The Harrod-Domar model

ECON 1910 spring 2007

Technology

We have an economy with capital stock K, workforce L, and production Y . To produce one
unit of goods, we need

units of capital and

1
v

units of labour, where

and v are numbers.

This is called a Leontief technology. It means that in most cases, we will have either excess
capital or excess labour (it could in theory also balance perfectly).
We will assume that there is plenty of labour so capital is the limiting factor. then
production is
1
Y = K:

Investments and savings

We assume a closed economy (no trade or capital ows). Then savings S must be used for
investments I, and investments can only come from savings. Hence they must be equal:
S = I:
We assume further that a constant fraction of income is saved. Call this fraction s; this
is the savings rate. Income comes from wages and the returns to savings, which in the end
come from production, so income is Y and hence savings are
S = sY:

The dynamics of the capital stock

In year t, the stock of capital is Kt . The year after, year t + 1, the capital stock is Kt+1 .
Changes in the capital stock comes from investments and the depreciation (wearing out) of
the capital stock. Depreciation occurs at a constant rate , so an amount Kt of capital
disappears every year. Hence the capital stock is
Kt+1 = Kt + It

Kt :

Solving the model

The growth rate of capital is dened as

gK =

Kt+1 Kt
:
Kt

We then get
gK =

Kt+1 Kt
It
Kt
It
=
=
Kt
Kt
Kt

Kt
sYt
=
Kt
Kt

Also, we know that Yt = 1 Kt , so

1

gK = s

Kt
Kt

As we are mostly interested in the rate of growth of GDP, we use that Yt = 1 Kt .Then we
get that growth in GDP is
g=

1
Kt+1 1 Kt
Kt+1 Kt
Yt+1 Yt
=
=
= gK ;
1
Yt
Kt
Kt

so as long as capital is the limiting factor, GDP and capital grow at the same rate. Hence
growth in GDP is
g=