Question

analyze the essential proposition of the neoclassical two sector growth theory, and how is the conclusion reached that investment does not matter for long run growth?

Answer 1

Answer:

The essential propositions in Neoclassical growth theory are:

1) Capital subject to diminishing returns: An important assumption of the neoclassical growth model is that capital is subject to diminishing returns provided the economy is a closed economy.

2) Impact on total output: Provided that labor is fixed or constant, the impact on the total output of the last unit of the capital accumulated will always be less than the one before.

3) Steady state of the economy: In the short term, the rate of growth slows down as diminishing returns take effect, and the economy converts into a “steady-state” economy, where the economy is steady, or in other words, in a relatively constant state.

Key Conclusions of the Neoclassical Model of Growth

a) Output as a function of growth: The neoclassical growth model explicitly states that total output is a function of economic growth in factor inputs, capital, labor, and technological progress.

b) Growth rate of output in a steady-state equilibrium: The growth rate of total output in a steady-state equilibrium is equal to the growth rate of the population or labor force and is never influenced by the rate of savings.

c) Increased steady-state per capita income level: While the rate of savings does not influence the steady-state economy growth rate of total output, it does result in an increase in the steady-state level of per capita income and, therefore, total income as well, as it raises the total capital per head.

d) Long-term growth rate: The long-term growth rate of an economy is solely determined by technological progress or regress.

Technological progress is the sole reason of long-term growth rate. Because, technology will create a balance between the appropriate level of input(factors of production) and the combined output with the synergy effect of all factors of production for long-term growth.