Adam Smith's Model of Economic Growth:

Adam Smith's model of economic growth is more or less available in the different parts of Smith's well reputed book "Wealth of Nations" written in 1776. This model primarily deals with capitalistic economies and their process of economic growth. In other words, this theory of economic growth portrays that process which enabled the developed and the rich nations of the world to attain economic growth.

In this model of economic growth we shall discuss the followings:

(i) Production Function, (ii) Natural Resources, (iii) Institutions, (iv) Labor Force and (v) Capital Accumulation.

(i) Production Function:

The classical economics is based upon 'Labor Theory of Value' which states that labor is the only factor of production and the costs of production entirely depend upon labor costs.

But Adam Smith includes land and capital, in addition to labor (because growth is a long run phenomenon) in the production function. Thus Smith's production function shows that the production of the economy depends upon labor, land and capital. It is as:

Y = f (L, K, N)

Where Y = national product, K = capital, L = labor and N = natural resources.

The Smith's production function is not subject to diminishing returns, rather it is subject to increasing returns. Smith says that as that:

Production increases the economies of scale are attained, both internal as well as external The market will be extended and real costs of production will decrease. He says that due to economies of scale not only division of labor is permitted, but the improvement in machinery also takes place. He further says that the difference in productivity of labor in different nations is attributed to difference in degree of division of labor. Smith says that the division of labor is limited by the extent of market. And the size of market is affected by the amount of capital and institutional framework. He further says that the size of the market and productivity of labor are influenced by regulation of domestic and international trade. This is the reason that Smith was in favor of domestic and international division of labor and specialization. As we presented earlier the Adam Smith's production function, it is as:

Y= f (K, L, N) ............. (1)

We also told that the productivity of labor (MP_L) and land (MP_N) are affected by stock of capital (K) and institutional framework (U). Therefore, following restrictions are placed on the above production function:

(ii) & (iii) Natural Resources and Institution:

According to Smith dU/dt is exogenously determined. Therefore, he considers such factor of production as given or fixed. It is as:

U = U (t) ........................ (7)

Regarding land Smith says that land is also fixed. In other words, there occurs no change in the supply of land with the passage of time, as:

Now the growth rate of the economy will be expressed as:

From the equation (9), we find that there are only two independent variables in Smith's model:

They are = dL/dt and dK/dt

Therefore, to understand this model we will discuss the determinants of labor force (dL/dt) and capital accumulation (dK/dt).

Here we consider the demand for labor as well as supply of labor. Regarding supply of labor. Smith says, it is related to the population. While in long run the population is affected by the wages given over to the labor. If the labor are given more actual wages (W) than the subsistence wages (W), then the marriages will take place leading to increase the population. On the other hand, if the actual wages are less than the subsistence wages the marriages will be postponed leading to decrease the population. If both the actual wages and subsistence wages are equal the population will remain constant. Therefore, the supply of labor will be expressed as:

dL_s/dt = q (W - W) ................ (10)

Here q > 0

Whereas the demand for labor is determined by wage fund. In other words, according to Smith there is a specific amount of 'Wage fund' in the economy Such wage fund determines the demand for labor. It is shown by the following equation:

dL_D/dt = a . dK/dt + b . dY/dt ............... (11)

According to equation (11) the demand for labor (dL_D) depends upon changes in capital (dK/dt), changes in income (dY/dt) and the parameters 'a' and 'b'.

Smith says that in long run because of perfect competition in the labor market demand for labor will be equal to supply of labor. It is as:

dL_s/dt = dL_D/dt .............. (12)