GROUP 3 PRESENTATION

• MEMBERS
MERCY VUGUSTA – K59/4862/2020
SHARON CHEMUTAI – K59/4879/2020
SANDRA HELLEN – K59/4890/2020
BRIAN MUUO – K59/4856/2020
JOSEPH OUMA DIBO – K59/4840/2020
FUNDAMENTALS OF
DEVELOPMENT
CLASSICAL AND NEOCLASSICAL THEORY OF
DEVELOPMENT
 Classical theory of development
• This theory was developed by economists during the industrial revolution.
• It explains economic growth as a result of capital accumulation and the reinvestment of profits
derived from specialization, division of labor, pursuit of comparative advantage .i.e the
economy is self regulating.
• Maintains that an increase in population growth leads to a decrease in economic growth
because when population increases, resources become limited causing decline in economic
growth.
• Population increase is caused by a temporary increase in a country’s real gross domestic
product. Due to higher demand and limited resources this leads to end of an economic growth.
 Classical theory of development
• A country’s economic growth decreases with increase in population and
limited resources.
• Temporary increase in GDP per person leads to population explosion,
limiting country’s resources, lowering GDP, slowing down economic
growth.
• Capital economists stress more on the capital accumulation and savings
that technological progress.
Structural model.
 Explaining the Structural model.
• Because of surplus, the capital formation process comes to effect. Demand
for labor increases, increasing total wages ( curve moves to GH). If
population remains constant, (ON) wages exceed subsistence wages,
NG>NR, total production will increase as curve moves to OM. Increase in
population= surplus generation
• E- wages and total income equalize and no surplus can be generated, an
economic stagnation; when technological progress disappears, it causes
the falling rate of profits which prevent further accumulation of capital.
 Relationship function

• Total output depends on labor size, capital, natural resources and technology.
• Q = f(L,K,N,T)
• Q- output
• L-labor
• K-capital
• N-natural resources
• T-technology
• N is constant as it cannot be increased quantitatively, but can rather be improved by technological
progress.
 Relationship function
• T = f (I)
• Investment depend Technology progress depends on investment.
• s on profits.
• I =△K =f ( R)
• K -net addition of capital
• R- return investment (profit)
• Profits depend on labor and technology
 Relationship function
• R =F (T,L)
• Level of technology depends on level of investment which in turn depends on level
of profit.
• T = f (I)
• = f [ I (R)]
• = f { R (T,L)}
• Labor size depends on size of wage fund. If wage fund is raised then labor force is
large.
 Relationship function
• Size of labor depends on investment level
• Wage fund depends on savings of capitalists and the savings find their
way into investments. These investments determine the size of wage fund.
• W =f (I)
• I - level of investment.
• W- wage fund.
 Closing Equation
• Q = R+W
• R - profits
• Q - Total output
• W - wage fund.
 Closing Equation
• Q = f(L,K,N,T)
• T = f(I)
• I = △K = f(R)
• R = f (T,L)
• L = f (W)
• W = f(I)
• Q = R+W
 Circulatory system

• Economic development implies level of output, increase is possible due to

technology improvement. Technology improvement depends on investment,
investment depends on level of profit, profit depends on size of wage fund.
Size of wage fund depends on labor force/ population growth. Population
growth leads to new scientific inventions which leads to increased total output.
• Q→T→I→R→W→L→Q.
• The end result of development activity is stagnation or the stationary state and
should therefore not be termed as underdevelopment.
 Weaknesses of the theory
• Equilibrium level doesn’t have to be full employment level since at equilibrium
aggregate demand may be equal to aggregate supply at less than full employment level
• It is applicable only in the long run. Full employment equilibrium in this theory is
attained only in the long run but in the long run we are all dead and after death there is
no economic or non-economic problem. Most of our problems arise in the short run
particularly the problem of employment so solutions must also be found in the short run.
• Full employment is not a normal situation. Unemployment is a general situation and full
employment is a rare exception which can rarely be attained by an economy.
.
 Weaknesses of the theory
• Existence of overproduction and underproduction cannot be overruled.
• Rate of interest is not the true determinant of saving and investment
.Decisions about saving and investment are taken by the two
fundamentally different groups of people. Saving is not only determined
by rate of interest but also the level of money income. Investment is not
only determined by rate of interest but also the marginal efficiency of
capital
 Weaknesses of the theory
• Ignorance with respect to technology: The classical model of growth ignores
the role efficient technical progress could play for the smooth running of an
economy. Advancements in technology can minimize diminishing returns.
• Inaccurate determination of total wages: The classical model of growth
assumes that total wages do not exceed or fall below the subsistence level.
However, this is not entirely true. Changes in the industrial structure and
substantial economic development can result in total wages exceeding or falling
below the subsistence level. Moreover, the classical theory of growth does not
consider the role played by trade unions in the process of wage determination.
 Neoclassical Theory of Development
• Robert Slow and Trevor Swan first introduced the neoclassical growth in 1956.
• It maintains that economic growth is a result of three factors ; labor , capital and technology.
• Is the model for long run economic growth and emphasizes that the role of technology in economic
advancement is crucial.
• Despite the fact that the capital accrued by a country is important to economic growth, the
integration of technology as well as labor productivity are also crucial to achieving a stable
economic growth.
• States that short term equilibrium results from varying amounts of labor and capital in the
production function (Y = AF(K,L) ) .Also argues that technological change has a major influence on
an economy and economic growth cannot continue without technological advances.
PRODUCTION FUNCTION IN THE NEOCLASSICAL GROWTH MODEL.

• Neoclassical growth model claims that capital accumulation in an economy and how people
make use of it is vital for determining economic growth.
• It further claims that the relationship between capital and labor in an economy determines its
total output.
• Finally, the theory claims that technology augments labor productivity, increasing increased
efficiency of labor.
• Therefore, the production function of the neoclassical growth model is used to measure the
economic growth and equilibrium of an economy.
• The general production function in the neoclassical growth model takes the following form:
 The equation
• Y = AF (K, L)
• Where:
• Y = Income, or the economy’s Gross Domestic Product (GDP).
• K = Capital.
• L = Amount of unskilled labor in the economy.
• A = Determinant level of technology.
• Also because of the dynamic relationship between labor and technology, an economy’s
production function is often restated as Y = F (K, AL). This states that technology is labor
augmenting and that workers’ productivity depends on the level of technology.
 STRENGTHS OF THE THEORY
• This growth theory posits that the accumulation of capital within an
economy, and how people use that capital, is important for economic
growth. Further, the relationship between the capital and labor of an
economy determines its output.
ASSUMPTIONS OF NEOCLASSICAL MODEL.

• Capital subject to diminishing returns: An important assumption of the neoclassical

growth model is that capital (K) is subject to diminishing returns provided the economy
is a closed economy.
• Impact on total output: Provided that labor is fixed or constant, the impact on the total
output of the last unit of the capital accumulated will always be less than the one before.
• Steady state of the economy: in the short term, the rate of growth slows down as
diminishing returns take effect, and the economy converts into a “steady-state”
economy, where the economy is steady or in other words in a relatively constant state.
 WEAKNESSES OF THE THEORY
• The neo-classical approach of the theory of economic development is narrow and inadequate. They
have minimised the significance of non-economic factors as the degree of political stability, the
attitude of population, legal and social institutions etc.
• Economic development is not a continuous process. The neo-classicists believe that economic
development is a gradual, continuous and harmonious process and hence they could not correctly
analyse the possibilities of cyclical fluctuations in the process of development. Historically, economic
development has been a discontinuous process.
• Unrealistic assumptions. Another drawback of the neo-classical analysis is its assumption of full
employment which is very unrealistic. Because of this assumption they could not analyse how an
economy can be maintained at the full employment level. In the field of capital formation they tend to
over-emphasises the importance of interest rate and minimises that of institutional factors.
 WEAKNESSES OF THE THEORY
• The neo-classical could not recognise the important role which
government can play in creating conditions for economic development. In
the present era intervention of Govt., is must to solve various problems of
the economy.
• Their analysis also suffers from the drawback that they were mainly
concerned with developed economies and hence their ideas and policies
have little relevance for under-developed countries.