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Tutorial 4 ans

Economics Of Developing Countries (La Trobe University)

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Tutorial 4 - Answers

1. Read the Article “Reserve army of underemployed” and answer the following questions:

a. Why some economists believe that the rural surplus labour in China had been
already used up by 2008?
b. What is the Lewis turning point? Explain and show the point on an industry
labour market diagram.
c. In what sense, according to the article, are the development stories of Great
Britain and China similar?
d. Why some economists believe that after passing the Lewis turning point the
current growth model in China will be exhausted?

Answer

a. According to the article what some economists believe is based on factory owners’
complains about labour supply shortages and rapidly rising wages.
b. The Lewis turning point refers to the situation where the rural surplus labour is
exhausted. After passing this point, as the industrial sector and the demand for rural
workers keep growing wages start to increase significantly.

Lewis turning point

From the graph, when the industrial sector grows its demand for labour (curve “m”)
increases (shifts to the right). Before reaching the turning point wages would not go
up but once the rural surplus labour is exhausted, i.e. the industrial sector demand for
labour has passed the Lewis turning point, wages start to grow.

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c. Until recent years, the migration of millions of rural Chinese workers to the industrial
sector had not produced a significant increase in wages of low-skilled workers, in line
with what Lewis suggests would happen in the presence of rural surplus labour. This
is similar to what was observed in Great Britain during the first 50 years of the
industrial revolution, as there was a migration of rural workers to the industrial sector
real wages remained more or less the same.
d. The growth model in China has been characterized by a rapid growth of the industrial
sector with a large component of labour intensive foreign direct investments taking
advantage of lower wages. This was then translated into competitive export prices,
which has been at the core of China’s high economic growth rates. With the
exhaustion of the rural surplus labour and a rapid increase in wages this model would
not be viable to achieve the same growth rates in the future.

2. Explain each of the components of the two main equations in the Solow Model.

The Solow Model consists of two main equations in “per-worker” terms. These
equations are (i) the production function and (ii) the change in capital equation.

(i)
(ii)

The production function (i) indicates that income per worker is a function of capital per
worker. This implies that, the standard of living of individuals in an economy depend on
how much capital (machines, tools, etc.) are available in per-worker terms.

For this reason, a better understanding of how capital per worker changes over time is key
to understand how income per worker evolves. Equation (ii) explains how capital per
worker changes over time. The first term on the right-hand side of the equation indicates
that capital per worker grows by the amount it is saved per worker in an economy. The
second term shows that capital per worker decreases over time because of depreciation
rate ( ) and population growth ( ).

3. Using the capital change equation explain what we mean by steady state in the Solow
Model.

The steady state of an economy happens when the amount saved per worker in an
economy is exactly equal to the capital per worker that is lost because of depreciation
and population growth. This implies that the change in capital per worker is zero
( ).

4. Draw the Solow Diagram. Mark the steady state on the graph. Explain why we can say
that the economy always heads towards the steady state (independently of whether we
start at a point before or after the steady-state capital per worker level).

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The steady state is at point “A” where capital per worker is and income per worker
is .

The economy is always moving towards its steady state independently of whether we
start at a capital per worker below or above . Suppose the economy starts at . At that
point per-worker savings are higher than what the economy loses of capital per
worker due to depreciation and population growth .

This implies that the change in capital is positive, moving towards the steady-state level
of capital per worker ( ) (i.e., capital per worker grows).

Now suppose the economy is at point . At that point per-worker savings are lower
than the losses in capital per worker produced by depreciation and population
growth .

This implies that the change in capital is negative, moving towards the steady-state level
of capital per worker ( ) (i.e., capital per worker decreases).

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