# Neo Classical Model

1134 WordsOct 26, 20105 Pages
Neo classical theory: An economic theory that outlines how a steady economic growth rate will be accomplished with the proper amounts of the three driving forces: labor, capital and technology. The theory states that by varying the amounts of labor and capital in the production function, an equilibrium state can be accomplished. When a new technology becomes available, the labor and capital need to be adjusted to maintain growth equilibrium. This theory emphasizes that technology change has a major influence on economic growth, and that technological advances happen by chance. The theory argues that econonomic growth will not continue unless there continues to be advances in technology. Neo classical theory maintains that…show more content…
Assuming for simplicity no technological progress or labor force growth, diminishing returns implies that at some point the amount of new capital produced is only just enough to make up for the amount of existing capital lost due to depreciation. At this point, because of the assumptions of no technological progress or labor force growth, the economy ceases to grow. Assuming non-zero rates of labor growth complicates matters somewhat, but the basic logic still applies – in the short-run the rate of growth slows as diminishing returns take effect and the economy converges to a constant "steady-state" rate of growth (that is, no economic growth per-capita). Including non-zero technological progress is very similar to the assumption of non-zero workforce growth, in terms of "effective labor": a new steady state is reached with constant output per worker-hour required for a unit of output. However, in this case, per-capita output is growing at the rate of technological progress in the "steady-state" (that is, the rate of productivity growth). Graphical representation of the model: [pic] The model starts with a neoclassical production function Y/L = F(K/L), rearranged to y = f(k), which is the red curve on the graph. From the production function; output per worker is a function of capital per worker. The production function assumes diminishing