H-D Model

Q1: What is the implication of Harrod-Domar model on the cause of growth?

A: In the 1940's Roy Harrod (1948) and Evsey Domar (1946) separately developed a macro-dynamic model through an extension of Keyns's theory. The model's original intent was to identify the source of instability in the growth of developed economies where effective denand is normally exceeded by supply capacity. In the 1950's and 1960's this model was applied to economic planning in developed economies.

[pic]Basic Equation The basic equation in the Harrod-Domar model is very simple, :

g=s/c (1)

where

- g is the growth rate of national income

- s=S/Y is the ratio of saving S to income,Y,

- c is marginal capital-output ratio

[pic]What is the implication? Under the assumption of constant c, g increases proportionally with s. Because s is considered to increase proportionally with income per capita, s is bound to be low and, hence, g will be low in low-income economies if savings and investment are left to private decision in the free market. The model implies, therefore, that the promotion of investment by government planning and command is needed to accelerateeconomic growth in low-income economies. Infact, the Harrod-Domar model provided a framework for economic planning in developing economies, such as India's Five Year Plan.

Q2: Why did Harrod-Domar model influenced the development aid?

A: The idea that aid-financed investment in dams, roads, and machines would yield growth goes back a long way. In April 1946, economics professor Evsey Domar published an article on economic growth, "Capital Expansion, Rate of Growth, and Employment," which discuss the relationship between short-term recessionns and investment in the United States.

[pic]Domar assumed that output (GDP) is propotional to machines Domar's approach to growth became popular because it had a wonderfully simple prediction:

- GDP growth will be proportional to the share of investment spending in GDP. ,

- so the...