Chapter 3 – Structural Change, page 1 of 11• this chapter considers differences in rates of growth for different sectors of an economy (suchas the agricultural, industrial, and services sectors) unlike the single-sector models in chaptertwo• the labor-surplus model:• the labor-surplus model is a dual economy model developed by W. Arthur Lewis, Fei,and Ranis:• this model considers the dualism between the agricultural/traditional sector and theindustrial/modern sector in developing countries; not only do these sectors use differenttechnologies (combinations of capital and labor) but also they differ in institutions• the agricultural/traditional sector:• the agricultural/traditional sector has a classical (pre-capitalist) economy• wages (earnings) are equal to the average product of labor (unlike theindustrial/modern sector where wage is determined by the marginal product oflabor)• the marginal product of labor in this sector equals zero (the last laborer addedcontributes nothing to total production – if he were removed, output would notdecrease); thus, there is an absolute surplus of labor because workers could beremoved without decreasing total output• if wages in the traditional sector were paid their marginal product then wageswould not be paid to the surplus labor• the marginal productivity of labor could even be less than zero but totalproduction will still be positive (it is produced by inframarginal labor – workersshort of the last ones, having a positive marginal product)• workers will not move to another farm/sector as long as the average product isgreater than the subsistence wage, unless the other sector is offering more thanthe traditional sector’s average product• the labor surplus can be as large as 20-30% of the work force• the industrial/modern sector:• this sector follows the neoclassical model• the wage rate depends on the marginal productivity of labor (MPL) • firms will hire all labor for which the marginal productivity of that labor isgreater than the wage – firms will lose money if they pay more than the marginalproduct of labor to workers; the last worker hired will have a marginal productequal to the wage• a diagram illustrating the neoclassical model of labor supply and demand:wagedemand for labor = (V)MPLwagelabor• page 93 – the three part diagram illustrates the labor-surplus model:Chapter 3 – Structural Change, page 2 of 11• the first diagram illustrates total agricultural output as a function of labor inagriculture:m’ g’agriculturaloutputmglabor in agriculture (LA)• labor in agriculture (LA) increases from right to left in the diagram• total output increases with additions of labor to agriculture until LAequals g; to the left of g output does not increase even if more labor isadded to agriculture• to find the average product of labor in agriculture, a ray is drawn infrom the origin to the point of total labor in agriculture and totalagricultural output: the height of the triangle equals total agriculturaloutput and the base of the triangle equals total labor in agriculture; thus:average product = baseheightLaloutputagriculturA=• beyond g, the total agricultural product ceases to grow so the averageproduct decreases but remains positive (mm’ = gg’)• it is impossible to sustain more workers when the average wage fallsbelow the subsistence wage; >mmm'subsistence wage• thus, in a poor developing country, there is an absolute overpopulationworking in traditional agriculture; for example, this might occur inpeasant agriculture• if half the labor is in absolute surplus, then it could move into anothersector without decreasing agricultural output but still increasing outputin the other sector (for example, industry)• labor exists in surplus because of a family institution that works onprinciples different from those of a firm; a firm would fire workers whosemarginal productivity equals zero because they are not profitable;however, a household works on traditional beliefs and cannot do this;thus labor “hides” in the agricultural sector• although this might appear to be inefficient, notice that if theagricultural sector suddenly switched to a modern wage economy basis,millions of people would be thrown out of work and made destitute;thus, it seems desirable that change be gradualChapter 3 – Structural Change, page 3 of 11• this illustrates how institutions can be different between the traditionaland modern sectors• the second diagram illustrates the value of the marginal product of labor inagriculture:value ofmarginal iproduct oflabor(VMPL) inagriculture hglabor in agriculture (LA)• to the left of g the marginal product of labor equals zero• to the right of g the marginal product grows to i• h is the subsistence wage of the traditional sector• the third diagram illustrates labor supply and demand in the industrial sector:industrywages supply k’ curve kdemand curveslabor in industry (LI)• workers whose marginal product in agriculture is zero would bewilling to move to the industrial sector for a small premium over thesubsistence wage h; industry will pay wage k, which includes a premiumover h to pay for migration costs, etc.• firms are willing to pay workers if their marginal product is greaterthan the wage; thus, the demand curve for labor is the marginal productof labor curve• dynamics of the labor-surplus model:• as profits are plowed back into capital accumulation, the demand curve shiftsright because workers have more capital to work with and their marginalproductivity increases• eventually removing labor from agriculture will reduce agricultural outputand at some point the wage industry offers must increase because: 1) the totalamount of food produced by agriculture decreases so prices increase and 2)industry competes with the wage offered by agriculture, which becomes aChapter 3 – Structural Change, page 4 of 11function of agriculture’s now increasing marginal product of labor; specifically,once the marginal product of labor in agriculture becomes greater than k, thelabor supply curve to industry starts rising because industry must compete withagriculture for labor (this model assumes the size of the total labor force is fixedand that labor is either in agriculture or in industry)• over time, the proportion of labor in agriculture decreases and the proportionof labor in industry increases• when the supply of labor is no longer