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Neoclassical Growth Theory

The neoclassical theory explains how steady economic growth rate can be achieved by proportionally applying technology, labor, and capital as the driving forces. According to this theory, when capital and labor are applied in during production in varying proportions, an equilibrium point will be reached. The theory further explains that technology is a major influencing factor in an economy; economy growth is proportional to technology advancement. This means that technology innovations are essential to drive growth in an economy.


The theory explains that unstable equilibrium is achieved with the right combinations of capital, technology, and labor. However, it clarifies that there is the difference between short-term balance and long term equilibrium which cannot be achieved with the application of the mention factors only.

The neoclassical growth theory is founded on the fact that economic growth is fueled by the accumulation of capital in an economy and how the people use this capital. The primary output determinants in an economy are labor and capital. Technology increases labor productivity, hence increasing the overall output.

The production function that determines growth and equilibrium in an economy is;

Y = AF (K,L)

Y – Gross domestic product of an economy (GDP)

K – Capital

L – Unskilled Labor in the economy

A - Level of technology determinant

Taking into consideration the relationship between labor and technology, the function can be rewritten as follows;

Y = F (K, AL)

It is noteworthy that;

  • Increase or decrease of these factors affects the GDP and equilibrium of an economy
  • These factors are not applied in equal proportions
  • There are diminishing returns for capital and the unskilled labor
  • Unlike other factors, technology is considered limitless in its influence on growth and overall output.