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IB ECONOMICS HL

Internal Assessment Microeconomics and Macroeconomics

UPDATED ON - 27 APR 2020
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This Economics HL IA is a mix of microeconomics and macroeconomics. It gives the students a better knowledge of revenue and costs, market structures and, supply and demand.

 

Table of Contents

  1. Austria downplays EU claims of betting monopoly
  2. Corn prices fall, groceries not yet
  3. Dollar "heading south"
  4. Field of Greens

 

Austria downplays EU claims of betting monopoly


Austria's finance minister on Tuesday downplayed suggestions by the European Commission that a betting monopoly operated in the country, as Vienna faces a possible court case for refusing to open its gambling market. By Staff, Reuters, October 11, 2006.


Austria's finance minister on Tuesday downplayed suggestions by the European Commission that a betting monopoly operated in the country, as Vienna faces a possible court case for refusing to open its gambling market.


"Many European and worldwide providers offer to gamble and betting in Austria via the Internet, so the question presents itself -- what makes a monopoly in this sector, a sector where there is worldwide competition on the Internet," Karl-Heinz Grasser told reporters."It will be interesting to see how the Commission argues this and what developments we will see in Europe over the next months." The bloc's internal market chief said many states were likely to face court action over gambling monopolies that make it difficult for others to compete."It will be Austria, Italy, and France on Thursday if everything goes according to plan," Charlie McCreevy told reporters. The legal steps need the green light from the Commission as a whole. It is due to meet on Thursday. "We would like to have more. We have complaints against another six or seven member states. I reckon overall there will be 15 or 16 member states," McCreevy said. The 25-nation EU's executive arm started legal action against Germany, Italy, the Netherlands, Denmark, Sweden, Finland, and Hungary in April and those proceedings will continue, McCreevy said. Italy now faces two separate proceedings related to gambling, McCreevy added. After conceding to member states' demands for the exclusion of betting from a new EU reform to boost cross-border competition in services within the bloc, McCreevy decided to take the legal path to open up the sector to competition. McCreevy's move confronts EU states that operate lucrative state-owned or sheltered sports betting services. Michael Engel‐Andreasen Economics HL Internal Assessment 1 article in many European countries, only the state is allowed to operate betting activities on soccer games and horseracing. Governments assert that this allows them to better regulate the sector and ensure vulnerable customers are protected. The European Court of Justice has ruled that restrictions seeking to protect consumers must be "consistent and systematic" in how they limit betting activities. Grasser acknowledged the importance of well-regulated casinos in Austria while adding: "I don't want to see a gambling temple on every corner."The minister added he would like to see more Austrian online betting firms that would adhere to stricter regulations and select their clients more carefully. Online gaming exploded in 2005 with a string of high-profile company flotations in London, which has become the industry's corporate center. However, Internet gambling companies have been hard hit by a new U.S. law designed to stop online gaming by making it illegal for banks to process payments to gambling Web sites. The bulk of revenue has always come from U.S. players. Several senior executives of online gaming firms have been arrested in the United States recently on charges of illegal gambling in individual U.S. states. France investigated the two chief executives of Austrian online betting company Bwin on suspicion of violations of gaming laws. Austria has a monopoly on sports betting. A monopoly is the single supplier of a good characterized by high barriers to entry. The Austrian government has made a law that protects its monopoly from the competition – the ultimate barrier to entry. The law prohibits new competition making it a statutory monopoly. Monopoly goods tend to have a relatively inelastic1 demand. Gambling in a sports betting facility in Austria is inelastic because there are few substitutes due to the restriction of competition, except internet gambling which many avid gamblers would not consider a viable substitute because of the thrill in state-owned sports betting environments. Gambling is a demerit good – over provided by the free market and can have negative externalities (a negative spillover effect on society of a good being produced and/or consumed). The negative spillover effect could be citizens who are victims of pathological gamblers having to steal or con money to satisfy a potential gambling addiction; this true cost to society is shown in Figure 1.

 

Negative externalities and monopolies are types of market failure that the government is meant to intervene in to protect consumers from unreasonable prices or adverse effects. This can be done by imposing taxes on the monopoly so that the external burden on society is internalized, meaning that the firm and/or consumers pay the external cost, not society. However, if the Austrian government deregulated itself it would mean sacrificing abnormal profits as shown in Figure 2 (pg. 2).

 

If the EU removes the barrier to entry, it could exacerbate rather than cure the externality. Gambling can be considered a perfectly competitive good – a homogeneous good with very close substitutes. If the barrier to entry is removed by the EU, new firms attracted by abnormal profits enter the gambling market forcing allocative efficiency resulting in more bets offered at a lower price. Perfect competition and monopoly are compared in Figure 3.

 

 

2
Additional revenue from producing an additional unit
3
The additional cost of producing an additional unit of output
4
Total revenue divided by the quantity
5
Average fixed costs + Average variable costs

 

This purported efficiency is suboptimal due to the externality of pathological gambling. Here the perfectly competitive free market does not correct the market failure and increases overconsumption further increasing the external cost and the distance between MSC and MPC (Figure 1, pg. 1). The betting monopoly has a higher incentive to limit production because of abnormal profits. So the betting monopoly—a type of market failure—helps correct the market failure of pathological gambling. After the EU deregulates the betting monopoly, Austria can maintain its social welfare by imposing a quota on the number of games citizens can bet on. This would prevent the market from overproducing the demerit good, minimizing the external cost to society. Furthermore, abnormal profits currently earned by the betting monopoly can be used to fund merit goods. These profits could be used to treat pathological gambling prematurely. Besides, supernormal profits can fund education and improve health care which increases social welfare and create positive externalities; not possible in the perfectly competitive gambling market. Thus deregulating the monopoly is undesirable unless coupled with the prevention of the increased externality.

 

 

Corn prices fall, groceries not yet
Rainfall in the Midwest has helped drive corn from record highs, but that hasn't translated to supermarket shelves.
By Jeff Cox, CNNMoney.com contributing writer July 25, 2007: 3:30 PM EDT

 

NEW YORK (CNNMoney.com) --Corn prices have taken a tumble over the last month, but that doesn't mean that the cost of milk, beef, and other food products will drop as quickly as they rose.After a wild surge over the past 18 months or so due mostly to ethanol demand, corn futures have cooled, settling Wednesday at $3.25 a bushel, about a dollar below their mid-June peak. Economists cited record corn plantings this year coupled with recent much-needed rainfall in the Midwest.But Purdue University economist Corinne Alexander said corn's story remains to be told as the season progresses. Should drought conditions return to the Corn Belt, prices could jump again in a heartbeat."We're in a classic weather market right now," Alexander said. "There were very serious concerns about a potential drought in the Corn Belt. Over the last week, the Corn Belt has seen great rains and alleviated some of those concerns."It will be a day-to-day look out the window and see what the weather is market."Still, just a month ago many analysts predicted corn would stay above $4 a bushel and could push toward $6 a bushel. The thinking was that the $4 mark would be considered a symbolic threshold, and traders would push prices up another 50 percent or so.One of those bullish analysts, Darin Newsom of Omaha, Neb.-based agriculture consulting firm DTN said corn prices still could climb further but will level off, at least for the time being."What we're finding now is we're actually into liquidation mode," he said. "It's very seasonal and could take us to the fall. We could drop maybe another 40 or 50 cents from where we are at this point. Longer-term, I still can't help but think that higher prices are just sitting out there."How the price of corn will hit consumer food prices is equally hazy.While the Consumer Price Index has risen a fairly modest 2.2 percent over the past year, the run-up in corn prices has made feeding livestock more expensive and pushed up prices for milk, beef, pork, poultry, and other food products. A gallon of whole milk cost $3.80 a gallon on average this month, up 25 cents from June. Cheese has been trading around an all-time high and is now at a national average of $3.08 a pound at the supermarket, the highest since January 2006.But consumers are unlikely to get much immediate relief from the recent drop in corn prices, Purdue's Alexander said. A primary reason is wheat prices, which have jumped on rising demand from Europe for U.S. wheat. European supplies have been hurt by widespread flooding."Food prices are more determined by long-term prices rather than short-term market fluctuations," she said. "One of the bigger factors [in supermarket prices] is higher wheat prices. They're not going to be affected by a pullback in corn prices at all."There has been some dispute lately over how much impact ethanol is having on food prices, with supporters of the biofuel arguing that higher transportation costs due to the rise in gasoline prices are pushing up the cost of food and other goods more than corn.Ken Bailey, a dairy analyst at Penn StateUniversity who for months has been warning of significant milk price increases and quoted a leveling off the price of $3.80 a gallon last month, scoffed at that reasoning."When you come up with a government policy that subsidizes the production of anything, there's going to be market ramifications," Bailey said. "When you take corn away from the livestock producer and put it in a plant to make ethanol, in the short run the cost of the feed is going to go up and livestock producers are going to get squeezed. There's a direct correlation and anything else is just misinformation."Analysts agree, though, that the big winner with lower corn prices is the ethanol industry. The $4 mark was considered a key in determining the economic viability of ethanol plants."Having this huge pullback in corn price is good news for anybody who is buying corn. That means livestock feeders, food processors and ethanol plants," said Alexander, who predicted that continuing high demand for ethanol will push corn higher for each of the next two years.Arlan Suderman, an analyst who writes a daily newsletter called Farm Futures Daily, said corn could fall as low as $2.81, but said traders shouldn't panic.Oil is a scarce resource on our planet and due to the mass consumption and dependency on oil for transportation, governments are beginning to subsidise1 the production of biofuels. The hope is that the increased consumption of biofuels for transportation will reduce fossil fuel consumption and in turn reduce the negative externality on society and the world. A negative externality is a negative spill-over effect borne by a third party who does not consume the good that produces this negative effect. An example is a pollution: people who ride bikes or walk as their main means of transportation have to breathe the polluted air created by cars; as will future generations. The negative spill-over effect is the health problems that could arise from non-consumers of fossil fuels breathing the polluted air created by fossil fuel burners. Since the US government subsidizes the production of biofuels, they are attempting to internalize the externality (i.e. decrease the Marginal Social Cost or increase the Marginal Private Cost).

 

The main crop used in the US to create biofuels is corn. It is a derived demand as the increased demand for corn—currently—is derived from the increased demand for ethanol. When demand increases and supply remains the same the price and quantity of the goods supplied will also increase, shown in Figure 2 below.

 

This could harm livestock producers eventually causing an increase in the cost of raising cattle or chickens which could cause the price of milk, meat and other livestock-related goods to increase. The subsidy aims to counteract the price effect that the heavy demand for ethanol and corn has on the price for livestock feed shown in Figure 3.

 

 

Given the precarious nature of crop growing in general, if the recent drought returns then the subsidy could partially go to waste if a crop is lost or destroyed; this could cause supply to shift backward (to the left) and corn prices could reach the feared price of “6$ per bushel.” Unless alternative growing methods are employed such as hydroponics systems that are less dependent on rainfall than traditional methods, prices could rise again if rain levels suddenly decrease. But if these different growing methods are used some of the subsidies will need to be spent on new equipment which could mean not as much corn will be produced as the government had hoped. It might even be more cost-effective for the US to begin importing biofuels from countries such as Brazil; currently the leading producer in the world of biofuels with its powerful production of sugar cane. Another issue is that currently oil is still the dominant fuel and still frequently needed to transport biofuels. Biofuels are essentially substituted for oil but due to the transitional phase of engines being produced that run on biofuels, there is no fall in the demand for oil – presently. However, in the long-long-run one could expect the demand for oil to decrease as it becomes cheaper to drive a car that runs on biofuels (see Figure 4 pg. 3) Q0+Q1 corn substitutes for Q1–Q0 oil.

 

Perhaps governments will begin to provide incentives for car producers, drivers, and mechanics to upgrade engines to biofuel engines in the form of grants and/or tax breaks as incentives for car manufacturers to design more cars that favor ethanol. The energy market remains volatile but market forces, government intervention, and oil companies will determine if biofuels are here to stay.

 


Dollar 'heading south'

BBC NEWS

Dollar plumbs new low versus euro


The US dollar slid to a new record low against the euro, as investors bet that the Federal Reserve would cut interest rates to help the economy this week. The dollar hit a record low against the euro in early Monday trading at $1.4438 - before pulling back to $1.4423 by late trade in New York. Lower interest rates can weaken a currency as investors move funds to assets that enjoy a higher return. The dollar's slide helped drive oil prices to a new record above $93. It also contributed to gold prices rallying to a 28-year high. The US central bank, the Federal Reserve, is widely expected to cut interest rates by at least a quarter of a percentage point to 4.5% on Wednesday to limit economic damage from the housing market downturn.

 

The dollar has been sliding since the Federal Reserve slashed rates from 5.25% to 4.75% in September in a bid to boost confidence in the world's largest economy."Regardless of the size of the cut anticipated by the market, all roads would appear to point south for the US dollar," said Neil Mellor, currency strategist at Bank of New York. The euro was not the only currency to benefit from the dollar's woes. The Australian and Canadian dollars also hit their strongest levels in over two decades against the US currency. Meanwhile, the pound hit $2.0627 before falling back slightly to $2.0591.At the heart of the dollar's decline have been problems in the US housing market, caused by the Fed increasing interest rates to slow accelerating inflation. As a result of the higher borrowing costs, an increasing number of borrowers have defaulted on loans, especially in the sub-prime mortgage market, which specializes in lending to people with poor credit histories. This, in turn, has spread to global credit markets, as many of the sub-prime mortgages were repackaged and sold on to European and UK banks as investment assets. The Fed cut its main interest rate in September to ease the pressure on consumers and reassure the global markets but last week's run of weak economic data raised expectations that further cuts were needed to rejuvenate the economy. An exchange rate is the price of one currency in terms of another. In a floating exchange rate system, the value of a currency is determined by supply and demand. Factors that contribute to the depreciation and appreciation of currency are the interest rate and the value of imports/exports of the nation. Demand for a currency is healthy when its interest rate is high; economic growth is expected and overall confidence in the currency is strong. One method of battling the depreciation of a currency is to increase the interest rate, which in theory increases the incentive to use the currency as savings enticing foreign investors to invest in the currency. However, the Federal Reserve loosened monetary policy and lowered the interest rate in September to stimulate consumption and investment (Figure 1) in the economy to avoid a feared recession.

 

In the short run, the US economy receives a needed boost. However, in the long-run lower interest rates increase the incentive for firms to borrow money to invest in technology. The production of goods increases because of more efficient technology and shifts aggregate supply to the right. This may not stabilize inflation completely but helps counter the effects of the lower interest rate on aggregate demand so the domestic value of the currency will not suffer too drastic a blow. On the foreign exchange market, the situation is different; the currency depreciates as shown in Figure 2.

 

Lower interest rates cause investors to invest in more valuable assets. This increases the supply of the currency they sell and increases demand the currency they trade for; further lowering the exchange rate of the USD shown in Figure 3.

 

The EUROs demanded by USD holders, cause a shift in the demand for EUROS from D1 to D2 so the EURO has appreciated in terms of USD. The increase in the supply of the USD from S1 to S2 on the foreign exchange market illustrates the depreciation of the USD in terms of the EURO. This is happening with many currencies against the USD which only contributes to its overall depreciation. Increasing the interest rate would stimulate the demand for the weak dollar and potentially lead to an appreciation of the currency. Dollars are highly demanded in the short-run when they are bought and traded for oil. However, US exports are less expensive overseas and as demand shifts for US exports and the USD, the currency could appreciate, improving the balance of payments. But the positive effect of current USD depreciation on the balance of payments has a lag-effect. It might initially appear negative because of the J-curve effect as it takes time for traders to adjust to new short term price levels. The J-curve effect is that initially, the current account may seem to worsen because of the near-constant demand for less valuable exports. In the longer term, the increased demand for cheaper exports should improve the current account. Depreciation boosts exports for US businesses but hurts domestic consumers when they buy imported goods. However, aggregate demand will initially decrease and then increase shifting right, increasing GDP and domestic employment. This could assist the waning US economy.

 

 

Field of greens
India is undergoing a second agricultural revolution - building the infrastructure that connects farm to supermarket.

By John Elliot, the Fortune contributor

October 2 2006: 12:12 PM EDT

 

 

(Fortune Magazine) -- Here's a business-school case study waiting to be written: a national distribution system that guarantees that a third of its goods never make it to market. That has been the problem with agriculture in India - a place that likes to tell the world these days that it is as efficient and growth-oriented as China.But consider the obstacles that have long been faced by farmers there.Until recently they were forced by law to sell their produce at mandis, a network of local markets originally introduced to protect poor farmers from exploitation but now controlled by cartels of traders, petty bureaucrats, and moneylenders. There they were paid the official minimum price or less for their produce, but no one told them what vegetable varieties sold well or showed any interest in improving quality.The produce was then sent via other middlemen on a slow and often hot journey to retail customers, where, according to estimates by agriculture expert Abhijit Sen, a member of India's planning commission, between 30% and 40% of it would rot before it got to market. With few refrigerated packing centers, no regional distribution network, and an inefficient fleet of trucks, India can't sustain large-scale vegetable production, let alone an export business.Now market pressure - the potential for export and a rapidly growing domestic demand for reliable produce from new supermarket chains-is driving change and opening up opportunities for investment by multinationals such as PepsiCo, which has been involved in Indian agriculture since the 1980s, and Britain's Tesco. "Organized supermarkets have to have an organized back end," says Lynn Forester de Rothschild, founder, and CEO of E.L.Rothschild, a British investment firm owned by a branch of the Rothschild banking family.E.L. Rothschild is a fifty-fifty investor in FieldFresh with Bharti Enterprises, one of India's two biggest telecom operators, which is planning to set up a nationwide retail chain, probably with Tesco, as well as India's first large-scale fruit and vegetable export business. "There is a compelling case for India to feed the world, using inherent strengths that haven't been exploited at all," says Bharti chairman Sunil Mittal, some of whose produce already goes to Tesco.No wonder Emann Singh Mann is a happy farmer-a rare commodity in India's northern state of Punjab, where overfarming and a falling water table have affected productivity on the broad plains that gave rise to India's first green revolution in the 1960s, a U.S.-led effort that helped feed India's starving millions by introducing high-yield varieties of wheat and rice. FieldFresh has leased 90 acres of Mann's land to grow vegetables that need less water than the wheat, rice, and sugarcane he used to grow. It will pay him slightly more than the $30,000 a year he was getting, and it hires his tractors as well as pays his workers. "I might have got out of agriculture," says Mann, 35, the son of a prominent local politician, who opened a computer-design school in nearby Chandigarh 18 months ago as a hedge. Now okra and chilies are grown on Mann's land go to a warehouse for cooling, then travel 125 miles by road in a refrigerated truck to Amritsar, where they're put on a flight to Britain.Michael Engel-Andreasen Economics HL Internal Assessment 4 Article FieldFresh has 78 farms with 4,200 acres on lease in Punjab producing beans, snow peas, carrots, okra, baby corn, and other vegetables for export to Europe and the Middle East. In other parts of India, it is buying produce on contract from farmers, guaranteeing to pay market prices, though farmers are free to sell elsewhere. This contract system will probably become FieldFresh's main business model once farmers have learned to produce consistently high- quality crops using new seeds, fertilizers, and techniques the company provides. The benefits are already visible: "It has had an astounding impact on my village," says Mann, "with more employment and higher family earnings, alleviating a lot of social problems-and I'm learning new ways of doing things."With low wages of $1 to $3 a day in a labor-intensive business, India has a clear cost advantage over many producing countries. But FieldFresh's initial export attempts last year proved disastrous: 15 out of 20 containers of grapes, as well as shipments of mushrooms and okra, were wasted because of bruised skins, pest attacks, and airport delays. "It was a learning phase," says Mittal, who has persuaded the government to set up India's first perishable- produce centers at airports in Delhi and Amritsar, and to relax lengthy and often corrupt customs procedures. But even though Tesco is among FieldFresh's overseas buyers, the production company is still finding it difficult to break into foreign markets and to achieve the required levels of quality and rapid delivery. FieldFresh hopes its exports will grow this year to $15 million, after an initial investment of $50 million.Reliance Industries, one of India's two largest industrial groups, has even bigger plans. In June its chairman, Mukesh Ambani, announced a $5.6 billion multiyear investment in agriculture and retail. He aims to make a new company, Reliance Retail, the sector's dominant player. Links are being established with farms on several thousand acres in Punjab, West Bengal, Maharashtra, and elsewhere, with rural centers providing goods for farmers and handling their produce. A supply chain is planned from these hubs to Reliance Retail's outlets as well as to foreign buyers. Ambani says he aims to deliver "better returns for the Indian farmer and producer by connecting them directly to Indian and global consumers, and lower prices and better product quality for consumers." He is already growing mangoes on land adjacent to Reliance's oil refinery at Jamnagar and plans to become India's biggest exporter, selling 3,600 tons annually within five years.With 77% of India's population relying on agriculture for a living, improvements in efficiency and new markets have the potential to benefit large numbers of people.The initiatives by Bharti, Reliance, and other companies will undoubtedly bring advantages of scale that have largely been missing in a nation where the average landholding is only 21⁄2 acres and 60% of agricultural output is consumed by farmers' families.But anything that might lead to consolidation or to farmers' being displaced from their land is politically sensitive-especially at a time when crop failures and bankruptcy have led to an average of 15,000 farmer suicides annually over the past five years, according to official records. Even Mann's father, Simranjit Singh Mann, who heads a Sikh political party in Punjab, has found it politically expedient to attack the state government for providing low-priced agricultural land to Reliance for a rural farming center.India Agriculture Secretary Radha Singh is backing the big companies' entry into vegetables and fruits because of the obvious growth potential and the impact they can have on other farmers' performance.She is also encouraging states to change laws to relax the mandis' monopoly and improve infrastructure, and slowly they are beginning to do so. "Until Michael Engel-Andreasen Economics HL Internal Assessment 4 Article recently," Singh says, "the government has never looked at linkages beyond basic food production because the focus has been on self-sufficiency." began working with Punjab farmers on pulping tomatoes in return for obtaining government permission to produce and sell its drinks in India. It introduced new varieties that have helped boost the state's tomato crop from 18,000 tons in 1988 to 300,000 tons this year. Although no longer involved with tomatoes, Pepsi has a five-year program with the Punjab government to provide several hundred farmers with four million sweet- orange trees by 2008 for its Tropicana juices. It is also developing a seaweed crop for a food- gelling agent on 4,000 rafts off the southern coast of India. And it has introduced Punjab farmers to high-yielding varieties of other crops, such as basmati rice, mangoes, potatoes, chilies, peanuts, and barley, that it uses for its Frito-Lay snacks and sells to domestic and foreign buyers. Last year its agriculture exports totaled $40 million. Pepsi (along with Coca- Cola) has recently been accused in India of having unsafe levels of pesticides in its cola beverage, which it denies. But that has not affected the agriculture initiatives. "This started as a government obligation," says Abhiram Seth, Pepsi's export director, "then became corporate social responsibility, and is now a business." India is a less developed country (LDC) under barriers to development including arid land and poor crops. The agricultural sector in India has long suffered from inefficient management, production methods and materials, and natural hindrances.
 

Indian farmers have to endure the poverty cycle. Victims of the poverty cycle have poor diets and overall health, are barely literate and often lack clean water supplies; signifying poor living standards. There is a fundamental distinction between economic growth and development. Economic growth is a quantitative measurement of GDP or GNP, whereas economic development is a qualitative measurement of an increase in the quality of life (illustrated in Figure 1).

 

India’s economy is a dual-sector economy composed of an agricultural—largely informal sector which 77% of Indians rely on for self-sufficiency—and a modern sector composed of industry and tertiary services. Many Indians rely on agriculture so it is necessary to optimize their production methods if there is to be any migration from the traditional to the modern sector (i.e. rural to urban). This is currently in progress with assistance from multinational corporations. The multinational corporation’s role in economic growth and development can be substantial. Before the MNC intervention, Indian agriculture lacked the machinery to optimize production methods. This results in low marginal productivity per laborer. MNCs are introducing FDI: new crops and machinery to utilize the Indian land and improve overall production. The effect of new machinery on agricultural production is shown in Figure 2 (pg. 2).
 

 

Capital infusions of new farming technology increase production per unit of labor and lower costs in the long-run. However, capital intensive labor introduced by MNCs may be inappropriate in India’s low-cost labor environment and may generate unemployment. Existing rural laborers might be entirely replaced by machinery leaving many with job skills that are now obsolete because of MNC intervention. Perhaps labor-intensive production coupled with cumulative training is more ideal to avoid increases in unemployment and thwarting development. MNC assistance could even put small farmers entirely out of business, but given the farmers’ focus on self-sufficiency, it is currently of little consequence. Besides, MNCs have little incentive to keep profits within the developing country, using profits to imbue growth and development in their own countries. This capital outflow is a concern that may hinder India’s development; farmers’ higher incomes alone may not be sufficient in breaking the poverty cycle. If the hoped-for-changes occur, the dual sector model of Arthur Lewis could be put into practice. The Arthur-Lewis model assumes a dual-sector economy composed of a traditional sector based in the rural areas and a modern sector in urban zones, like India’s. The model also assumes the marginal productivity per worker in the rural sector is zero – thus the opportunity cost for migrating to the modern sector is also zero. The zero opportunity cost implies there are a seemingly limitless supply and availability of labor that can migrate to urban areas and work in the modern sector. The new machinery and crops used by farmers could mean that the opportunity cost for migration truly is zero (Figure 2). But jobs in urban areas require higher levels of education that migrating farmers may lack. Thus increased education is necessary before the Lewis model can take effect. However, in the long-run, after farmers have been re-educated and earn higher incomes and hold more savings, the poverty cycle can finally break and development can progress.

 

 

 

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