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Home Theories of Economic Growth J.E. Meade's Model of Economic Growth

J.E. Meade's Model of Economic Growth or Neo-Classical Model of Economic Growth:

 

Introduction:

 

The model of economic growth which has been constructed by J.E. Meade describes those conditions which will be helpful for a sustainable economic growth in the presence of constant technical progress and a constant increase in population of a country. According to Meade along with economic growth:

 

(i) The production of capital equipments increases because savings are made out of current incomes.

 

(ii) The ratio of working force increases.

 

(iii) Because of technical progress it is possible to produce goods and services in the presence of fixed resources.

 

Assumptions:

 

(i) There is a closed economy having no financial and trade links with other countries.

 

(ii) 'Laisseze Fair' economy where govt. neither imposes taxes, nor makes expenditures.

 

(iii) There exists perfect competition in goods and factor markets.

 

(iv) Constant returns to scale exist.

 

(v) The machines constitute the capital goods and all machines are alike.

 

(vi) The ratio of labor to machines can easily be changed in short run and long run.

 

(vii) The production of consumer goods and capital goods is substitutable.

 

(viii) A certain proportion of machines becomes prey to depreciation. Therefore, there rises the need for replacement of machines.

 

Production Function:

 

The production function in Meade's model is as:

 

Y = f (K, L, N, t)

 

Where:

 

Y = Net production of the economy.

 

K = Stock of machines.

 

L = Amount of labor.

 

N = Land or productive resources.

 

t = State of technology which goes on to change along with change in time.

 

According to Meade the production of the economy can increase if:

 

(i) The stock of capital goods (K) increases in the economy. The increase in capital stock will increase the savings of the people leading to increase the real capital accumulation in the economy. The increase in stock of capital is represented by ΔK. If we represent the value of marginal product of machine by "V", the increase in the output of the economy will be represented as: VΔK.

 

(ii) The working force of the economy (L) increases which is represented by ΔL. If we accord W as the value of marginal product of labor then the increase in production of the economy will be represented as: WΔL.

 

(iii) Even no change occurs in capital, labor and natural resources the production of the economy can change due to technical progress which is shown by ΔY/.

 

Thus the increase in the production of the economy can be represented as:

 

ΔY = VΔK + WΔL + ΔY/

 

Dividing this equation by basic factors of production of the economy shown in production function. In other words, by dividing ΔY/s equation by Y/s equation:

 

ΔY//Y = VK/Y . ΔK/K +  WL/Y .  ΔL/L + ΔY//Y

 

Here ΔY/Y shows annual rate of growth of income of the economy. While ΔK/K shows the annual rate of growth of stock of capital. ΔL/L represents the annual rate of growth of labor and ΔY//Y means the annual rate of growth of income due to technical progress.

 

We use the symbols like y, k, l and r to represent such propornate rates of growth. The term VK/Y shows the proportion of capital in total output while WL/Y shows the relative share of labor in total production of the economy. Out of VK/Y a certain percentage of national income is accrued to the owners of the capital in the form of net profits which is shown by 'U'. While a certain proportion of national income which is accrued to labor in the form of wages is shown by 'Q'. Therefore, in the light of these symbols the national income equation is written as:

 

y = Uk + Ql + r

 

According to this equation the total output of the economy (y) is summation of three outputs:

 

(i) Uk [the product of rate of capital growth (k) and proportion of profits (U)].

 

(ii) Ql [the product of rate of labor growth (l) and proportion of wages (Q)].

 

(iii) The growth of technical progress (r).

 

Subtracting (l) from the both sides of above equation:

 

y = Uk + Ql + r

 

y - l = Uk - l + Ql + r

 

y - l = Uk - l (1 - Q) + r

 

Where y - l shows the difference in between growth rate of production and growth rate of labor force. Thus it shows the growth of per capita income. The above equation shows that y - l can be increased with Uk and r. Whereas y - l decreases with l (1 - Q).

 

Now we introduce savings in this equation. The Uk is presented in some other way. As we assumed that all of savings are invested. Therefore, the increase in the amount of capital (ΔK) will be equal to the savings made out of national income (SY). It is as:

 

ΔK = SY where SY = annual savings

 

Dividing both sides by K.

 

ΔK/K = SY/K

 

As Uk = VK/Y . ΔK/K putting SY/K in place of ΔK/K, then:

 

Uk = VK/Y . SY/K or UK = Vs

 

Putting the value VS in place of Uk in the above equation:

 

y - l = Vs - l (1 - Q) + r

 

Changes in Growth Rate:

 

After analyzing the determinants of growth rate of income we discuss those conditions whereby growth rate of the economy will increase or decrease. As Meade assumed the constancy of growth rate of population (l) and growth rate of technology (r), then the changes in y - l would be depending upon the behavior of s, V and Q.

 

As no change occurs in population and technology and savings increase the amount of capital. But in this way, the MPK will come down. Thus because of increase in savings there will be a slower increase in the production. In such state of affairs the 'Vs' will decrease. If technical progress takes place such negative effect on V will be offset. It means that if with the passage of time the changes in 'r' occur it will have an effect on V. It is so because that the productivity of all factors will increase because of 'r' leading to increase savings. Moreover, the savings in an economy also depend upon distribution of income. If the share of profits in national income distribution increases the savings will increase.

 

Technical Progress and Economic Growth:

 

The technical progress can be measured with those effects which occur on the MPs of different factors. The nature of technical progress can be labor saving as well as labor intensive. If technical progress leads to labor saving the MPL which is shown by Q = WL/Y will increase. If because of technological change the use of labor increases the MPL = Q = WL/Y will decrease. The technical progress which leads to increase the use of machinery the MPK = U = VK/Y will increase. While because of technological change which is labor intensive

the U will decrease.

 

The above discussion shows that the rate of economic growth of an economy (y) is determined by the rate of capital accumulation (VS) and technical progress (r), population remaining the same. It is as:

 

y = VS + r

 

If r remains constant the economic development will entirely depend upon Vs. It is shown by the figure/diagram.

 

 

Here the curve OG1 represents that level of output which can be produced with the help of a specific amount of capital in a year. If we employ OL of machinery the level of output is LR. If amount of machinery is increased to OM, the production will rise to ME. As the slope of the curve OG1 has gone down at E as compared with the point R. This shows that here the MPK has gone down. If we take the next year the new curve OG2 comes into being because of technical growth. As in the second year the technical progress has taken place, then with the same capital (OL), the LD output is being produced, which is more than earlier. Again, with OM capital in the presence of technical growth, the MF output is being produced. All this means that technical change may have the effect of boosting national output.

 

Conditions of Steady Growth:

 

If the level of technical progress remains same and population increases at some particular rate, then the steady economic growth requires the fulfillment of following conditions:

 

(i) The nature of technical progress should be neutral for all the factors of production.

 

(ii) The elasticities of substitution between factors of production are equal to one.

 

(iii) The ratio of wages, profits and rent remains the same.

 

According to first and second condition the. proportion of profits in NI (U), the proportion of wages in NI, (Q) and proportion of rent in NI (Z), all remain same when the economy is passing through the process of economic growth. In this connection, Meade introduces new symbols. They are as:

 

The Sv shows the savings out of profits; the Sw the savings out of wages and Sg represents the savings out of rent. Thus the savings of the economy are as:

 

S = SvU + SwQ + SsZ

 

We rewrite the basic equation:

 

y = Uk + Ql + r

 

As U, Q, l and r remain constant, then the production depends upon capital (K). If amount of capital remains fixed the production will remain constant. As growth of capital is equal to SY/K where SY represents that annual increase in capital which became possible due to savings. As we assumed above that 's' remains constant. Hence SY/K would remain constant if Y/K remains constant. This would happen if K and Y grow at the same rate.

 

Thus according to Meade the equilibrium growth rate of the economy depends upon growth rate of capital accumulation. Meade says that there exists a critical rate of growth of capital accumulation where growth rate of income and growth rate of capital would be equal. Now we introduce such critical growth of capital accumulation (a) in the model.

 

a = Ua + Ql + r or a - Ua = Ql + r

 

a (1 - U) = Ql + r or a = Ql + r/(1 - U)

 

At such critical growth rate of capital accumulation (a), the y = k, where growth rate of income will remain constant. Therefore, if the growth rate of capital accumulation is Ql + r/(1-U), the rate of increase in production will also be [Ql + r/(1 - U)] and here the conditions of steady growth will be met. If SY/K > Ql + r/(1-U) which means that growth rate of capital accumulation will be more than its counter part critical rate. In such situation, the MPK and profits will decrease leading to reduce the savings. In this way, the SY/K will fall till it reaches the

critical level Ql + r/(1-U). If at any time SY/K < Ql + r/(1-U), this shows that income will grow more than increase in capital leading to increase the savings till it reaches the critical level Ql + r/(1-U).

 

All this shows that Ql + r/(1-U) is a condition to maintain the steady economic growth which Meade calls "Critical Rate of Growth".

 

Evaluation of the Model:

 

The Meade's model tells that economic development is based upon growth of population, capital accumulation and technical progress. It means that the model presents the determinants of steady growth in a better way. But this model is close to classical model when it also assumes perfect competition and constant returns to scale. But this model fails to entertain the social and sociological effects in the growth process. Therefore, it is hardly applicable in case of UDCs where the social and sociological obstacles hinder economic growth.

 

Criticism:

 

The neo-classical model of economic growth is a reaction against Harrod-Domar (H-D) model of economic growth which states that the ratio of capital to labor remains fixed. Hence there are reduced chances of equality between warranted growth rate and natural growth rate. Whereas the neo-classical economists dismiss the assumption of constancy of capital-labor ratio. They are of the view that both labor and capital are substitutable. The neo-classical model also portrays the process of economic growth, but it is better than H-D model, because it reaches a stable equuilibrium level whereas it was not the case with H-D model. Still this model suffers from following drawbacks, according to Prof. A.K. Sen.

 

(i) The neo-classical model tries to create equality between GW and Gn, but fails to create an equality between G and GW.

 

(ii) In neo-classical model we do not find the existence of investment function. If it is introduced, the results will be different.

 

(iii) In this model the prices of factors have been assumed flexible, but such assumption may serve an obstacle in the way of economic development.

 

(iv) The assumptions of the model like perfect competition and constant returns to scale may not be true in practical life.

 

(v) The neo-classical model assumes technical progress as an exogenous factor. Therefore it ignores investment in research, and capital accumulation for technical progress.

 

Meade Model and UDCs:

 

So many economists are of the view that neo-classical model does not apply in case of UDCs. In this respect, they give following arguments.

 

(i) In UDCs the well defined production function is non-existing.

 

(ii) The marginal productivity theory loses its efficacy in UDCs where the concept of family labor prevails, rather wage labor.

 

(iii) In UDCs the structure of the market and financial mechanism operates in such a way that it is difficult to equalize the rate of interest and rate of profit. Such equality may be possible, perhaps of organized money markets in the cities.

 

(iv) In UDCs it is difficult to determine the nature of capital. Moreover, here all the units of capital are not alike.

 

(v) The neo-classical- model is based upon the concept of marginal productivity. But in case of UDCs it is difficult to assess marginal productivity. Here the rains as well as droughts may change the marginal productivity. Accordingly, how wages will be determined on the basis of marginal productivity.

 

Relevant Articles:

 

Adam Smith's Model of Economic Growth
Ricardo's Model of Economic Growth
Classical Model of Economic Growth
Marxian Model of Economic Growth
J.E. Meade's Model of Economic Growth
Schumpeter Model of Economic Growth
Secular Stagnation - Hansen's Thesis
Kaldor - Mirrlees Model of Economic Growth
Golden Rule of Economic Growth
Neo-Classical Theory of Economic Growth
 

Principles and Theories of Micro Economics
Definition and Explanation of Economics
Theory of Consumer Behavior
Indifference Curve Analysis of Consumer's Equilibrium
Theory of Demand
Theory of Supply
Elasticity of Demand
Elasticity of Supply
Equilibrium of Demand and Supply
Economic Resources
Scale of Production
Laws of Returns
Production Function
Cost Analysis
Various Revenue Concepts
Price and output Determination Under Perfect Competition
Price and Output Determination Under Monopoly
Price and Output Determination Under Monopolistic/Imperfect Competition
Theory of Factor Pricing OR Theory of Distribution
Rent
Wages
Interest
Profits
Principles and Theories of Macro Economics
National Income and Its Measurement
Principles of Public Finance
Public Revenue and Taxation
National Debt and Income Determination
Fiscal Policy
Determinants of the Level of National Income and Employment
Determination of National Income
Theories of Employment
Theory of International Trade
Balance of Payments
Commercial Policy
Development and Planning Economics
Introduction to Development Economics
Features of Developing Countries
Economic Development and Economic Growth
Theories of Under Development
Theories of Economic Growth
Agriculture and Economic Development
Monetary Economics and Public Finance
History of Money

 

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