CHAPTER-3

cont’
B. MEADE’S NEO CLASSICAL MODEL OF
ECONOMIC GROWTH

 Professor J. E. Meade has constructed a neoclassical model of

economic growth.
 Meade has put forward a model intended to explain the process of
equilibrium growth (i.e., the steady-state growth).
 This model is designed to show the way in which the simplest
form of economic system would behave during a process of
equilibrium growth.
 This model provides the relation to increase the income and
population. It analyses the influence of income, capital, labour and
technology on development. It also gives the conditions under
which the growth of economy is possible. He tries to establish a
relationship between population growth and income growth.

 It is based on the following assumptions :

 The economy is closed and laissez-faire
 Perfect competition in the product and input markets

 The economy is producing in two types of commodities- consumption

goods and capital goods. The consumption goods satisfy all the human
needs of consumption and the capital goods are used to produce capital
goods. (There is perfect substitutability between the two commodities-
consumption goods and capital).
 Labour and capital (machines) have homogeneous units.
 Machines are the only form in which the capital is assumed.
 The ratio of labour to machinery can be changed both in the short and long
run.
 Factors are paid according to their marginal productivity
 Flexibility of wages and interest rates.
 All savings are invested via flexibility of interest rate and all workers can
be fully employed via flexibility of wages.
 Elasticity of factor substitution is unity.
 The economy is classed as having no economic or financial relations with
other countries.
 In Meade’s model, the net output produced depends upon four
factors. (Determinants of Economic Growth or Explanation of
the Model):

 The net stock of capital available in the form of machines

 The amount of labour force available
 The availability of land and natural resources
 The state of technical knowledge which continues to improve
through time.
 This relationship is expressed in a production function as: Y= f(K,L,N,t)
 Where Y is net output or net national income,
 K is the existing stock of capital

 L the labour force

 N Land & natural resources

 t is time, signifying technical progress

 Assuming the amount of land to be fixed, output can

increase when there is an increase in K, L and t. This
relationship is shown as:
 ΔY= VΔK + WΔL + ΔY' ………………………….e1
 Where:
 ΔY= change in output
 ΔY'= change in output due to technological progress
 ΔL & ΔK= changes in labour and change in capital respectively
 V= marginal product of capital
 W= marginal product of labour
 Dividing both side of e1 by Y, we get proportional growth
rate of output. That is
 ΔY/Y = VΔk/Y + wΔL/Y + ΔY‫׀‬/Y………………e2

 Equation e2 can be rewritten as:

 ΔY/Y = Vk/Y. ΔK/K + WL/Y. ΔL/L + ΔY‫׀‬/Y……..e3

 ΔY/Y= proportionate growth rate of output

 ΔK/K= proportionate change in capital
 ΔL/L= proportionate change in labour
 ΔY‫׀‬/Y= proportionate change in output due to technical progress
 Vk/Y= relative elasticity of capital
 WL/Y= relative elasticity of labour
 Equation e3 shows that the rate of growth of
output or the economic growth rate is equal
to the sum of:
 the elasticity of output with respect to capital (or the relative
contribution of capital to output) multiplied by the rate of
growth of capital stock plus
 the elasticity of output with respect to labour (or the relative
contribution of labour to output) multiplied by the rate of
growth of labour force plus
 the rate of growth of output due to technological change
 Assuming y stands for ΔY/Y, l for ΔL/L, k for ΔK/K, U for
Vk/Y, Q for WL/Y, r for ΔY‫׀‬/Y, then equation e3 can be
rewritten as
Y=Uk + QI + r
 The real index of growth of an economy is the growth rate of
real income per head rather than the growth rate of income (y).
 The growth rate of real income per head is given by
subtracting the growth rate of population (l) from the growth
rate of income (y). Example, if income grows by 8% and
population grows by 3%, then the growth rate of per capita
income is 5%.
**The state of Steady Growth: is a state in which the
growth rate in total output (income) is constant and so is
the growth rate in income per head.
 It is assumed that population is growing at a constant
proportionate rate (1) and the rate of technical progress
does not change.
 The state of steady economic growth requires the
existence of the following three conditions to ensure a
constant growth rate in total income:
 Elasticity of substitution between the various factors are
equal to unity
 Technical progress is neutral towards all factors
 The proportion of profit saved, wages saved, and of rent
saved are all constant
Given that:
 the growth rate of income is y=Uk + QI+ r and
 U, Q, I, and r are assumed to be constant
 Therefore, for y to be constant (as required by the steady
economic growth), k should be constant.
 We know that k=SY/K. But S is assumed to be constant above.
So k will be constant if Y/K is constant. Y/K will be constant if
the rate of growth of Y and K is the same which implies the
equality of y and k itself, i.e., y=k.
 Therefore, Meade came into the obvious conclusion that the
growth rate of income will be constant if the growth rate of
capital stock (k) is equal to the growth rate of national
income (y).
**Critical Growth Rate: The equilibrium position ultimately
depends upon the rate of accumulation of the capital stock.

 According to Meade, there is a critical growth rate of the capital

stock which makes the growth rate of income equal to the growth
rate of capital stock.
 A higher or lower growth rate in capital than this critical growth
rate will not equalize Y and K and the state of steady growth is
not achieved.
 If we denote the critical growth rate by ‘a’ then the basic
relationship will be
a= Ua + QI+r
a-Ua= QI+r
a(1-U)= QI +r
a= (QI + r)/1-U
 It is this critical rate which will make y=k and keep the growth
rate of the national income constant at the steady growth level.

 If at any time there is any deviation from this level of steady

growth, forces will set in to bring the growth rate of the capital
stock at the equilibrium level of (Ql + r)/1-u.
 Suppose k or SY/K > (Ql+r)/1-U. In this situation income will
be growing at a lower rate than the capital stock.
 As a result savings will decline, so will the growth rate of
capital.
 The converse is also true when SY/K<Ql+r/1-U.
CRITICISM OF MEADE’S MODEL
 Meade’s model has been severely criticized due to its unrealistic
assumptions.
 Its assumption of the classical tradition of perfectly competitive economy is
unrealistic.
 The assumption that capital is homogenous is unrealistic.
 The assumption of only constant returns to scale is also defective. In the
growth process, there are increasing returns to scale rather than constant
returns to scale.
 The model also completely neglects the role of institutional factors in the
development process.
 Despite to these defects, the Meade model has the chief merit of
demonstrating the influences of population growth, capital accumulation
and technical progress on the growth rate of national income and per
capita real income over time.