Question

Using a suitable economic growth model, analyse how a labour surplus economy that starts with its entire population engaged in agriculture, can shift a large part of that population to the industry or other employment with no reduction in agricultural output. State all assumptions involved in explaining the model and justify your answer with an appropriately labelled diagram.

Answer 1

Labor surplus theory was given by the Arthur Lewis. Lewis postulated that how such excessive labor in agricultural sector can be transferred to the manufacturing sector.

Assumption of of model:

• Marginal product of labor in Agricultural sector is Zero.
• Supply of labor for manufacturing sector perfectly elastic.
• Co-existence of capitalistic and subsistence sectors.
• Wage rate in manufacturing sector is higher than subsistence level.

Lewis further says, that larger chunk of labor is disguisedly employed in agricultural sector. If such labor is transferred from agricultural sector to manufacturing sector, there will not be any fall in agricultural products. Thus, manufacturing output can be increased significantly. Following is diagram:

In above diagram., W wage rate is above the subsistence rate of S. So labors get attracted towards manufacturing sector. Profits of firm rises, so it demands more labor, so demand for labor keeps on shifting to right.

In this way, developing countries can achieve higher level of growth. Disguised unemployment in agricultural sector is considered as hidden saving,