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DTE NOTES
1. Demography and Development
Demographic concepts; birth and death rates, age structure, fertility and
mortality; demographic transitions during the process of development; gender
bias in preferences and outcomes and evidence on unequal treatment within
households; connections between income, mortality, fertility choices and
human capital accumulation; migration.
Readings -Debraj Ray, Development Economics, Oxford University Press, 2009.

UNIT 1
CHAPTER – 9 Population growth and Economic
development
 Theory of demographic transition
 Micro – Inertia & Macro – Inertia
 Fertility choice& Missing market
Mortality & Fertility
 Hoarding and targeting
 Cost-benefit approach
 Is fertility too high?

Theory of demographic transitions

 Economic changes → fast

 Social changes → slow

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Theory of demographic transition

Explains effect of economic development on population growth. According to this theory, every
economy past through three different stages.

In stage 1st which is characterized by initial stage of development both birth rate and death rate are
high and as a result, population growth rate is low. Death rate is high due to lack of medical facilities
while birth rate is high due to lack of education and other factors.

In the 2nd stage death rate declines steeply due to improvement in medical facilities while birth rate
declines gradually because it depends on social factors that changes slowly. In the 2nd stage
population growth rate is high due to micro inertia and macro inertia.

In the final stage of demographic transition both birth rate and death rate declines as economy
develops and as time overcomes micro inertia and macro inertia. In this stage population growth
rate is low. These three stages jointly make up what is known as demographic transition.

Macro & Micro – Inertia

To explain adjustment of birth rate during demographic transition it is useful to distinguish between
two forms of inertia. One at the level of overall population (macro inertia) and other at the level of
family (micro inertia).

Distribution of population by age play an important role in demographic transition. The fact that
both birth rate and death rate more initially high in a poor country makes net population growth
rate low, just as in rich countries but there is a second implication which is quiet different. The
population of poos countries will be very young on average. This feature tends to keep overall birth
rate high even if fertility rates are reduced. The inertia of age distribution guarantees that young
people of reproductive age continue to enter into population. This is inertia at aggregate level i.e.,
macro inertia.

In addition to macro – inertia, micro – inertia also operate at household level and it is determine by
societal norms regarding children and other socio economic factors.

Fertility choice and missing market

Fertility → HH

Missing Market → social security such as old age pension

In developing countries children are generally considered as substitute for various missing
institutions and market, particularly the institution of social security in old age. The absence of such
institutional arrangement forces a couple to make fertility choice based on recognition that some of
their children will die. These potential death must be compensated by larger no. of birth.

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Children are considered as “investment good” i.e., a source of support to the family in old age and
more generally as a form of insurance. In developing countries where per capita income is low most
of income is spent on consumption. As a result, they have less income available to purchase assets
that provides return in future. In this context children are considered as asset.

Considered the probability that a child will grow up to look after parents. This probability is
determined by several factors:

1) The child may die young due to high infant mortality rate.
2) The child may die in early childhood due to high child mortality rate.
3) There is possibility that child may not be an adequate income earner.
4) A child may not look after parents in their old age.

The limited possibility that some child might not do so may have opposite effect on fertility. It means
in state of lowering it or reducing it. It may increase it as parents attempt to compensate for this
contingency.

Summarizing the overall probability that a given child will grow up to look after parents by ‘P’. It is
not unreasonly to take this probability 1/2. Now contrast this with probability ‘q’ that a couple find
acceptable as a threshold probability of receiving support from at least one child. And it is not
unreasonable to consider this probability 9/10.

Suppose a couple has ‘n’ no. of children than the probability that none of them will look after is
(1 − 𝑃 )𝑛 .
Consequently, the rule would be to choose 𝑛 just large enough so that
[1 − (1 − 𝑃 )𝑛 ] > 𝑞
1 9
Therefore, for 𝑃 = 2 & 𝑞 = 10,

𝑛 must be at least 4(𝑛 > ,4)

If couples are more risk – averse and if we add gender biasness then no. of children will increase.

Hoarding and Targetting

The above discussion contains an implicit assumption that parents must make their fertility decision
about later children without being able to use information about faith of their earlier children.
Whether it is unreasonable or not depends on which component of probability is dominant in
parental psychology. If parents worry that child may not earn enough in adulthood then they will
prefer to have more children in advance and this phenomenon is known as hoarding.

However, if infant mortality rate and child mortality rate is dominant form of uncertainty then in
such situation wait and see approach acquire greater feasibility. A couple can have a child and
condition it next fertility decision on the survival of this child. The desired no. of children can be
attained sequentially. This strategy called targeting.

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Cost – benefit approach for fertility decision

Cost of child rearing has two components:

a) Direct cost in the form of food, cloth, education, health, etc.

b) Indirect cost or opportunity cost which is measured by amount of income forgone in the
process of bringing up child. Time spent at home with children is time not spent earning
income. So, opportunity cost of children is proportional to wage rate multiplied by no. of
hours spent in parenting.

On the other hand, benefit of child is in the form of social security in old age.
The cost – benefit approach to fertility choice has been used by many economists. According to this
approach parents have children up to the point where marginal benefit equals marginal cost.

In societies where opportunity cost is low, fertility rate tends to be high. Gender biasness also have a
role to play. In many societies, it is presumed that women must allocate bulk of their time to the
upbringing of child. In such societies wages for women’s work are low as well. This brings down
opportunity cost of having a child and thereby keeps birth rate high. Similarly, if there are high rates
of unemployment then also opportunity cost of children comes down, which increases fertility rate.

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As wage rate increases, it increases opportunity cost and thereby causes income effect and
substitution effect both. Due to substitution effect no. of children decreases but due to income
effect no. of children increases. Therefore, entire effect is ambiguous.

If there is an increase in increase of family from sources other than wage income then there will be
only income effect. due to this income effect no. of children increases.

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The cost and benefit approach determines optimum no. of children where difference between
benefit and cost get maximised i.e., net benefit gets maximised. At optimum position, marginal
benefit must be equal to marginal cost.

Note: We must note that in a joint family opportunity cost of raising a child will be less as there are
other members in family for child care. With reduction in total cost optimum no. of children tends to
be higher.

Is fertility rate too high?

So far we have provided explanation about why fertility rates are high in the phase of declining
death rate, but high fertility rate does not necessarily mean sub – optimal fertility rate. If a family
chooses to have large no. of children then why should social considerations dictate anything
different?
There are three answers to this question:

1) Information and Uncertainty

2) Externality
3) Social norm

1) The first answer relies on incompleteness of information. People may not internalise the
general observation that death rate have reduced. In such a case, the no. of children that
couple may have may not be socially optimal. Faced with fresh information regarding infant
mortality rate and child mortality rate that influences their fertility choice, the couple would
revise their fertility decision. Another important point is that there is distinction between
decisions that are made ex-ante and their ex-post consequence.

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2) The presence of externality create divergence between private cost and social cost as a
result private optimal and social optimal gets, diverged. Since, external cost are not
internalized by decision maker. So, fertility choices that are privately optimal may not be
socially optimal.
E.g., Consider the provision of free public education provided by government. In that case
social cost is higher than private cost. Accordingly, private optimum will be more than social
optimum.

Social cost = Private cost + External cost (edu. not beard by family. Free edu)

As represented in diagram, social cost is greater than private cost because education is
provided by government. Accordingly, social optimum no. of children will be 𝑛∗∗ where
marginal social cost is equal to marginal benefit. However, private optimum number of
children will be 𝑛∗∗ where marginal private cost is equal to marginal benefit.

3) The other reason for high fertility rate is social norm. generally, people do what other do.
Therefore, earlier societal norm was to have large size of family. Therefore, conforming to
that social norm resulted into high fertility rate. However, such social norm changes
gradually. Therefore in that transition phase fertility rates continues to remain high.

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Chapter – 10
10.2 → Lewis Model – structural change theory
10.3 → Harris – Todaro Model – Classical rural – urban migration

Lewis Model
↓

Dualism
↙ ↘

Traditional sector Modern sector

(Agriculture) (Industry)
𝑇𝑃
𝑊𝑎𝑔𝑒 = 𝐿
= 𝐴𝑃 𝑊𝑎𝑔𝑒 = 𝑉𝑀𝑃

According to Lewis Model, economic development is progressive transformation of traditional sector

into modern sector. This model is structural change theory of development. It focuses on the
mechanism by which underdeveloped economies transform their domestic economic structure from
focus on traditional sector to focus on modern sector.

The starting point of Lewis Model is the idea of dual economy. Dualism is co-existence of traditional
and modern sector. (The traditional sector is equated to agriculture sector while modern sector is
equated to industrial sector). (Traditional sector uses, old techniques of production that are labour
intensive and employs simple instruments. In contrast, modern sector uses new technology which is
capital intensive). (In addition, traditional sector has traditional form of economic organisation based
on family labour and overall output is distributed to each family member. In contrast, modern sector
is based on modern form of economic organization that uses wage labour and the objective is to
maximize economic profit. So, wages are paid according to marginal productivity.

According to Lewis Model, economic development is process of migration of workers from

traditional sector to modern sector. The traditional sector is regarded as supplier of labour which
modern sector employs. However, entire labour force is not employed by modern sector because
supply f capital to modern sector is limited.

Therefore, capital accumulation in modern sector is engine of development. The fundamental

assumption is that labour is unlimited in supply and it can be withdrawn from traditional sector
without loss of output in traditional sector.

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The main idea of Lewis Model is that there is large surplus of labour in traditional sector of economy
that can be removed at very little or no potential cost by cost we mean opportunity cost i.e., loss of
traditional sector output as labour supply is reduced.

As shown in diagram, there are diminishing returns of input because land is fixed. When amount of
labour reduces from A to B then there is no loss of output because marginal product of labour is
zero. At this stage an important question arises that if 𝑀𝑃𝑙 is zero then how that labour was hired?
The explanation has been provided by Lewis that in traditional sector which uses family labour,
wages are not determined by MP.

In fact, total output is shared by family members. This imply that wages are determined the average
productivity which is measured by slope of straight line joining total product to origin.

Two extensions of labour surplus concept

There are two important extensions of surplus labour concept.

1 – First of all, there is question of efficient allocation?

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If marginal product is zero in some activity and positive in some other activity then there are
efficiency gains by switching resources from the former activity to the later activity. However, zero
marginal productivity of worker in agriculture has been questioned by many economists. They argue
that it is not necessary that marginal product in traditional sector is exactly zero. As long as, marginal
productivity is lower than in activities elsewhere then efficiency gains can be realized by re-
allocation of resource. This extended concept is known as disguised unemployment and it can be
measured roughly by difference between existing labour input and the labour input that equates
marginal product to wage (at C).

2 – Labour & Labourers

The other extension of labour –surplus concept is surplus labour vs surplus labourer. It has been
argued that there is migration of labourer and not of labour hour. It means total no. of labour hour
remains some even when some workers have move to modern sector. It imply that remaining
workers are working more than earlier.

Economic development and Agriculture surplus

Lewis – Ranis –Fei

Economic development proceeds by transfer of labour from agriculture to industry and

simultaneous transfer of food grains that sustain that part of labour force engaged in non –
agriculture activity. The diagrammatic representation of this process has been provided by Ranis &
Fei and that is why this model is known as Lewis – Ranis – Fei model.

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Chapter – 10

10.2: Lewis Model → Dualism

↙ ↘

Traditional Modern
Sector Sector
𝑇𝑃
𝑊𝑎𝑔𝑒 = = 𝐴𝑃 𝑊𝑎𝑔𝑒 = 𝑉𝑀𝑃
𝐿

𝑊 = 𝑃 × 𝑀𝑃
𝑊
𝑃
= 𝑀𝑃

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Lewis – Ranis – Fei

In the traditional agriculture sector, there is disguised unemployment as well as surplus labour and
wage rate is given by income sharing. The industrial sector is capitalistic. Economic development
proceeds by transfer of labour from agriculture to industry and simultaneous transfer of surplus
food grain production which sustains that part of labour force engaged in non – agricultural activity.

It is best to read above diagram from bottom up. In the lowest part, we have drawn agricultural
production function except that it is drawn from right to left. There is a phase of surplus labour
provided that entire labour force is in agriculture. In addition, if wages in this sector are decided by
income sharing than average wage is W. If traditional sector behaves as modern organization then it
will employ less labour, that excess labour in traditional sector is interpreted as disguised
unemployment.

In the case of surplus labour, supply curve of labour in industrial sector is perfectly elastic. The
demand for labour by modern sector is marginal productivity curve. So, employment of labour in
modern sector is determine by position of demand curve. When capitalist re-invest its profit then
demand for labour increases in industrial sector. As a result, more workers migrate from traditional
sector to modern sector. This process of migration from traditional to modern sector results in
economic development.

If we begin with entire labour force in agriculture and then suppose that we decrease this by a small
amount so that we are still in labour – surplus phase then total wage will in agriculture falls along the
diagonal straight line. Provided that wage in agriculture does not rise, at the same time output does
not fall because we are in surplus labour phase. Therefore, agriculture surplus arises and when we
divide that agriculture surplus by no. of transferred worker then it becomes average agriculture
surplus.

Limitation

1) It is based on the assumption that profit is re-invested in some technology. However, if

profit is re-invested in labour – saving technology then employment of labour will not
increase in modern sector.
2) This model assumes that there is surplus labour in agriculture while there is full employment
in industries.
3) It is based on assumption of competitive modern sector that guarantees continuous
existence of constant urban real wage. But this assumption is not realistic because in
modern sector workers are organized in the form of union.

Agriculture taxation
↗
Policy issues
↘
Agriculture pricing policy

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1. The assumption that wage rate in agriculture is fixed until the phase of commercialization is
very strong assumption. As labour is progressively withdrawn from agriculture sector there
is more income left for remaining workers to share. However, an important question is why
do not they share it and raise wage upward?
If they do then there are two effects:

i) Aggricultural surplus available to industry is reduced

ii) The compensating wage paid to transferred worker must rise even in the phase of
surplus labour.

This observation uncovers a problematic issue in Lewis Model. Industry has a vested interest
in taxing agriculture because it is only through taxation that income of family farmers stay
low as labour is withdrawn.

2. Agricultural taxation is not the only way to extract food surplus. This policy has several
problems which include informational problem, political problem and economic problem.
Therefore, agriculture pricing policy in the form of minimum support price (MSP) is adopted
by government to induce farmers to sell their output in market at a profitable price. In
addition, inputs used by farming can be subsidized to reduce their cost of production and
thereby increase agricultural surplus.

10.3: Harris – Todaro Model

Classical theory of rural – urban migration

↙ ↘ P Formal

Rural Urban ↗

Sector Sector ↘

(1 − 𝑃) Informal

𝑊 < 𝑊

CONCEPT / MAIN IDEA

The classical theory of rural – urban migration is based on Harris – Todaro Model. The main idea of
this model is that formal urban sector pay higher wage to workers and it is this higher wage that
creates urban unemployment. There are many reasons for high urban wage:

a) This sector is unionized and subject to collective bargaining over wage whereas other sectors
of economy are not organized so that wages are more flexible in those sectors.
b) Urban formal sector is more controlled by government policy so that minimum wage law is
more effective.

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c) Firms in urban formal sector may deliberately pay higher wage so that they can hire more
productive workers.

In contrast to higher wage in formal urban sector the informal urban sector and rural sector
have low wages that fluctuate according to supply and demand consideration. There is no labour
union and government policy is difficult to implement. Therefore, migration in Harris – Todaro
Model is considered as a response to significant wage gap. Obviously, not everyone can be
observed by formal sector at higher wage. So, some workers feel to find job and in that case
they turn to urban informal sector. Therefore, migration decision is similar to living behind a
relatively certain income of agriculture sector for great uncertainty of employment by formal
sector.

Basic Model

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The basic Harris – Todaro Model assumes that there are only two sectors in economy i.e., a rural
sector and formal urban sector. It is assumed that in both sector wages are fully flexible. In that case,
market equilibrium requires that wages in both sector must become equal and there is full
employment in rural sector as well as in the formed sector.

However, it is not unreasonable to argue that formal urban sector wage is too high for market
clearing to occur. The reasons for high urban formal wage has been explained above.

As represented in diagram, the formal sector wage is 𝑊 which is above the intersection of labour –
demand curve. At that wage, labour employed by formal sector is LF. So, an important question
arises that where remaining workers are employed? One possibility is that all remaining individuals
are employed in agriculture sector but in that case, wage in agriculture sector reduces to 𝑊. But this
cannot be an equilibrium situation because workers will prefer to migrate to urban area. Now, if we
try to impose equality of wage then also it will not be labour – market equilibrium as some workers
remain unemployed. Given that agriculture has flexible wage, unemployed workers cannot be
physically present in rural sector. Now, we have a situation in which workers migrate to urban sector
even when wages are some and there is significant risk of unemployment. So, this situation cannot
be an equilibrium situation. The main idea is that potential migrants choose between relatively sage
option i.e., to stay in agriculture sector and the gamble of moving to urban sector where high paying
formal sector job may or may not be attainable. The probability of getting such a job is determined
by ratio of formal job seeker and formal job available. Those who do not get a job might be referred
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as unemployed but this description is not entirely accurate because formal job seeker may enter
informal sector where jobs are easy to find but wages are very low.

P Formal −𝑊

↗
Agriculture
↘
(1 − 𝑃) Informal −𝑊1

10.3: Harris – Todaro Model

Classical theory of rural – urban migration
↓ ↓
Flexible ← 𝑊𝐴 𝑊𝐹 → Rigidity
<

Rural Urban
↓ ↙ ↘
𝑊𝐴 Formal Informal
𝑊1 𝑊2

P Formal Sector → 𝑊
↗
Agriculture
WA ↘
(1 − 𝑃) Informal Sector → 𝑊𝟏

In the above description there are two set of boxes. The left set is a single box, that’s, agriculture
sector with wagw, WA. The right side shows various options open in urban sector, associated with
their probabilities:

a) There is formal sector having higher wage, 𝑊 and probability of getting that job is 𝑃.
b) There is informal sector where wage is 𝑊1 and probability of getting that job is (1 − 𝑃).

Therefore, expected wage in urban sector is:

𝑃 × 𝑊 + (1 − 𝑃)𝑊1

It is this expected wage that is compared to wage in agriculture sector. However, if we add
possibility of unemployment then calculation of expected wage changes.

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P Formal Sector → 𝑊
↗
Agriculture → (1 − 𝑃) q Informal Sector → 𝑊𝟏
WA ↘
(1 − 𝑞) Unemployment → 𝑊 = 0

After introducing the situation of unemployment the overall expected wage is

𝑃𝑊 + (1 − 𝑃)𝑞𝑊1 .

It is this expected wage which is compared with agriculture wage to take migration decision.
Ignoring the situation of unemployment in urban sector we can write Harris – Todaro equilibrium
condition as:

𝐿𝐹 𝐿𝐼
𝑊𝐴 = [ ]𝑊 +[ ]𝑊
𝐿𝐹 + 𝐿𝐼 𝐿𝐹 + 𝐿𝐼 1

This equation indicates that if agriculture sector wage is equal to expected urban sector wage then
no person will prefer to migrate. However, we must note following observation.

i) The equilibrium condition represent a situation where ex-ante (planned) people are
indifferent between migrating and not migration but ex-post, they will not be
indifferent.
ii) The equilibrium concept implies a particular allocation of labour between three sectors
of economy. However, with change in population and migration the respective
probabilities will also change and that will change calculation of expected urban wage.
iii) The equilibrium concept does not require that we must stick to only two sub-sectors of
urban economy.

Government Policy
Paradox of urban job creation

Informal sector is an outgrowth of the factor that formal sector has mages that are too high so that
not everyone is capable of obtaining employment in this sector. At the same time, not everyone can
stay in agriculture because that would make formal sector wage too high and thereby induce great
deal of migration. The informal sector is result of this migration.

According to Harris – Todaro Model, informal sector act as necessary counter-might to the
attractiveness of formal sector job and thereby slowdown the pace of rural – urban migration.

However, for government increases size of informal sector is a cause of concern because
unregulated economic activity in this sector is generally responsible for congestion, pollution and

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high crime rate. Therefore, the obvious policy for government is to somehow accelerate the rate of
absorption of laour in the formal sector. Although wages are fixed, government can provide various
incentives (such as tax holiday), so that there will be more formal sector job created. Due to this
probability of finding formal sector job increases. As a result, expected urban wage exceeds
agricultural wage. This results into further migration of labour from rural to urban area. In that way
we say that size of urban sector is endogenous and migration will rise in response to this policy. With
this migration of labour from agriculture sector wages start rising in agriculture sector and the
change will continue so that new allocation must satisfy new Harris – Todaro equilibrium condition.

𝐿𝐹 𝐿𝐼
𝑊𝐴 = [ ]𝑊 +[ ]𝑊
𝐿𝐹 + 𝐿𝐼 𝐿𝐹 + 𝐿𝐼 1

𝐿′ 𝐹 𝐿′ 𝐼
𝑊 ′𝐴 = [ ] 𝑊 + [ ]𝑊
𝐿′ 𝐹 + 𝐿′ 𝐼 𝐿′ 𝐹 + 𝐿′ 𝐼 1

We must note that there is an apparent paradox. It means a government policy designed to absorb
people from informal sector ends up increasing the size of informal sector. As a matter of fact, there
is no. paradox but an observation that we see repeated in one developing country after another.
Attempts to increase the demand for labour in the formal sector may enlarge the size of informal
sector as migrants respond to better job conditions that are available. The migration effect
dominates the initial ‘soak up effect’.

Efficient allocation and migration policy

Considered two policies that reduce or remove informal sector. One Policy is physically restrict
migration. If this policy can be enforced then migration restriction will certainly get rid of informal
urban sector. However, given democratic set-up and fiscal migration this policy is not feasible.

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The second policy is to offer subsidy to employers in the formal sector for every unit of labour that
they hire, suppose that government gives a subsidy of ‘S’ per unit of labour in that case wage that is
paid by employer is effectively (𝑊 − 𝑆). On the other hand, workers receive that full wage, 𝑊.
Thus, the effect is to push out the demand for labour at formal wage.

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Subsidy

As shown in diagram, when subsidy is given to formal sector employer then employment of labour
by formal sector will increase because effective wage for employer will get reduce. On the other
hand, as less labour will be available in agriculture, wage in agriculture sector will also increase. So,
when there is parity of wage in both sector then there will be no migration.

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