Regional Growth, Factor Allocation and

Balance of Payments
NEOCLASSICAL REGIONAL GROWTH

Solow (1956) and Swan (1956)

Two major components of neoclassical approach to regional growth are:
• The first component concerns the question of the regional allocation and migration of
production factors.
The analysis of this issue is based on two analytical frameworks known as the “one-
sector” and “two-sector” models of factor allocation

• The cecond component concerns the question of the nature of the relationship
between production factors an technological change, and this is generally analysed
within a production function framework.
 The neoclassical growth models assume that the economy is competitive, in the sense
that factors are paid according to their marginal product. And also the factors are quickly
able to be reallocated so as to be employed in their most productive use.
THE ONE-SECTOR MODEL OF REGIONAL FACTOR ALLOCATION AND
MIGRATION
Based on the law of variable factor propotions
The marginal productive properties of factors are perceived to depend on the relative
quantities of each of the factors employed.

The basic principle underlying this The Law of Diminishing Productivity

The marginal product of the variable factor falls as a greater quantity of the variable
factor is employed, holding one factor constant.
K is Capital and L is Labour, these are two input for production.

In the case of fixed capital stock, the greater the level of labour employment, the lower will
be the marginal product of labour. In other words, as the quantity of labour increases
relative to the quantity of capital employed, the lower will be the marginal product of labour.

In the case of fixed quantity of labour, the greater the level of capital employed, the lower
will be the marginal product of capital. In other words, as the quantity of capital increases
relative to the quantity of labour employed, the lower will be the marginal product of capital.

The Law of Diminishing Marginal Productivity

(as long as the other factor is held constant)
For reasons of analytical simplicity, the following sections will assume that all production
activities are the result of the combination of two factors.

K contains all non-labour inputs

L contains all labour inputs

It’s assumed that in general, capital K and labour L are complementary inputs, and the
relative quantities of capital and labour employed can be defined in terms of
capital/labour ratio K/L.
If the quantity of capital is high relative to the quantity of labour emplolyed, in other
words the K/L ratio is high, the marginal product of capital will be low and the marginal
product of labour will be high.

Conversely, if the quantity of capital is low relative to the quantity of labour employed,
K/L ratio is low, the marginal product of capital will be high and the marginal product of
labour will be low.
In Regional Context
Two regions A and B. 𝐾
  𝐴 > 𝐾𝐵
K/L ratio in region A is higher than region B or 𝐿𝐴 𝐾 𝐵

In that situation, the marginal product of capital in region A will be lower than the
marginal product of capital in region B. Meanwhile, the marginal product of labour in
region A will be higher than the marginal product of labour in region B.

In other words, assuming that production factors are paid according to their marginal
productivities, marginal profit will be higher in region B while wages will be higher in
region A.
If Factors are mobile, the different regional capital/labour ratios will encourage labour to
migrate from region B to region A.

In the same situation, capital will migrate from region A to region B

The two factors will continue to migrate in opposite directions as long as there is still a
difference in the regional K/L ratios. This process of inter-regional factor migration will
therefore only cease when the K/L ratios in both regions are the same or
𝐾
  𝐴 =𝐾𝐵
𝐿𝐴 𝐾 𝐵
Factor Reallocation between regions, in which capital moves from the high K/L ratio
region (A) to the low K/L ratio region (B), will increase the marginal productivity of the
mobile capital.

Factor Reallocation between regions, in which labour moves from the low K/L ratio
region (B) to the high K/L ratio region (A), will increase the marginal productivity of the
mobile labour.

This process of factor migration and reallocation, in which the marginal products of both
mobile factors are increased, must therefore necessarily increase aggregate national
output.