Of the two economic growth theories, which is the most optimistic about the chances of real GDP per person growing indefinitely? Which is the most pessimistic? What accounts for the differences?

Question

What will be an ideal response?

Answer 1

The most optimistic is the new growth theory, which concludes that real GDP per person can continue to grow indefinitely. The most pessimistic is the classical theory, which concludes that growth in real GDP per person will stop and that people will produce only the subsistence level of real GDP per person. The difference in the two conclusions can be traced to differences in assumptions in three key areas. First, the new growth theory concludes that technology will advance forever because people, seeking profit, make decisions to develop new technology. Classical growth theory assumes that technological advances are rare and infrequent. Second, the new growth theory assumes that the economy is not subject to diminishing returns. Hence, as the economy accumulates more capital, the returns to capital do not diminish and so the incentive to add yet more capital continues undiminished. The classical growth theory assumes that capital (and labor) is subject to diminishing returns. Thus as more capital is accumulated, the returns diminish, and so the incentive to continue adding more capital disappears. Thus the capital stock eventually stops growing. Finally, the new growth theory assumes that the population does not grow more rapidly as real GDP per person increases. The classical theory assumes that whenever real GDP per person exceeds the subsistence level, rapid population growth occurs and, because of diminishing returns to labor, the increased population drives the level of real GDP back to the subsistence amount.