Neoclassical Growth Theory - Definition

Updated at December 19th, 2020

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Neoclassical Growth Theory Definition

In economics, the neoclassical growth theory is an economic model that maintains that the stability of economic growth rests on three major factors:

the availability of capital,
the availability of labor, and
State of technology.

These factors influence the growth of the economy significantly. Robert Solow and Trevor Swan developed the neoclassical growth theory, this theory is sometimes referred to as the Solow-Swan model. Right from 1956, the neoclassical growth theory has been the model for long-run economic growth.

Neoclassical Growth Theory Extended

The neoclassical growth theory is one that maintains that a well-adjusted capital, labor and technology is important for a stable economic growth. For this to happen, a temporary equilibrium is required, that is, for an economy to function adequately, a proportional capital size and appropriate labor coupled with technology must be in place. This is however, different from a long-term equilibrium that features none of the three factors. The theory also places much importance on the role of technology in the growth of an economy. Here are the key points you should know about the neoclassical growth theory;

The theory was introduced in 1956 and has since then been used as a long-run economic growth.
The theory was introduced by Robert Solow and Trevor Swan.
Steady economic growth is derived from three factors which are; labor, capital and technology.
The role of technology in economic advancement is crucial according to the neoclassical growth theory.

The Production Function of the Neoclassical Growth Theory

The economic growth that a country enjoys and the equilibrium of the economy is determined using the neoclassical growth theory. The formula for estimating neoclassical growth theory is; Y = AF (K, L). Y symbolises the GDP of a country. K stands for share of capital L is the level unskilled labor in an economy A symbolises the level of technology. According to this theory, despite the fact that the capital accrued by a country is important to economic growth, the integration of technology as well as labor productivity are also crucial to achieving a stable economic growth.

Technology's Influence on the Growth Theory

The influence of technology on the economic growth of a nation is crucial, so also the other two driving forces of the economy; labor and capital. It is important to know that these three factors have diverging influence on the economy. While technology has a limitless impact on the stable growth of the economy, the influence of unskilled labor and capital can diminish due to certain factors.

Real Word Example

The neoclassical growth theory is not only in theory, it is also in practise. Technological innovations however play an immeasurable role in the growth of an economy. The role of technology in the neoclassical growth theory examined in a study carried out by Dragoslava Sredojevi, Slobodan Cvetanovi, and Gorica Bokovi in 2016. These authors in their study considered technology as a major contributor to the economic growth.

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