factors behind current
economic outcomes, or they can address those factors with control variables such as
controlling for geographic characteristics of a region (e.g., how far it is from the capital
city, whether it has direct ocean access or not, how hilly the region is). While the
historical data is somewhat limited, they also show that the choices of locations of
missionaries seem to be largely uncorrelated with economic outcomes between 1750-
1950.
Succinctly explain at least two points of critique of this quasi-experimental design,
based on concepts and knowledge in ECOS3002.
Section 4. Short essays
7. (15 points) The great aid debate. One of the “great debates” in international
development is around the role of international development aid. Jeffrey Sachs is
framed as one of the main proponents of foreign aid, a great believer in its effectiveness,
particularly to reduce poverty in the developing world. He and his allies have been
strong proponents of rich countries having larger foreign aid budgets (e.g., spending
1% of GNI on foreign aid), and for projects like the Millenium Villages, a signature
development project in sub-Saharan Africa where villages were provided with a range
of simultaneous support in terms of education, health, infrastructure, skills
development, etc. On the other side are aid skeptics like William Easterly and Dambisa
Moyo. Easterley is particularly critical of how aid has been administered in the past,
without accountability to the desires of aid recipients. Moyo highlights the corrosive
effects of aid on governance and in stimulating increased corruption, suggeseting that
all aid should be eliminated, outside of emergency aid.
After going through ECOS3002, what is your stance on this debate? Provide at least
three arguments either for or against the pro-aid thesis. As much as possible, use
concepts and knowledge from ECOS3002 in constructing your arguments.
8. (20 points) The role of RCTs in development economics. In their book Poor
Economics: A Radical Rethinking of the Way to Fight Global Poverty, the 2019 Nobel
Prize-winning development economists, Abhijit Banerjee and Esther Duflo, provide
one of the first book-length reviews of the so-called RCT revolution in development
economics, discussing various findings from RCTs across a series of topics. The
development economist Mark Rosenzweig reviewed the book in his 2012 Journal of
Economic Literature article, entitled “Thinking Small: A Review of Poor Economics:
A Radical Rethinking of the Way to Fight Global Poverty by Abhijit Banerjee and
Esther Duflo.” Rosenzweig characterizes the RCT-based approach as “thinking small”
– trying to optimize small interventions for the poor using scientific methods, to
“marginally improve their welfare.” While he acknowledges that knowledge generated
by RCTs can help improve welfare, he argues that this research focus distracts us from
studying an helping to optimize the big forces that really cause improvements in
economic development – such as major phenomena such as the Green Revolution in
the 20th century, or broad structural adjustment through migration, trade, etc.
Suppose you are Banerjee or Duflo, how would you respond to this critique, to defend
the RCT-based approach to development economics? Provide at least three counter-
arguments to Rosenzweig’s thesis. As much as possible, use concepts and material from
ECOS3002 in constructing your arguments.