In the below diagram in figure 1.1, we can see that in the industrial sector, as the total product increases, so too does the quantity of labor. If we recall one of Lewis’ assumptions was that profits and investments are reinvested back into the sector, causing total product to increase. If we derive this curve we are left with figure 1.2, which shows the real wage in the industrial sector. Figure 1.2 shows that if investments and profits are reinvested back into the labor market, that demand for labor will rise, shown by points B, C and D.
Now if we have a look at figure 2.1, we see the total product for the rural sector of the economy. Labor will increase until the average total production (TPA) and Average labor quantity (LA) meet at point A. At point A workers in the rural sector will be earning WA, as shown at point E in figure 2.2, after point A surplus labor will occur and the workers average product will decrease and move down the curve.
WA represents the average wage that a worker in the agricultural sector will earn, when comparing this to Wbar in figure 1.2, Lewis assumes that employers in the industrial sector can hire as many workers from the rural sector that they want, and wont need to worry about increasing wages, because the industrial wage is fixed at a higher rate than the rural (Todaro & Smith, 2011). So as labor is drawn out of the rural sector and put into the industrial sector, per capital income will rise.
Todaro & Smith argue that the Lewis model isn’t effective in explaining recent trends where mass movements from rural areas to industrial areas occur despite increasing unemployment in city areas (p. 337). To explain this occurrence we use the Harris-Todaro migration model. In this model there is also an agricultural and urban sector, but the urban sector is split between the urban formal sector and the urban informal sector. The urban formal sector is comprised of workers hired officially on contracts, whereas the urban informal sector is comprised of those individuals who don’t have regular jobs. More conventional names for the urban informal sector can be workers for the black market or off the book workers. To make the decision on whether workers will migrate or not, we can use the following equation:
Wa < (Lf / Lf + Li) x Wf + (Li / Lf + Li) x Wi
Lf = formal sector
Li = informal sector
Wf = urban formal sector wage
Wi = urban informal sector wage
Wa = agricultural sector wage
Equilibrium in the Harris-Todaro model when the wage in the agricultural sector is equal to the expected wage in the urban sector; this can also be