Eco Dev - Orenday

HARROD
DOMAR MODEL
Group 2
What is Harrod Domar Model?
The Harrod–Domar model is used in development

economics to explain an economy's growth rate in terms of
the level of saving and productivity of capital. It suggests that
there is no natural reason for an economy to have balanced
growth.
The model was developed independently by Sir Roy F.
Harrod in 1939 and Evsey Domar in 1946. The Harrod–Domar
model was the precursor to the exogenous growth model.
The Harrod Domar Model suggests that the rate of
economic growth depends 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.
The Harrod–Domar model makes the
following a priori assumptions:
◦1: Output is a function of capital stock
◦2: The marginal product of capital is constant; the production
function exhibits constant returns to scale. This implies capital's
marginal and average products are equal.
◦3: Capital is necessary for output.
◦ 4: The product of the savings rate and output equals saving, which
equals investment
◦5: The change in the capital stock equals investment less the
depreciation of the capital stock
◦ (i) A full-employment level of income already exists.
◦ (ii) There is no government interference in the functioning of the economy.
◦ (iii) The model is based on the assumption of “closed economy.” In other words, government
restrictions on trade and the complications caused by international trade are ruled out.
◦ (iv) There are no lags in adjustment of variables i.e., the economic variables such as savings,
investment, income, expenditure adjust themselves completely within the same period of time.
◦ (v) The average propensity to save (APS) and marginal propensity to save (MPS) are equal to
each other. APS = MPS or written in symbols,
◦ (vi) Both propensity to save and “capital coefficient” (i.e., capital-output ratio) are given
constant. This amounts to assuming that the law of constant returns operates in the economy
because of fixity of the capita-output ratio.
◦ (vii) Income, investment, savings are all defined in the net sense, i.e., they are considered over
and above the depreciation. Thus, depreciation rates are not included in these variables.
◦ (viii) Saving and investment are equal in ex-ante as well as in ex-post sense i.e., there is
accounting as well as functional equality between saving and investment.
In summation, the savings rate times the marginal product
of capital minus the depreciation rate equals the output
growth rate. Increasing the savings rate, increasing the
marginal product of capital, or decreasing the depreciation
rate will increase the growth rate of output; these are the
means to achieve growth in the Harrod–Domar model.
Criticisms of the model
◦ There is no reason for growth to be sufficient to maintain full employment;
◦ t, critics claim that the model sees economic growth and development as the same;
in reality, economic growth is only a subset of development
◦ poor countries should borrow to finance investment in capital to trigger economic
growth; however, history has shown that this often causes repayment problems later
◦ Developing countries find it difficult to increase saving. Increasing savings ratios may
be inappropriate when you are struggling to get enough food to eat.
◦ 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.
◦ 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.
◦ There are examples of countries who have experienced rapid growth rates despite a lack of savings,
such as Thailand.
◦ 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.
◦ 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.
Harrod’s growth model raised
three issues:
◦(i) How can steady growth be achieved for an economy with a
fixed (capital- output ratio) (capital-coefficient) and a fixed
saving-income ratio?
◦(ii) How can the steady growth rate be maintained? Or what
are the conditions for maintaining steady uninterrupted
growth?
◦(iii) How do the natural factors put a ceiling on the growth rate
of the economy?
The Actual Growth Rate
is the growth rate determined by the actual rate
of savings and investment in the country. In other
words, it can be defined as the ratio of change in
income (AT) to the total income (Y) in the given
period.
Warranted Growth
refers to that growth rate of the economy

when it is working at full capacity. It is also
known as Full-capacity growth rate.
Natural Growth Rate
Natural growth rate is determined by

natural conditions such as labour force, natural
resources, capital equipment, technical
knowledge etc.
Domar’s theory was just an extension of Keynes’
General Theory, particularly on two counts:
1. Investment has two effects:

(a) An income-generating effect and
(b) Productivity effect by creating capacity.
2. Unemployment of labour generally attracts attention and one
feels sympathy for the jobless, but unemployment of capital
attracts little attention
The main points of the Harrod-Domar analysis are
summarised below:
1. Investment is the central variable of stable growth and it plays a double role; on
the one hand, it generates income and on the other, it creates productive capacity.
2. The increased capacity arising from investment can result in greater output or
greater unemployment depending on the behaviour of income
3. Conditions concerning the behaviour of income can be expressed in terms of
growth rates i.e. G, Gw and Gn and equality between the three growth rates can
ensure full employment of labour and full-utilization of capital stock.
4. These conditions, however, specify only a steady-state growth. The actual growth rate may
differ from the warranted growth rate. If the actual growth rate is greater than the warranted
rate of growth, the economy will experience cumulative inflation. If the actual growth rate is
less than the warranted growth rate, the economy will slide towards cumulative inflation. If
the actual growth rate is less than the warranted growth rate, the economy will slide towards
cumulative deflation.
5. Business cycles are viewed as deviations from the path of steady growth. These deviations
cannot go on working indefinitely. These are constrained by upper and lower limits, the ‘full
employment ceiling’ acts as an upper limit and effective demand composed of autonomous
investment and consumption acts as the lower limit. The actual growth rate fluctuates
between these two limits.
ZHAIRA B. ORENDAY
MARLY LIEZA DARAWAY
ORLAN GEMUEL MARIGOSIO
MARY GRACE BRIONES
JAVIER RUZ
AUDREY LYNN ROSALES
GROUP 2

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HARROD

The Harrod–Domar model is used in development

◦Level of Savings (higher savings enable higher

refers to that growth rate of the economy

Natural growth rate is determined by

1. Investment has two effects:

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