 Farzana sher muhammad  Aleena ilyas  Saeeda  Saqiba

Harrod-Domar Model  The Harrod Domar Model was developed in 1940’s. It is the first approach of the classic theories of economic development which explains how economic growth is possible in developing countries. Basically, it is a growth model which states the rate of economic growth in an economy is dependent on the level of saving and the capital output ratio.

Main Theme of Model  If there is a high level of saving in a country, it provides funds for firms to borrow and invest. As a result, the Investment increases the capital stock of an economy and generates economic growth through the increase in production of goods and services.  Furthermore, they assume some direct economic relations between size of the total capital stock (K) and total GDP (Y). This relationship is called capital output ratio. This capital output ratio measures the productivity of the investment that takes place. If capital output ratio decreases the economy will be more productive, so higher amounts of output is generated from fewer inputs. This again, leads to higher economic growth.

 According to this model, the equilibrium growth rate for the economy is.  Let Y be GDP and S be savings. The level of savings is a function of the level of GDP, say S = sY. where s represents net saving ratio (a fixed proportion of national income or GDP).  Net investment is defined as an increase in the existing capital stock (k) I = ΔK  Where, the level of capital K needed to produce an output Y is given by the equation K = σ Y where σ is called the capital-output ratio. Investment is a very important variable for the economy because Investment has a dual role.  Investment represents an important component of the demand for the output of an economy as well as the increase in capital stock. Thus ΔK = σ ΔY. For equilibrium there must be a balance between supply and demand for a nation's output. In simple case this equilibrium condition is I = S. Thus,

I = ΔK = σΔY S =sY= I = ΔK = σ ΔY So simply as, sY= σ ΔY therefore, the rate of economic growth(g) is g = ΔY/Y = s/ σ  This equation tells us that the growth rate is directly related to the saving ratio and negatively related to economies capital output ratio.

Obstacles in Harrod Domar Model  At that time, many economists considered labor force as an important component of economic growth. Because labor is assumed to be abundant in developing countries and can be hired as needed to capital investment. In this model labor force is not described explicitly.  In this model, capital output ratio is assumed to be fixed at 3:1 i.e. if σ =3% and net saving ratio is 15% of GDP. Then growth rate is g = ΔY/Y = s/ σ =15%/3% = 5%.It means that for the growth rate of 5% country must save 15 % of GDP, which is impossible in developing countries.  Rate of interest is fixed in this model.  Depreciation of machinery is excluded.  Government intervention is ignored in the model.