CASE 1: Economic Development Theories-Structural Approach: Lewiss Model of Unlimited Supply of Labor Question 1.

1 Discuss what are the basic underlying assumptions and the essence of the model? How the model argues it can sustain economic growth?

The basic underlying assumptions of Lewis Model: 1. In the third world nations or underdeveloped economy consists of 2 sector (i) Traditional sector It is subsistence sector which most people work in agriculture. In this sector, there are overpopulated rural labors marginal labor productivity therefore is zero. It implies that labor is unlimited labor surplus. Thus transformation of labor out from traditional sector does not affect to loss of output. (ii) Modern sector Modern sector is a high- productive industrial sector. It needs to absorb more labor into workforce. So Lewis aimed to change structural economy for higher productivity in modern sector by migration labor from tradition sector. Transformation of labor would reduce the difference between both sectors and develop the economy of the nation into high income level country. 2. Capitalists reinvest all their profit which is earned by excess of modern-sector profit over wage. Hence, accelerator and amount of investment bring to labor transfer and modern-sector employment growth. 3. Wage in modern sector was constant. This reflected to the supply of labor is horizontal which supported Lewiss assumption that labor supply is perfect elastic. However, wage in modern sector should be higher than traditional 30 percent to motivate labors who are agrarian to move out from rural area into capital market. The working process of the model for the economic growth sustenance: Refer to graph 3, it is production function of traditional sector which change in production depends only on variable input, labor only capital stock nearly unchanged because the characteristics of subsistence sector are closed market and no innovation. When total output is produced at TPA and an employment at LA, the marginal product of labor is zero which is consistent with Lewiss assumption that zero marginal productivity happened so this sector is surplus labor. While modern sectors production function is varied because Lewis believed that Capitalist will always reinvest equal to how much profit they earned and the factor of technology that is continuously innovative. Firstly, total product is at TPM1 with labor hiring L1 and capital stock is KM1. Marginal product of labor is equal to demand of labor D1 and the equilibrium in labor market of modern sector is at F where supply of labor from subsistence sector is equal to WA. As Lewis stated that capitalist will reinvest all profit, the production

function change to TPM (KM2) and at this scale of production the industry needs more labor demand for labor shifts to D2. Therefore transformation of labor from traditional to modern sector is possible and an employment is at L2 and Total product is TPM2. Because the labor supply of traditional sector is horizontal or perfect elastic, the real wage is still the same. These are the circle of modern economy and it will increase continuously the production and economic growth of the country.

Question 1.2 Analyse the strengths and weakness of the model? How relevant is the model to the economic growth and experience of any developing countries? Justify your answers. Strengths 1. It is suitable for developing countries to drive economy into industrial sector. 2. To reduce the unemployment problem. 3. The economy expands vastly and continuously. Weakness 1. It did not consider about the change of real wage which could be occurred even there was unemployment. 2. Producers do not always reinvest all profit. 3. Ignorance of agriculture sector, development is in only industrial side.

The developing countries needs to use this model in development too much because most developed countrys economy focus on industrial side. So to be overdeveloped economy the nation needs to improve more industrial sector by changing the structure of economy from traditional structure into modern concept such as applying technology in agriculture sectors to get optimal efficiency and equity and simultaneously solve unemployment problem.