link to Carleton Home

Richard Carson

Link to Student Technlogy Assistants
                              Home Page


ECON 2002

ECON 3870


ECON 4807/5807

Scholarship in Comparative Economics




Department of Economics






Welcome to Comparative

Economic Systems, ECON

3870, in Summer Session


July-August, 2014.

The Final Exam is scheduled

for Aug. 23rd, 9 a.m., in Azrieli


The Class Assignment is

 below, followed by the

 answer key to the Class


This is followed by the

midterm exam and answer

key.  The midterms have been

returned to the CUOL Student

 Centre, D283 Loeb.


Most readings for this course, other than the text, are available on Library Reserve.  Most of these in turn are available electronically through ARES.  To access ARES, please go to the Library Homepage and click on ARES under POPULAR LINKS at the bottom of the page on the right-hand side.  You will need your student computing account information. 


Richard Carson, Instructor 
  B850 Loeb Building 
  (613)520-2600, x1751. 



July 2014


                                                                                 CARLETON UNIVERSITY
                                                                                  Department of Economics

                                                                                              Econ 3870V

                                                                                                     Instructor: R. Carson


Please do each question below.  The question weights are as indicated.  Use graphs where you find them useful, but be sure to explain them.  In general, be sure to explain yourself well enough that the grader understands you and knows that you know what you are doing.  Finally, please type your answers double spaced, with adequate margins.  Please draw your graphs neatly and legibly.  Illegible answers will be considered incorrect.  Sok scerencset

1a.  (30%).  In 1970, the economic historian, Evsey Domar, said that it would be impossible to have at one and the same time "free" land, "free" labour, and a land-owning aristocracy.  If "free" land means land that is in super-abundant supply relative to demand--and therefore has a zero price--and "free" labour means labour that is free of bondage, explain why this combination would be impossible.

1b. (20%).  If land is "free" in the sense above, what three organizations of an agrarian economy are possible?  Explain why these are possible and why they are the only three that are possible.  Which factors determine which of the three will prevail at any given place and time?

1c.  (10%).  If bondage arises in conditions where land is free as above, what basic changes in economic conditions could bring about its peaceful demise?  Would the result necessarily be to make labour better off?  Explain.

2.  (10%). What is meant by the "scattering of strips" in medieval agriculture?  Explain how this was a response to conditions existing in Europe during the Middle Ages and what its advantages were under these conditions.  (Please give two distinctly different advantages.)  What factors would cause this practice to disappear?

3.  (30%). What  was the Neolithic Revolution?  Explain carefully what basic changes caused this "Revolution" and what basic changes in property rights accompanied it.  In what fundamental way did society change and why did this change accompany the Neolithic Revolution--that is why could it not have occurred before and why was it necessary afterward?  Also what was the role of learning in the Neolithic Revolution?  How did this increase specialization and division of labour?


July 2014


                         CLASS TAKE-HOME ASSIGNMENT

  Answer Key


Econ 3870V




1a.  Let us first graph the two “frees” mentioned by Domar.  Abundant land means that diminishing returns to labour on

 land in agriculture have not yet appeared. The marginal product (MP
L) of labour is horizontal and equal to the average

product (AP
L) or output per unit of labour, say Q/L. We get the following:




Supply of labour graph


With “free” labour, the equilibrium is at C, where the demand for labour (or MPL) equals the supply. There MPL equals the

real wage, regardless of whether this is paid in money or in kind.


Thus MPL = W/P = Q/L = APL at C.  But then WL = PQ = national income. National income is entirely paid out as wages

or earnings of labour.  Nothing is left for the poor aristocracy!  Thus if labour and land are both free, there can be no

dominant economic class. Society consists of independent family farms.



1b. If we start with the assumption that land is free (with freedom of labour unspecified), three basic organizations of an

agrarian economy are possible:


1.     Slavery

2.     Serfdom

3.     Independent farmers


Villages featuring the latter organization have existed since the Neolithic Revolution. They were predominant in many

places in ancient and medieval times; many were examples of pre-industrial democracy.  They existed where the land was

relatively marginal, and therefore relatively easy to defend, so that residents only had to contribute to defence on a

part-time basis.



A weak central government—as in Western Europe during the Middle Ages—was not strong enough to force runaway

slaves to return to their previous masters in most cases, forcing the latter to ease conditions of bondage. The stronger is a

central government, the larger is its realm, and the greater the political power of the employers, the more likely it is that

bondage will be relatively harsh – slavery rather than serfdom.


If there is a dominant class in conditions where land is “free”, some form of bondage must prevail, in the sense that

labour’s freedom of occupational choice and amount of labour supplied will be restricted, in order to keep the real wage

below the marginal product of labour.


Bondage can be ended by population growth and/or technological change when those make land scarce. As a result

MPL and APL begin to fall, and MPL slips below AP
L.  A free labour market will then give some of national income to employers, even with all-around competitive pricing.




Marginal Product



Specifically, employers get (APL – MPL)L* in a competitive market.  If there is enough labour competing for available

jobs, they will force the wage down to subsistence.


Even a free labour market can produce subsistence wages – shades of Malthus – and Marx also thought that this would

happen under capitalism, although for him the culprit was labour-saving technological change rather than population

growth. Thus the demise of bondage will not necessarily make labour better off, although in most cases, it has.




2. In medieval Western Europe, a farmer who owned land would rarely have his

land-holdings consolidated into a single parcel of land in one place.  Instead, his

holdings would consist of several long, thin strips that were separated from one another and scattered through the open

fields surrounding his village. To hold 40 different strips of land would not be unusual.


This seems inefficient because more land was required for boundaries and roads, and more time was lost going to, from,

and between strips than would have been required had land holdings been consolidated. There were more boundary

disputes, and whatever a peasant did on one strip—sowing, weeding, irrigation, drainage, fertilization,etc.—would affect

his neighbours. Therefore why did it occur? 

We can give three reasons, only two of which are required.


1.     The first cause was the decentralization of government authority down to the regional level of government

—central authority was weak—plus the low level of trade between regions and the low value of land.  In absence of

central authority, trade routes were blocked or too dangerous to use, and land was plentiful.


This meant regional self-sufficiency, which increased the number of different crops that every village and every

peasant had to grow.  Each manor grew several different kinds of crops and divided its land according to crop.  It

could take several days to plant or harvest a given crop, and seasonal patterns varied from crop to crop.


          The scattering of strips allowed a peasant to own at least one strip of land

          within the area devoted to each crop.  With scattering of strips, each peasant

          could work for himself throughout the planting and harvesting seasons for

          each crop, rather than having to hire out his labour to other peasants. 


          Many serfs owned little or no land and largely worked for other peasants

          who did.

          The scattering of strips enabled each landless peasant to work for just one or

          two peasant employers throughout the planting and harvesting season. The

          scattering of strips thus minimized the costs of the transactions that peasants

          would have to make with one another to carry out planting, caring for, and

          harvesting of crops.


While a typical peasant would grow several different crops, he would likely not grow as many as 40.  There were

often local markets and local trade. Thus a second reason for the medieval scattering of strips is that it was also a

way of insuring against the risk of crop failure, as well as from theft or destruction of crops.  A local lord had the

right to trample crops down in pursuit of game, for example, and his animals might eat part of a crop—crop land was

usually not enclosed.  Crop blight, pestilence or drought would typically cause greater losses in some areas than in

others.  A poor crop in one part of the manor did not necessarily imply the same degree of failure elsewhere.  Thus

the scattering of strips was a form of risk management or of insurance.


The scattering of strips also appears to have been a way to give each peasant

some good and some bad land, thereby treating peasants more fairly than if

some had only good land and some had only bad.



The practice came to an end with the rise of the nation state and the expansion of trade at the end of the Middle Ages. The

rise of the nation state meant that stronger central governments could promote trade within their jurisdictions, reducing the

need for local or regional self sufficiency. Peasants could now specialize, growing fewer crops. Growing trade between

nations reduced self sufficiency at the national level.



3.  The Neolithic Revolution was an agricultural revolution. Nomadic tribes settled

down and switched from hunting and gathering to farming. Private and state property rights to land emerged, and exclusion

replaced free access. It marked the beginning of the end of pre-history and of primitive communism.  It was also a

necessary condition for the development of complex societies and of civilization, which cannot develop in conditions

where people are nomadic, with groups of nomads frequently splitting up and merging.  Migration limited investment in

both physical and human capital—in physical capital because this would either have to be abandoned (thus reducing the

return on it) or taken at some cost with the band as it migrated. Generally, human capital was limited to skills useful in

hunting/gathering and physical capital to equipment useful in these activities (such as spears and bows and arrows).







Prior to Neolithic revolution, the human population was small relative to the plant and animal resources on which humans

lived. They were hunters and/or gatherers and migratory.  Humans did not plant food or herd livestock. They did not renew

the resource base on which they lived.


Given this, they had to be nomadic, since they would otherwise reduce supplies of animals and plants in a given area to the

point where the local resource base would be too small to allow a band to survive.  Scarcity did emerge locally, but could

be relieved by migrating to a new area and allowing the resource base of the old area to renew itself.


There was also technological progress during the hunter-gatherer period, such as improved hunting weapons, better

organization of hunting, and use of fire to stampede animals over a cliff, which made animals easier to kill.  Population

growth further increased the demands of humans on resources. Eventually, diminishing returns to labour in

hunting/gathering set in.


In Fig. 4.2 on p. 120 of Market and State in Economic Systems, this occurs at L0.

As labour increases above L0, the marginal product of labour falls, and eventually,

the average product of labour will fall as well.  It is also at L0 that resources become scarce.  Living standards begin to fall, and conflicts increase.


Thus the Neolithic Revolution was caused by diminishing returns to labour in hunting and gathering, as wild animals and

plants became scarcer, owing to population growth and technological progress.  A tool-making revolution preceded the

Neolithic Revolution and speeded this up.  On the graph below, the tool-making revolution raises the marginal product of

labour at first, but also causes animal resources to vanish more quickly.  Beyond some point—the intersection of the two

curves below—this revolution therefore lowers MPL.






The changeover to agriculture occurred when diminishing returns in hunting/gathering pushed hunter-gatherers to

subsistence.  This changeover was then a question of  survival.  With the emergence of farming, planters first got the right

to crops and then to land in order to expand their time horizons and to motivate soil preservation and investment.


The Neolithic revolution transformed bands into tribes or chiefdoms (with hereditary inequality) and eventually into

states, with socio-economic class differences and division of labour based on inherited status, age, gender, and skill.

Relations among individuals came to depend less on kinship and more on socio-economic roles. 


The settling down and adoption of agriculture has been called the GREAT DIVIDE in human history.  It required the

emergence of land ownership, in order to provide exclusive claims to its present and future output. Exclusion was

necessary to motivate the required work effort and the investment.  Efficient agriculture thus put demands on farm owners

and workers that ended or greatly reduced nomadism.  Farmland had to be worked much of the year, fertility of the soil

had to be maintained, and crops and cropland had to be protected all year round.


July 2014


Department of Economics

ECON 3870V

Instructor: R. Carson

Directions: Please do each question below, noting the weights, which add to 100%. Use graphs where you find them useful, but be sure to explain them. In general, be sure to explain yourself well enough that the grader understands you and knows that you know what you are doing. Finally, please write on every other line. Sok szerencsét.


1a. (20%).  What basic conditions with respect to the property-rights context in which firms operate are most favourable to innovation?  Which conditions are least favourable to innovation?  Give explanations in each case.

1b. (15%).  Using your answer to 1a explain how economic growth in Soviet-type economies differed from that in Western economies with respect to the sources of economic growth.  Also explain why growth in STEs differed from that in Western economies.  What does this imply about the sustainability of growth in each type of economy?


2.  Suppose we have an economy with the following features:  There is a high tax rate on profits, say 100%, plus a high rate of subsidy on losses--say 100% as well.  In addition, there are official price ceilings on all goods and services, but these ceilings are not well enforced--firms are able to get around them by collecting side payments.  Finally, profits taxes and subsidies on losses are applied only to profits or losses earned at official prices.

a. (10%).  In this environment, suppose that firms maximize after-tax profit.  Show how such a firm will set price and output, where by "price" here we mean the price actually charged of customers.  Please explain your answers.  At the official price, will there be a surplus or shortage of this firm's product.  Explain.

b. (15%).  Suppose that the government changes the official price with no change in product demand.  What is the firm's supply curve as a function of the official price?  Explain.  Is this a normal supply curve?  Can changes in the official price lead to a balance between supply and demand at the official price?  Again, please explain.  If demand increases, but the official price remains unchanged, how will the firm's output respond?

c. (10%)Are outputs rational in such an economy?  That is, do they reflect buyer preferences and real costs of production?  Explain.  If taxes on firms are a major source of government revenue, how would we expect the budget surplus or deficit to change over time?  Why?


3a. (15%).  What two basic views of the relative expansion of the public sector in market economies since World War II can we distinguish?  Explain and compare them briefly.  How does national income accounting make it possible to have different views about the nature of this expansion?

3b.  (15%). In particular, social insurance has been a rapidly-growing expenditure item.  Briefly explain why, using a graph to assist you.  What is the advantage of having the "money follow the patient" rather than letting the "patient follow the money?"  Be sure to indicate the difference between these two approaches.


ECON 3870

July 2014 Midterm Answer Key



Note: The answers below are more thorough than student answers are expected to be.

1(a). If innovation is to flourish, four basic conditions should be met, all of which are absent in STEs:


A.   Firms must have the power to introduce new products and production methods. Therefore, basic production and investment decisions should be decentralized down to the firm itself. They should not be controlled by state agencies above the firm.


B.   The success of the firm’s products should depend on the willingness and ability of users to buy them at prices that cover the costs of supplying them. 


C.   There should be competition between firms for market share, which gives rise to the Red Queen effect. Firms are forced to keep on improving their products and their methods of production just to hold on to their customers. An oligopolistic market structure, with low barriers to entry and active competition, but within which firms have enough financial strength to survive some failures, is probably the one most favourable to innovation.


D.   The rewards of enterprise management should be tied to the firm’s profits and losses. The budget constraint should be "hard", forcing the firm’s owners and managers to bear the cost of unsuccessful ventures, while allowing them to benefit from successful ventures.  It also helps if there is not too much separation between ownership and control, since top management then bears most of the benefits and costs of entrepreneurship directly.


It is possible to distinguish a fifth point as well, although this is not required.


E.   Well-developed financial markets are also important to innovation, which usually requires financial resources beyond those of the innovator.  Credit constraints are a major barrier to the entry and subsequent expansion of small enterprises and in this way to innovation.


In connection with (a), investment must be controlled to a large extent by profit-seeking firms. It must not respond too much to political or ideological considerations. It is medium-sized and even small firms, whose top management is likely to own a major share of the equity in the enterprise—and whose internal procedures and lines of communication are more likely to be informal, flexible, and open, especially between research workers and top management—that do most of the basic innovating in market economies.

By contrast, no one has the right to buy and sell equity in any state-owned enterprise.  In addition, STEs relied on

bureaucratization of decisions, along with routinization, excess demand, price and structural rigidity, planning from the

achieved level, and quantitative evaluation of subordinates on the basis of current output. These factors simplified the task

of state management, but they suppressed innovation.


1(b). Growth based on innovation is the only permanently-sustainable growth over the long run, if we are talking about

growth of GDP per capita.  Extensive growth is growth of output owing to growth of inputs with technology held constant. 

In terms of per-capita growth, this results largely from relocating labor from agriculture to industry and then raising the

capital-to-labor ratio in industry. Intensive growth is growth of output owing to broadly-defined technological progress

with inputs held constant.


          Once most of the gains from re-locating labour are exhausted—along with the gains from taking advantage of

economies of scale—purely extensive growth declines owing to diminishing returns to capital, as the capital-to labor ratio

increases.  Eventually, stagnation sets in.  Only intensive growth can be permanently sustained.  It raises the marginal

products of both capital and labour and in this way renews the opportunities for further extensive growth.  As far as is

known, this can continue indefinitely.

         Intensive growth can result from importing technology already in use abroad, and adapting this to the domestic

economy, or from domestic innovation and sharing of new technology developed abroad.  The first type, technology

catch-up, will come to an end once the economy in question has caught up with more advanced nations while the second

type is permanently sustainable.  The first type is often state-managed, with a multitude of controls, restrictions, and

subsidies being used both to promote growth and to prioritize it with respect to the industries and technologies the

government wants to promote.  In addition, governments may use protections and subsidies to spread prosperity to the rest

of the economy. 

        Unfortunately, these controls, protections, and subsidies, once established, will be politically difficult to get rid of. 

Those who benefit from them will organized for political action and try to bring down any government that threatens their

benefits.  Ultimately, governments suppress innovation because it increases competitive pressures on earnings from past

investments, as well as on benefits, such as monopoly profits, from existing protections.  Successful new products or

production methods make former products or methods obsolete.  Suppressing innovation protects these earnings, as well as

those of human and physical capital used in making the old products.  As a result, state-managed growth may catch up to

technological leaders for awhile, but will subsequently stall.  Type (c) growth—or growth based on innovation—will not



2a.  The economy described here is similar in key respects to a Soviet-type economy.  If a firm is to earn positive

after-tax profit in such a system, it must charge more than the official price.  Consider the graph below.


Consider the graph below.




























In the graph above, which is the same as the graph in website Article #13, let DD be the demand for a product,

with MR denoting its marginal revenue.  Let P0 be the official price of the good, and let Q0 be the quantity demanded at price P0. 


What price and quantity would the firm set if it is a profit maximizer and has to turn all its official profit over to

the state—this is its profit at price
P0—but can keep its unofficial profit?  In the above graph, A gives the intersection of MR with P0.  Let QB0 be the output at which MR = P0.  Then QB0 is the output that maximizes unofficial profit, and PB0 is the profit-maximizing price.  Note that QB0 is less than Q0—thus there is a shortage of the good at the official price—while PB0 is greater than P0.


In fact, P0 is the marginal cost to the firm of the product, rather than its marginal revenue.  If the seller supplies one more unit of output, P0 is what it must pay in additional costs of production and profit tax turned over to the state budget.  Thus output is determined by buyer preferences as well as the irrational official price of the good. 

The good’s real cost of production is not taken directly into account, and P0 is not likely to reflect this—the firm may have either an official profit or an official loss at price P0.


If the seller could sell every unit of output at PB0, its "unofficial" profit would be the area of rectangle PB0EAP0.  This is the part of its profit that it can keep.  Instead of actually selling the product at price PB0, it might sell at price P0, and collect a bribe or other payment or favour, equal in value to length EA in the graph—in effect charging for the right to buy the good now rather than wait or do without. 

Total payments or bribes would equal area PB0EAP0.


2b. Suppose the official price rises from P0 to P1 with no change in demand for the good.  In the graph above, this represents an increase in the product's marginal cost to the firm, as well as a reduction in the firm’s unofficial profit.

With higher marginal cost, the firm will supply less of the good; at official price P1, the profit-maximizing output is QB1, less than QB0.  A rise in the official price reduces supply, the reason being that an increase in the official price is like a cost increase to the supplier rather than a revenue increase.

More generally, the quantity supplied at any official price will be the quantity at which MR equals the official price.  As a result, the firm's marginal revenue curve is its supply curve in a limited sense—it gives quantity supplied as the official price changes, with no shift of demand for the good.  An MR curve is normally downward-sloping, which implies that the firm's supply curve is backward-bending.  When the official price rises, quantity supplied falls instead of rising, as with a "normal" supply curve, which would be based on marginal cost. One result is that raising official prices will not get rid of shortages at these prices. 

However, if the demand for the firm’s product goes up, marginal revenue is likely to rise, although by less than demand.  The firm will then increase its output, although the shortage will also increase.  For example if demand is linear, quantity supplied is half of quantity demanded at the official price.


2c. Outputs in such an economy do not reflect real costs of production, and in this sense are irrational.  Instead

of the true production cost, the firm takes the state-set official price as its marginal and average cost.  Output is

determined by buyer preferences interacting with the irrational official price of the good.  The good’s real cost of

production is not taken directly into account, and P0, which is set administratively instead of by the market, is not likely to reflect this.


Because the soft budget constraint is alive and well here—profits are taxed away and losses are subsidized—the

firm has an inadequate incentive to control costs.  The state budget bears the burden of this.  As a result, net

revenue from profits taxes is likely to fall over time putting upward pressure on the budget deficit.  This will

become inflationary pressure if rising deficits are financed at least partly by money-supply expansion.



3a. We can identify two underlying views of public sector expansion.  These are possible because separate measures of

supply prices and quantities
—of Q2 and P3 belowfor goods and services financed by government are usually unavailable.  All we observe is total expenditure (P3Q2).  The two views in question are as follows:


1.     To some, government has become leviathan, exercising monopoly power over its citizens.  For these observers,

     the growth of government is mainly a price effect, in which citizens pay higher and higher tax prices for publicly

     financed goods and services, plus a nationalization effect in which services such as health care come to be paid

     for, and in some cases to be supplied by, government agencies.  Nationalization also leads to higher effective

     prices because of the moral hazard effect.  According to this view, the expanded share of GDP accounted for by

     goods and services that are now publicly financed results mainly from the fact that the average supply price

     of these products has risen faster than the average price of privately-financed goods and services.


2.     To others, relative prices of goods and services that are now publicly financed may have risen, but quantity and

     quality increases have also occurred. To these observers, democratically elected governments have reflected voter

preferences and carried out the wishes of their citizens faithfully.   According to this view, at least a significant
part of the increase in the share of GDP accounted for by publicly-financed goods and services is a relative

quantity and/or quality increase.


There are two reasons why much of the expanded share of national income accounted for by the public sector could be in

the form of increases in relative prices of publicly-financed goods and services, rather than an increase in the relative

quantity and quality of these products:


First, because expansion of social insurance substitutes tax and payroll fee financing for direct financing in the form of

prices charged of users, there is a reduced incentive to economize on insurance-financed services. The result is to increase

quantity demanded at any given supply price—the moral hazard effect.  This is shown in the graph below.  The more

inelastic is the supply curve of these services, the greater would be the increase in their supply prices and the smaller would

be the increase in their quantities.

Those who hold the leviathon view argue that artificial (monopoly) barriers exist which impede the movement of resources

into the production of health care and other benefits financed through social insurance.  This would be done to raise the

earnings of inputs (such as doctors) which benefit from these barriers.  There may also be work rules that require more

intensive use of these inputs.  These barriers and rules would make the supply curve more inelastic.

, government may have taken advantage of the fact that higher prices are not always perceived as such by voters

when they are paid indirectly, in the form of higher taxes (or in the form of a failure to lower taxes when costs of tax

collection fall).  Therefore, politicians may not be penalized at election time for these tax increases (or failure to lower

taxes).  As a result, the government would be able to exercise some monopoly pricing power over the supply of goods and

services that it largely finances.



3b. As social insurance becomes more widespread, more insurance benefits are supplied at reduced or zero prices, being

largely financed instead by taxes and payroll fees, as noted above. As a result, there is an increase in the quantity of these

benefits that is demanded. This is the "moral hazard" effect, although it has little to do with morals.


Consider the graph below. With the introduction of social insurance, demand shifts downward slightly, owing to increased fees or taxes, which reduce disposable incomes, thereby giving rise to an income effect. Total cost rises from to .

This is both an increase in supply price, from to, and a quantity increase, from to .  Note that while the demand

price is falling, because demand is downward-sloping, while the supply price is rising, with government covering the

growing difference between the two.  Quantity is also rising because demand is downward-sloping.  Here there is both an

increase in quantity and an increase in price.



4.gif (4486 bytes)





The above graph, which may not be visible, is the same as that in website article #11.  Consider the financing of hospitals in Germany vs. Canada.  Canada lets "the patient follow the money."  That is, money is given to hospitals, and patients must go to a hospital which has a vacancy.  Patients have little or no choice, and there are long wait times for elective surgeries.  In Germany, the money follows the patient.  That is, patients needing hospital care choose which hospital they want to go to.  Much information about hospitals is available to aid in this choice.  Hospitals compete for patients because they can only obtain money by attracting patients--the money follows the patient.  As a result, wait times have either disappeared or are quite short for every type of surgery.  Many hospitals have excess capacity, but costs are lower than in Canada.  Thus the advantage of letting the money follow the patient, is that hospitals have to compete for patients by offering better and more timely care. 

Carleton Home

Carleton Directories

Campus Map

Contact Carleton

Carleton Index

Carleton Search


Website developed and maintained by the Educational Development Centre @ Carleton University