The Harrod-Domar Growth Model

This study note for A-Level and IB economics considers the Harrod-Domar Growth Model

The Harrod-Domar Growth Model, developed independently by Sir Roy Harrod and Evsey Domar in the 1930s and 1940s, is an early post-Keynesian model of economic growth. It focuses on the relationship between growth rates, savings, and capital-output ratios, emphasizing the importance of investment in driving economic growth.

Key Components of the Harrod-Domar Growth Model

1. Production Function
   • The model uses a linear production function: Y=KvY=vK​
     • YY = output (GDP)
     • KK = capital stock
     • vv = capital-output ratio
2. Savings and Investment
   • Savings are a fixed proportion of output: S=sYS=sY
     • SS = savings
     • ss = savings rate
   • Investment is crucial for growth, given by: I=ΔKI=ΔK
     • II = investment
     • ΔKΔK = change in capital stock
3. Growth Rate
   • The growth rate of output (gg) depends on the savings rate (ss) and the capital-output ratio (vv): g=svg=vs​
4. Equilibrium
   • The model highlights the conditions for equilibrium growth where planned saving equals planned investment.

Application of the Harrod-Domar Growth Model

• Real-World Example: Post-War Reconstruction
  • The model was used to guide economic policy in post-war Europe. For instance, the Marshall Plan incorporated ideas from the Harrod-Domar model to help European economies recover by focusing on increasing investment and savings.
• Development Economics
  • Many developing countries used the Harrod-Domar model as a framework for economic planning, emphasizing the need to increase savings and investment to stimulate growth.

Contributions of Key Economists

• Sir Roy Harrod
  • Developed the model in 1939, focusing on the instability of economic growth and the need for continuous investment.
• Evsey Domar
  • Independently developed a similar model in 1946, emphasizing the relationship between capital formation, productivity, and economic growth.
• Joan Robinson
  • Critiqued and expanded on the model, highlighting issues of capital accumulation and distribution.
• Anne Krueger
  • Contributed to development economics and trade policies, emphasizing the importance of institutions and policies in growth.

Timeline of Key Economic Events and Policy Responses

• 1939: Roy Harrod publishes "An Essay in Dynamic Theory," introducing his growth model.
• 1946: Evsey Domar publishes "Capital Expansion, Rate of Growth, and Employment," presenting a similar growth model.
• 1948-1952: The Marshall Plan is implemented in Europe, incorporating investment-driven growth strategies.
• 1950s-1960s: Developing countries adopt the Harrod-Domar framework for economic planning.
• 1980s: Transition to endogenous growth models that incorporate factors like technology and human capital.

Critique of the Model

• Assumptions: The model assumes fixed capital-output ratios and savings rates, which are unrealistic in dynamic economies.
• Instability: The model suggests that economies are inherently unstable and require continuous investment to maintain growth, which is overly pessimistic.
• Lack of Technological Progress: The model does not account for technological progress, which is a major driver of long-term growth.
• Capital-output Ratio: It assumes a constant capital-output ratio, ignoring the possibility of changes due to technological improvements or shifts in production processes.

Glossary

• Capital-Output Ratio: The ratio of capital used to the output produced.
• Equilibrium Growth: A situation where the economy grows at a steady rate without any external shocks.
• Investment: The process of allocating resources, usually in the form of capital, to generate economic returns.
• Production Function: A mathematical relationship describing the output produced from different combinations of inputs.
• Savings Rate: The proportion of income that is saved rather than consumed.

Essay-Style Questions

1. Discuss the role of investment in the Harrod-Domar Growth Model and its implications for economic policy.
2. Evaluate the strengths and weaknesses of the Harrod-Domar Growth Model in explaining economic growth.
3. How does the Harrod-Domar Growth Model address the issue of economic instability?
4. Compare the Harrod-Domar Growth Model with the Solow Growth Model, highlighting their key differences.
5. Analyze the relevance of the Harrod-Domar Growth Model for developing countries in the 21st century.

Recommended Articles and Papers

1. Harrod, R. F. (1939). "An Essay in Dynamic Theory." The Economic Journal, 49(193), 14-33.http://www.jstor.org/stable/22...
2. Domar, E. D. (1946). "Capital Expansion, Rate of Growth, and Employment." Econometrica, 14(2), 137-147.http://www.jstor.org/stable/19...
3. Robinson, J. (1956). "The Accumulation of Capital." Macmillan.https://www.cambridge.org/core...
4. Krueger, A. O. (1974). "The Political Economy of the Rent-Seeking Society." American Economic Review, 64(3), 291-303.https://www.jstor.org/stable/1...
5. Thirlwall, A. P. (1983). "A Plain Man’s Guide to Kaldor’s Growth Laws." Journal of Post Keynesian Economics, 5(3), 345-358.http://www.jstor.org/stable/45...

These notes provide a comprehensive overview of the Harrod-Domar Growth Model, its key components, applications, and contributions from notable economists. They also offer additional resources, potential essay questions, and critiques to deepen students' understanding of the topic.