BINDURA UNIVERSITY OF SCIENCE

EDUCATION

FACULTY OF COMMERCE

DEPARTMENT OF ECONOMICS

BACHELOR OF SCIENCE HONOURS DEGREE IN ECONOMICS

NAMES : MUTODZWA SHANTEL

REGISTRATION NUMBER : B1850369

DEGREE PROGRAMME : ECONOMICS

COURSE CODE : EC107

COURSE NARRATION : ECONOMICS PRINCIPLES 2

LECTURER : Rev. MAZURU

ASSIGNMENT : 2

QUESTION: Evaluate the extent to which different theories on economic

development. Explain how nations can develop.

The branch of social science called macroeconomics essentially examines the factors that
lead to changes in the main characteristics of the economy output, employment, inflation, and
interest rates. A set of principles that describes how the key macroeconomic variables are
determined is called a macroeconomic theory. Typically, every macroeconomic theory comes
up with a set of policy recommendations that the proponents of the theory hope the
government will follow. The theories are Keynesian economics, Monetarism, Laissez- faire
and Neo-classical and Classical.

Firstly the macroeconomic theory of development that dominated capitalist economies prior
to the advent of Keynesian economics in 1936 has been widely known as the classical
macroeconomics (Blinder, 2012). The classical economists believed in free markets and that
the economy would always achieve full employment through forces of demand and supply.
So, if there were more people seeking work than the number of jobs available, wages would
fall until all those seeking work are employed. Thus, the full employment of workers was
guaranteed by market forces. The level of full employment resulted in a fixed aggregate
output/income. The price level (and thus the inflation rate) was determined by the supply of
money in the economy. Since, the output level was fixed, a 10 percent increase in money
supply would lead to a 10 percent increase in the price level too many dollars chasing too few
goods. The real interest rate (the nominal interest rate minus the inflation rate) was also
determined by forces of demand and supply in the market that is the demand and supply for
lendable funds. The nominal interest rate was then simply the sum of the real interest rate and
the prevailing inflation rate.

The classical economists thus had an unwavering faith in a self-adjusting market mechanism.
For the market mechanism to work, however, the market structure had to be that of perfect
competition, and wages and prices had to be fully flexible because an increase in product
prices would therefore be quickly matched by higher costs, which would eliminate any
incentive to expand output. However nations develop when proponents of wage flexibility
contend that it leads to lower unemployment because fewer people are looking for work,
employees have to offer higher wages to entice people to work for them, meaning incomes
will go up which can be interpreted as an improvement in the standards of living. If real
G.D.P increase over a period this may imply that the volume of goods and services consumed
had increased. However, contend that it leads to lower financial security among workers.
More so the classical economists did not see any role for the government (McConnel and
Brue 2012). Laissez-Faire is an economic policy that says governments should not interfere
with the free market and the market should develop on its own. This means that the
government cannot control restrictions, taxes, or businesses. It essentially means that the
economy should be left alone for people to do as they please. As market forces led to full
employment equilibrium in the economy, there was no need for government intervention. The
theory was not so effective because the monetary policy would only affect prices it did not
affect the important factors of output and employment. Fiscal policy on the other hand, was
perceived to be harmful. For example, if the government borrowed to finance its spending, it
would simply reduce the funds available for private consumption and investment
expenditures a phenomenon popularly termed as crowding out. Similarly, if the government
raised taxes to pay for increased spending, it would reduce private consumption in order to
fund public consumption. Instead, if it financed the spending by an increase in the money
supply, it would have the same effects as an expansionary monetary policy. Thus, the
classical economists recommended use of neither monetary nor fiscal policy by the
government.

However, laissez faire works best for economic growth because it provides individuals with
the greatest incentive to create wealth because of the self-interest whereby firms will act in
ways which lead to maximum profits and consumers spend on these things which yield
maximum satisfaction. Wealth of a country leads to greater efficiency which leads to higher
profits and encourages investment and thus economic growth. Basically, people work harder,
better, and longer when they are working for themselves or a private business than when they
have to work for the government.

Monetarism is a theory of Economic Development which is an attempt by conservative

economists to re-establish the wisdom of the classical laissez-faire recommendation
according to the article keys to economic development. The monetarists argued that while it
is not possible to have full employment of the labour force all the time, it is better to leave the
economy to market forces. Friedman contended that the government's use of active monetary
and fiscal policies to stabilize the economy around full employment leads to greater
instability in the economy. He argued that while the economy would not achieve a state of
bliss in the absence of the government intervention, it would be far more tranquil.
Furthermore monetarists believed that if the money supply increases in line with real output
then there will be no inflation (Hess, Peter and Clark, 1987). This is because in the short-term
velocity (V) is fixed that is the rate at which money circulates is determined by institutional
factors, e.g. how often workers are paid does not change very much. Milton Friedman
admitted it might vary a little but not very much so it can be treated as fixed. Monetarists also
believe output Y is fixed. They state it may vary in the short run but not in the long run
(because LRAS is inelastic and determined by supply-side factors). Monetarists argue that if
the Money Supply rises faster than the rate of growth of national income, then there will be
inflation. Following a rise in the Money Supply, consumers have more money and therefore
spend more money on goods. Firms respond by increasing output and national output exceeds
the equilibrium level of output. Therefore there is an inflationary gap.

In essence, monetarism contends that the use of fiscal policy is largely ineffective in altering
output and employment. Moreover, it only leads to crowding out. On the other hand, while
monetary policy is effective, monetary authorities do not have sufficient knowledge to
conduct a successful monetary policy manipulating the money supply to stabilize the
economy only leads to greater instability. Hence, monetarism advocates that neither
monetary nor fiscal policy should be used in an attempt to stabilize the economy, and that the
money supply should be allowed to grow at a constant rate.

According to the article Keynesian Economics by (Blinder, 2012) it is a theory of total

spending in the economy (called aggregate demand) and its effects on output and inflation. If
aggregate demand in the economy fell, the resulting weakness in production and jobs would
precipitate a decline in prices and wages. . The cycle of low demand (and perhaps falling
prices) can be difficult to break especially when consumer and business confidence is low.
However a lower level of inflation and wages would induce employers to make capital
investments and employ more people, stimulating employment and restoring economic
growth. Keynes advocated, government borrowing to provide an injection of demand into the
economy. Government borrowing can benefit growth that is budget deficit can have positive
effects if it is used to finance capital spending that leads to an increase in the stock of national
assets For example, spending on transport infrastructure improves the supply side capacity of
the economy.

Nations can also develop through increased investment in health and education which
boost productivity and employment. An increase in borrowing can be a useful stimulus to
demand when other sectors of the economy are suffering from weak or falling spending. If
crowding out is a major problem fiscal policy can play a cyclical role leaning against the
wind of the cycle. Low interest rates make sense to the state to borrow when interest rates are
low and inject demand to the economy especially when private sector demand is low
(McConnel and Brue 2012).

A criticism of Keynesianism is that it is hard to make minor changes to fiscal policy to

influence demand sufficiently to ensure stable growth. High levels of state borrowing and
debt risk causing a run on a currency. This is because the government may find it difficult to
find sufficient buyers of debt and credit rating agencies may decide to reduce the sovereign
debt. Foreign investors may choose to spend their money overseas perhaps causing a
currency crisis. Therefore, Keynesianism has a tendency to increase the size of the state,
which some see as a major drawback.

Another theory of Economic development is the Neo-Classical theory (Blinder, 2012). Two
economists, T.W. Swan and Robert Solow, made important contributions to economic growth
theory in developing what is now known as the Solow-Swan growth model. The theory
focuses on three factors that impact economic growth, labour, capital, and technology, or
more specifically, technological advances. The output per worker increases with the output
per capita but at a decreasing rate. This is referred to as diminishing marginal returns.
Therefore, there will become a point at which labour and capital can be set to reach an
equilibrium state. Since a nation can theoretically determine the amount of labour and capital
necessary to remain at that steady point, it is technological advances that really impact the
economic growth. The theory states that economic growth will not take place unless there are
technological advances, and those advances happen by chance. Once an advance has been
made, then labour and capital should be adjusted accordingly. It also suggests that if all
nations have access to the same technology, then the standard of living will all become equal.

There were two major concerns with this era of theories. One is the conclusion that
continuous economic growth can only occur with technological advances, which happen by
chance and therefore cannot be modelled. Secondly, it relies on diminishing marginal returns
of capital and labour. However, there is no empirical or real-life evidence to support this
claim. Therefore the model is known for identifying technology as a factor in growth but fails
to ever substantially explain how.
In conclusion all the theories are important in fostering economic development since they
provide positively to the economy hence nations develop through these theories. Therefore
the government should monitor these theories effectively.

REFERENCES
Blinder, A.S (2012) Keynesian Economics – Econlib

https://www.econlib.org/library/ Enc/Keynesians Economics html

McConnel C.R and Brue S.C (2012) Microeconomics: Principles, Problems and Policies,
Unemployment and Rate of Change of Money Wages 15th Edition, McGraw Hill Boston.

Pettinger, T (2017)

https://www.economicshelp org>Economics help blog> economics

Hess, Peter and Clark G. Ross. Economic development, Theories, Evidence, and Policies:
HBJ College and School Div, 1987

Keys to Economic Development / Principles of Economics

https://openlibum.edu/principles economics/...keys-to-economic-development