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Economic Transformation and Growth AAEC 3204 Dr. George Norton Agricultural and Applied Economics Virginia Tech Copyright 2008 Objectives 1. 2. 3. Discuss economic transformation that occurs with development Review production economics concepts 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 more 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 in nonfarm jobs 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 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 agriculture • Initial rise in # of farmers means environmental pressures • Technologies 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. depends on growth in food production Labor will bear some adjustment costs Important Production Economics Concepts Production function Marginal product Law of diminishing returns Isoquant Typical Production Function Quantitu of labor Typical Isoquant Structure C A L 1 200 L B 2 150 100 50 0 C 1 C 2 Quantity of capital Units of output (Y) Marginal Product Curve 0 Marginal product K J Units of input (x) What is the law of diminishing returns? Why is the law of diminishing returns important? Major Sources of Economic Growth • Population growth • Increased utilization of natural resources • Capital accumulation • Increases in scale or specialization • Increases in efficiency • Technological progress • Human capital and institutions Population Natural Resources Capital Accumulation Increase in human-made physical items such as buildings, machinery, tools, etc. 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 Allocative (MR = MC) Market Technical Efficiency Qty. of output (e.g. rice) Output at each level of input * use Technically efficient point Technically inefficient * 0 K J Qty. of input (e.g. labor) Allocative (Price) Efficiency Qty. of output (e.g. rice) line whose slope is P(labor)/P(rice) Highest-profit point along the production function Qty. of input #1 (e.g. labor) Lowest-cost point along the isoquant line of slope P(machines)/P(labor) Qty. of input (e.g. labor) Qty. of input #2 (e.g. machinery) Market efficiency 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. Examples of new technologies • • • • Higher yielding plant varieties Improved methods of pest control More efficient thresher Improved livestock feeding system Technological Progress Output Input Technological Progress Price D S1 S2 Quantity Scale or specialization Can raise productivity and facilitate trade Division of labor and specialization can make workers more efficient • Even more important in industry than agriculture, but also important for agriculture Human Capital and Social Institutions Human capital: education, improved health Institutions: Rules of the game Examples: laws, grades and standards, social organizations Conclusions Economic transformation is inevitable as development occurs 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