Neo Classical Theory

of Economic Development
1 The term was ‘Neoclassical ’originally introduced
by Thorstein Veblen in 1900, in his article
'Preconceptions of Economic Science', to
distinguish marginalists in the tradition of Alfred
Marshall from those in the Austrian School.

2 1857 –1929 American economist and sociologist,

and a leader of the institutional economics
movement. Besides his technical work, he was a
critic of capitalism, as shown by his best known
book ‘’The Theory of the Leisure Class
(1899).’’
Other Neoclassical
economic theorists:

Trevor Winchester Swan was an Australian

economist best known for his work on the
Solow–Swan growth model, published
simultaneously by American economist Robert
Solow.
Robert Merton Solow is an American
economist particularly known for his
work on the theory of economic growth
that culminated in the exogenous growth
model named after him
 INTELLECTUAL CHALLENGE IN NEOCLASSICISM!

1 In neoclassical economics, the entire edifice of the

theory of growth is built on a concept of decline –
DRS: The concept of diminishing returns.
‘DECLINE’ AS A
2 Because of this reliance on the concept of
diminishing returns, growth theory in neoclassical PHENOMENA
economics has left most practitioners very TO HOST
unsatisfied with the theory as it now stands. GROWTH
3
The crux of the problem is that it is difficult, if not
impossible, to describe how something increases if
the main process used to describe the increase is a
process of decreasing values.
An increase in some inputs relative to other fixed
inputs will, in a given state of technology, cause
total output to increase:

but after a point, the extra output resulting from

the same additions of extra inputs is likely to
become less and less.
Samuelson &
This falling off of extra returns is a consequence of “The law of
the fact that the new doses‟ of the varying
EXAMPLE:
resources have less & less of the fixed resources to Diminishing
work with” Returns”
If one has a particular fixed area of land, the
addition of more and more labor will result in
diminishing returns to each additional unit of labor.

However, If both land and labor are increased at

the same rate, there may be no diminishing
returns; there may be “constant returns to scale”-
CRS
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 works by Robert Solow and T.W. Swan who Phenomena of
independently developed relatively simple growth
‘’Productivity
models.
Growth”
Solow's model experimented with 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 (vintage) 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. Old vs. New K
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,
&labor.
MAIN IDEAS

Neoclassical economics is
characterized by several
assumptions common to many
schools of economic thought.

There is not a complete agreement

on what is meant by neoclassical
economics, & the result is a wide
range of neoclassical approaches to
various problem areas and domains
— ranging from neoclassical
theories of labor to neoclassical
theories of demographic changes
etc.
Neoclassical Economics largely
rests on 3 Assumptions:
1. People have rational preferences
among outcomes that can be
identified & associated with a value.
2. 2. Individuals maximize utility &
firms maximize profits.
3. 3. People act independently on the
basis of full & relevant information.
Neoclassical economics dominates
microeconomics, and together with Keynesian “Rise of South
economics forms the neoclassical synthesis, which Asian Economic
dominates mainstream economics today.
Tigers is a
Although neoclassical economics has gained Classical Case
widespread acceptance by contemporary Example of
economists, there have been many critiques of
neoclassical economics, often incorporated into
Economic
newer versions of neoclassical theory as human Neoclassicism”
awareness of economic criteria changes.
 FOCUS

Neoclassical economics is a term

liberally used in economics focusing
TO DETERMINE:
on the determination of:
Often mediated
Prices, Outputs,
Prices, Outputs, and income through a
and income
distributions in markets through hypothesized
distributions in
maximization of
supply and demand and ….. 1 markets through
utility by income
supply & demand
constrained
Often mediated through a Forces …..
individuals …..
hypothesized maximization of utility THEORY
by income-constrained individuals OF V A L U E Employing
….. 2 & available
information and
and of profits by
Profits by cost-constrained firms factors of
cost constrained
employing available information production, in
firms
accordance with
and factors of production, in
rational choice
accordance with rational choice theory.
theory….3
 RATIONAL CHOICE THEORY

1 Rational Choice Theory is a framework for

understanding and often formally modeling
social and economic behavior.
2
Now main theoretical paradigm in WANTING
3 microeconomics.
MORE RATHER
Rationality (here equated with "wanting more THAN LESS OF
rather than less of a good") is widely used as A GOOD
4 an assumption of the behavior of individuals in
microeconomic models of human decision-
making.

It is also central to some of modern political

science and is used by some scholars in other
disciplines such as sociology & philosophy.
Gary Becker was an early proponent
of applying rational actor models more
widely.

He won the 1992 Nobel Memorial Prize It attaches "wanting more"

in Economics for his studies of
discrimination, crime, and human
capital.
“Rationality" described by rational
choice theory is different from the
colloquial & most philosophical use of
the word.
to instrumental rationality,
which involves seeking the
most cost - effective means
to achieve a specific goal
without reflecting on the
worthiness of that goal.
 Rationality in
economics has
For most people, "rationality" means "sane," "in nothing to do
a thoughtful clear-headed manner," or knowing
and doing what's healthy in the long term. with Morality

Rational choice theory uses a specific and narrower

definition of "rationality" simply to mean that an
individual acts as if balancing costs against
benefits to arrive at action that maximizes
personal advantage

Rather Value
for Money is
more Rational
 CONCLUSION

On the Flip Side

In spite of intellectual challenges within Global Economic Integration has led to
1 1
neoclassical frame work, it several Melt Down Effects.
revolutionized global economic
2 approach to idea of productivity. Seems to be a Model of
2 Corporatization of World Economy.
The idea became far more intense in
3 1990s starting with International 3 ‘Factory Asia’ concerns are not totally
Economic Globalization. unfounded.
FTAs & such Trade Models are examples 4
Marxian Approach is precisely just the
of global economic productivity. opposite of economic neoclassicism.
THANK YOU!