Karl Marx:

- Like Smith and Ricardo, Marx believed that the profit rate would decline as capitalist economies
developed, and that this would reduce investment and therefore the rate of economic growth.
- He saw the eventual demise of investment as resulting initially from the pressure of capital
accumulation on the labor market, which would tend to push up wages.
- He argued that capitalists might seek to resist this by direct action to hold wages down, which
would give rise to social conflict.
- They might increase the capital intensity of production by increasing the ratio of spending on
capital equipment and industrial raw materials, Marx’s Constant Capital, to the wage bill (variable
capital).
- However, increasing capital intensity absorbs more capital and reduces the profit rate, and saw it
is not a long term solution.
- Moreover, as machinery replaces men, the labor force (consumers who create effective demand)
can no longer purchase all of goods being produced, causing deficit Effective Demand. And
consequently, the system will collapse, leading to a transition to socialism.

Keynesian Growth – the Harrod-Domar Model:

- Harrod-Domar Model was designed to extend Keynesian analysis into the growth area.
- The Harrod-Domar Model predicted serious inherent instability for capitalist economies and much
subsequent decision of growth focused on this issue.
- They found that most possible combinations of values of the savings rate, the level of investment,
the capital-output ratio, and the growth rate of labor force would result in a tendency for the
economy to be unstable with growing unemployment of either labor and capital stock and to
possess no self correcting mechanism.
- Our focus has been on the use of the basic equation of Harrod-Domar Model to estimate the
saving and investment requirements for particular rates of growth.
- The Harrod-Domar Model uses a very simple production function.
- This function says that there is a fixed, constant relationship between the amounts of capital (K)
invested and the amount of output (Y) produced using the capital. That is, the capital output ratio
(K/Y) is constant. let (V) to call the ratio.
- As constant returns to scale is assumed, it also applies to any increase in the capital stock ΔK,
and to the associated increase in the output ΔY, produced by this new capital stock.

1
Example:
Given the following information for an economy, Saving rate is 30% (30 percent of output is saved for investment
purposes) and the capital output ratio is 3 (each additional unit of output requires 3 units of capital to produce it),
what is the growth rate of output.
Answer:
S 30
G= = =10 percent annum
V 3