| 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.
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)
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