Question

Explain the processes that will bring the growth of real GDP per person to a stop according to a. Classical growth theory. b. Neoclassical growth theory. c. New growth theory.

Short answer

Classical growth theory predicts growth stops due to resource limits; neoclassical growth theory attributes the halt to diminishing returns on capital; new growth theory argues continuous growth is possible through innovation and knowledge.

Step-by-step solution

- Classical Growth Theory

Classical growth theory posits that real GDP per person will stop growing due to the law of diminishing returns. As the population grows, resources such as land and capital become limited, leading to decreased rates of productivity. Eventually, these constraints will halt growth since outputs cannot keep pace with an ever-increasing population.

- Neoclassical Growth Theory

In neoclassical growth theory, real GDP per person stops growing because of diminishing returns to capital. The theory argues that technological advances can temporarily boost economic growth, but without continual innovation and new technologies, the benefits from investment in capital will decrease over time, causing growth to plateau.

- New Growth Theory

New growth theory suggests that real GDP per person will not necessarily stop growing as it emphasizes the role of ideas, knowledge, and innovation in driving sustained growth. Unlike the classical and neoclassical theories, this perspective argues that investment in human capital, innovation, and knowledge can lead to perpetually increasing returns, thus continuous growth.

Key concepts

Classical Growth Theory

Classical Growth Theory, developed by early economists like Adam Smith, states that the growth of real GDP per person will eventually halt due to the law of diminishing returns. In this theory, as the population increases, essential resources like land and capital become scarcer.

When resources are limited, productivity decreases. For example, if more workers continue to farm the same piece of land, each additional worker will contribute less to the overall output than the previous one. This diminishing marginal productivity means that, eventually, growth will stop as outputs can't keep pace with the growing population.

The theory assumes that technological advances are not enough to offset these diminishing returns permanently. Over time, the limits in resources make it impossible to sustain economic growth indefinitely.

Neoclassical Growth Theory

Neoclassical Growth Theory builds on the Classical Growth Theory and incorporates technological development into the growth equation. It primarily focuses on how factors like labor, capital, and technology contribute to economic growth. However, this theory also suggests that real GDP per person will eventually stop growing due to diminishing returns to capital.

Initial investments in capital (machinery, infrastructure, etc.) can spurt growth, but over time, as more capital is added, the additional output perceived from it diminishes. This is the law of diminishing returns.

Technological advancements can temporarily boost growth by making production more efficient, but Neoclassical Growth Theory argues that without continual innovation and new technology, the benefits from capital investment will decline, causing growth to plateau. To maintain continuous growth, continuous technological innovation is essential.

New Growth Theory

New Growth Theory differs significantly from Classical and Neoclassical theories by arguing that economic growth can continue indefinitely. This theory places a strong emphasis on knowledge, innovation, and human capital as primary drivers for sustained growth.

According to New Growth Theory, the economy can continually improve productivity through innovation and the generation of new ideas. These innovations can create positive spillover effects that benefit other industries. Hence, growth doesn't necessarily face a point of diminishing returns as in the other theories.

New Growth Theory also states that investment in human capital (education, skills) can lead to increasingly higher returns. The more knowledge and skills people have, the more they can innovate, leading to sustained long-term growth. This perspective emphasizes the importance of fostering a culture of research and development.

Law of Diminishing Returns

The law of diminishing returns is a fundamental concept in economics that describes how adding additional units of a factor of production while keeping others constant will result in smaller increases in output over time.

For example, imagine a factory that keeps adding more workers to the same amount of machinery. Initially, output will increase substantially, but as more and more workers are added, each additional worker contributes less to output than the one before. Eventually, the factory becomes too crowded, and productivity decreases.

This principle is pivotal in Classical and Neoclassical growth theories as it explains why growth cannot continue indefinitely with limited resources and capital.

Technological Innovation

Technological innovation refers to the development of new technologies or methods that improve productivity and efficiency. Innovation can significantly impact economic growth by enhancing production capabilities and creating new markets.

In Neoclassical Growth Theory, technological advances can temporarily boost growth, but their benefits diminish over time without continuous innovation.

In contrast, New Growth Theory sees technological innovation as a continual process that drives sustained growth. New technologies can create new industries and opportunities, leading to continuous economic development and increased GDP per person.

Human Capital Investment

Human capital investment involves spending resources on education, training, and health care to improve the productivity and efficiency of the workforce.

According to New Growth Theory, investing in human capital is crucial for sustained economic growth. A more educated and skilled workforce can drive innovation and productivity, leading to continuous improvements in GDP per person.

Workers with better education and training adapt more quickly to new technologies and can contribute to developing new ideas, further enhancing economic growth. Thus, investment in human capital is vital for fostering a culture of innovation and maintaining long-term growth.