CHAPTER

43
von Growth The von Neumann Growth Model
INTRODUCTION
John von Neumann, the great German mathematician presented A Model of General Economic Equilibrium at the Princeton University in 19321.

THE NEUMANN GROWTH MODEL

The von Neumann model is a multisector mathematical balanced growth model of an expanding economy. It associates growth of production and consumption with every economic process in a dynamic framework. Assumptions. The model is based on the following assumptions : 1. Every commodity is either an output or an input in the production process. 2. All outputs are used as raw materials for further production. 3. The supply of land, labour, capital and other factors of production is unlimited so as to
1. This paper was first published in an Austrian mathematical journal edited by Karl Menger in 1938. Its English translation by George Morton appeared in Review of Economic Studies Vol. 13, 1945-46, pp 1-9.

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permit the indefinite expansion of the economy. 4. There is no independent source of demand for commodities. 5. Each production process uses as inputs the goods produced in the previous period by itself and by other sectors of the economy. 6. The amount of any commodity used at a particular period of time must not exceed the amount of that commodity available at that time. 7. The production process intensities in any period do not require more than the available raw material inputs or the outputs of the preceding period. 8. There is a linear homogeneous production function which exhibits constant returns to scale. 9. There is unchanged technology in the production process. 10. It is a closed system (i.e. economy) 11. There is perfect competition in the system. THE MODEL Given these assumptions, the Neumann model examines the possibility of balanced growth at a constant rate in an expanding economy. The model tries to find out whether there is a maximal value of and a maximum uniform rate of expansion of the economy, and the characteristics of this highest attainable growth rate. The model assumes that the economy is engaged in the production of n commodities ( j = 1,2,3, .... n) with m processes (i = 1, 2, 3, ..., m). Each of the processes turns out some inputs into outputs in fixed proportions. Suppose the process i is carried out at the unit level of intensity. Further, aij and bij denote the input and output respectively of the jth commodity in the ith process. Thus the economy will use aij of j commodity as an input and will produce bij of j commodity as an output. If process i does not use j commodity as an input, then aij = 0. Similarly, if process i does not produce j commodity, then bij = 0. But in the economy, aij > 0 and bij > 0. Now Neumann uses a set of process intensities corresponding to m processes so as to equalise the growth rate of commodities in the economy. Suppose 1 units of process i are used by the economy during a period. So the total use of j commodity as an input to process i will be a ij i and the total output of j commodity by this process will be the total amount of j commodity used by all processes will be . Thus

and its total output will

be

b
ij i =1

If inputs and outputs are to grow at the growth rate , any input which was

in period

t will expand to

one period later. But that input must come from the preceding periods

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total supply of output

b
ij i =1
m

(as per assumption 5). Therefore, the first condition for the

Neumann model is that the inputs used tomorrow must not exceed the supply made available today. This is expressed as :

i =1

a ij i

b
ij i =1

...(1)

(for all j = 1 to n) This inequality shows that some goods grow faster with given process intensities. This leads to maximising the growth rate of the economy. According to Neumann, for this there is nothing as a negative level of operation of a process so that

>0

Neumann carries his model further by taking a set of output prices P1,...P2,...Pn and an interest factor, = 1 + z / 100, (where z is the percentage interest rate) in a system of perfect competition. In this case, prices will be so set that any process will yield zero profits. To explain this no-profit condition, suppose a unit of process i uses a ij units of j input and each unit costs Pj dollars. So the total input cost of the unit of process i will be
n

b
j =1

a
j =1

ij

P j . But when

ij

Pj

the inputs are used after one period, their cost , including their interest cost, will increase from

j =1
n

a ij Pj to

a
j =1

ij

Pj .

In that period, the process will produce bij quantities of outputs having total market value of

b
j =1

ij

P j . Therefore, with no profits, the total cost of the unit of process

a
j =1

ij

Pj must equal

its total money yield (revenue),

b
j =1

ij

Pj .

Since under perfect competition, profits must be non-positive, therefore for the i process, its total cost must be greater than or equal to the sum of all revenue in that period. This leads to the second condition of the Neumann model.

a
j =1

ij

Pj

....(2)

If inequality holds for some processes which yield only losses (i.e. total cost is greater than total revenues), they get rejected as inefficient processes. For any such inefficient process i', we will have i = 0 which means that the process will remain unutilised. It may be expressed as

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The Economics of Development and Planning

If

j =1

a ij Pj >

b
j =1

ij

Pj

....(3)

i = 0 then Leaving this exceptional case of losses, we assume that atleast one process is not inefficient where one equality sign holds in equation (2) of the system. The last requirement of the system is that any particular commodity j will be a free good for which its price Pj = 0 , if an excess quantity of this commodity is available. In other words, if its available supply from all processes exceeds the quantity of that commodity which will be needed as an input in the next period, it will be a free good and hence its price will be zero. This condition can be expressed as If then

i =1

a ij i <

b
i =1

ij

....(4)

Pj = 0 .

The central point in Neumanns analysis is that there exists a unique solution to his model. The proof given by him is beyond the mathematical level of our understanding. He shows that whatever the values of the parameters of his model, so long it satisfies the conditions described above, there will always be set of values for 1 ,.... m , P1 ..... Pn and and requirements of maximum growth in the model. which satisfy the

The model determines the values of and uniquely in the system. Neumann proves that in an optimal solution, a single maximum growth rate of the system must equal a single minimum interest rate of the system to cover the cost of investment in inputs. This is in keeping with the no-profit condition following from the assumption of perfect competition. If some outputs , the interest cost of such process, is exceed inputs by more than per cent per period while less than , the entire process will be profitable. In the final analysis, there will be no sustainable growth rate, say , greater than the equilibrium growth rate, . For if there were available alternative processes capable of yielding a higher growth rate, , then the growth rate would not be consistent with equilibrium. Entrepreneurs would switch to these alternative processes because with interest rate at the old rate, they would make a profit. With the interest rate then raised to = to eliminate this profit, the old now maximal growth-rate processes would only be operational at a loss. Prof. Koopmans 2 gives a geometrical representation of the Neumann growth path on a two-dimensional diagram. According to him, Neumann limited his explanation to a proportional growth path where all goods grow at the same rate and at the fastest rate.
2. T.C. Koopmans, Economic Growth at a Maximal Rate, Q.J.E., Vol. 78, 1964.

Fig. 1

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Suppose there are two activities x1 , x 2 and y1 , y 2 where proportions are constant over time and they grow at the same rate. They are measured on x-axis and y-axis respectively. In Fig. 1, their proportional growth path is represented by a rising straight line PG where the output pair of each periods activity equals the input pair for that of the next period. PG is a unique maximal growth path of the system which is called the proportional growth path. A CRITICAL APPRAISAL Neumann presented a path-breaking model of growth under perfect competition in a general equilibrium context which explains economic growth in general and maximum possible growth rate in particular. It is a highly complex mathematical model which has been solved, interpreted and extended by Dorfman, Samuelson and Solow, and by Radner, Mckenzie, Morishima, Koopmans and others. The Neumann model has been criticised due to its unrealistic assumptions on the following grounds: 1. The assumption of unchanging technology of production and consumption is highly unrealistic. 2. An other defect is that consumption is not treated as an end in itself. Consumer goods are treated as inputs to processes and labour as an output. As the economy expands and more labour is required, more is produced by getting more consumer goods. It implies that there are only labour-producing processes that are utilised to absorb the minimum consumer goods to produce the required labour as output. This labour appears to be drawn from some subsistence sector having a reserve army of labour. 3. It is unrealistic to assume that all production and consumption activities grow in time at the same proportional rate. 4. The model assumes a capital stock at time t1 that leads to proportional growth at a maximal rate through competitive equilibrium. This is unrealistic because the model ignores completely the given slock of capital at the beginning of time t. 5. The assumption that every commodity enters every production process either as an input or as an output, is unacceptable in practice. How can ice-cream be used as one of its inputs or outputs? The question is absurd. On these counts, Koopmans characterises this model as poor economics.