How the Models Relate to Economic Growth - Essay Example

Economic development and economic growth are inter-related terms. Economic development refers to the modernization or westernization, increase in social and technological progress as a result leading to prosperity and a higher standard of living. It also refers to the change in the way goods and services are produced. Economic growth refers to the output per capita of a country to increase over a long period of time. Economic development refers to the long run where the whole structure of the economy has to change to bring growth and progress. Numerous growth models have been developed by scientists to explain economic growth; Basic Economic Growth Model This model explains that output is a function of two variables, capital stock and labor, in which capital stock includes the infrastructure such as roads, bridges, land etc and labor is the population that are willing and able to work. The formulae that explains this function is Y=F (K, L) where Y stands for output being a function of K and L, capital stock and labor respectively.  The two variables increase resulting in increase in the output Y. This increase can be brought about by investments and population growth. The supply of labor is actually dependent on the demographics of a country. The model given below explains the same relation i.e. when capital and labor increase so does the output giving it a directly proportional relationship.         Basic Economic Growth Model   Harrod-Domar Growth Model This was developed in the 1940s by two economists Roy Harrod and Evsey Domar. This model is based on a function by the name of constant returns to scale, which basically means that the two variables capital and labor are used in a constant ratio to each other.  Output is derived in this model by the combination of the capital and the labor, where their graphs meet, called as the isoquants. This model has the assumption that capital and labor are always used in a fixed proportion to each other. The equation for this model is Y=K/v where v represents the capital output ration that can be found by dividing capital with the output or the investment Y.  In the graph below we see that capital and labor are being used in the same proportion giving us an intersection point and when a line is drawn through those points to get an isoquant (Van den Berg & Lewer, 2007, p. 200).   Harrod-Domar Growth Model This model was later adopted to predict the investment rate needed to achieve the targeted economic growth as more investment in the economy leads to capital being accumulated or rather more savings generating economic growth and prosperity. However it has to be kept in mind that the model only remains in equilibrium when both labor and capital are used which might actually be difficult to have in proportion. Solow (Neoclassical) Growth Model An economist by the name of Robert Solow brought some changes to the Harrod model, addressing the limitations of the previous model. Rather than having fixed factors of production, capital and labor could be substituted providing flexibility, having a curved isoquant and not the L shaped one that was present before. So this means that output can be increased in three ways, by firstly increasing capital and labor in equal proportion, to increase capital or to increase labor. In this model a change in technology would also lead to increase in the output.             Solow (Neoclassical) Growth Model Solow also developed a procedure by the name of ‘sources of growth analysis’ which explains how much of the economic growth can be attributed to capital, increase in the labor force or their efficiency. The formulae that can be applied is Y=F(K, L, A) where K and L are capital and labor respectively whereas A is a variable that can be anything beside the two variable that can influence growth, for example technology, skill level, health, education etc. So A can be anything that can be an ignored factor helping the economic progress. However to identify these numerous factors can be a difficult task (Baroo, 2008, p.70). Endogenous or New Growth Theory Romer, who produced the theory, states that technology is firstly an economic good and the driving force behind economic growth. Technological change, he explains is something that happens when market incentives are given and it is different from all the other economic goods. He says that technology is a non rival good. A rival good is one which can be possessed by only one person at a time whereas non rival can be used unlimitedly example a software program etc. Technology is a non rival good that is partially excludable meaning that it can be limited to some extent. It is said that imperfect markets require the support of the government and their incentives for technology (Miles & Scott, 2002, p.115). The value chain procedure says that investments in technology are necessary for improved productivity which would subsequently lead to economic growth.     Virtuous Cycles – Endogenous Growth Model PART II Progress and economic growth are related. President Obamas address on 25th January stresses on the importance of innovation related to growth of a country. He clearly states that growth cannot be measure by overall progress of an economy but instead can be seen by the better lives of people all over America. Two years after the worst recession hit America, the American people are trying hard for the betterment of their lives. Paychecks are getting bigger and better thanks to the tax cuts and America realizes the need to invest in research and technology. In order to get a better idea of the whole situation we need to take a deeper look at the models. If we look at the different economic models to explain economic growth and unemployment, the Harrod Domar model focus on short term growth statistics and does not take into account technological change and productivity gains. This model remains in balance only if there is full employment and capital and labor is employed extensively. After the recession, unemployment in the U.S rose as the number of job seekers increased. It is argued that the more the government intervenes, the more stringent the labor laws become. Hence they increase the cost of labor and it becomes risky for firms to hire more people which in turn increase the supply of labor. Focusing on the Solow model and President Obamas address, the gist of his speech tells us that the for growth, America needs to focus and invest in research and education to strengthen the economy. In 1986, China made it compulsory to provide nine year basic education to every child and by 2007, there were 396, 567 primary schools, 94, 116 secondary schools and 2,236 higher education institutions. China stressed on the importance of education by later making the first nine year education completely free for all children. Free course books were also provided to children. Thus elementary and middle school education was made completely free for children. Chinese were intelligent enough to realize the importance of education earlier on as national scholarship budget was tripled by 2009 by 223.5 billion Yuan with extra government funding in the next five years (Huizi, 2007). By 2009, china reaped results of this smart move as Chinese students from shanghai received the best results in mathematics and science. India has gone along the same lines by stressing on education. Elementary and primary education has risen in India also. All these statistics indicate growth in an economy keeping in mind the solow model. China has maintained a 10 % increase in growth in its GDP which rose significantly in the years 2010 and 2011 thanks to the rise in Chinese scholars and emphasis on the education system. Due to this, international students increased their interest in Chinese education system .Hence this clearly states that investment in physical capital leads to intense growth of an economy (AFP, 2010). The president’s address also highlights the fact that as more is spent on research and development, it creates a boom in the industries and millions of jobs are thus created battling unemployment and again leading to economic growth. China spends a huge proportion of its income on research and development which strengthens its economy. References n.d. 2010, World Bank Warning over China Trade imbalance risk. AFP, [online] 3 November. Available at: [Accessed 1 February 2011] Barro, R.J. 2008. Macroeconomics: a Modern Approach. Mason: Thomson South-Western, International. Huizi, l. 2007. Premier Wen announces hefty education investment. XINHUA. [online] 5 March. Available at: [Accessed 2 February 2011] Miles, D. and Scott, A. 2002, Macroeconomics: Understanding the Wealth of Nations. New York: Wiley Van den Berg, H. & Lewer, J.J. 2007, International trade and economic growth. M.E. Sharpe Read More