Tuesday, 9 April 2013

Assumptions of the Harrod Domar Model

  1. There is a direct relationship between size of total capital stock, k, and total GDP Y, it follows that any net additions to the capital stock in the form of new investment will bring about corresponding increases in the form of national output. 
  2. Assume unemployed labor, so there is no constraint on the supply of labor. 
  3. Production is proportional to the stock of machinery. 
  4. The Harrod-Domar model assumes that savings and investment are all that is needed to generate growth. In reality, several complementary factors are required – for example, a healthy and educated workforce, growth in infrastructure (roads, water, electricity etc) to support growth in production, political stability, and the existence of financial institutions such as banks to channel savings into investment. Institutional factors have been assumed to be given in these models. But the reality is that economic development is not possible without institutional changes in such countries. Therefore, these models fail to apply in underdeveloped countries.
  5. An implicit assumption of the Harrod-Domar model is that there are no diminishing returns to capital.
  6. These models start with the full employment level of income but such a level is not found in underdeveloped countries. There exists disguised unemployment in such countries which cannot be removed by the methods suggested by Harrod-Domar. Thus the main assumption of the Harrod-Domar models being absent in underdeveloped countries, these models are not applicable to them.
  7. The Harrod-Domar models are based on the assumption that there is no government intervention in economic activities. This assumption in not applicable to underdeveloped countries because they cannot develop without government help in such countries the role of the state as a 'pioneer entrepreneur' in starting large industries and in regulating and directing private enterprise has been increasingly recognized.
  8. The Harrod-Domar models are based on the assumption of a closed economy. But underdeveloped countries are open rather than closed economies where foreign trade and aid play very crucial roles in their economic development. Both these factors are the bases of their economic progress.
  9. These models are based on the unrealistic assumption of a constant price level. But in underdeveloped countries price changes are inevitable with development
  10. Capital depreciation and gestation lags break the equation : S=I.
  11. Difficulty to define the determinants of the saving rate. No perfect policy to raise it. 

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