Theory of Growth and Development

Endogenous Growth Model

Company
Presented By:
LOGO
 Development Economics

Development economics is the study of fulfilling unlimited

human wants by best utilization of scarce resources and it
emphasizes over the infrastructural development as well.

It involves the creation of theories and methods that aid in
the determination of policies and practices and can be
implemented at either the domestic or international level.
 Growth and growth rate

Increasing gross national product of a country in a

particular time usually one year is known as the
growth.

y1 − y 0
Growth = × 100
y0

Where,
y1 = Gross National Product of the current year
y0 = Gross National Product of the previous year
 Growth vs. Development

Increasing the production in one or more sectors of a country

is known as growth. On the other hand, economic
development is long-term process, by which national income
of a country increases continuously along with infrastructural
development.

If there is a growth in a country, there may not be any
development. But if there is any development there must be an
economic growth.
 Theories of growth

Why these theories?

Popular Theories:
 Classical theory (Harrod-Domar Model)
 Neo-Classical theory (Solow-Swan Model)
 Endogenous Growth Theory
 Harrod-Domar Model

Limitations:
 In this model, savings ratio and capital
formulation ratio are assumed to be constant. But
they fluctuate a lot.
 The theory is based on ‘Laissez Faire’ economy,
where there will be no Govt. interference. But in
Roy F. Harrod
practical, pure Laissez Faire doesn’t exist at all.
(1900-1978)
 And, the last one, it is not applicable in the
developing countries like Bangladesh, India, Sri
Lanka and Pakistan.
 Neo-Classical Model

Limitations:
 It doesn’t provide any new theory of
development. It just solves the problem of
Harrod-Domar model.
 This theory emphasizes over
technological advancement, but it
couldn’t show the exact determinants of
the technological progress. Robert Solow
 This theory is based on diminishing
marginal return, which only can ensure a
steady rate for the short term, not a long-
run growth in the economy.
 Evolution of Endogenous Theory

Endogenous means ‘internally derived’.

Developed in 1980 by Paul Romer and Robert Lucas.

Endogenous growth theory attempts to explain growth rates as
functions of societal decisions, in particular saving rates.

Paul Romer Robert Lucas

 Main Theme

The model defines that output and growth depend on the internal
variable saving rate. It is the saving rate that is converted into
human capital investment (investment for innovating new ideas and
methods).

It also holds that technological progress is essential for economy’s
long-run growth. But the determinant of the technological progress is
the saving rate.
 Assumptions

No population growth

No depreciation

Technological progress is essential

Increasing returns to scale

Marginal product of capital is constant

This model assumes that investment in education and research will

not only have positive effect on the firm or individual who is making
the involvement, but also will have on others of the entire economy.
 Important Terms

Returns to scale:
Spillover Effect:

 Constant returns to scale Spillover effects which involve
 Increasing returns to scale involuntary imposition of costs
or benefits.
 Decreasing returns to scale
 Theory Explanation

This theory emphasizes education, knowledge, experience,

research and training are the sources of growth, because these
things create a process of innovation.

Innovation are of two types:

 Horizontal Innovation
 Vertical Innovation
 Algebraic Expression & Graphical Representation

Y = aK...........(1)
∆K = sY ..........(2)
∆K = saK ............(3)
∆K / K = sa
∆Y / Y = sa
 Ending Point

How this theory is
better than others?
 This theory ensures
sustainable growth over a
long period of time
 It removes the problems of
the previous theories

Drawbacks:
 Based on Traditional
Assumptions like other
theories
 It overlooks the influential
factors
 It ignores short-run and
mid-run growth
Questions and Answers

Company
LOGO