The Harrod-Domar Model I

After World War II, many newly independent nations aimed for rapid economic development. The Harrod-Domar model, proposed by Roy Harrod and Evsey Domar, provided a simple rule:

Growth rate = Saving rate ÷ Capital-output ratio.

The model links growth to two key ideas:

First, the saving rate refers to the portion of national income that is saved. For example, if people save ten dollars out of every one hundred dollars earned, the saving rate is ten percent. The model assumes that all saved income is invested, which increases the capital stock.

Second, the capital-output ratio shows how many units of capital are needed to produce one unit of output. For instance, if 50 dollars of capital generates 10 dollars of output, the capital-output ratio is five. A lower capital-output ratio means less capital is needed to produce one unit of output.

Now, if a country has a saving rate of ten percent and a capital-output ratio of two, its growth rate would be five percent.

In short, the model says that more savings and more efficient investments drive faster economic growth.