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The Harrod – Domar Growth Model

One of the principal strategies of development necessary for any takeoff was the mobilization

of domestic and foreign saving in order to generate sufficient investment to accelerate economic growth The economic mechanism by which more investment leads to more growth can be describe in terms of the Harrod - Domar growth model that described a functional economic relationship for the growth rate of GDP “g” is directly proportional to national net saving ratio “s” and inversely

proportional to national capital-output ratio “c” .

g = s/c (g=Growth rate of GDP, s= Net saving ratio, c=Capital output ratio) The growth rate of GDP is a functional economic relationship and national net saving ratio that shows the units of capital required to produce a unit of output over a given period of time.Net saving ratio that is expressed as a proportion of fixed income over some period of time. Net saving (S) some proportion , s, of national income(Y) such as the equation

S = s Y (S=Net saving, s=Net saving ration, Y=National income)

Net investment (I) is defined as the change in the capital stock, K and can be represented by K as

I = K (I=Net investment, K= Capital stock change)

But the total capital stock, K ,bears a direct relationship to total national income or output, Y , as expressed by the capital-output ratio, c , it follows that

c = K/Y or c = K/ Y so, K = c Y

And net national savings, S , must equal net investment, I, that describe as

S = I so, I = sY (where S = sY) , Finally, I = K = c Y = sY = S Also, sY = c Y ,Divided by Y therefore, s = c Y /Y and then, divided by c

so, Y/Y = s/c

The above equation is the famous equaton in the Harrod – Domar growth theory of economic, states simply that the rate of growth of GDP ( Y/Y) is determined jointly by the net national savings ratio, s, and the national capital - output ratio, c. More specially that in the absence of government, the growth rate of national income will be directly or positively relative to the ratio and inversely or


Also that can express in terms of gross saving, sG,in which case the growth rate is given by Y/Y = sG /c - d* (where sG =Gross savings, d* = Rate of capital depreciation).

The above economic growth theory of Harrod – Domar that is very simple. In additional to investment, two other components of economic growth are labor force growth and technological

progress. The components of economic growth are prime importance, there are briefly describe that three as below,

1. Capital accumulation, including all new investments in land, physical equipment, and human resources through improvements in health , education, and job skills.

2. Growth in population and hence eventual growth in the labor force

3. Technological progress – new ways of accomplishing tasks

The Harrod - Domar model, labor force growth is not described explicitly, because labor is assumed to be abundant in a developing – country context and can be hired as needed in given population to capital investments, this assumption is not always valid. In a general way, technological progress can be expressed in the Harrod - Domar model context as a decrease in the required capital – output ration, giving more growth for a given level of investment that followed from the equation

Y/Y = s/c.

Lewis Theory of Development

Structural change model focuses on the mechanism by which underdeveloped economies transform their domestic economic structures from a heavy emphasis on traditional subsistence

agriculture to a more modern, more urbanized and more industrially diverse manufacturing and service economy.

Two important example of such models are:

1. Lewis’s Model

2. The pattern of development empirical analysis by Chenery

two-sector model became the work horse during the 1960s and early 1970s.In the Lewis-model, a underdeveloped economy consists out of a traditional, overpopulated rural subsistence sector

and a high-productivity modern urban industrial sector. Primary focus of the model , process of labor transfer and the growth of output and employment in the modern sector.

The traditional agricultural sector of Lewis’s Model


Total output TPA is determined by changes in the quantity of labor employed in agriculture, LA,

where as the level of technology tA as well as the amount of capital KA is fixed and see in figure-A

. In the figure- B, the average and marginal product of labor curves, APLA and MPLA which are

derived from total product curve shown immediately above. The quantity of agricultural labor QAL

available is the same on both horizontal axes and is expressed in millions of workers. As per Lewis is describing an underdeveloped economy where much of the population lives and works in rural areas. Lewis makes two assumption about the traditional sector that the surplus labor MPLAis zero, and all

rural workers share equally in the output so that rural real wages is determined by the average and not the marginal product of labor. That will be the case in modern sector. The wage rate in agriculture equals the average product of labor, thus WA=TPA/LA. Assume thatthere are LA agricultural workers

producing TPA food, which is equal to TPA/LA and the marginal product of these LAworks is zero as


The modern sector of Lewis’s Model

The total output manufacturing goods in the modern industrial sector denoted by TPM is produced

again with variable labor input LM and given capital stock KM at a given level of technology, tM. Lewis

allows capital to grow, as a result of the reinvestment of profits is equal to capital incomes. The labor market in the modern sector is perfectly competitive. See below figure, C. The process that will generate these capitalist profits for reinvestment and growth is illustrated in the figure-D. The figure-D presents as

the average level of real subsistence income in the traditional rural sector. WM in figure-D is the real wage

in the modern capitalist sector. At this wage, the supply of rural labor is assumed to be unlimited or

perfectly elastic as WMSL where the SL is labor supply, in figure. Lewis assumes that at urban wage WM

above rural average income WA, modern sector employers can hire as many surplus rural workers as they want without fear of rising wages.

Criticisms of the Lewis model Capital incomes are reinvested. There is no capital flight. Labor saving technical progress would increase capital income while labor income and employment levels remain constant. Assumption of rural surplus labor is generally not valid. Prior to the 1980s in almost all developing countries wages rose substantially, in absolute terms and relative to rural incomes.

Diminishing returns in the modern industrial sector are at least debatable. There is increasing evidence for increasing returns, posing special problems for policymaking.