Neoclassical Growth Theory and Assumptions

The neoclassical growth theory was derived from the Harrod-Domar model of 1946 by including the concept of productivity growth. Moreover, this theory borrowed a lot from the work of Swan and Solow who developed simple growth models in 1956. These models are used to date by the economists in the estimation of effects on the growth of the economy resulting from changes in labor, capital, and technology.

Assumptions

The neoclassical growth theory has one major assumption: that in a closed economy, capital is subject to diminishing returns. As per this assumption, we can derive the following facts;

• If laborfactor is fixed, the last unit of accumulated capital will always result in output that is less than the previous one.
• No economic growth per-capita. This means that in the short run, there is slow growth as the returns diminish and this is followed by an economy convergence to a constant and steady growth rate. Though the concept of non-zero labor growth rate may be complicated, this logic of diminishing returns still applies.
• With the assumption that there is no change in technology and labor force, the concept of diminishing returns states that at some point, there will only be just enough new capital produced to replace the amount of capital lost due to depreciation. When this point is reached, the economy experiences no growth.
• In the non-zero labor force growth assumption, constant output per worker-hour per output unit will ensure a steady state I reached. It should, however, be noted that the rate of technology growth dictates the per-capita output growth in the steady state. This is the rate of productivity growth.