2. Introduction
• Extended form of Keynesian analysis to long run
• Dual effect of investment:
i. Increase AD and Income through multiplier process,
ii. Raises productive capacity ( ignored by Keynes)
• Seeks to determine unique rate at which investment and
income must grow- full employment for long run
• As investment increases - Income increases - AD
increases - Output increases - Employment increases
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3. Domar’s Growth Model
• Fundamental Growth Equation
∆Y = ∆K. (∆Y/∆K)
Where, ∆Y = Increase in National Income during a period
∆K = I
∆Y/∆K = marginal output-capital ratio (= Y/K
assume = σ)
So, ∆Y = Iσ ………..(i)
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4. • Demand or income effect of investment
Increase in income is given by the increase in investment and
size of multiplier
∆Y = ∆I/s …….. (ii)
Where, 1/s = size of investment multiplier
• Domar’s Growth Equation in terms of rates of Growth
∆Y/Y= (∆K/Y).(∆Y/∆K)
Gy = (I/Y).(∆Y/∆K)
Gy = (I/Y).σ
To maintain full employment, S = I
Gy = (S/Y).σ
Gy = s.σ ( where, s = saving ratio) …….(iii)
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5. • Equilibrium Growth Condition
From equations (i) and (ii), we get rate of investment
Iσ = ∆I/s
Or, ∆I/I = sσ ……(iv)
From equations (iii) and (iv), Equilibrium growth is given by,
Gy = ∆Y/Y = ∆I/I = sσ
Thus, rate should be equal to the propensity to save (s)
multiplied by output-capital ratio (σ).
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6. Harrod’s Growth Model
• Truly Dynamic one
• Seeks to explain secular cause of unemployment and
inflation and the factors determining equilibrium and
actual rate of capital accumulation
• Three basic elements:
a) population growth,
b) output per head as determined by level of investment,
and
c) capital accumulation
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7. • Two assumptions:
i) Saving in any period of time is constant proportional to
rate of increase in income
S = sYt
ii) The investment is proportional the rate of increase in
income
∆K or I = ν(Yt – Yt-1)
Since, saving must be equal to actual investment, we have
ν(Yt – Yt-1) = sYt
ν(Yt – Yt-1)/Yt = s
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8. (Yt – Yt-1)/Yt = s/ν
Gy = s/ν
Warranted rate of Growth : Fundamental growth equation
• Describes Equilibrium growth at steady rate
• A rate of growth if it occurs will keep the entrepreneurs
satisfied that they have produced neither more or less
than the right amount
Gw = s/νr
Where, νr = required ICOR to sustain the warranted rate of
growth
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9. • It is determined by the state of technology and the nature
of goods constituting the increment in output
Condition for the equilibrium growth rate
• if incremental capital-output (ν) actually realized happens
to be equal to required capital-output ratio (νr) warranted
by technological and other conditions, then
Gy = Gw
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