1.1. Harrod – Domar Growth Model

Harrod and Domar analyzed the dynamic nature of investment and demand and showed how variations in capital and in demand were responsible for instability in economic growth. Therefore, this model suggests that the economy’s growth rate depends on two factors:

Incremental Capital-Output Ratio The incremental capital output ratio (ICOR) is a metric that assesses the marginal amount of investment capital necessary for an entity to generate the next unit of production. For example, suppose that Country X has an incremental capital output ratio (ICOR) of 10. This implies that $10 worth of capital investment is necessary to generate

$1 of extra production.

♤ Level of savings; and

♤ Productivity of investment i.e. Capital to Output ratio.

Hence the rate of economic growth in a country depends on the rate of investment and capital-output ratio. Harrod and Domar arrived at the following relation:

Growth Rate = Investment * (1/Capital-Output Ratio)