The Basic Neoclassical Growth Model: A Review

Delano Villanueva, Roberto Mariano, Diwa C Guinigundo and Abbas Mirakhor

Chapter 1 in Economic Adjustment and Growth:Theory and Practice, 2023, pp 1-9 from World Scientific Publishing Co. Pte. Ltd.

Abstract: The basic neoclassical growth model of Solow (1956) and Swan (1956), henceforth S-S, has been the workhorse for economic growth theorists for the past six and a half decades. Earlier, the growth frameworks of Harrod (1939) and Domar (1946), henceforth H-D, had assumed a constant capital-output ratio v (or a constant output-capital ratio 1/v). Saving S is a constant fraction s of income Y. Gross investment I equals saving S, less depreciation δK, where K = capital stock and δ = constant depreciation rate. Thus, capital growth K˙/K (the warranted rate) equals s/v − δ. (A dot over a variable denotes time derivative, K˙=d(K)dt). Labor growth L˙/L (the natural rate) = λ + n, where L = AN, L = effective labor, A = labor-augmenting technology/productivity multiplier, N = working population, and λ + n = constant growth rates of A and N, respectively. Long-run, full employment equilibrium with price stability requires that the warranted rate (S = I) matches the full employment natural rate, or s/v − δ = λ + n. Since this equality happens only by accident, the economy is on a “knife-edge.” An inequality between the warranted and natural rates implies either a deflationary (unemployment) or inflationary spiral. There is no assurance of full employment with price stability…

Keywords: Adjustment and Growth; Testing Growth Models; Labor Participation; Human and Intellectual Capital; Finance and Growth; Adaptive Inflationary Expectations; Learning by Doing; Optimal Saving; Sustainable Foreign Debt; Stabilization and Structural Policies; Emerging Economy Case Study (search for similar items in EconPapers)
JEL-codes: E E02 F4 O11 O4 (search for similar items in EconPapers)
Date: 2023
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