In Chapters 3 and 6, we have shown that demand affects the level of total output. As the old Keynesian economics claims, demand is relevant. However, the claim is normally taken to be relevant only for the short run. The long run is the realm of the neoclassical economics, whereby economic growth is determined solely by supply factors. In this chapter, we challenge this standard neoclassical view, and argue that demand actually plays a central role in the process of economic growth.

Introduction

In the standard literature, the fundamental factor restraining economic growth is diminishing returns to capital in production or R&D technology. In this chapter, we present a model suggesting that “saturation of demand” is another important factor restraining growth.

In the less mathematical literature and casual discussions, the idea of demand saturation has been popular. Every businessman would acknowledge saturation of demand for an individual product. In fact, plot a time series of production of any representative product such as steel and automobiles, or production in any industry, against year, and, with few exceptions, one obtains a S-shaped curve. Figure 8.1, from Rostow (1978), demonstrates this stylized fact. The experiences of diffusion of such consumer durables as refrigerators, television sets, cars, and personal computers tell us that deceleration of growth comes mainly from saturation of demand rather than diminishing returns in technology.