Increasing Returns Long Run Growth and Endogenous Technological change
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1. Introduction: Theories of Economic Growth
For centuries, economists have tried to explain economic growth and what it depends upon. Earlier models, provided by Adam Smith and Robert Solow, emphasized the role of capital accumulation. For instance, in Solow's model (exogenous), growth depends upon increasing the stock of capital goods to expand productive capacity. Thus, the combination of capital deepening and technological improvement by nations explains the important tendencies in economic growth. However, his view is based on the fact that adding more capital goods to a fixed amount of labour will diminish the returns to capital. Also, increased accumulation of capital will force downwards the rate of return and eventually, the returns will be so low that no more accumulation of capital takes place. That leaves the technological progress, which is entirely exogenous to the model. So in reality, economic growth is left unexplained!
One can say that, in the long-run, Solow's model is stable, because it assumes a tendency towards equilibrium, a balanced economy, since the growth rate of all the variables is constant...