Neoclassical Growth Theory

Neoclassical Growth Theory

The neoclassical growth model is a better starting point for economic growth related studies due to many reasons which we are going to discuss in this section. Solow (1956) and Swan (1956) were the most influential economists who first constructed this model. The neoclassical model basically highlights the role of capital accumulation in the process of economic growth whilst showing how economic policy can influence the growth of an economy by encouraging more savings.

The Solow-Swam growth model can be explained by starting from aggregate production function of an economy with a given supply of labor and state of technological knowledge. Further, these two variables are supposed to be constant over the period of

Further, the production function has the property of homogenous of degree one. Hence,

F(λK,λL)=λF(K,L) for all λ,K,L>0 (2.14)

In this production function, it is assumed that the state of technology is given. By doubling both labor and capital, an economy will be able to double the output. The meaning of doubling both labor and capital is that the extra labor can use the extra capital in the production process. If it is assumed that each people in the economy supply one unit of labor per unit of time, and the economy is in full employment, then labor input equal to the population. The population or the labor growth of the economy per year is denoted by n and supposed to be grown at the constant exponential rate.

The per capita production function has been derived by the neoclassical growth model as follows. By assuming a constant return to scale, capital stock per person k≡k/L will determine the output per person y≡Y/L. In the special case of λ=1/L, then the equation (2.14) can be written as,

Y/L=F(K,L)/L=F(K/L,1) (2.15)

Per capita production function can be defined

If the population growth rate n increase, the curve which is representing depreciation and population growth rate will shift upward creating new k* with lower capital per worker than original k*. Hence, Solow has pointed out that countries with higher population growth have a lower rate of capital per worker than the countries with lower population growth rate. In other words, countries with higher population growth will have a lower income per person with lower economic growth.

Up to this point, we have been discussing the impact of saving and population growth on economic growth in the neoclassical frame. The other important factor for economic growth is the technology. In the neoclassical frame, technology is considered as exogenous. It is important to discuss how the Solow model extended to capture technological progress in the process of economic growth.

The equation 2.22 is an extension of equation 2.13 which shows the aggregate production