📘 Economic Development — Detailed Notes

✏ Multiple Equilibria & The Big Push Model

— Explained Fully, In Easy Words (For Exam) —

① What is "Multiple Equilibria"?

In economics, an equilibrium is a "resting point" — a situation where things balance out

and there's no natural push to change further. Normally we think there is just one such
resting point. But in many real situations, more than one resting point is possible for the
exact same economy, with the exact same rules. This is called multiple equilibria.

📌 Definition:
A condition in which more than one equilibrium exists for the same economy. These
equilibria can often be ranked — meaning one is better (preferred) than another — but
the free, unaided market will not automatically move the economy to the better
outcome by itself.

Why does this matter? Because it means two countries (or two firms) with identical
conditions could end up in very different places — one rich, one poor — just because of
which equilibrium they happened to fall into. This is one of the most important ideas in
development economics, because it explains why some countries stay poor even when
nothing is technically stopping them from growing.

🖼 Diagram 1 — The S-Curve of Expectations

 Fig 1: Privately Rational Decision Function (S-curve) crossing the 45° line at D1, D2, D3

Reading the diagram, step by step:

● The horizontal axis shows what a firm expects other firms/agents to do (their
average investment level).
● The vertical axis shows how much this particular firm decides is rational to invest,
given that expectation.
● The straight 45° line represents every point where "what I expect others to do"
exactly equals "what I actually decide to do." It is simply a reference line for
balance.
● The curved S-shaped line is the actual real-world relationship: as this firm
expects others to invest more, it also decides to invest more — but not in a straight
line, in an S-shape.
● Anywhere the S-curve touches or crosses the 45° line, expectation = actual
decision, so nothing wants to change — that point is an equilibrium. In this diagram,
that happens three times: at D1, D2, and D3.

Stable vs Unstable Equilibrium

Not all equilibrium points behave the same way when something disturbs them slightly:

🟢 D1 and D3 — STABLE
 Imagine expectations shift a tiny bit above or below these points. Firms will naturally
adjust their investment back towards D1 or D3 again. That's because the S-curve
crosses the 45° line from above to below (steep to less steep) — a shape that pulls
things back in.

🔴 D2 — UNSTABLE
Here, the S-curve is steeper than the 45° line at that point. If expectations dip even
slightly below D2, the system keeps falling all the way down to D1. If expectations rise
slightly above D2, it keeps rising all the way up to D3. So D2 could only ever be an
equilibrium "by chance," and it would not last.

💡 Easy way to remember:

D2 is like a pencil balanced on its tip — technically balanced, but the smallest touch
makes it fall one way or the other. D1 and D3 are like a marble sitting at the bottom of
a bowl — nudge it, and it rolls right back.

Why is the curve S-shaped?

This shape comes from a complementarity — meaning one agent's action becomes more
valuable when other agents also take the same action (like everyone investing, or
everyone adopting a technology).

● Low levels: if only a handful of firms invest, they're mostly acting alone — not many
spillovers. The curve rises slowly.
● Middle levels: once a reasonable number of firms have invested, a "snowball effect"
kicks in — spillovers multiply, and the curve rises very fast.
● High levels: most of the possible gains have already been captured by earlier
investors, so the curve flattens out again.

🌍 Example:
Think about firms joining an export market. If very few local firms export, each is
isolated — not much spillover. Once several successful exporters exist, others learn
from them, share contacts, and benefit from established trade routes — a fast
"snowball." Eventually, once most firms that can profitably export already do, the pace
slows again.

② Pareto-Ranked Equilibria
Since multiple equilibria can exist for the very same economy, a natural question is: are
they equally good, or is one better than the other? Very often, one equilibrium gives
everyone a higher payoff/utility than another. When this happens, economists say the
equilibria are Pareto-ranked.

📌 Pareto Improvement:
A change that makes at least one person better off, while making no one worse off.
Moving from a "lower" equilibrium to a "higher" one, where everyone benefits (or at
least nobody loses), is a Pareto improvement.

💡 Example:
Think of a messaging app. If more people use it, it becomes more useful for everyone,
including those already using it. So the equilibrium "many people use it" is Pareto-
superior to "few people use it" — nobody is worse off, and many are better off.

The catch: even though the "better" equilibrium exists and is genuinely superior for
everyone, the free market does not automatically move the economy there. Each
individual firm or person only reacts to what they expect others to do — nobody wants to
be the first to switch if they're not sure others will follow. This is exactly the same
"coordination problem" that will come up again with the Big Push.

This is the classic example used in economic development: when the rate of return on one
investment depends on how much other investment is also happening around it (e.g.,
building a factory only pays off if there's a good road, and building the road only pays off
if there are factories using it), the market can get trapped at the low-investment
equilibrium — even though everyone would be better off at the high-investment one. This
is precisely why government policy (like coordinated infrastructure and industrial
planning) is often argued to be necessary — not because the market is broken in general,
but because coordination itself is the missing piece.
③ Starting Economic Development: The "Big Push"

🚀 Big Push idea (in full):

Many development economists argue that a poor economy cannot industrialize one
small step at a time. Instead, it needs many industries to invest and grow together, at
the same time — a large, coordinated "push" — because each industry's success
depends on the others also succeeding.

🇦🇷 Real Example — Argentina

About a century ago, Argentina was seen as one of the most promising economies in the
world — many expected it to become a major global economic power, similar to the
United States or Australia. Yet, instead, Argentina experienced more than fifty years of
relative economic stagnation.

→ The lesson: it is very difficult to get modern economic growth started in the first place,
but once a country has a track record of growth, it becomes much easier to sustain it. This
raises the core question of this whole topic: why is it so hard to start growth, even when
better technology is available and known?

Why is starting growth so hard?

Common sense might suggest that if a better technology exists, someone will simply use
it, and growth will follow. But this often does not happen automatically. Economists point
to market failures — situations where individually rational decisions do not add up to the
best outcome for the group. The most important such failure here is the pecuniary
externality.

📌 Pecuniary externality:
A positive or negative spillover effect on another agent's costs or revenues, which
works through the market — through prices, wages, or demand — rather than through
any direct technological link.

This is different from a normal externality (like pollution, which directly harms people). A
pecuniary externality works indirectly: my decision to invest changes market prices or
incomes, which then changes how profitable it is for you to invest too. Because this effect
travels through the market, no individual firm accounts for it — leading the whole
economy to under-invest compared to what would be best.

🧩 Rosenstein-Rodan's Coordination Problem — Step by Step

The most famous explanation of coordination failure in development economics is the "Big
Push" model, first proposed by economist Paul Rosenstein-Rodan. Imagine a poor
subsistence economy considering whether to industrialize (assume it cannot export — a
new factory must sell only to local buyers):

Step 1. In a subsistence economy, ordinary workers have no spare money to buy new
manufactured goods — they spend everything just to survive.
Step 2. So if just one entrepreneur opens a factory, there is nobody to buy the goods it
produces. The factory cannot be profitable acting alone.
Step 3. However, each time a new factory opens and hires workers, those workers earn
wages, and spend part of it on other products in the economy. So one factory's success
depends on whether other factories also open.
Step 4. Workers from a subsistence background must first be trained to work in a
modern factory. Training is costly, limiting how high a wage the first factory can afford
and still stay profitable.
Step 5. Once the first firm has trained its workforce, other entrepreneurs — who paid no
training cost — can lure those trained workers away with a slightly higher wage.
Step 6. The first entrepreneur, anticipating this, realizes training workers is a bad
investment — competitors will capture the benefit. So they refuse to pay for training at all.
Step 7. Since no one is willing to be first, no training happens, no factory opens, and
industrialization never gets started — even though everyone would be better off if it did.

💡 In short:
Everyone is waiting for someone else to move first, and this mutual waiting is exactly
what economists call a coordination failure.
④ The Big Push — Graphical Model

To make the "Big Push" idea precise, economists build a simple graphical model with clear
assumptions. Learning these assumptions properly will help you both understand and
reproduce the diagram in an exam.

Basic Assumptions — Explained One by One

1. Factors of production: Only one input — labour. Total labour in the economy is fixed
at L. Growth here is about how labour is used, not about adding new resources.
2. Factor payments (wages): Traditional-sector workers earn a wage of exactly 1 (a
normalized unit). Modern-sector workers earn a higher wage, W, where W > 1. This wage
gap is a real-world fact in almost every developing country.
3. Technology: There are N different products. In the traditional sector, each worker
produces exactly one unit — constant returns to scale. In the modern sector, no output at
all can be produced unless a minimum number of workers, F, are hired first (a fixed cost).
After that, each extra unit needs less labour than in the traditional sector — this is
increasing returns to scale. Written as: L(Q) = F + cQ, where Q is output and c is the extra
labour needed per extra unit once production has started.
4. Domestic demand: Every good gets an equal share of total spending. If national
income is Y, consumers spend exactly Y/N on each of the N goods.
5. International trade: The economy is closed — no importing or exporting. This
isolates the story to purely domestic coordination problems.
6. Market structure: The traditional sector has perfect competition, free entry, and no
economic profits — so price equals labour cost (1). In each market, at most one modern-
sector firm is allowed to enter.

Setting Up the Question

Imagine we start in a completely traditional economy — no modern production anywhere.
A potential entrepreneur, who has access to the modern technology, is deciding: is it
worth entering this market? The answer depends on (1) how much more efficient the
modern technique is, and (2) how much higher the modern wage (W) is compared to the
traditional wage.

🖼 Diagram 2 — The Big Push Graph

 Fig 2: Traditional vs Modern firm production & wage-bill lines, showing Points A and B

Reading the diagram, in full detail:

● The vertical axis (Q) measures output/revenue (price = 1, so revenue = output).
The horizontal axis (L) measures labour used.
● The Traditional-sector line is a straight line from the origin with slope = 1: it
represents both output and the wage bill, since traditional workers earn exactly 1
and produce exactly 1 unit each.
● The Modern-sector line stays at zero output until the firm hires at least F workers
(the fixed-cost hurdle). After that, it rises steeply with slope 1/c > 1 — modern
workers are more productive once the firm is running.
● The dashed lines W1, W2, W3 are three possible wage-bill lines for the modern
firm at wage rate W. A higher W means a steeper line.
● Point A marks where the modern firm's revenue exactly equals its cost, assuming
it is the only firm entering — demand comes only from the existing local market.
● Point B marks a higher output level where revenue equals cost assuming all
industries modernize together — incomes are much higher across the economy,
creating more demand for every good.
⑤ The Three Wage Cases (Most Important for Exam)

🟢 Case 1 — Wage line W1 passes below Point A

The modern wage is relatively low. Even if the firm enters completely alone, its
revenue already exceeds its costs (including F) — so it happily enters. Since
technology is the same for every good, the same incentive exists in every market. One
by one, every industry modernizes purely through ordinary market incentives.

➡ No coordination failure — the market does the job by itself.

🟠 Case 2 — Wage line W2 passes between Points A and B ⭐ MOST

IMPORTANT
If the firm enters alone, at this wage its costs exceed revenue — it makes a loss, so it
will not enter. But if modern firms enter simultaneously in every industry, total
income rises sharply, demand for every good increases, and at Point B revenue now
exceeds cost — the firm is profitable.

So at this exact wage, two different equilibria are both possible for the same economy:

● (a) No modern firm enters anywhere — output and wages stay low (the "bad"
equilibrium).
● (b) Modern firms enter in every industry together — output, wages, and
profits are all higher (the "good" equilibrium).
Crucially, workers are also better off in the second case — higher wages, more affordable
goods, and they moved to the modern sector voluntarily. So the "good" equilibrium really
is preferable for everyone.

🔑 Key insight of the whole Big Push theory:

Even though the good equilibrium is clearly better for everyone, the market, left
completely alone, will not automatically move the economy from the bad equilibrium
to the good one. No single firm wants to move first, because acting alone still means a
loss. Only if many industries move at the same time — a coordinated "push," often
requiring government involvement — can the economy jump to the better equilibrium.

⭐ If a question asks you to "explain the Big Push using the diagram," this W2
case is the one to focus on.

🔵 Case 3 — Wage line W3 passes above Point B

The modern wage is so high that even in the best possible scenario — every industry
modernizing together — revenue at Point B would still fall short of costs. Industrializing
simply does not make economic sense at all, no matter how well coordinated the effort
is. The traditional technique remains the only viable option.

📋 Quick Summary Rule

Wage line below Point A → the market industrializes by itself, no push is needed.
Wage line between Points A and B → industrializing is genuinely worthwhile, but
the market alone will not get there — a coordinated Big Push is required.
Wage line above Point B → industrializing is never worthwhile, with or without
coordination.
⑥ Full Exam Summary

📝 Summary
Multiple equilibria teach us that an economy governed by exactly the same rules and
technology can settle at more than one resting point — and some of these resting
points are clearly worse than others. Since firms and people only react to what they
expect others to do, the economy can remain permanently "stuck" at a poor outcome,
even when a better outcome is entirely possible. The Big Push theory, developed by
Rosenstein-Rodan and formalized with the modern graphical model, explains why this
stuck point can occur in the specific context of industrialization: because one firm's
profitability depends on other firms also being active (through wages, demand, and
training spillovers), no single firm wants to move first. The theory concludes that only
large-scale, coordinated investment across many industries at once — frequently
requiring government policy to organize — can move a poor economy from its low-
level trap to a much better, self-sustaining, high-growth equilibrium.

🔑 Key Terms to Remember

● Multiple equilibria — more than one possible balance/resting point for the same
economy under the same rules
● Stable equilibrium — after a small disturbance, the system returns to the same
point
● Unstable equilibrium — after even a small disturbance, the system moves away
permanently to a different point
● Pareto improvement — a change that benefits at least one person/agent and
harms no one
● Pecuniary externality — a spillover effect on another agent's cost or revenue
that travels through market prices, wages, or demand, rather than directly
● Coordination failure — a situation where everyone is individually better off
waiting for others to act first, so nobody acts, even though everyone acting
together would make everyone better off
● Big Push — the idea that many industries must invest together, at the same time,
to escape a coordination failure and reach industrialization
● Point A — the output level at which a modern firm entering completely alone
breaks even
● Point B — the output level at which a modern firm breaks even only when every
industry modernizes together (higher economy-wide demand)
✍️Exam Tip
If a question asks you to "explain with a diagram," always: (1) draw the correct
diagram (S-curve for multiple equilibria, or Figure 4.2 for the Big Push), (2) clearly
label all key points (D1/D2/D3, or A/B and W1/W2/W3), and (3) write 3–4 lines
explaining why the market fails to reach the better equilibrium on its own — this
"why" is usually worth the most marks.