Neoclassical Growth Model

Basic Assumptions:
o the neoclassical growth model describes an
economy in which a single homogeneous output is
produced by two types of inputs- capital and labor.
o The economy is always competitive and always
operates at full employment output.

Aggregate Production Function was the tool use by

the neoclassical model

Aggregate Production Function for the

Neoclassical Model [Q=F(K/L)]
We will assume that there is a single kind of
capital good---we would call it K
L would represent the number of workers
The (K/L) is equal to the quantity of capital per
worker

Capital Deepening
The process by which the quantity of capital per
worker increases over time .
Capital deepening occurs when the stock of
capital grows more rapidly than the labor force.
In the absence of technological change, capital
deepening will produce a growth of output per
worker, of the marginal product of labor, and of
real wages; it also will lead to diminishing returns
capital and therefore to a decline in the rate of
return on capital.

What happens as the society accumulates

capital?
As each worker has more and more capital to
work with, the economy moves up and to the
right on the aggregate production function

Long-Run Steady State

Eventually the capital-labor ratio will stop rising.
In the long-run the economy will enter a steady
state in which capital deepening ceases, wages
stop growing, and capital returns and real
interest rates are constant.