What is neoclassical growth model of economic growth?
1 Answer
Neoclassical growth theories came to the fore around late 1950’s and 1960’s and added an exogenous factor like technology to the classical production function.
Neoclassical theories show how appropriate quantities of three forces – labour, capital and technology contribute towards the accomplishment of a steady growth rate for any economy. Effectively this theory highlights the influence of technology on economic growth.
Therefore, under the neoclassical growth model, the production function looks different from the classical version, as Y = AF (K, L). Here, Y stands for Gross Domestic Product (GDP), K denotes the stock of capital, L denotes the volume of unskilled labour and A is the newly added exogenous factor, technology.
The neoclassical model basically assumes that increase in labour and capital both are subject to diminishing returns and that countries will make the most efficient use of available resources.
Based on these premises, the neoclassical model makes a few important predictions as:
- Economic growth is boosted by increase in capital, as increase in
capital brings about higher productivity among people - Each investment in capital creates higher returns in poor countries than in rich countries
- Increase in capital is subject to diminishing returns – hence all economies will ultimately reach a point where economic growth is no longer stimulated by increase in capital. This is the steady state.
The steady state can be crossed over by implementing new technology. Improved technology pushes up the steady state level of capital which in turn brings forth higher investments and thus higher growth.
Robert Solow, Frank P Ramsey and J. E. Meade are some of the biggest contributors to the neo-classical theory.
