Neo Classical Model

Neo classical theory: An economic theory that outlines how a steady economic growth rate will be accomplished with the proper amounts of the three driving forces: labor, capital and technology. The theory states that by varying the amounts of labor and capital in the production function, an equilibrium state can be accomplished. When a new technology becomes available, the labor and capital need to be adjusted to maintain growth equilibrium. This theory emphasizes that technology change has a major influence on economic growth, and that technological advances happen by chance. The theory argues that econonomic growth will not continue unless there continues to be advances in technology.
Neo classical theory maintains that economic growth is caused by: • increase in the labour quantity (population growth) • improvements in the quality of labour through training and education • increase in capital (through higher savings and investment) • improvements in technology.
The neo-classical model was an extension to the 1946 Harrod–Domar model that included a new term: productivity growth. Important contributions to the model came from the work done by Robert Solow, in 1956, Solow and T.W. Swan developed a relatively simple growth model which fit available data on US economic growth with some success. In 1987, Solow received the Nobel Prize in Economics for his work. Solow was also the first economist to develop a growth model which distinguished between vintages of capital. In Solow 's model, new capital is more valuable than old capital because—since capital is produced based on known technology, and technology improves with time—new capital will be more productive than old capital. Both Paul Romer and Robert Lucas, Jr. subsequently developed alternatives to Solow 's neo-classical growth model. Today, economists use Solow 's sources-of-growth accounting to estimate the separate effects on economic growth of technological change, capital,