The Harrod-Domar Model of Economic Growth
The Harrod-Domar model was created in 1939 by British economist Roy Harrod and Russian-American economist Evsey Domar. It is used in macroeconomics to explain the relationship between saving, capital stock and economic growth. The model is based on the assumption that saving is a determinant of the capital stock and that an increase in capital stock results in an increase in economic output. The Harrod-Domar Model is a cornerstone of macroeconomic theory, as it provides a simple way to analyze the dynamics of economic growth and its implications for policy.
The Harrod-Domar model is an aggregate production model that is based on the neoclassical exogenous growth model. It shows how different economic variables such as savings, investment, production, and consumption are related to each other and how they determine economic growth. The model is built on three basic assumptions: 1) that economic growth is caused by an increase in the capital/output ratio, 2) that the capital/output ratio is determined by the level of economic activity, and 3) that the level of economic activity is determined by the level of saving and investment.
The model states that the economic growth rate is proportional to the savings rate and inversely proportional to the ratio of capital to output. This means that an increase in the savings rate results in an increase in the rate of economic growth, while an increase in the capital/output ratio results in a decrease in the rate of economic growth.
In order to analyze the effect of saving on economic growth, the Harrod-Domar model assumes that saving is a determinant of the capital stock, which is the total amount of capital equipment available for production. The model assumes that the capital stock is determined by the level of economic activity due to the effects of savings. In other words, higher levels of savings will lead to more capital accumulation and subsequently higher levels of economic growth.
The model also suggests that the size of the capital stock is limited by the level of economic activity. That is, higher levels of economic activity will eventually deplete the capital stock and cause it to become too small to sustain economic growth. According to the model, this is why it is important for governments to encourage savings in order to maintain a certain level of economic activity and prevent long-term stagnation.
The Harrod-Domar model has been widely used in economic analyses for almost 80 years and it is one of the most fundamental models in macroeconomics. The model is particularly useful for policymakers, as it gives them an insight into the dynamics of economic growth and the policies that can be implemented to improve it. For example, the model suggests that higher levels of savings will lead to higher levels of economic growth, while lower levels of savings can lead to stagnation. This provides an incentive for governments to develop policies that promote saving, such as tax incentives and financial education programs.
The model also has some limitations, however, as it ignores other factors such as technological advances, population growth, and government policies that affect economic growth. In addition, the model is only a static representation of the economy and does not take into account changes in the level of saving or investment caused by expectations of future growth. Nevertheless, the Harrod-Domar model is a valuable tool that is still used to this day to help explain the relationship between saving and economic growth.
