Question 1

What are the main assumptions of the Neoclassical Growth Model?

Accepted Answer

The Neoclassical Growth Model assumes a closed economy where output is consumed or saved, with a constant savings rate fully invested in physical capital. It also assumes diminishing marginal returns to capital and labor, constant labor force growth, fixed capital depreciation rates, and exogenous technological progress that improves productivity at a steady, predetermined rate independent of other variables.

Question 2

How does diminishing marginal returns affect economic growth?

Accepted Answer

Diminishing marginal returns means each additional unit of capital or labor produces less extra output than the previous unit. As economies add more machines or workers without technological improvement, growth slows because the productivity gains decrease. This effect demonstrates why capital accumulation alone cannot sustain long-term growth indefinitely.

Question 3

What role does net investment play in the Neoclassical Growth Model?

Accepted Answer

Net investment equals gross investment minus depreciation and represents the physical capital available to expand production and support workforce growth. When net investment only replaces worn-out capital and meets the needs of a growing labor force without increasing capital per worker, the economy reaches a steady state where total output grows but per-worker productivity remains constant.

Question 4

Why is technological progress considered the key to sustained long-run growth?

Accepted Answer

Technological progress is exogenous in the model, improving productivity at a constant rate independent of other factors. While saving and capital accumulation are essential, they eventually encounter diminishing returns. Only continuous technological advancement—new ideas, better techniques, and innovation—can keep productivity rising indefinitely and enable sustained growth in per capita income and living standards.

Question 5

How do savings and investment interact in the Neoclassical Growth Model?

Accepted Answer

A constant share of output is saved and fully invested, creating a steady stream of investment in machines, tools, and buildings. This continuous investment increases the resources available for production and accumulates physical capital. However, investment must also replace depreciated capital and support a growing workforce, limiting net capital growth per worker without technological improvements.

Question 6

What is the steady state in the Neoclassical Growth Model?

Accepted Answer

The steady state occurs when net investment only replaces worn-out capital and meets the needs of a growing workforce, leaving capital per worker unchanged. In this situation, the economy continues to grow in total size but output per worker remains constant. Reaching steady state demonstrates why the model emphasizes technology as essential for achieving long-run growth in per capita income.

Question 7

How do capital, labor, and technology work together in the Neoclassical Growth Model?

Accepted Answer

Capital, labor, and technology are the three primary drivers of output in the model. Physical capital and labor accumulate through investment and population growth, but their contributions face diminishing returns. Technology acts as the multiplier that enhances the productivity of both capital and labor, allowing economies to overcome diminishing returns and achieve sustained economic expansion over time.

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