Theory of Economic Growth

Theories of Economic Growth – Discussed!

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This is based on the concept that when there is a growth in GDP, population will increase.

Explaining Theories of Economic Growth

The increase in population thus has an adverse effect on GDP due to the higher demand on limited resources from a larger population. The GDP will eventually lower back to the steady state. When GDP deviates below the steady state, population will decrease and thus lower demand on the resources.

In turn, the GDP will rise back to its steady state. Next, we have Neo-Classical theory. Swan and Robert Solow, made important contributions to economic growth theory in developing what is now known as the Solow-Swan growth model. The theory focuses on three factors that impact economic growth: The output per worker growth per unit of labor increases with the output per capita growth per unit of capital but at a decreasing rate.

This is referred to as diminishing marginal returns. Therefore, there will become a point at which labor and capital can be set to reach an equilibrium state. Since a nation can theoretically determine the amount of labor and capital necessary to remain at that steady point, it is technological advances that really impact the economic growth.

The theory states that economic growth will not take place unless there are technological advances, and those advances happen by chance. Once an advance has been made, then labor and capital should be adjusted accordingly. It also suggests that if all nations have access to the same technology, then the standard of living will all become equal.

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There were two major concerns with this era of theories. One is the conclusion that continuous economic growth can only occur with technological advances, which happen by chance and therefore cannot be modeled. Secondly, it relies on diminishing marginal returns of capital and labor. However, there is no empirical or real-life evidence to support this claim. Therefore the model is known for identifying technology as a factor in growth but fails to ever substantially explain how. While the Neo-Classical model concluded that if all nations had access to the same technology, the standard of living between the nations would be the same.

However, that is not what is seen in practice. Nations today do have access to the same technologies, but standards of living still vary drastically. The New Growth Theory assumes that marginal product of capital is constant rather than diminishing as in the neo-classical theories. The reason is the new growth theory includes investments in knowledge, research, and human capital.

Economic Growth Theory

No one can ever have too much knowledge. Therefore, there are no diminishing marginal returns with knowledge. This explains why countries that invest more in knowledge and research, providing incentive for innovations, will have larger economic growth than those invest less. Therefore the investment creates motivation to create new technology and it's the knowledge and research that results in technological advances. It is measured as percentage increase in real gross domestic product GDP , which is gross domestic product GDP adjusted for inflation.

Three main sets of economic growth theories were described including Classical, Neo-Classical, and New Growth. Classical theory suggests that there is an equilibrium steady state of growth. Neo-Classical theories are based on the idea of diminishing returns for capital and labor and focuses on technological advances as the key for economic growth.

However, there is a lack of real world evidence to support those claims. The only conclusion from that era of theories is technology does contribute but they failed to successfully explain why and how. Lastly, the New Growth Theory assumes constant marginal product of capital and labor because it includes knowledge. Therefore, the nations that invest more in research and development have more technological advances, therefore increases in economic growth.

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They also emphasized that capital accumulation not only generates income, but also increases the production capacity of the economy. For instance, if a construction plant is established, it would generate income for suppliers of different materials, such as cement, bricks, steel, and machinery with simultaneous increase in capital and production capacity of the economy. The newly generated income from capital accumulation produces demand for goods and services.

According to Harrod-Domar theory, the most necessary condition for the growth of an economy is that the demand created due to newly generated income should be sufficient enough, so that the output produced by the new investment increase in capital should be fully absorbed.

If the output is not fully absorbed, there would be excess or idle production capacity. This condition should be satisfied consecutively to maintain full employment level and achieve steady economic growth in the long term. According to this assumption, the national output which is equal to national income is directly proportional to capital stock, which is expressed as follows: Therefore the increase in the growth of national output per unit time is equal to the increase in the growth of capital stock per unit time.

After that, the extra capital required to produce the extra output can also be obtained. The capital stock and net investment I are equal to each other. Therefore, saving is a function of income, and saving function can be written as follows: On the basis of these assumptions, Harrod-Domar has determined the growth rate, which is as follows: The equilibrium growth rate shows the capacity of utilizing capital stock.

Warranted growth rate refers to the growth rate at which the amount of production is accurate neither too much nor too less. The increase in marginal propensity to save would result in the increase of saving, which further leads to an increase in investment. Consequently, the income and production capacity of a nation also increase, which further increases the output of the nation.

The increase in the production capacity in a particular period increases the income for coming years. The increase in income leads to increase in saving and investment, and higher incomes in succeeding years. According to the principle of acceleration, the investment increases at a faster rate. In aforementioned discussion, we have explained the Harrod-Domar model of economic growth with respect to capital accumulation.

However, another important aspect that has been discussed in the model is the employment of labor. The assumptions of the employment of labor aspect as per the Harrod-Domar model are as follows: This denotes that the potential labor supply restricts economic growth at full employment condition. British conservative politician and journalist Nigel Lawson has deemed carbon emission trading an 'inefficient system of rationing '. Instead, he favours carbon taxes to make full use of the efficiency of the market.

However, in order to avoid the migration of energy-intensive industries, the whole world should impose such a tax, not just Britain, Lawson pointed out. There is no point in taking the lead if nobody follows suit. Many earlier predictions of resource depletion, such as Thomas Malthus ' predictions about approaching famines in Europe, The Population Bomb , [] [] and the Simon—Ehrlich wager [] have not materialized.

Diminished production of most resources has not occurred so far, one reason being that advancements in technology and science have allowed some previously unavailable resources to be produced. In the case of the limited resource of land, famine was relieved firstly by the revolution in transportation caused by railroads and steam ships, and later by the Green Revolution and chemical fertilizers, especially the Haber process for ammonia synthesis.

Resource quality is composed of a variety of factors including ore grades, location, altitude above or below sea level, proximity to railroads, highways, water supply and climate. These factors affect the capital and operating cost of extracting resources. In the case of minerals, lower grades of mineral resources are being extracted, requiring higher inputs of capital and energy for both extraction and processing.

Copper ore grades have declined significantly over the last century. Offshore oil and gas have exponentially increased cost as water depth increases. Some physical scientists like Sanyam Mittal regard continuous economic growth as unsustainable. In , The Limits to Growth study modeled limitations to infinite growth; originally ridiculed, [] [] [] these models have been validated and updated.

Malthusians such as William R. Such advances and increases in efficiency, they suggest, merely accelerate the drawing down of finite resources. Catton claims that increasing rates of resource extraction are " From Wikipedia, the free encyclopedia. Gross domestic product real growth rates, — and —, in selected countries.

Rate of change of Gross domestic product , world and Organisation for Economic Co-operation and Development , since History of economics Schools of economics Mainstream economics Heterodox economics Economic methodology Economic theory Political economy Microeconomics Macroeconomics International economics Applied economics Mathematical economics Econometrics. Economic systems Economic growth Market National accounting Experimental economics Computational economics Game theory Operations research.

Bank reserves requirements Discount window Gold reserves Interest rate Monetary authority central bank currency board Monetary base Monetary currency union Money supply. Non-tax revenue Tax revenue Discretionary spending Mandatory spending. Balanced budget Economic growth Price stability. Fiscal adjustment Monetary reform. Productivity improving technologies economic history.

Rostow's stages of growth. This section is about a neoclassical growth model. It is not to be confused with Steady-state economy. Further information on Energy role in economy: Further information on Energy efficiency: The Limits to Growth. Economics of global warming. Energy returned on energy invested and Substitute good. Mining and Peak minerals. Exceeding global limits to growth. Structural Change and the Slowdown of U.

The Rise and Fall of American Growth. Archived from the original PDF on Inside the Black Box: Journal of Monetary Economics.

A complete understanding of the nature and value of human economic life. Handbook of Economic Growth. A Farewell to Alms: A Brief Economic History of the World. Press Syndicate of the University of Cambridge.

The Transportation Revolution, — New York, Lincoln, Shanghi: Diffusion curves for various innovations start at Fig. A Great Leap Forward: From to the growth rate was 1. Africa has to spend carefully. World Economic Outlook Database — October Long Term Productivity Growth".

The similarity of the growth rates in — with —, and of —96 with — is quite remarkable. Productivity and Growth" PDF. Journal of Economic Perspectives. Department of Commerce Bureau of Economic Analysis. Archived from the original on The Journal of Economic History. The Origins of Power, Prosperity, and Poverty.

Crown Business division of Random House. History of Economic Thought: A Paradox in China".

Journal of Economic History. The Origins of Modern Freedom in the West.

In Aghion, Philippe; Durlauf, Steven. Volume 1, Part A. Saving Capitalism from the Capitalists. Explorations in Economic History. The Mystery of Capital: Journal of Economic Geography. Journal of Business Venturing. Chamber of Commerce Foundation. An Essay on the Principle of Population.

Definition

Oxford University Press published Quarterly Journal of Economics. Journal of Political Economy. The Mystery of Economic Growth. Handbook of Economic Growth , Elsevier doi: History of Economic Theory: Scope, Method, and Content. Imperfections, Institutions and Policies. Retrieved July 13, Two Sides of the Same Coin".

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Review of Economic Studies. The Review of Economic Studies. Review of Developmental Economics. What the Data Say". Journal of Economic Growth. Journal of Economic Literature. Journal of Policy Modeling. Capital in the Twenty-first Century. Gregory ; Romer, David ; Weil, David Journal of Human Capital. The Knowledge Capital of Nations: Education and the Economics of Growth. Historical Perspective on Electrification".

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