Simple Growth Model

a.k.a Harold Domal Model (1946)

Two important factors

• Savings of the Economy - $S$
• ICOR¹ - $V$ (Incremental Capital Output Ratio)

Savings rate, $s$ = $\frac{S}{Y}$ where $S$ is nominal Saving rate and $Y$ is nominal income

$ICOR$ reflects the productivity

Say, $ICOR=\frac{\Delta K}{\Delta Y}=v=4$ meaning, we require 4 unit of capital to increase output by 1 unit

In terms of units / money $\to$ ₹4000 of capital required to increase output by ₹1000

If I invest 4000 now, I get back 1000 each year, so I get back my investment in $4$ years. This is the same as the $ICOR$ value.

$ICOR$ cannot be amended easily Efficiency of Capital is very difficult to meddle with in the short run

• Saving rate in India right now is about $30\%$ so the growth rate (which is currently $7\%$) can be computed as

$$g^{\ast }=\frac{s}{v}=\frac{30\%}{4}=7.5\%$$

Rate of growth of economy can be calculated by Harold Domal Model (1946)

$$\boxed{g^{\ast }=\frac{s}{v}}\text{\hspace{1em}(1)}$$

which captures the interrelationship between the growth rate $g^{\ast }$, saving rate $s$ and the productivity of capital $v$. It ignores the role of labor altogether (limitation) thus, taking labor also into consideration is the Solow’s Model of Economic Growth.

Footnotes

1. Incremental Capital Output Ratio. The Capital Output Ratio is the ratio between the capital and the output. How much of capital is required to get one unit of output? The I is incremental (additional unit of capital required to create an additional unit of output) ↩