Harrod – Domar Model
THE HARROD – DOMAR MODELS
Both Harrod and Domar are interested in discovering the rate of income growth necessary for a smooth and uninterrupted working of the economy. Harrod and Domar assign a key role to investment in the process of economic growth. So long as net investment is taking place, real income and output will continue to expand.
Assumptions
1. There is an initial full employment equilibrium level of income.
2. There is the absence of government interference.
3. These models operate in a closed economy which has no foreign trade.
4. There are no lags in adjustments between investment and creation of productive capacity.
5. The average propensity to save is equal to the marginal propensity to save.
6. The marginal propensity to save remains constant.
7. The capital coefficient, i.e., the ratio of capital stock to income is assumed to be fixed.
8. There is no depreciation of capital goods which are assumed to possess infinite life.
9. Saving and investment relate to the income of the same year.
10. The general price level is constant. 11. There are no changes in interest rates.
12. There is a fixed proportion of capital and labour in the productive process.
13. Fixed and circulating capitals are lumped together under capital.
14. There is only one type of product.
The Domar model
According to Domar, to maintain full employment equilibrium level of income, aggregate demand should be equal to aggregate supply. Thus we arrive at the fundamental equation of the model: ∆I*(1/α) = Iσ, where σ
∆I*(1/α) = ∆Y=Aggregate demand 1/α =multiplier, ∆I = change in investment σ = productivity of capital
α = marginal propensity to save (1-MPC) Iσ = Aggregate supply
Solving this equation by dividing both sides by I and multiplying by α we get:
(Aggregate
Both Harrod and Domar are interested in discovering the rate of income growth necessary for a smooth and uninterrupted working of the economy. Harrod and Domar assign a key role to investment in the process of economic growth. So long as net investment is taking place, real income and output will continue to expand.
Assumptions
1. There is an initial full employment equilibrium level of income.
2. There is the absence of government interference.
3. These models operate in a closed economy which has no foreign trade.
4. There are no lags in adjustments between investment and creation of productive capacity.
5. The average propensity to save is equal to the marginal propensity to save.
6. The marginal propensity to save remains constant.
7. The capital coefficient, i.e., the ratio of capital stock to income is assumed to be fixed.
8. There is no depreciation of capital goods which are assumed to possess infinite life.
9. Saving and investment relate to the income of the same year.
10. The general price level is constant. 11. There are no changes in interest rates.
12. There is a fixed proportion of capital and labour in the productive process.
13. Fixed and circulating capitals are lumped together under capital.
14. There is only one type of product.
The Domar model
According to Domar, to maintain full employment equilibrium level of income, aggregate demand should be equal to aggregate supply. Thus we arrive at the fundamental equation of the model: ∆I*(1/α) = Iσ, where σ
∆I*(1/α) = ∆Y=Aggregate demand 1/α =multiplier, ∆I = change in investment σ = productivity of capital
α = marginal propensity to save (1-MPC) Iσ = Aggregate supply
Solving this equation by dividing both sides by I and multiplying by α we get:
(Aggregate