An overview of the classical model of the economy

Many of the most famous classical thinkers, including Smith and Turgot, developed their theories as alternatives to the protectionist and inflationary policies of mercantilist Europe. Classical economics became closely associated with economic, and later political, freedom. Rise of the Classical Theory The classical theory developed shortly after the birth of western capitalism.

An overview of the classical model of the economy

An overview of the classical model of the economy

The neoclassical growth theory was developed in the late s and s of the twentieth century as a result of intensive research in the field of growth economics. Meade are the two well known contributors to the neo-classical theory of growth.

This neoclassical growth theory lays stress on capital accumulation and its related decision of saving as an important determinant of economic growth. Neoclassical growth model considered two factor production functions with capital and labour as determinants of output.

Besides, it added exogenously determined factor, technology, to the production function. Thus neoclassical growth model uses the following production function: Note that labour-augmenting technological change implies that it increases productivity of labour.

The second important way of incorporating the technology factor in the production function is to assume that technological progress augments all factors both capital and labour in our production function and not just augmenting labour.

What is 'Keynesian Economics'

It is in this way that we have written the production function equation i above. To repeat, in this approach production function is written as Y-AF K, L Considering in this way A represents total factor productivity that is, productivity of both factor inputs. Unlike the fixed proportion production function of Harrod-Domar model of economic growth, neoclassical growth model uses variable proportion production function, that is, it considers unlimited possibilities of substitution between capital and labour in the production process.

That is why it is called neoclassical growth model as the earlier neoclassical considered such a variable proportion production function. The second important departure made by neoclassical growth theory from Harrod-Domar growth model is that it assumes that planned investment and saving are always equal because of immediate adjustments in price including interest.

Therefore, unlike Harrod-Domar growth model, it does not consider aggregate demand for goods limiting economic growth. The growth of output in this model is achieved at least in the short run through higher rate of saving and therefore higher rate of capital formation.

However, diminishing returns to capital limit economic growth in this model. Though the neoclassical growth model assumes constant returns to scale which exhibits diminishing returns to capital and labour separately.

We explain below how neoclassical growth model explains economic growth through capital accumulation i. Note that for income per capita and capital per worker to remain constant in this steady state equilibrium when labour force is growing implies that income and capital must be growing at the same rate as labour force.

Neoclassic growth theory explains the process of growth from any initial portion to this steady state equilibrium. Production Function and Saving: As stated above, neoclassical growth theory uses following production function: To obtain the above production function in per capita terms we divide both sides of the given production function by L, the number of labour force.The economy, according to the classical model, is self-correcting.

The Keynesian model, however, was devised by John Maynard Keynes during the Great Depression. Keynesian economic theory comes from British economist John Maynard Keynes, and arose from his analysis of the Great Depression in the s.

The differences between Keynesian theory and classical. Classical economics or classical political economy is a school of thought in economics that flourished, primarily in Britain, in the late 18th and early-to-mid 19th century.

Its main thinkers are held to be Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Robert Malthus, and John Stuart Mill.

An overview of the classical model of the economy

Classical economics became closely associated with economic, and later political, freedom. Rise of the Classical Theory The classical theory developed shortly after the birth of western capitalism. Classical economics or classical political economy is a school of thought in economics that flourished, primarily in Britain, in the late 18th and early-to-mid 19th century.

The Classical Theory

Its main thinkers are held to be Adam Smith, Jean-Baptiste Say, David Ricardo, Thomas Robert Malthus, and John Stuart Mill. With these assumptions, neo­classical growth theory focuses its attention on supply side factors such as capital and technology for determining rate of economic growth of a country.

Therefore, unlike Harrod-Domar growth model, it does not consider aggregate demand for goods limiting economic growth.

Classical Economics