Neoclassical Growth Theory

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According to this theory of neoclassical growth in population, there is a real growth in GDP of per person, courtesy to certain changes that are associated with their GDP factor. These associated factors include, certain technological changes that further causes greater saving and investment, which on an extension results in growth of per hour labor supply.

 According to diminishing marginal returns in regards to both labor as well as capital, the total amount of growth stops if there is no technological change. This theory was suggested in the 1950’s by Robert Solow of MIT. It is this unique view on population growth that has resulted in its increasing popularity in present times.

Theory of population growth and neoclassical growth:

The 18th century England saw a sudden growth in population courtesy to certain factors. It is this sudden population explosion that created the classical theory of growth and after a certain point of time, the growth process ended. There was a fall in rates of birth, rise in death rates, and increase in population was fairly moderate.

There was a huge sociological change during this period that resulted in sudden decrease of this increased growth rate. The opportunity cost associated with a woman’s time was now being attributed to the economy. There was an increase in women’s wage rates, which further increased their prominence in the service sector, with widened opportunities, and it also raised opportunity costs of children. Naturally, in such a scenario, a family, to manage expenses in a proper manner and with a wish to improve standard of living, will have fewer children. This further leads to a reduction in birth rates and on the whole population explosion is managed to a great extent.

Also, it is to be noted that when technological advancements are introduced in the economy, there arises facilities of health care and this extends life to a great extent. Thus, higher income is a necessity in present times to have a life that is better. Hence, it can be seen that due to this income rise, there is decrease in both birth rates and death rates, which further results in opposing forces forming a tie with each other, further causing an increase in population rates.

However, both these modern format of population growth as well as historical trends that are existent to a great extent places a view that is against the classical view that is placed forth by the economists. For them, there will be more people on this planet than what people can actually support.

Changes in technology and diminishing returns:

As per the neoclassical theory of growth, the economic growth rate is influenced to a great extent by rate of technological change. However, economic growth rate in no way can influence the rate of technology that is present in the society, since these changes are purely based on inventions and people’s demand.

To correctly understand the theory of neoclassical growth, it is important to understand the world when this theory was introduced. Back in 1950’s, according to Robert Solow’s ideas, income per person was on an average of $12,000 in current monetary status. With an average population growth to be taken at 1 percent, it can be seen that both investment and saving constituted up to 20 percent of GDP amount. With all these details, the quantity of labor on an hourly basis was kept at a constant. The per capita income was growing but at an acceptable pace.

At the next step, technology increases to a great extent and other associated activities rise at a rapid pace. Some of the best examples that were to be found in the 18th century in terms of scientific inventions and technological changes include, presence of new plastics, interstate highway systems as well as jet airlines. Thus, on the whole, it is a huge technological boost that happens.

 This technological boost brings forth another set of associated advances wherein, businesses advance to a great extend as well as profits, investment, savings increase to a great extent. As per the neoclassical growth theory, this prosperity that the economy faces will continue for a long time, however with technology not increasing to a great extent it is not possible that growth will also continue in the same manner.

This prosperity level continues to a great extent primarily because, there is no growth in classical population that would result in fall in rate of wages. Hence, per person gain is maximum in regards to this.

But this is not the same with growth rates, since a stop in technological growth rate will also reduce this rate to a great extent. The diminishing marginal returns to capital factor starts working in regards to that, since the high rates of profit bring forth both saving and capital accumulation. However, at times negative returns can be found.

Keeping in tune with higher rates of profit, it can be found that a greater number of projects are taken up, which to a great extent reduces the rate of diminishing marginal returns. This results in failure in return that further reduces incentives that are available on each of these products. Hence, more and more people tend to reduce their incentive rates when it comes to such products and therefore with lower incentives to save and invest, it so happens that both capital accumulation rates as well as saving rates are reduced to a great extent.

Now as a result, it happens that capital accumulation reduces comparatively and it is in tune only with population growth. Per worker capital range is maintained at a constant during this scenario.

Issues associated with Neoclassical theory of growth:

Since, all the technologies that are being introduced in the market are similar, it can be taken into account that capital that is to be used on a global rate is free all over the market and therefore rate of real interest associated with it is also similar.

Until the rates at which returns are taken to be equal to each other and per hour rate of capital are equal, capital amount will keep flowing. Also, rates of income and GDP will converge for people who are placed all over the world. But the problems are, convergence rates are slow and it is not imminent for all the countries available.

It is this backlog of neoclassical theory that New Growth theory helps in ending.


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