Neoclassical Growth Theory Ppts 4th Chapter

Main Ideas

Neo Classical Theory of Economic Development

Productivity Growth Rational Choice Theory Theory of Value Approach  Individuals maximize utility  & firms maximize profits  Old vs. New Capital BITS Pilani, K K Birla Goa Campus

 The term was ‘Neoclassical’originally introduced by Thorstein Veblen in 1900, in his article 'Preconceptions of Economic Science', to distinguish marginalists in the tradition of Alfred Marshall from those in the Austrian School. 1857 –1929- American economist and sociologist, and a leader of the institutional economics movement

Besides his technical work, he was a critic of capitalism, as shown by his best known book The Theory of the Leisure Class (1899).

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 Other Neoclassical economic theorists- Robert Solow & T.W. Swan, Harrod–Domar, Ricardo, Keynes, Gilpin, North, Samuelson

Trevor Winchester Swan was

Robert Merton Solow is an

an Australian economist best known for his work on the Solow–Swan growth model, published simultaneously by American economist Robert Solow.

American economist particularly known for his work on the theory of economic growth that culminated in the exogenous growth model named after him

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The Harrod–Domar model is a postKeynesian model of economic growth.

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Used in Dev. economics to explain an economy's growth rate in terms of the level of saving and productivity of K. BITS Pilani, K K Birla Goa Campus

Intellectual Challenge in Neoclassicism!  In neoclassical economics, the entire edifice of the theory of growth is built on a concept of decline – DRS  The concept of diminishing returns.  Because of this reliance on the concept of diminishing returns, growth theory in neoclassical economics has left most practitioners very unsatisfied with the theory as it now stands.

‘Decline’ as a phenomena to host Growth

 The crux of the problem is that it is difficult, if not impossible, to describe how something increases if the main process used to describe the increase is a process of decreasing values. BITS Pilani, K K Birla Goa Campus

An increase in some inputs relative to other fixed inputs will, in a given state of technology, cause total output to increase;  but after a point, the extra output resulting from the same additions of extra inputs is likely to become less and less.  This falling off of extra returns is a consequence of the fact that the new doses‟ of the varying resources have less & less of the fixed resources to work with”

Samuelson & “The law of Diminishing Returns”

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 Example If one has a particular fixed area of land, the addition of more and more labor will result in diminishing returns to each additional unit of labor. -- Ricardo

 However, If both land and labor are increased at the same rate, there may be no diminishing returns; there may be “constant returns to scale”- CRS

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 The neo-classical model was an extension to the 1946 Harrod–Domar Model that included a new term: productivity growth.

 Important contributions to the model came from the works by Robert Solow and T.W. Swan who independently developed relatively simple growth models.  Solow's model experimented with available data on US economic growth with some success. In 1987, Solow received the Nobel Prize in Economics for his work.  Solow was also the first economist to develop a growth model which distinguished between vintages of capital.

Phenomena of Productivity Growth

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 In Solow's model, new capital is more valuable than old (vintage) capital because —since capital is produced based on known technology, and technology improves with time —new capital will be more productive than old capital.  Both Paul Romer and Robert Lucas, Jr. subsequently developed alternatives to Solow's neo-classical growth model.  Today, economists use Solow's sources-of-growth accounting to estimate the separate effects on economic growth of technological change, capital, &labor.

Old vs. New ‘K’ Impact of Each Factor of Production to Factor Productivity BITS Pilani, K K Birla Goa Campus

Main Ideas  Neoclassical economics is characterized by several assumptions common to many schools of economic thought.

 There is not a complete agreement on what is meant by neoclassical economics, & the result is a wide range of neoclassical approaches to various problem areas and domains—ranging from neoclassical theories of labor to neoclassical theories of demographic changes etc.

 Neoclassical Economics largely rests on 3 Assumptions1. People have rational preferences among outcomes that can be identified & associated with a value.

2. Individuals maximize utility & firms maximize profits. 3. People act independently on the basis of full & relevant information. BITS Pilani, K K Birla Goa Campus

 Neoclassical economics dominates microeconomics, and together with Keynesian economics forms the neoclassical synthesis, which dominates mainstream economics today.  Although neoclassical economics has gained widespread acceptance by contemporary economists, there have been many critiques of neoclassical economics, often incorporated into newer versions of neoclassical theory as human awareness of economic criteria changes.

Rise of South Asian Economic Tigers is a Classical Case Example of Economic Neoclassicism

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Focus  Neoclassical economics is a term liberally used in economics focusing on the determination of ---

 Prices, Outputs, and income distributions in markets through supply and demand and ….. 1  Often mediated through a hypothesized maximization of utility by income-constrained individuals ….. 2  & of profits by cost-constrained firms employing available information and factors of production, in accordance with rational choice theory….3 BITS Pilani, K K Birla Goa Campus

To Determine Prices, Outputs, and income distributions in markets through supply & demand Forces …..

T H E O R Y

Often mediated through a hypothesized maximization of utility by incomeconstrained individuals …..

OF and of profits by costconstrained firms

V A L U E

Employing available information and factors of production, in accordance with rational choice theory. BITS Pilani, K K Birla Goa Campus

Rational choice theory  Rational Choice Theory is a framework for understanding and often formally modeling social and economic behavior.  Now main theoretical paradigm in microeconomics.  Rationality (here equated with "wanting more rather than less of a good") is widely used as an assumption of the behavior of individuals in microeconomic models of human decision-making.

wanting more rather than less of a good

 It is also central to some of modern political science and is used by some scholars in other disciplines such as sociology & philosophy. BITS Pilani, K K Birla Goa Campus

 Gary Becker was an early proponent of applying rational actor models more widely.

 It attaches "wanting more" to instrumental rationality,

 He won the 1992 Nobel Memorial Prize in Economics for his studies of discrimination, crime, and human capital.

 which involves seeking the most cost-effective means

 “Rationality" described by rational choice theory is different from the colloquial & most philosophical use of the word.

 to achieve a specific goal without reflecting on the worthiness of that goal. BITS Pilani, K K Birla Goa Campus

 For most people, "rationality" means "sane," "in a thoughtful clear-headed manner," or knowing and doing what's healthy in the long term.  Rational choice theory uses a specific and narrower definition of "rationality" simply to mean that an individual acts as if balancing costs against benefits to arrive at action that maximizes personal advantage

Rationality in economics has nothing to do with Morality Rather Value for Money is more Rational BITS Pilani, K K Birla Goa Campus

 buying a new dress, or committing a travel, business deals etc.  In rational choice theory, all decisions, crazy or sane, are postulated as mimicking such a "rational" process.  Thus rationality is seen as a property of patterns of choices, rather than of individual choices:  There is nothing irrational in preferring Mess Food to Monginis only first time,

 But there is something irrational in preferring Mess Food to Monginis and preferring Monginis to Mess Food regularly.

Case Example of Rational Choice Theory Amartya Sen sees the model & people who follow rational choice model as “Rational Fools." BITS Pilani, K K Birla Goa Campus

Conclusion On the Flip Side 1.

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In spite of intellectual challenges within neoclassical frame work, it revolutionalised global economic approach to idea of productivity. The idea became far more intense in 1990s starting with International Economic Globalization. FTAs & such Trade Models are examples of global economic productivity.

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Global Economic Integration has led to several Melt Down Effects.

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Seems to be a Model of Corporatization of World Economy.

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‘Factory Asia’ concerns are not totally unfounded.

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Marxian Approach is precisely just the opposite of economic neoclassicism. BITS Pilani, K K Birla Goa Campus

Thank You

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