The Harrod-Domar Growth Model
The Harrod-Domar models of economic growth are based on the experiences of advanced
capitalist economies to analyse the requirements of steady growth in such economy. The Harrod-Domar
economic growth model stresses the importance of savings and investment as key determinants of
growth. The model emphases on the dual character of investment:
1. It creates income which is regarded as the ‘demand effect’.
2. It augments the productive capacity of the economy by increasing its capital stock
which is regarded as the ‘supply effect’ of investment.
The main assumptions of the Harrod-Domar models are as follows:
1. A full-employment level of income already exists.
2. There is no government interference.
3. The model is based on the assumption of closed economy.
4. There are no lags in adjustment of variables.
5. The average propensity to save (APS) and marginal propensity to save (MPS) are equal to each
other. Symbollically, S/Y= ∆S/∆Y
6. Both propensity to save and “capital coefficient” (i.e., capital-output ratio) are given constant.
7. Income, investment, savings are all defined in the net sense and hence they are considered over
and above the depreciation.
8. Saving and investment are equal in ex-ante as well as in ex-post sense.
Given the above main general assumptions, we shall discuss both models separately as below.
Although Harrod and Domar models differ in some aspects, they are similar in substance as both the
models stress the essential conditions of achieving and maintaining steady growth.
The Harrod Model:
An English economist, Henry Roy Forbes Harrod (13 February 1900 – 8 March 1978) tries to
show in his model how steady growth may occur in the economy. Once the steady growth rate is
interrupted and the economy falls into disequilibrium, cumulative forces tend to perpetuate this
divergence thereby leading to either secular deflation or secular inflation.
The Harrod Model is based upon three distinct rates of growth as below:
1. The actual growth rate (G)
2. The warranted growth rate (Gw)
3. The natural growth rate (Gn)
1. The actual growth rate (G): It is defined as the ratio of change in income (∆Y) to the total
income (Y) in the given period. Mathemaically; G = ∆Y/Y
The actual growth rate (G) is determined by:
(a) Saving-Income ratio (s) known as the Average Propensity to Save which is expressed
as s =S/Y
(b) Capital- Output ratio (C) which is expressed as C=∆K/∆Y where ∆K denotes change in
Capital stock which equal investment (I)
, The relationship between the actual growth rate and its determinants is expressed as: GC = s ------(1)
Now;
The above equation so derived explains that the condition for achieving the steady state growth is
that ex-post (actual, realized) savings must be equal to ex-post investment.
2. The warranted growth rate (Gw): Warranted growth Rate also known as Full-capacity
growth rate refers to that growth rate of the economy when it is working at full capacity. In other words,
Gw is interpreted as the rate of income growth required for full utilization of a growing stock of capital.
Warranted growth rate (Gw) is determined by capital-output ratio and saving- income ratio and
their relationships is expressed as:
Gw Cr = s
or Gw=s/Cr
where ;
Cr denotes the amount of capital-output ratio needed to maintain the warranted
s denotes the saving-income ratio.
The above equation reflects that if the economy is to advance at the steady rate of Gw at its full
capacity, income must grow at the rate of s/Cr per year.
3. The natural growth rate (Gn): The natural growth rate also known as the potential or
the full employment rate of growth is the rate of economic growth required to maintain full
employment. The natural growth rate regarded as ‘the welfare optimum’ by Harrod is the
maximum growth rate which an economy can achieve with its available natural resources.
The Natural growth rate is determined by natural conditions such as labor force, natural
resources, capital equipment, technical knowledge etc. The third fundamental relation in Harrod’s model
showing the determinants of natural growth rate is expressed as: GnCr = or ≠s
Condition for the Achievement of Steady Growth:
According to Harrod, the economy can achieve steady growth when there is equality between G
and Gw at the same time between C and Cr. This condition can be expressed as:
G = Gw and C = Cr
Harrod states that a slight deviation of G from Gw will lead the economy away and further away
from the steady-state growth path. Thus, the equilibrium between G and Gw at this junction is considered
as a knife-edge equilibrium.
The Harrod-Domar models of economic growth are based on the experiences of advanced
capitalist economies to analyse the requirements of steady growth in such economy. The Harrod-Domar
economic growth model stresses the importance of savings and investment as key determinants of
growth. The model emphases on the dual character of investment:
1. It creates income which is regarded as the ‘demand effect’.
2. It augments the productive capacity of the economy by increasing its capital stock
which is regarded as the ‘supply effect’ of investment.
The main assumptions of the Harrod-Domar models are as follows:
1. A full-employment level of income already exists.
2. There is no government interference.
3. The model is based on the assumption of closed economy.
4. There are no lags in adjustment of variables.
5. The average propensity to save (APS) and marginal propensity to save (MPS) are equal to each
other. Symbollically, S/Y= ∆S/∆Y
6. Both propensity to save and “capital coefficient” (i.e., capital-output ratio) are given constant.
7. Income, investment, savings are all defined in the net sense and hence they are considered over
and above the depreciation.
8. Saving and investment are equal in ex-ante as well as in ex-post sense.
Given the above main general assumptions, we shall discuss both models separately as below.
Although Harrod and Domar models differ in some aspects, they are similar in substance as both the
models stress the essential conditions of achieving and maintaining steady growth.
The Harrod Model:
An English economist, Henry Roy Forbes Harrod (13 February 1900 – 8 March 1978) tries to
show in his model how steady growth may occur in the economy. Once the steady growth rate is
interrupted and the economy falls into disequilibrium, cumulative forces tend to perpetuate this
divergence thereby leading to either secular deflation or secular inflation.
The Harrod Model is based upon three distinct rates of growth as below:
1. The actual growth rate (G)
2. The warranted growth rate (Gw)
3. The natural growth rate (Gn)
1. The actual growth rate (G): It is defined as the ratio of change in income (∆Y) to the total
income (Y) in the given period. Mathemaically; G = ∆Y/Y
The actual growth rate (G) is determined by:
(a) Saving-Income ratio (s) known as the Average Propensity to Save which is expressed
as s =S/Y
(b) Capital- Output ratio (C) which is expressed as C=∆K/∆Y where ∆K denotes change in
Capital stock which equal investment (I)
, The relationship between the actual growth rate and its determinants is expressed as: GC = s ------(1)
Now;
The above equation so derived explains that the condition for achieving the steady state growth is
that ex-post (actual, realized) savings must be equal to ex-post investment.
2. The warranted growth rate (Gw): Warranted growth Rate also known as Full-capacity
growth rate refers to that growth rate of the economy when it is working at full capacity. In other words,
Gw is interpreted as the rate of income growth required for full utilization of a growing stock of capital.
Warranted growth rate (Gw) is determined by capital-output ratio and saving- income ratio and
their relationships is expressed as:
Gw Cr = s
or Gw=s/Cr
where ;
Cr denotes the amount of capital-output ratio needed to maintain the warranted
s denotes the saving-income ratio.
The above equation reflects that if the economy is to advance at the steady rate of Gw at its full
capacity, income must grow at the rate of s/Cr per year.
3. The natural growth rate (Gn): The natural growth rate also known as the potential or
the full employment rate of growth is the rate of economic growth required to maintain full
employment. The natural growth rate regarded as ‘the welfare optimum’ by Harrod is the
maximum growth rate which an economy can achieve with its available natural resources.
The Natural growth rate is determined by natural conditions such as labor force, natural
resources, capital equipment, technical knowledge etc. The third fundamental relation in Harrod’s model
showing the determinants of natural growth rate is expressed as: GnCr = or ≠s
Condition for the Achievement of Steady Growth:
According to Harrod, the economy can achieve steady growth when there is equality between G
and Gw at the same time between C and Cr. This condition can be expressed as:
G = Gw and C = Cr
Harrod states that a slight deviation of G from Gw will lead the economy away and further away
from the steady-state growth path. Thus, the equilibrium between G and Gw at this junction is considered
as a knife-edge equilibrium.
