Harrod-Domar Model | Exogenous Growth model | Surplus Labor Model | Harris-Todaro Model

HARROD-DOMAR MODEL

The Harrod-Domar model developed in the 1930s suggests savings provide the funds which are borrowed for investment purposes.

The Economy's rate of Growth depends on:

- the level of saving and the savings ratio
- the productivity of investment i.e. economy's capital-output ratio

Further Analysis of the Model

The Harrod-Domar model developed in the 1930’s to analyse business cycles. it was later adapted to ‘explain’ economic growth.

- Economic growth depends on the amount of labour and capital i.e. NY = f(K,L)

- Developing countries have an abundant supply of labour. So it is a lack of physical capital that holds back economic growth hence economic development.

- More physical capital generates economic growth. (use Production Possibility Boundaries to illustrate)

- Net investment (i.e. investment over and above that needed to replace worn out capital (deprecation) leads to more producer goods (capital appreciation) which generates higher output and income. Higher income allows higher levels of saving.

Implications of Harrod-Domar Model

Economic growth requires policies that encourage saving and/or generate technological advances, which lower capital-output ratio.

Criticisms of the Model

According to Domer, Domar's purpose was to comment on business cycles, not to derive "an empirically meaningful rate of growth."

- It is difficult to stimulate the desired level of domestic savings

- Meeting a savings gap by borrowing form overseas causes debt repayment problems later.

- Diminishing marginal returns to capital equipment exist so each successive unit of investment is less productive and the capital to output ratio rises.

- The amount of investment is just one factor affecting development eg supply side approach (free up markets); human resource development (education and training)

- Economic growth is a necessary but not sufficient condition for development

- Sector structure of the economy important (i.e. agriculture vs. industry vs. services)