Neo-classical growth model

Neo-classical growth model (also known as the Exogenous or Solow growth model) is a term used to sum up the contributions by various authors in the framework of neoclassical economics.

The most important contribution was probably the work by Robert Solow. In the 1950s he developed a relatively simple growth model, which fit the data on US economic growth remarkably well.

A common prediction of neoclassical growth models is that an economy will always move towards a steady state (or "balanced growth path"). In this steady state the long run growth rate of the economy depends only on the rate of technological progress. Policy measures like tax cuts or investment subsidies are believed to have no effect on this long-run growth rate, though they can increase growth in the short run by increasing the output at the steady state.

The steady state is the point at which the output per worker curve, y=A*f(k), (where y is the output per worker, A is a total factor productivity multiplier (of which technology is a major factor), and f(k) is some function of the capital stock, k, in the economy that determines the amount of growth attributed to an increase in capital) crosses with the line y=(δ/s}*k (where δ is the rate of depreciation of the capital, s is the rate of saving in the economy, and k is again the amount of capital in the economy). An economy, over time, approaches the steady state, much like a market approaches an equilibrium point in modern microeconomic theory.

Neoclassical growth theory boils down to saying that long run economic growth comes from technological progress. The next step is then to ask "Where does technological progress come from?", and this question has led to the development of endogenous growth theory.

Within the Solow growth model, the Solow Residual or total factor of productivity is an often used measure of technological progress.