Posted in Finance, Accounting and Economics Terms, Total Reads: 253
Definition: Classical Growth Theory
Classical Growth Theory states that the economic growth of a country slows down due to population growth and limited resources. As the Gross Domestic Product of a country increases, the population of a country also increases. Due to the increase in population, the demand for resources increases which are limited and hence it has an adverse effect on the economy. Due to limited resources the economy growth rate starts to fall down which eventually reduces the population too.
The Classical Growth Theory is based on the combinations of contributions of Robert Malthus, Adam Smith and David Ricardo. It is based on a ‘subsistence level’ of an economy. Whenever the income grows beyond the subsistence level, the limited availability of resources and population growth will bring the real GDP to the subsistence level. In the same way, when the real GDP drops below the subsistence level, part of the population will reduce and hence the real income will increase to the subsistence level. It is like an equilibrium which always brings the real GDP to that.
The main components of Classical Growth Theory are the production function, size of labor, investment, technological progress and determinants of profit.
Production Function: The production Function can be written as
Y=f (K, L, N, S)
Which means that the output depends upon stock of capital, labor force, land and level of technology.
Size of Labor: The size of the labor depends on the wage fund created. When the wage fund grows, it leads to an increment in the wage levels above the subsistence level. This rise leads to growth in the population which increases supply of labor which eventually brings down the wages at the subsistence level.
Investment: According to the classical economists, profit is the sole motivation for all economic or productive activities. Investments depend on the rate of profit earned by the entrepreneurs who invest in various activities.
Technological progress: For technological progress, capital is required. Hence to achieve technological progress, capital accumulation can be done by savings and investment.
Determinants of Profit: Profit depends on two factors: Size of Labor and Technological Progress.
• The theory underlies the relationship between the growth in agricultural sector and industry.