1. In the 1950s, facing massive unemployment in the cities (much of it disguised in the informal sector), the Kenyan government embarked on a "Keynesian" policy of creating new urban jobs through public investment. By many accounts, the size of the informal sector in Kenya went up instead of dropping in the months that followed. Give an economic explanation of this phenomenon, using the Harris-Todaro model.
2. a. Sketch the following capacity curve: For all payments up to $100, capacity is zero. Then it begins to rise by 2 units for every additional dollar paid. This happens until anincome of $500 is paid out. Therefter, an additional dollar paid out increases capacity byonly 1.1 units, until toal income paid is $1,000. At this point, additional payments haveno e§ect on work capacity
b. Now consider a family of 5 members, who each have this capacity curve. Assumethat this family has savings of $400. Draw a new capacity curve for one of these family1members, assuming they split the $400 equally. (This will shift in the capacity curve,because the worker is able to consume something before getting any labor income).
(c) Assume that one unit of capcity work can fetch a wage of 50 cents. Show that noone in the family will be able to sustain any work capacity, so labor income will be zero.
(d) Find allocations of the nonlabor income that give rise to positive wage income. Compare this allocation to the allocation in part(c) from an e¢ ciency and an equity pointof view.