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5 views

CH 2

Uploaded by

Shereen Ahmed Abdallah
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Chapter Two

Neoclassical Theories
The main argument of Neoclassical is that:

- Underdevelopment results from poor resource


allocation due to incorrect pricing policies and
too much government intervention.

- It is the state intervention in economic activity


that slows the pace of economic growth.
Neoclassists argue that developing world is
underdeveloped because of the heavy hand of
the state and the corruption.

What is needed, therefore, is not a reform.


Rather, it is simply a matter of promoting free
market, where market prices guide resource
allocation and stimulate economic growth.
There are 3 approaches under this theory:
1- Free Market Analysis:
Market alone are efficient- Perfect competition- Technology
is free and available- any gov’t intervention is distortionary.
Characteristics: Privatization, free trade, export
expansion, eliminating government interference.

2- Public Choice Approach: “government can


do nothing right”
Characteristics: Bureaucrats, corruption, using the
power of the authority for own selfish needs.
Net result is not only a misallocation of resources but
also, a general reduction in individual freedoms.
3- Market Friendly Approach:
Characteristics:
-Government facilitate the operations of markets.
- providing a suitable climate for private
enterprise.
- public – private sector’s cooperation.

Due to many imperfections in developing countries,


government do have a key role to play in facilitating
the operation of markets through a market friendly
interventions. (health care facilities, educational
institutions).
Traditional Neoclassical Growth Theory
According to the traditional neoclassical
growth theory, output growth results from
one or more of 3 factors:

Increase in Increase in capital


Technological
changes
labor

If we have shortage in labor or capital, this


may be substituted by technology.
We have 2 types of economies:

1- Closed economies “with no external


activities”

2- open economies” with trade, foreign


investment…..”
Traditional Neoclassical Growth theory

Exogenous Growth Endogenous


Model Growth
“Solow Model” theory
Exogenous Growth Theory:
Solow Model:
Solow model begins with the production
function:
Y= K (AL)
Y= gross domestic product, k= stock of capital (human & physical), L= labor,
A=productivity of labor

- Economic growth comes from: capital- labor-new technology


- Solow’s neoclassical growth model assumes that there are
diminishing returns to the use of labor and capital (each addition
to capital should generate small addition to output)
- Technological progress given exogenously, that is why it is
called “exogenous” model .
Solow Model:
- Solow model is the best known model for economic growth.
It implies that economies will conditionally converge to the
same level of income if they have the same rates of savings,
depreciation, labor force growth and productivity growth.

- the more capital with which each worker has to work, the
more output that worker can produce.

- Due to diminishing return to capital, countries with small


capital stock should grow rapidly (high productivity)….high
growth rate. eg: China

- The concave shape of f(k), that is, increasing at a decreasing


rate- reflects diminishing returns to capital per worker.
Solow Model
Problems of Neo-Classical Growth
Model = Solow Model

• The growth model itself does not explain the


Technological Advances, and technical
innovation happens out of blue, and is
injected into Solow Model.
Endogenous growth theory:
Romer
- Endogenous growth theory seeks to explain the existence of
increasing returns to scale and the divergent long term growth
patterns among countries. whereas technology plays an
important role in this model.

- It addresses technological spillovers (in which one firm’s


productivity gains leads to productivity gains in other firms)
that may be present in the process of industrialization.

- The model is consistent with perfect competition


Endogenous growth theory:

- Human Capital with Knowledge; It is separate Physical


Capital with Technical Innovation; we can have an
accumulation/evolution function for Human Capital.

- The contribution of this model is that it emphasizes the


link between technical innovation, Human Capital, and
Institutions including Government.
• Technological change is the result of the
intentional actions of people, such as Invention,
and Research and Development

• Some institutions promote innovation and R & D,


and others inhibit R & D.

• Romer supports Government-funding for


Educational Institution and R & D.

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