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Chapter Four Growth Theories

1) The document discusses several growth theories including the Harrod growth model, Domar growth model, Solow growth model, and Kaldor model. 2) The Harrod and Domar models suggest that an economy's growth rate depends on the savings rate and capital productivity. They argue that investment must grow at an increasing rate to maintain full employment. 3) The Solow model introduces technological progress and diminishing returns. It shows that an economy will converge to a steady-state growth path determined by the savings rate, labor growth, and technological progress.

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127 views

Chapter Four Growth Theories

1) The document discusses several growth theories including the Harrod growth model, Domar growth model, Solow growth model, and Kaldor model. 2) The Harrod and Domar models suggest that an economy's growth rate depends on the savings rate and capital productivity. They argue that investment must grow at an increasing rate to maintain full employment. 3) The Solow model introduces technological progress and diminishing returns. It shows that an economy will converge to a steady-state growth path determined by the savings rate, labor growth, and technological progress.

Uploaded by

notes.mcpu
Copyright
© © All Rights Reserved
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CHAPTER FOUR

GROWTH THEORIES

1. HARROD GROWTH MODEL:


Developed by Sir R. F. Harrod in 1939 AD.
This Model is used to explain an economys growth rate
in terms of level of saving and productivity of capital.
This model suggests that there is no natural reason for
an economy to have balanced growth.
This is the first theory to introduce dynamic analysis in
the literature of growth.
It was designed to support Keynesian attack on
classical theory that full employment equilibrium is not
guaranteed.

PROPOSITIONS:
The economys saving during time period t is a constant
proportion of income of that period.
Mathematically,
S = sY (0<s<1) .(1)
Where, S = Saving
s = Marginal propensity to save(mps)
Y = Income
2. Entrepreneur's or investors desired investment during time
period t is equal to constant (v, acceleration coefficient) times
the increase in income of that period over the previous period.
Mathematically
dY
(v 0)
(2) I v
1.

dt

MODEL:

The investors desire to invest is to be satisfied then,


S= I

dY
sY v
dt
dY
s

Y
dt
v
1 dY
s
..................(3)
Y dt
v

Integrating from 0 to t we get,


t

1
s
0 Y dY v

dt
0

s t
log Y t 0
v
Yt
s
log
t Taking Antilog on both sides ..
Y0
v
t
0

( )t
Yt
e v
Y0

s
v

Yt Y0 e

s
( )t
v

is Harrods warranted growth rate which tells how income


should behave if investors desire to invest to be satisfied.

The equilibrium growth rate of output is equal to the ratio of


MPS (s) and accelerator or Capital output Ratio(v). Since,
s>0 & v>0, the time path of income is monotonically
increasing implies that if income grows today, it must grow
by higher absolute amount tomorrow if full employment
equilibrium is to be maintained in the economy.
There are 3 types of growth rate, which are:
1. Actual growth rate: (G) = s/v
2. Warranted growth rate:(Gw)= s/vw
3.

Natural growth rate:(Gn) = n (when technology is


introduced , Gn = n+m)

According to this model, at steady-state full employment


growth , G=Gw=Gn. If G>Gw or s/v>s/vw actual stock of
capital<desired stock of capital i.e. deficiency of capital . If
G<Gw, actual stock>desired stock of capital i.e. surplus of
capital.

2. DOMARS GROWTH MODEL:


This model is developed by Evesey Domar in 1946 AD.
The basic proposition of the model is that any change in
the investment flow per year has dual role- it will
increase capacity of the economy to produce more
output in the future in one hand and generate
income to stimulate aggregate demand in the
economy on the other.
Fundamental conclusion is that, if investment grows
today it must grow by higher absolute amount tomorrow,
if full employment equilibrium is to be maintained.

ASSUMPTIONS:
1.
2.
3.
4.
5.
6.

Investment has dual character.


Economy is at full employment level of income or full
capacity growth rate = full employment growth rate.
APS & MPS are equal.
No change in technology.
The substitution between factors of production is
possible.
There is no automatic adjustment between supply and
demand in different sectors etc.

MODEL:
Supply side:
Domar assumes that the amount of output (Y) that the
economy can produce is proportional to the size of
capital stock.

Y p K ............(1)
Where, =capital coefficient or given COR.
Then we have,

dYP
dK

I ................( 2)
dt
dt

Demand Side:

Yt C I
Yt cYt I
Yt cYt I
Yt (1 c ) I
1
Yt
I
1 c
dYt
1 dI

dt
1 c dt
dYt
1 dI

.....................(3)
dt
s dt

MACROECONOMIC EQUILIBRIUM:
Demand Side = Supply Side
1 dI
I
s dt
dI
or ,
sI
dt
1 dI
or ,
s
I dt
Integrating , weget

1
dI s dt
I
or , log I st
or ,

or , I t I 0 e st

It shows that, investment


must
grow
at
an
exponential rate of s to
maintain
a
balance
between
capacity
and
demand over time.

Investment

Graphically,
It=I0 est

I0
O

Time

If r(growth rate of income) >s Shortage of capacity


To cope with this, investors will invest more which means
increase in r but it is already more than s.
If r<s Surplus of capacity
To cope with this, investors will decrease investment which
is already less than s.

INTEGRATION OF HARROD-DOMAR
MODEL:
Both Harrod and Domar model reach to same conclusion
that investment is the central element in growth process.
If investment grows today, it must grow by higher
absolute amount tomorrow, if full employment equilibrium
is to be maintained in the economy.
But the way of Harrod and Domar are different.
Harrod is Backward Looking i.e. his analysis is based on
the response of current investment to a change in the
economys output or real income or it examines whether a
change in output in current period is sufficient enough to
induce the net investment equal to realized saving at full
employment equilibrium.

Domar Model is forward looking i.e. it examines the


role at which the investment must grow tomorrow in
order to fully warrant the productivity of the economys
unleashed by todays investment.
Harrods model can easily be explained as Domars
model without effect in fundamental conclusion.
Both models show that, to maintain full employment,
desired savings out of a full employment level of income
must be offset by an equal amount of desired
investment.

Let, S is desired saving. I is desired investment.

S sYwhere0 s 1
I vY
WhenS I
sY vY
Y
s

Y
v
Y
1
s
Y
v
Y
s
Y

Therefore, Harrods warranted


growth is equal to the
equilibrium rate of growth.
Thus depends on the size of
multiplier
(s)
and
the
productivity of capital ().
It means the mere-conclusion of
both the models is same.

SOLOW GROWTH MODEL:

This model is developed by Robert Solow in 1956 AD.


It was also tested by Trevor Swan in 1956 AD. So, this model
is also called as Solow-Swan Model.
Harrod-Domar
model believed that the equilibrium
maintains at knife-edge balanced situation, if there is
deviation from that path, it would result into further move
away from the path.
But Solow-Swan argued that COR of H-D model should not
be regarded as exogenous.
They proposed a growth model where COR (or v) was
precisely the adjusting variable that would lead a system
back to its steady-state growth path.
This model is also called as Neo-classical growth model.

MODEL:

This model starts with Constant Returns to Scale of


Homogeneous Production function of degree one.
i.e. Q = f (K,L)
i.e. zQ = f(zK, zL) (CRS applies)
It is assumed that, marginal productivities of both factors
of production (K &L) are positive.
i.e. fk>0, fL>0
it is also assumed that, there is diminishing returns to
each inputs.
i.e.
fkk<0, fLL<0

If the given production function is linearly homogeneous,


Q
K L Increase in K&L by 1/L,
f
, Q will also increase by 1/L.
L
L L
K
QL Q *and
K*
L
Q * f ( K * ,1)
or , Q * f ( K * )
Q
*
Since, Q
L
Q
f (K * )
L
Q Lf ( K * )................( a )

Here, MP f dQ
K
K

dK

Lf ( K *
dK
dF ( K * )
L
dK
dF ( K * ) dK *
L
dK * dK
K )
d
(
L
LF ' ( K * )
dK
'
* 1
LF ( K )
L
F ' ( K * ) 0.....................(i )

And,

'

FKK
FKK
FKK

d ( f K ) dF ( K )

dK
dK
d [ F ' ( K * )] dK *

*
dK
dK
"
*
F (K )

0
L

Since, L will not be less than 0,

F " ( K * ) 0...............(ii )

In an equilibrium economy,
S=I

Here, I is the change in Capital stock in the economy, it is


continuous change,

dK
I
K t K t 1 K
dt
Savings at any time is ,

S sY
or , S sQ (0 s 1)
whenS I

K sQ

Solow defines a labor equation, L=L0et


K sQ

from.....( a )Q LF ( K * )
K sLF ( K * )
K sL0 e t F ( K * )..............(iii )
K*

K
, or , K K * L
L

We know that,
dK
d

( K * L)
dt
dt with respect to t we get,
Differentiating
K
*
dL
dK
L
dt
dt
t
*
d
(
L
e
)
dK
0
K*
L0 e t
dt
dt
K*

dK
K * L0 e t L0 e t K *
dt

K K * L0 e t L0 e t K *
t

sL0 e F ( K ) K L0 e
*

L0 e K

sF ( K * ) K * K *
K * sF ( K * ) K *
It is Solows Fundamental Equation.

Graphically,

K *
K*

sF(K*)

K*1

K *2

K*3

K*
K *

E is the equilibrium of the economy with Capital per capita K* 2,


Which is Stable.

Test for stability:


If K * 0, K * Cons tan t

K
Cons tan t
L
It means when L increase at constant rate of , both
L&K increase at rate at equilibrium.
or ,

At
At

K *1 , K *

dK *
0, Should
0,be
i.e.increasing.
K*
dt

K *3 , K *

dK *
0, Should
0,be
i.e.decreasing.
K*
dt

Technology
is
increasing function of
t, it means when
technology
is
introduced and as the
state of technology
improves over time,
sF(K*)
curve
will
secularly
shift
upwards.
Increasing
K* at higher point E1
resulting
a
higher
value of K*.

K*

WHEN TECHNOLOGY IS INTRODUCED:


K*

E1
E

K*1

sFt(K*)
sF(K*)

K*t

K *t

K*

IMPLICATIONS OF THE MODEL:


1.When,

sF ( K * ) K *
F (K * )

*
K
s
Q
L
K
s
L
Q

K
s
Q
s
K
s

,K
C .O.R (v )
Q
K
Q
s

v

Here, s/v is Harrods warranted growth rate.

2. When, s = 0
K * sF ( K * ) K *
K * K *
K *

*
K

Growth rate of K* should be or proportionate change


in capital output ratio is negative of . Which implies
that capital output ratio will decline with the growth
in labor.

3. When =0
K * sF ( K * )
Q
K s
L

K
K
K *
K sQ
L K

K
K
K * K *
K*
K
L
K * K

*
K
K
*

It shows that in case of no growth in labor, proportionate


change in capital-labor ratio is equal to the
proportionate change in capital.

KALDOR MODEL:
As we know, Harrod-Domar Model is based on static
saving-Income Hypothesis.
Professor Kaldor developed new growth model assuming
the variability of saving-Income Hypothesis.
This model is based on the classical saving function i.e.
S=F(Y).
According to Kaldor, Multiplier model can be used to
determine the relationship between Price and wage rate
when the level of production and employment is given.

ASSUMPTIONS OF THE MODEL:


Economy will be at full employment when gross
output/income is given.
Wage and Profit are only included in NI.
MPC of poor is higher than that of rich people.
Income Output (I/Y)ratio is independent.
There exists imperfect competition or monopoly in the
economy.

MODEL:
According to Professor Kaldor,
Y=W+P or, W=Y-P
where, Y=National Income
W=Wage
P=Total Profit
Again, S=Sw+Sp
or, S=swW+spP
When,

S=I
I=swW+spP

or, I=spP+sw(Y-P)
or, I=spP+swY-swP
or, I=(sp-sw)P+swY

Dividing both sides by Y, we get

I ( s p sw ) P swY

Y
Y
Y
I
P
( s p sw ) sw .............(1)
Y
Y
P I
( s p sw ) sw
Y Y
sw
P
1
I


.................( 2)
Y ( s p sw ) Y ( s p sw )
Hence, ratio of profit and Income is determined by the ratio
of Investment and income,when MPS is given.

When, sp>sw, increase in I/Y also increases P/Y.


Graphically,
I/Y, S/Y

S/Y1
S/Y0

I/Y1

E1
F

I/Y0

P/Y

P/Y1

P/Y

According to Kaldor Model,


1
is sensitivity multiplier of income distribution.

s p sw

When the difference between sp and sw is less, the value of


multiplier will be high. It means, small change in I/Y may
also bring high change in P/Y.

1
When sw=o, P itI means when sw=0, Profit
sp
depends on the consumption of profit income by the
capitalists rather than labor. This problem is called as
widow curse and a special condition in which economy is
controlled by capitalists and there is no role of labor.

Limitations of Kaldor Model:


1. sw<I/Y
economy
enters
into
permanent
unemployment problem.
2. Sp>I/Y- economy enters into permanent inflation.
Hence Kaldor model explains how Profit distribution
and investment creates long term equilibrium of the
economy through the solution of above stated two
limitations.

RECENT INNOVATIONS IN GROWTH


MODEL:
Economic growth and its theories got Considerable attention
directly after second world war.
Contributions from different economic schools such as NeoKeynesian (The Harrod-Domar Model), the Post-Keynesian
(Kaldor Model) and Neo-classical (Solow Model) explained about
the determinants and paths of economic growth in their own ways.
According to Bart Verspagen in Journal of Macroeconomics, Some
recent literature in the neo-classical tradition dealing with the
relation between endogenous technological change and economic
growth is summarized. The main results of this new neo-classical
appraoch to economic growth are compared to the basic (Solow)
neo-classical growth model. Special attention is paid to the role of
government in the process of economic growth and endogenous
innovation.

From the Above statement it is clear that Technology as


endogeneous factor is considered as most important in
recent develpoments in Growth model.
The extent of Externalities and Increasing returns in the
production process is also considered as Innovations in new
Neo-classical models.

SCEMATIC REPRESENTATION OF MAIN


ARGUMENTS FOUND IN NEW NEO-CLASSICAL GROWTH
THEORIES ON INTERNATIONAL TRADE AND ECONOMIC
GROWHT.

Reference

Difference

Character of

Trade and/or

between

technological

Technology policy

Lucas(1988)-II

Endowments

Localized learning
at different rates in
different sectors.

Not explicitly treated


in the model.

Grossman and
Helpman(1991)

Endowments

Stochastic quality
improvements

Trade
policy
not
effective , technology
policy effective

Grossman and
Helpman(1990)

Endowments ,
technological
Capabilities

New varieties of
intermediate goods

Possibly
(both)
to
growth rate.

effective
increase

Grossman and

Endowments ,

New varieties of

Possibly

effective

countries

change

effective?

THANK YOU!

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