Some applications of neoclassical model – Discussed!

Applications of neoclassical model

There are so many applications of neoclassical model. This model can be discussed in the following context.

Depriciation of capital stocks.

This is a modified form of the fundamental equation of the Solow model. The basic analysis that we studied, carrier over for the case of depreciating capital; we merely need to replace n by (n + 5).

Variable saving rate to look at the situation this model denotes that if the saving rate increases from s to s₂, this means that the sf (k) curve shifts upwards. This means the sf(k) curve will cut the nk curve at a new point which is higher and to the right of the earlier point of intersection. This means equilibrium k and y will both rise.

So an increase in the rate of savings does push up the output per man in the Solow model. But it is also important to note that in the Solow model, the savings rate is a key determinant of the level of capital per person if the saving rate is high the economy will have a large capital stock and output.

But saving has only a temporary effect on the growth in output per person. The economy will grow only till the economy reaches a new equilibrium capital per person level.

It shows that a permanent change in the savings rate has only a temporary effect on the economy’s growth rate is called the Solowian paradox of thrift.

This point is important to note since it is often suggested that developing nations should raise their savings rate as far as possible, this is supposed to push up the growth rates of per capita income. This proposition is present in the theories of development economists like Nurkse, Rostow and Lewis.

Here we should keep in mind that increasing the saving rate would push up growth rates only temporarily. The basic lesson of the Solow model is that permanent increase in the growth rate of per capita income comes about only through a change or improvement in technology.

We can now examine in the Solow model the effect of a growth in population. We have seen that capital accumulation by itself cannot explain long-term growth. This can come about through technical progress. The other source is a growth in population.

Population Growth. If we population increase at a rate n, what effect does this have on the steady state growth? Once the number of workers rises, this will cause capital per worker k to fall.

We know that Ak = sf(k) – nk. So increase in population (not the rate, but the level) reduces k, of course, we had seen this while studying the basic model. The steady state level of k is determined from the point where the curve sf(k) cuts the line nk. Dropping a perpendicular from this point to the horizontal axis (which measures k) gives us the steady state value k.

Now, it is essential to see what happens when the rate of population itself changes, that is, n itself undergoes a change. If the rate of population growth increase from n, to n₉. This means that the nk line will tilt upwards. If the sf(k) curve remains the same the new nk line will cut the sf(k) curve to the left of the earlier intersection point.

This results in the steady state capital per worker k to fall. Since y = f(k), a reduction in k results in y falling. Thus in the Solow model, if the rate of growth of population rises, output per worker will fall.

This has lessons for developing nations. These nations should not allow the rate of population to increase as this may have detrimental effect on the per worker output.