Neoclassical growth theory is an economic approach to understanding the process of economic growth. Developed in 1956 by Robert Solow and Trevor Swan, it is based on the concept of diminishing marginal returns and combines both macroeconomic and microeconomic theory. The main premise behind the neoclassical growth theory is that an economy’s growth rate is directly related to its ability to efficiently allocate resources among labor, capital, and technology.

The neoclassical growth theory states that economic growth depends on increases in factors of production, such as labor and capital, combined with technological advances. When it comes to productive capital (or physical capital), economic growth is determined by savings, which is then used to invest in new capital equipment. As capital accumulates and becomes more efficient, the incentive to innovate and improve technological processes increases, leading to faster economic growth.

At the center of neoclassical growth theory is the concept of diminishing marginal returns. This states that as a resource is increased, the productivity gain that is achieved by adding more units of the resource eventually decreases. This idea is also referred to as diminishing returns, and is often illustrated in a graph as a downward sloping curve.

The neoclassical growth theory is still widely accepted by many economists today. It is often applied in many macroeconomic models and assumptions, such as the Solow–Swan model. This model takes the concept of diminishing returns into account when measuring economic growth, and it is often used to determine whether the increases in capital and labor input are sufficient to increase productivity.

The neoclassical growth theory is important not only to macroeconomics, but also to international trade and investment. For example, countries that specialize in industries that require large investments in capital and labor, such as manufacturing, may be more successful at achieving economic growth than countries that specialize in sectors that require less of these inputs, such as services. The neoclassical growth theory enables economists to predict what type of investments countries should make in order to be most successful in terms of economic growth.