The Harrod-Domar Model Explained

Quick Definition: The Harrod-Domar model is a growth model used in development economics that states an economy’s growth rate is dependent on the level of saving and the capital output ratio.

What is the Harrod-Domar model?

The Harrod-Domar model was developed independently by Sir Roy Harrod in 1939 and Evsey Domar in 1946. It is a growth model which states the rate of economic growth in an economy is dependent on the level of saving and the capital output ratio.

If there is a high level of saving in a country, it provides funds for firms to borrow and invest. Investment can increase the capital stock of an economy and generate economic growth through the increase in production of goods and services.

The capital output ratio measures the productivity of the investment that takes place. If capital output ratio decreases the economy will be more productive, so higher amounts of output is generated from fewer inputs. This again, leads to higher economic growth.

Rate of growth (Y) = Savings (s)/ capital output ratio (k)

What are its implications?

This model is mainly used in development economics. It suggests that if developing countries want to achieve economic growth, governments need to encourage saving, and support technological advancements to decrease the economy’s capital output ratio. The Harrod-Domar model provides a framework for economic development and has been an important influence to government policies, such as India’s Five Year Plan (1951- 1956).

Key terms
  • Capital output ratio – Amount of capital needed to produce one unit of output.
  • Capital stock – The total physical capital available in an economy at any given time.
  • Economic growth – This is when a country’s production of goods and services increases over time.
  • Investment – This is spending that aims to generate income in the future. E.g. building factories and buying machinery.
  • Productivity – This is a measure of output per unit of input.