Theory of Economic Growth

1. In Chapter VI we introduced consumer's choice into the conventional framework of economic growth originated by J. von Neumann. We assumed that consumers are classified into two broad groups of persons, within each of which differences in tastes may be ignored. Both giant consumers, the Worker and the Capitalist, have their own, exogenously given propensities to save and they spend all the rest of their income (after subtracting savings) on current consumption. The total amount of expenditure of a Consumer is distributed among goods so as to maximize his utility function subject to his budget constraint. Clearly, the competitive equilibria of the Lindahl-Hicks-Malinvaud type discussed in Chapter VIII as well as the solutions of the balanced growth equilibrium of the Cassel-von Neumann variety in Chapter VII depend on the derived consumption functions.

In Chapter IX we observed that a balanced growth equilibrium obtained when only the Worker consumes and only the Capitalist saves is distinguished as the 'best' one from all other possible states of balanced growth and is, therefore, referred to as the Golden Equilibrium. Attention was then concentrated in Chapter X upon a particular economy where the Capitalist is thrifty enough to carry out no consumption of goods at all while the Worker is well paid so that he can buy goods in the Golden Equilibrium amounts. Such a specification enabled us to establish convergence to the Turnpike.

This summarizes our previous treatment of consumption of goods. Clearly, the history should not end here, because the hypothesis, that the Worker consumes goods in any non-equilibrium state exactly in the same amounts as in the Golden Equilibrium, is true only when his tastes for goods can be described by a family of L-shaped indifference curves. In other more natural cases his demand for consumption goods would be such as to allow substitution in response to price changes. When the current position of an economy is off the Golden Equilibrium path, prices of goods will generally change, and the Worker will adjust his consumption so as to maintain his maximum satisfaction from goods. The following question is then naturally asked: is the Golden Equilibrium still stable when the assumption of rigid consumption is replaced by the more realistic one that the Worker's demand for consumption goods depends on prices and the wage income?

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