Economic Transformation and Growth Dr. George Norton Agricultural and Applied Economics Virginia Tech Copyright 2006

Objectives Discuss economic transformation that occurs with development Discuss economic transformation that occurs with development Review production economics concepts Review production economics concepts Identify potential sources of economic growth Identify potential sources of economic growth

Economic Transformation Increase in the size of the non-agricultural sector (income and employment) relative to agriculture What are the Causes? 1. Increased agricultural productivity 2. People spend more of their income on non-food items as development proceeds (income elasticity of demand for food declines) 3. Specialization in agriculture (produce less non-ag goods on the farm) and in the industrial sector itself

Agriculture’s share of national income versus national income

Agriculture’s share of employment versus national income

Factors influencing the speed of economic transformation Rate of growth of the total labor force Rate of growth of the total labor force Rate of growth in non- farm jobs Rate of growth in non- farm jobs Proportion of labor force initially in agriculture Proportion of labor force initially in agriculture

What happens to the number and size of farms? (U.S. example)

Implications ET means share of agriculture falls ET means share of agriculture falls Number of farmers rises and then falls Number of farmers rises and then falls Initial rise in number of farmers against a fixed land base means a rise in poverty until productivity increases occur in agricultureInitial rise in number of farmers against a fixed land base means a rise in poverty until productivity increases occur in agriculture Initial rise in # of farmers means environmental pressuresInitial rise in # of farmers means environmental pressures Technologies needed during rising and falling stages may differTechnologies needed during rising and falling stages may differ

Implications for Agriculture E.T. affects the size of the agricultural labor force, farm size, and per capita income in agriculture E.T. affects the size of the agricultural labor force, farm size, and per capita income in agriculture E.T. depends on growth in food production E.T. depends on growth in food production Labor will bear some adjustment costs Labor will bear some adjustment costs

Important Production Economics Concepts Production function Production function Marginal product Marginal product Law of diminishing returns Law of diminishing returns Isoquant Isoquant

Typical Production Function

C A B L 1 L 2 C 1 C 2 Quantity of capital Quantitu of labor 0 Typical Isoquant Structure

Marginal Product Curve

What is the law of diminishing returns? Why is the law of diminishing returns important?

Major Sources of Economic Growth Population growth Population growth Increased utilization of natural resources Increased utilization of natural resources Capital accumulation Capital accumulation Increases in scale or specialization Increases in scale or specialization Increases in efficiency Increases in efficiency Technological progress Technological progress Human capital and institutions Human capital and institutions

Population

Natural Resources

Capital Accumulation Increase in human-made physical items such as buildings, machinery, tools, etc. Increase in human-made physical items such as buildings, machinery, tools, etc. Increase in human capital such as educated population Increase in human capital such as educated population Where does it come from? Savings and investment

What is efficiency improvement? Getting more for the same inputs by allocating them in a better way

What are the three types of efficiency? Technical Technical Allocative (MR = MC) Allocative (MR = MC) Market Market

Qty. of output (e.g. rice) K0J Output at each level of input use Qty. of input (e.g. labor) * * Technically efficient point Technically inefficient Technical Efficiency

Qty. of input #2 (e.g. machinery) Qty. of output (e.g. rice) Qty. of input (e.g. labor) Qty. of input #1 (e.g. labor) Highest-profit point along the production function line whose slope is P(labor)/P(rice) line of slope - P(machines)/P(labor) Lowest-cost point along the isoquant Allocative (Price) Efficiency

Market efficiency Refers to the type of economic system and degree of market power Refers to the type of economic system and degree of market power A relatively free market with many buyers and sellers tends to have greater market efficiency as no one or small number of buyers and sellers can control the prices.A relatively free market with many buyers and sellers tends to have greater market efficiency as no one or small number of buyers and sellers can control the prices.

Examples of new technologies Higher yielding plant varieties Higher yielding plant varieties Improved methods of pest control Improved methods of pest control More efficient thresher More efficient thresher Improved livestock feeding system Improved livestock feeding system

Technological Progress Output Input

Technological Progress Price Quantity DS1 S2

Scale or specialization Can raise productivity and facilitate trade Can raise productivity and facilitate trade Division of labor and specialization can make workers more efficient Division of labor and specialization can make workers more efficient Even more important in industry than agriculture, but also important for agricultureEven more important in industry than agriculture, but also important for agriculture

Human Capital and Social Institutions Human capital: education, improved health Human capital: education, improved health Institutions: Rules of the game Institutions: Rules of the game Examples: laws, grades and standards, social organizations Examples: laws, grades and standards, social organizations

Conclusions Economic transformation is inevitable as development occurs Economic transformation is inevitable as development occurs Several major sources of economic growth with their relative importance having changed over time Several major sources of economic growth with their relative importance having changed over time Both technological and institutional change are vitally important; without institutions to provide incentives there will be little growth Both technological and institutional change are vitally important; without institutions to provide incentives there will be little growth