Page 28 - FINAL CFA II SLIDES JUNE 2019 DAY 4

LOS 12.i: Compare classical growth theory, neoclassical
growth theory, and endogenous growth theory – 3 Models! READING 11: CURRENCY EXCHANGE RATES: UNDERSTANDING EQUILIBRIUM VALUE

MODULE 12.3: GROWTH AND CONVERGENCE THEORIES

Endogenous Growth Theory: Contends that technological growth emerges as a result of investment in both physical and
human capital (hence the name endogenous which means coming from within). Unlike the neoclassical model, there is no
steady state growth rate, so that increased investment can permanently increase the rate of growth.

It is based on assumption that certain investments increase TFP (i.e., lead to technological progress) from a societal standpoint.
Increasing R&D investments, for example, results in benefits that are also external to the firm making the R&D investments.
Those benefits raise the level of growth for the entire economy.

The model theorizes that returns to capital are constant; hence unlike the neoclassical model, it implies that an increase in
savings will permanently increase the growth rate.

Total factor productivity is the key difference between the two theories:
• Neoclassical theory assumes that capital investment will expand as technology improves (i.e., growth comes from increases
in TFP not related to the investment in capital within the model).
• Endogenous growth theory, on the other hand, assumes that capital investment (R&D expenditures) may actually improve
total factor productivity.