Theories of Economic Development

• Subsistence Theory
• Theory Of Comparative Advantage
• Labour theory Of Value
• Theory Of Rent
• Balanced Growth Theory

• Theory Of Economic Growth

 Theories of Economic Development

• .David Ricardo (1772–1823, Classical Economist)

• David Ricardo was an 18th-century English economist renowned for his

contributions to economic theory.

• He developed the comparative advantage theory, labour theory of value, and

the theory of rents, which have founded other schools of thought and form the
basis of current economic policies and decisions.
 Theories Of Economic Development

1) Subsistence Theory ( Theory Of Wage)

• This theory was propounded by David Ricardo . According to this theory, “The
laborers are paid to enable them to subsist and perpetuate the race without
increase or diminution”. This payment is also called as „subsistence wages‟.
• If workers are paid less than subsistence wages, the number of workers will
decrease as a result of starvation death; malnutrition, disease etc. and many
would not marry. Then, wage rates would again go up to subsistence level.
Since wage rate tends to be at, subsistence level at all cases, that is why this
theory is also known as „Iron Law of Wages‟.
• It assumes that when they were paid more than the subsistence level, they
might indulge in enjoyment and consequently their numbers would increase,
and this would result in a low rate of wages.
 Theories of Economic Development
B) The Theory of Comparative Advantage
• Countries can benefit from international trade by specializing in the production
of goods for which they have a relatively lower opportunity cost in production
even if they do not have an absolute advantage in the production of any good.
• Economists have been not commonly uniform in proposing free trade policies
for centuries, and comparative advantage is the reason why. The theory
suggests that total welfare of economy in all countries is improved when
countries focus on those industries where they have the highest success ,
expertise and the lowest opportunity costs.
 Theories of Economic Development
C) Labour Theory of Value
• The value of a good could be measured by the labour that it took to produce it.
The cost should not be based on the compensation paid for the labour, but on
the total cost of production.
• One example of this theory is that if a chair takes two hours to make, and a
table takes one hour to make, one chair is worth two tables, regardless of how
much per hour the makers of the chair and tables were paid. The labor theory
of value would later become one of the foundations of Marxism.
 Theories of Economic Development
D) Theory of Rents
• Benefits that accrue to the owners of assets solely due to their ownership rather
than their contribution to any actual productive activity. Therefore, benefits of a
rise in grain prices will tend to accrue to the owners of agricultural lands in the
form of rents paid by tenant farmers.
• According to Ricardo rent arises as the difference between production of Marginal land (On
which zero rent accrues) and superior land.

• The most fertile land will attract highest rent and Marginal land will attract no
rent indicating the land to be the infertile one. There is a direct relation
between the value of output and rent earned thereof keeping the amount spent
on land same on every piece of land .
 Theories of Economic Development

Criticism on David Ricardo

• It did not see the potential for sustained and rapid economic growth because its
theory minimized scientific discoveries and technological advances.
 Theories of Economic Development
• Ragnar Wilhelm Nurkse (1907-1959)
• An Estonian-American economist and policy maker mainly in the fields of
international finance and economic development.
• The balanced growth theory is an economic theory pioneered by the
economist Ragnar Nurkse
A) Balanced Growth (Ragnar Nurkse,1956)
• Nurkse believes that the vicious circle of poverty can be broken through
balanced growth. He was of the view that vicious circle can be broken by
enlarging the size of the market which cannot be done by individual investor.
It would be possible with the help of a group of investors in the market .
 Theories of Economic Development
• Nurkse was of the view that the principle of balanced growth needs a balance
between different sectors of the economy during the process of economic
growth and development. These are:
1. balance between agriculture and industry;
2. balance between domestic and foreign trade; and
3. balanced between demand and supply factors.
This theory argues that government of any underdeveloped country needs to make
large investments in several industries simultaneously.
• An unbalanced growth is there when the investment is made only in
leading/strategic sectors of the economy (Hirschman & Lindblom, 1962)
 Theories of Economic Development
• Criticisms of Nurkse’s Theory of Balanced Growth

• One of the most important question remains that for balanced growth in the
underdeveloped countries they require a huge investment for which the
underdeveloped countries have to depend on the developed countries which is
a difficult proposition.
 Theory of Growth
1) Classical Theory Of Growth (18th and early-to-mid 19th centuries)
• Classical growth theory was developed by (mostly British) economists during the Industrial
Revolution.
• Classical growth theory explains economic growth as a result of capital accumulation and the
reinvestment of profits derived from specialization, the division of labor, and the pursuit of
comparative advantage.
• The conclusions of classical growth theory supported the ideas of free trade among nations,
individual free enterprise, and respect for the accumulation of private property.
• A theory based on the belief that economic growth ceases when a population grows. Supporters
of this theory believe that an increase in gross domestic product results in an increase in
population. This increase in population has a negative impact on the economy as resources
become limited as a result of increased demand. As resources become scarce, GDP declines.
 Theory Of Economic Growth
Limitations of the Classical Growth Model or Criticism

• Ignorance with respect to technology

• Inaccurate determination of total wages
 Theory of Growth:
• 2) Neoclassical Theory of Growth (between the 1950s and the 1970s)
• This theory describes how a stable economic growth rate will be achieved with
the appropriate amount of the three driving forces: labour, capital and
technology.
• According to this theory ,by varying the quantities of labour and capital in the
function of production a state of equilibrium can be accomplished.
• As new technology becomes available, labour and capital must be adjusted to
maintain growth equilibrium.
• The theory postulates that short-term economic equilibrium is a result of
varying amounts of labor and capital that play a vital role in the production
process. The theory argues that technological change significantly influences
the overall functioning of an economy.
• However, the theory puts emphasis on its claim that temporary, or short-term
equilibrium, is different from long-term equilibrium and does not require any of
the three factors.
 References
David D. Friedman, Price Theory: An Intermediate Text, 2d ed. (Cincinnati: South-Western Publishing,
1990), p. 618.
Baumol, William J. and Alan S. Binder, 'Economics: Principles and Policy', p. 50
O'Sullivan, Arthur; Sheffrin, Steven M. (2003) [January 2002]. Economics: Principles in Action. The
Wall Street Journal: Classroom Edition (2nd ed.). Upper Saddle River, New Jersey: Pearson Prentice
Hall: Addison Wesley Longman. p. 444. ISBN 978-0-13-063085-8.
Korotayev, A., Goldstone, J. A., & Zinkina, J. (2015). Phases of global demographic transition correlate
with phases of the Great Divergence and Great Convergence. Technological Forecasting and Social
Change, 95, 163-169.
Hirschman, A. O., & Lindblom, C. E. (1962). Economic development, research and development,
policy making: some converging views. Behavioral science, 7(2), 211-222.
Nurkse, R. (1956). Balanced growth on static assumptions. The Economic Journal, 66(262), 365-367.
Ranis, G., & Fei, J. C. (1961). A theory of economic development. The American economic review,
533-565.
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