Neoclassical Growth Theory

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Explain and evaluate the neo-classical theory of long-run economic growth. In light of this theory what useful insights can be gained concerning the economic growth process of the UK economy over the past few decades?

In recent year’s macroeconomists have become increasingly dissatisfied with Solow’s neoclassical theory of long run economic growth, through scrutiny of its application to the real world. (Gordon, 2006). In this essay these criticisms are going to be addressed first by explaining the theory, then considering the effect of changing different variables such as the savings rate, population growth and technical progress. The theory will then be applied to the UK economy over the past few decades discussing its relation to slow and rapid growth in certain periods. To conclude, criticisms will then be discussed to value the theory against reality. The neoclassical theory of long term economic growth is determined by marrying the production function and the savings investment line (Gordon, 2006). The production function studies the relationship between real GDP (Y) and the ‘autonomous’ growth factor (A) along with capital (K) and labour (N). This is shown by the equation Y=AF (K, N) (Gordon, 2006). The function tells us that sources causing an increased standard of living derive from the autonomous factor and the capital intensity. The per person production function shows how much output can be produced by a given quantity of factor input and is illustrated in Figure 1 where returns are diminishing. The savings-investment relation describes how savings are used to fund the required amount of investment to maintain a constant amount of capital intensity (Gordon, 1956). Considerations in maintaining capital intensity are additional capital for an increasing population or replenishment for depreciated capital. This point at which national…...

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