Keynes’ model and Keynesian models were developed to explains business cycles: a short run phenomena
As such they attribute a major role to aggregate expenditures (demand side)
Regarding the supply side, they assume that there is unemployment: production responds fast to increases in aggregate demand because capital and labor is unemployed.
Factors presentsin Keynesian’s growth model
Aggregate Demand, AD
– AD = C + I + G + X-M
– C, Consumption expenditures
– I, Investment expenditures
– G, Government expenditures
– X-M, Foreigners’ Expenditures
– AS < ASfe
– Aggregate Supply, at full employment
– AS = AD
– S = I
A Keynesian growth model takes a long run perspective.
– Aggregate demand(or savings=investment) still is important, but
– It also includes the aggregate supply
Investment has two impacts:
On expenditures (in the short run)
On capital stock (in the long run)
Keynesian’s growth model graphic
The representation of Keynesian growth model:
Economic growth can be accelerated by
– changing the saving rate
– improving technology.
Saving rates andtechnology can be changed
– government interventions without consideration to prices
The Harrod-Domar Growth Model
The Harrod–Domar model is used in development economics to explain an economy's growth rate in terms of the level of saving and productivity of capital. It suggests that there is no natural reason for an economy to have balanced growth.
This model suggests savings providethe funds which are borrowed for investment purposes.
The model suggests that the economy's rate of growth depends on two factors:
• the level of saving
• the productivity of investment i.e. the capital output ratio
At the beginning the Harrod-Domar model was developed to help analyse the business cycle. However, it was later adapted as an explanation of economic growth. It concluded that:
•Economic growth depends on the amount of labour and capital.
• As Least Developed Countries often have an abundant supply of labour it is a lack of physical capital that holds back economic growth and development.
• More physical capital generates economic growth.
• Net investment leads to more capital accumulation, which generates higher output and income.
• Higher income allows higherlevels of saving.
Implications of the model
The key to economic growth is to expand the level of investment both in terms of fixed capital and human capital. To do this, policies are needed that encourage saving and/or generate technological advances which enable firms to produce more output with less capital i.e. lower their capital output ratio.
Basically, the Harrod Domar model can beresumed in one equation:
- g is the growth rate of national income
- s=S/Y is the ratio of saving S to income,Y,
- c is marginal capital-output ratio
Under the guess of constant c, g increases proportionally with s. Because s is considered to increase proportionally with income per capita, s is bound to be low and, for this reason, g will be low in low-income economies if savingsand investment are left to private decision in the free market. The model implies, therefore, that the promotion of investment by government planning and command is needed to accelerate economic growth in low-income economies. In fact, the Harrod-Domar model provided a structure for economic planning in developing economies, such as India's Five Year Plan.
Problems of the model
• Economic growthand economic development are not the same. Economic growth is a necessary but not sufficient condition for development. We have to consider the human being as a part of the economic development.
• Practically it is difficult to stimulate the level of domestic savings particularly in the case of Least Developed Countries where incomes are low.
• Borrowing from overseas to fill the gap caused...