Classical Theory of development

Classical Economics: Political Economy

The pursuit of economic growth and development as a socially desirable goal is contemporaneous with the rise of capitalism as an economic system (and with the emergence of the industrial revolution).

Two objectives of classical political economists inquiry are:1. To explain the reasons for rapid economic expansion of total

economic wealth that accompanied industrialization2. To explain the enigma of the extreme of wealth and poverty that

attended this process.Who are the classical economists?• Adam Smith• Thomas Malthus• David Ricardo• John Stuart Mill• Karl Marx

THEORIES OF ECONOMIC GROWTH• Classical Growth Theory

• Classical growth theory• The theory that the clash between an

exploding population and limited resources will eventually bring economic growth to an end.

• Malthusian theory• Another name for classical growth theory

—named for Thomas Robert Malthus.

The Basic Idea• Advances in technology and the

accumulation of capital bring increased productivity and increased real GDP per person.

• Classical growth theory says that the increase in real GDP per person will be temporary because prosperity will induce a population explosion and the population explosion will decrease real GDP per person.

Classical Theory of Population Growth• When the classical economists were

developing their ideas about population growth, an unprecedented population explosion was under way.

• To explain the high rate of population growth, the classical economists used the idea of a subsistence real income (real GDP per person).

• In classical theory, when real income exceeds the subsistence real income, the population grows.

• The increasing population decreases capital per hour of labor and eventually decreases real income to less than subsistence real income.

• If the actual real income is less than the subsistence real income, some people cannot survive and the population decreases.

• No matter how much technological change occurs, real income (real GDP per person) is always pushed back toward the subsistence level.

• This dismal implication led to economics being called the dismal science.

Figure shows classical growth theory.

1. The economy starts at point A on productivity curve PC0 with real GDP at the subsistence level and the population constant.2. As capital per hour of labor increases, real GDP per person rises above the subsistence level—the economy moves to point B.

3. As technological advance (and human capital accumulate) increase productivity,the productivity curve shifts upward to PC1—the economy moves to C.

4. With real GDP above the subsistence level, the population grows and capital per hour of labor decreases downward along PC1.

5. At point D, the economy is back at the subsistence level of real GDP per hour of labor.

Process of Economic Growth

According to Classical economists, there are two states of the process of growth as:

1. Progressive State2. Stationary State

Y Progressive Regressive Stationary Phase Phase Phase W

Q K

C

apita

l Acc

umul

atio

n

L L1 Employment

X O

…A Classical Model Of Economic Growth

• The Rate of economic growth depends on the rate of physical capital accumulation.

- The faster physical capital accumulates, Faster is economic growth.

• The limit on the rate of growth: diminishing returns. - fL decrease as L rises, until eventually

the point when per capita income reaches a steady state level.

The Classical ModelThe Classical Model of growth may be expressed

in the form of following relationships:1. The Production Function O= f (L,K,Q,T)Here O= Output; L= labour power; K= capital

accumulation;Q=natural resources; T= level of technology2. Technical Progress T=f(I)Here, T= Technical Progress; I= Investment3. Investment I=f(R) I= Δk=f(R)Here I = investment ;R=profits ; K=increase in

capital stock

4) Profit Profit depends upon two factors, according to the classical

view :a) Supply of labourb) Level of Technology R=f (L,T) Here R =profits, L= supply of labour, T level of technology5) Supply of Labour W=f (I) Here W is wage fund 6) Wage Fund W = f ( I)7) Closing System O=R+W Here O = total output ,R = profit, W = wages This equation explains that total output is equal to total profit

and total wages

Stages of growth

• Progressive State of Growth ΔK ΔT ΔR ΔK• Stationary State of Growth ΔK ΔW ΔL ΔK

Criticism• Over Emphasizes the law of Diminishing Returns• Less Importance of Technological Progress• Not only the Capitalists Save• Malthusian Theory of poulation does not Apply• Say’s Law of Markets does not Apply• Wages are not flexible • Wrong Notation About Wages and Profits• It Ignores Government Interference

Relevance of classical Model for underdevelopmentcountries

• Importance of Agriculture Sector• Balanced Growth• Capital Accumulation• Population Growth• Laissez- faire Economy

Thanks***