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    Harrod

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    vikram inamdar
    The Harrod-Domar model suggests that economic growth depends on the level of savings and the capital-output ratio. A higher savings rate enables more investment, and a lower capital-output ratio means investment is more efficient. The model has several limitations, including that it ignores factors like technological innovation, productivity, and diminishing returns to capital. It also oversimplifies the complex factors that influence economic growth in developing countries.

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    Harrod

    Uploaded by

    vikram inamdar
    182 views7 pages
    The Harrod-Domar model suggests that economic growth depends on the level of savings and the capital-output ratio. A higher savings rate enables more investment, and a lower capital-output ratio means investment is more efficient. The model has several limitations, including that it ignores factors like technological innovation, productivity, and diminishing returns to capital. It also oversimplifies the complex factors that influence economic growth in developing countries.

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    The Harrod-Domar model suggests that economic growth depends on the level of savings and the capital-output ratio. A higher savings rate enables more investment, and a lower capital-output ratio means investment is more efficient. The model has several limitations, including that it ignores factors like technological innovation, productivity, and diminishing returns to capital. It also oversimplifies the complex factors that influence economic growth in developing countries.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
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    182 views7 pages

    Harrod

    Uploaded by

    vikram inamdar
    The Harrod-Domar model suggests that economic growth depends on the level of savings and the capital-output ratio. A higher savings rate enables more investment, and a lower capital-output ratio means investment is more efficient. The model has several limitations, including that it ignores factors like technological innovation, productivity, and diminishing returns to capital. It also oversimplifies the complex factors that influence economic growth in developing countries.

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    of 7

    Harrod-Domar Model of Growth and its Limitations

    he Harrod Domar Model suggests that economic growth rates


    depend on two things:

    Level of Savings (higher savings enable higher investment)


    Capital-Output Ratio. A lower capital-output ratio means
    investment is more efficient and the growth rate will be
    higher.
    A simplified model of Harrod-Domar:

    Harrod-Domar in more detail


    Level of savings (s) = Average propensity to save (APS) –
    which is the ratio of national savings to national income.
    The capital-output ratio = 1/marginal product of capital.
    The capital-output ratio is the amount of capital needed to
    increase output.
    A high capital output ratio means investment is inefficient.
    The capital-output ratio also needs to take into account the
    depreciation of existing capital
    Main factors affecting economic growth

    1 Level of savings. Higher savings enable greater investment in


    capital stock
    2 The marginal efficiency of capital. This refers to the
    productivity of investment, e.g. if machines costing £30
    million increase output by £10 million. The capital-output
    ratio is 3
    3 Depreciation – old capital wearing out.
    Warranted Growth Rate
    Roy Harrod introduced a concept known as the warranted
    growth rate.
    1 This is the growth rate at which all saving is absorbed into
    investment. (e.g. £80bn of saving = £80bn of investment.
    2 Let us assume, the saving rate is 10%. the Capital output
    ratio is 4. In other words, £10bn of investment increases
    output by £2.5bn
    3 In this case, the economy’s warranted growth rate is 2.5
    percent (ten divided by four).
    4 This is the growth rate at which the ratio of capital to output
    would stay constant at four.
    The Natural Growth Rate
    1 The natural growth rate is the rate of economic growth
    required to maintain full employment.
    2 If the labour force grows at 3 percent per year, then to
    maintain full employment, the economy’s annual growth rate
    must be 3 percent.
    3 This assumes no change in labour productivity which is
    unrealistic.
    Importance of Harrod-Domar
    It is argued that in developing countries low rates of economic
    growth and development are linked to low saving rates.
    This creates a vicious cycle of low investment, low output and
    low savings. To boost economic growth rates, it is necessary
    to increase savings either domestically or from abroad. Higher
    savings create a virtuous circle of self-sustaining economic
    growth.

    Impact of increasing capital

    The transfer of capital to developing economies should enable


    higher growth, which in turn will lead to higher savings and
    growth will become more self-sustaining.
    Criticisms of Harrod Domar Model
    1 Developing countries find it difficult to increase saving.
    Increasing savings ratios may be inappropriate when you are
    struggling to get enough food to eat.
    2 Harrod based his model on looking at industrialised
    countries post-depression years. He later came to repudiate
    his model because he felt it did not provide a model for long-
    term growth rates.
    3 The model ignores factors such as labour productivity,
    technological innovation and levels of corruption. The Harrod
    Domar is at best an oversimplification of complex factors
    which go into economic growth.
    4 There are examples of countries who have experienced
    rapid growth rates despite a lack of savings, such as Thailand.
    5 It assumes the existences of a reliable finance and transport
    system. Often the problem for developing countries is a lack
    of investment in these areas.
    6 Increasing capital stock can lead to diminishing returns.
    Domar was writing during the aftermath of the Great
    Depression where he could assume there would always be
    surplus labour willing to use the machines, but, in practice,
    this is not the case.
    7 The Model explains boom and bust cycles through the
    importance of capital, (see accelerator theory) However, in
    practice businesses are influenced by many things other than
    capital such as expectations.
    8 Harrod assumed there was no reason for the actual growth
    to equal natural growth and that an economy had no
    tendency to full employment. However, this was based on the
    assumption of wages being fixed.
    9 The difficulty of influencing saving levels. In developing
    economies it can be difficult to increase savings ratios –
    because of widespread poverty.
    10 The effectiveness of foreign capital flows can vary. In the
    1970s and 80s many developing economies borrowed from
    abroad, this led to an inflow of foreign capital however, there
    was a lack of skilled labour to make effective use of capital.
    This led to very high capital-output ratios (poor productivity)
    and growth rates didn’t increase significantly. However,
    developing economies were left with high debt repayments
    and when interest rates rose, a large proportion of national
    savings was diverted to paying debt repayments.
    11 Economic development implies much more than just
    economic growth. For example, who benefits from growth?
    does higher national income filter through to improved health
    care and education. It depends on how the capital is used.

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