RDP 9215: The Evolution of Employment and Unemployment in Australia Appendix 1: A Model of Einployinent and Productivity in Agriculture

Jerome Fahrer and Alexandra Heath

December 1992

As discussed in the text, rapidly rising productivity, falling employment, and falling terms of trade have been prominent recent features of the Australian agricultural sector. These stylised facts are consistent with the following model.

Suppose the economy consists of two sectors, agriculture and services. The mobility of labour ensures that the real wages are equal across sectors; moreover, the labour market is competitive and the real wages are equal to the marginal product of labour, and all labour is employed. This economy is depicted in Figure A1.1. The demand for labour in the service sector is shown by the curve MPLS, the marginal product of services, while the demand for labour in agriculture is shown by the curve MPLa.Pa/Ps, which is the value of the marginal product of labour in agriculture divided by the price of services. Equilibrium is at point 1, the intersection of the two curves. Employment in agriculture is Ea1 and is Es1 in services. The real wage, in terms of the price of services, is (W/Ps)1, in both sectors.

Figure A1.1: Two Sector Economy – Agriculture and Services
Figure A1.1: Two Sector Economy – Agriculture and Services

Suppose there is an increase in the marginal productivity of agricultural labour. The demand for labour curve shifts out (away from Oa origin) to MPLa'. The real wage increases in agriculture, and draws labour away from the service sector. A new equilibrium is established at point 2, with more labour employed in agriculture and less in services. Suppose, however, that in addition to this increase in productivity, the price of agricultural goods falls relative to the price of services. The demand for labour in the agricultural sector shifts back to MPL'a.Pa'/Ps, as the value of the marginal product of labour falls. Equilibrium is established at point 3, with employment levels Ea3 and Es3 in the two sectors. Compared to the original equilibrium, employment in agriculture is lower, productivity is higher, and the relative price of agricultural goods has fallen.