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Harrod -Domar Model introduction

Harrod -Domar Model introduction. We owe the modern theory of growth to the economist Roy Harrod with his article An Essay in Dynamic Theory (1939), inspired by the nascent Keynesian doctrine He developed what was then known as the Harrod-Domar model

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Harrod -Domar Model introduction

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  1. Harrod-Domar Modelintroduction We owe the modern theory of growth to the economist Roy Harrod with his article An Essay in Dynamic Theory (1939), inspired by the nascent Keynesian doctrine He developed what was then known as the Harrod-Domar model Dynamic extension of the Keynesian analysis of static equilibrium It has inspired a vast literature, in part still in place, and many economic policy actions Instead, the neoclassical model of growth, which will later be developed, derived from the dominant influence of Alfred Marshall’s Principles of Economy (1890) and was developed by Solow (later) Unlike traditional, development and growth are natural phenomena Static analysis, a typical neoclasssical hypothesis

  2. Harrod-Domar Model Mainquestions for Harrod • If the  Y =>  I, which is the growth rate of Y which ensures equality between planning I and S, so as to ensure an increase in balance in the long term? • Is there any guarantee that prevail growth rate necessary to ensure such equality? Otherwise, what happens? • In the static model of Keynes, if different from S I, triggered by automatic adjustment multiplier. Instead, for H., if overall productivity growth rate is not enough, what happens?

  3. Harrod-Domar Model GrowthRates • To answer the question -> threegrowthrates: • Currentgrowth rate (g): • whatoccursconcretely : • g = s / c = (Y / Y) / I /  Y = Y / Y • equal to the ratio between the propensity to save and the current capital-output ratio • Guaranteed rate of growth (gw): • onethatleaveseveryonesatisfied with the necessaryincrease in production (no more, no less), the necessary I: • (gw) =  Y / Y = s / cr • equal to the ratio betweenplanned and propensity to consume the extra capital required per unit of product • Natural growth rate (gn): • Y = L (Y / L) • onethatensuresgrowththatabsorbs the availablelabor force in relation to its production capacity

  4. Harrod-Domar Model Current rate of growth (Harrod) g = s / c = (Y / Y) / (I /  Y) =  Y / Y sis the propensity to save c: incremental capital-output ratio, ie K /  Y = I /  Y, providedthatS = I So, sinceS = I, the rate of increase of the product: g = (S / Y) / (I /  Y) =  Y / Y

  5. Harrod-Domar Modelwarranted rate of growth (Harrod) (gw) = Y / Y = s / cr According to the static model of K: -S = sY (propensity to save) -The applicationisgiven by the principle of acceleration, secondcoefficientcr: cr = Kr  /  Y = I / Y -ie, the amount of additional capital or I needed to produce additionalproductunitsat a giveninterest rate and given the technologicalconditions -The question, then: I  Y = cr -Ensurethat the plannedS are equal to I planned, wehave: sYcr =  Y -therefore:  Y / Y = s / cr = gw For dynamicequilibrium, the productshouldgrowatthis rate, that consumer spending must equal the value of production But, if shock-> deviation from equilibrium, itmayhappenthat c <crnamelythat the I collapse; thiscausesdeficiencies in equipment etc.. Thenmanifests incentive  I, but in this case the current rate can growbeyond the guaranteed (c> cr), then surplus capital, and fallevengreatergrowth rate In short, away from equilibrium, ratherthannarrow, resultingoscillations of increasing

  6. Harrod-Domar Modelnatural rate of growth (Domar’s contribution) • Evesey Domar, an american, workingindependently, concluded by H., but in a different way • I have a two-edgedsword: • increasedemand via the multiplier • increasesupply via effects on capacityexpansion • So, what rate of growthbecause I offergrowth = growth in demand and youhave full employment?

  7. Harrod-Domar Model natural rate of growth (Domar’s contribution) • D. introduces the natural rate of growth • Y = L (Y / L) • Twocomponents, bothexogenous 1. growth of the labor force (L) 2. growth of laborproductivity (Y / L) • A change in the level of I, demand: Yd =  I /S and I increasesif the sameoffering: Ys = Ip (p, capital productivity,  Y / I) • In order to haveYd=Ys, itisnecessarythat: I /s = Ip or I / I = sp • I.e. I has to growat a rate suchthatitmatches the propensity to save and the productivity of capital • The natural rate of growthissp (equal 1/crequilibriumHarrod) • But, evenif the growthensures full utilization of capital, itissaidalso to have full employmentlabor, whichdepends on the gn

  8. Harrod-Domar Model natural rate of growth (Domar’s contribution) • Role of the Harrod model: 1. Defines the rate of growth of production capacity that ensures the long-term equilibrium between S and I in order to have full employment 2. Fixing the upper limit of the current rate of growth that would lead to a useless accumulation . • If g> gw, -g can continue to diverge until it reaches gn when all the work is absorbed -it can never exceed gn because not enough work • In the long run, the relationship between gw and gn is crucial • Full employment of capital and labor requires: g = gw = gn • That is the famous "golden age" recovery of Cambridge’s economist Joan Robinson

  9. Harrod-Domar Model natural rate of growth (Domar’s contribution) Deviations between gw and gn gw> gn, excess capital and savings, tendency to depression due to lack of work (g fails to stimulate growth in demand The amount of savings that match with job) Typical of the crisis of '29 and maybe of today’s gw <gn, overwork, inflation (g grows more than necessary to match savings for labor), unemployment and lack of capital investment Typical of developing countries example: If population (2%) and productivity  L (3%) ->  workforce in terms of efficiency (5%) while  propensity saving (9%), requires a K / Y (3%): gw = 6 (gn = 5) Consequences: work efficiency> capital accumulation (rising unemployment) and  saving>  I (inflationary pressure) Unemployment and inflation together is not a paradox, but indicates that there are opportunities for increased investment to grow  K / Y up to 4, so that gw and gn can equalize in the long run

  10. Harrod-Domar Model natural rate of growth (Domar’s contribution) Adjustments between gw and gn in the event that gn> gw g S/Y I/Y gn 1/cr gw S/Y,I/Y 0 Vertical axis: growth. Horizontalaxis: savings and investment Growth and investment are related to K / Y (iecr) Propensity to saveisindependent from the growth To seek to balance the policies are: reduce laborsupply or productivity so as to reduce gngw adoptexpansionarymonetary or fiscal policies to moveS / Y to the right or evenstimulatelabor-intensive techniques, so as to raisegwgn

  11. Harrod-Domar Modelpolicy contributions • Not only interpretation but indications of policy • Eg. if country sets target growth of 5% and if the ratio K / Y is 3, the need for savings and investment is 15% of GDP

  12. Harrod-Domar ModelTheoreticaldebate • Of automatic adjustment related to the fact that L, L productivity, savings and demand for K are determined independently and HD themselves admit that in the long run propensity savings may vary, although it tends towards adjustment (in depression -> S may fall, in inflation -> grow) • Cambridge School (Robinson, Nicholas Kaldor, Richard Kahn, Luigi Pasinetti) -> emphasis on the functional distribution • In depression (gw> gn), share profits on wages is reduced, profits from savings> savings from wages, and this reduces the overall propensity to save and reduces to gn gw • In inflation (gn> gw), share of profits increases wages which deepens and increases propensity S gw to gn • In both cases, there are limits: the fall in profits acceptable for businesses, the fall in wages acceptable for workers

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