I had a question in the last CFAI mock about Neoclassical growth theory. I never heard of this although I guess the concept should be explained in CFAI Equity books. Does someone have a quick explanation to this concept? tks PS: I now realize that every inch of info is testable wow
Neoclassical growth theory assumes that marginal productivity of capital declines as more capital is added. Thus, it predicts that the long-term level of GDP depends on the country’s savings rate but not the long-term growth rate because of diminishing marginal returns and reaching a steady state. This implies increase in dividends, as the new level of GDP is reached, but not an increase in the dividend growth rate. Short run implications * Policy measures like tax cuts or investment subsidies can affect the steady state level of output but not the long-run growth rate. * Growth is affected only in the short-run as the economy converges to the new steady state output level. * The rate of growth as the economy converges to the steady state is determined by the rate of capital accumulation. * Capital accumulation is in turn determined by the savings rate (the proportion of output used to create more capital rather than being consumed) and the rate of capital depreciation. Long run implications In neoclassical growth models, the long-run rate of growth is Exogenously determined - in other words, it is determined outside of the model. A common prediction of these models is that an economy will always converge towards a steady state rate of growth, which depends only on the rate of technological progress and the rate of labor force growth. Assumptions The key assumption of the neoclassical growth model is that capital is subject to diminishing returns. Given a fixed stock of labor, the impact on output of the last unit of capital accumulated will always be less than the one before. Assuming for simplicity no technological progress or labor force growth, diminishing returns implies that at some point the amount of new capital produced is only just enough to make up for the amount of existing capital lost due to depreciation. At this point, because of the assumptions of no technological progress or labor force growth, the economy ceases to grow. Assuming non-zero rates of labor growth complicates matters somewhat, but the basic logic still applies - in the short-run the rate of growth slows as diminishing returns take effect and the economy converges to a constant “steady-state” rate of growth (that is, no economic growth per-capita). Including non-zero technological progress is very similar to the assumption of non-zero workforce growth, in terms of “effective labor”: a new steady state is reached with constant output per worker-hour required for a unit of output. However, in this case, per-capita output is growing at the rate of technological progress in the “steady-state” (that is, the rate of productivity growth).
dont forget homogenious growth theory which states no decline in capital…and then constant return to scale—always earn the same amount
Policy measures like tax cuts or investment subsidies can affect the steady state level of output but not the long-run growth rate. But wouldn’t tax’s affect the amount of money you bring home to save? I read that whole thing you wrote 3 times and it’s still very confusing to me lol. But thanks 4 trying
the key assumption for neoclassical is that as you increase capital, the returns decline…from economics but also in equity analysis “diminishing marginal return to capital”
Capital applies to new projects?
Yes, and then it attempts to link GDP growth as a predictor of how capital starts to decline
Gotcha, so how does this relate to the savings rate?
Thanks for the info!! Stalla books did not mention this theory…
Stalla def went over this, just didn’t make a big deal about it
book 5 cfa…only 1 pg though in equity valuation