Economics Assignment: Classical and Neo-Classical Theories
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Added on 2020-05-28
Economics Assignment: Classical and Neo-Classical Theories
Added on 2020-05-28
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Running head: ECONOMICSClassical and Neo-Classical Theories of Economic GrowthName of the Student:Name of the University:Author note:
1ECONOMICSClassical Theory of Economic Growth Economic growth refers to the increase in the capability of an economy in the productionof goods and services from one time period to another. It is usually measured in the percentagerate of increase in the real or nominal terms of gross domestic product (GDP) (Kuznets 2016).There are two major branches of economics that explain the economic growth in two differentangles. One of them is the Classical theory of economic growth. The pioneers of economics,Adam Smith, David Ricardo, Thomas R. Malthus and J. S. Mill provided the essence ofeconomic growth, known as, classical theory of economic growth. As stated by North (2016), the theme of classical theory is that the growth of an economydepends on capital accumulation, increasing returns to scale and specialization. Adam Smith firstproposed the idea of economic growth in his 1776 book, ‘Wealth of Nations’. He argued thatthere are several elements in the economy that can lead to increased growth. Those elements are:Markets playing important role in the determination of demand and supplyProductivity of labor and its influence on per capita incomeSignificant role of trade in enabling more specializationIncreasing returns to scale, resulting in more specialization in the modern world (Rosenand Gayer 2014).The classical model was developed by Malthus and Ricardo. In this model, they assumedthat the change in technology is constant and expansion in the inputs results in diminishingreturns to scale. Malthus highlighted in his theory that, the world’s population would grow fasterthan the capacity to feed itself because he did not consider any technological improvement(Chakravarty 2017).
2ECONOMICSWTotal product (TP), total wage (W)LaborOPTP1TP2EMNABSTVRosen and Gayer (2014) stated that according to the classical economists, one of themajor features of a growing economy is the higher level of capital accumulation. This allowsincrease in the total output for the community by increasing the productivity of land and laborand increasing the allocation of available productive resources. Along with that, the total amountof profit is dependent on two factors, namely, total product of labor and wage level (Scully2014). Thus, in turn it also depends on the marginal productivity of labor. The productivity oflabor in turn depends on the capital stock and available techniques. The market wages could riseabove the subsistence level in the short run and this would bring an increase in the population.However, in the long run, as the population growth increases, the wage reaches the subsistencelevel and then the growth in the population would stop. Hartwell (2017) pointed out that thesurplus that is earned by the capitalists will be reinvested again in the production and the entireprocess will come to a stop when the diminishing returns set in the production process.
3ECONOMICSFigure 1: Classical theory of economic growth(Source: Author)In the above diagram, the line OW shows the subsistence level of wage, and TP1 is thetotal product curve. When the population level is at OM, the level of total product is OP. The percapita wage is MS, and surplus or profit is ST. At this stage, the capital formation starts and thatresults in increase in the demand for labor, leading to a rise in the wages, as the economy movesfrom T to B. With this movement, the level of working force increases and it shifts to the right,from OM to ON. Increase in population results in more amount of surplus and it is reinvested inthe economy. The process will continue till it reaches the point E. With every step in themovement, the amount of surplus capital gets decreased. At E, there will be no capital or surplus,and output and wage become equal. It is a stationary situation where there will be no economicgrowth, and the population would remain stagnant at OV. TP2 represents the total product curvewhen there is another factor, that is technological factor and that increases the level of totalproduct of the economy. According to the classical economists, even if there is technologicalfactor, the economy would still reach the stagnation when there is no capital surplus (Keynes2016). Neo-Classical Theory of Economic GrowthThe neo-classical theory of economic growth is established on the basis of theunderstanding that, growth in the output of an economy depends on the capital formation, laborand technology. According to this theory, an economy can achieve the state of equilibrium bychanging the amount of labor and capital in the production function. In this theory, the role oftechnology on the production has been accepted.
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