DOMAR’S GROWTH MODEL
Prof. Prabha Panth,
Domar’s Growth Model (1946)
• Objective: to find that rate of growth of NY which
full employment requires – i.e. Full employment,
• Domar was interested in analysing: How an
economy that has reached full employment, can
grow at a constant rate in the future.
• His model analyses long term growth of capitalist
• Post Keynesian model,
• I =→ S, investment equals savings, and
importantly determines savings.
Features of Steady Growth
• Steady growth: the rate of growth should remain
constant over time.
• NY of an economy should grow at a constant rate;
e.g. if NY is growing at 3%, it should always
increase at 3%.
• If it keeps fluctuating then there is unsteady
• Steady growth is also called ‘Equilibrium growth.’
• In steady growth, aggregate supply = aggregate
demand while the economy is growing.
In Steady growth all the following grow at the
the rate of Investment (I/I),
= the rate of growth of capital stock (K/K), or
= the rate of growth of income or output (∆O/O)
= the rate of growth of employment (N/N)
As such the following remain constant in steady
• aggregate capital output ratio (K/O),
• the aggregate savings ratio (S/Y),
• the capital intensity (K/L)
Assumptions of the model
1. Aggregate model: aggregate Y, C, I, and S.
2. No changes in price level,
3. Net investment = ∆K (K
accumulation), durable K.
4. O/K ratio () is constant, given by technology,
5. Keynesian framework, I → ∆Y → ∆C and
∆S, i.e. I = S.
6. S/Y = ∆S / ∆Y and both are constant,
7. Full employment and full capacity utilisation,
Steady Growth Equation
1) Supply side: Y = I × , where = ∆O/ ∆K, the
incremental output-capital ratio.
2) Demand side: ∆Y = 1/s × ∆I, where 1/s = multiplier.
Steady growth requires S = D, or
(Y = I × ) = (∆Y = 1/s × ∆I)
∆Y/Y = (I × = 1/s × ∆I), or
Or ∆Y/Y = ∆I/I = G = s ×
This is Domar’s equation of Steady growth: G = s ×
The exponential growth equation: It = I0 e(s)t
Example if s = 0.2, and = 0.4, then G = 0.08 = 8%
Twin Effects of Investment
• Following Keynes, Domar showed that I = → S.
• After full employment is reached, Investment
has two simultaneous effects:
1) It leads to increase in National Income via the
multiplier, thus increasing Aggregate Demand.
Keynes, short term analysis.
2) But investment also leads to increase in the
productive capacity of the economy, i.e. increase
in the stock of capital, Domar: long term growth.
• DUAL nature of investment:
(a) Investment leads to increase in Y and
increase in C, i.e. Aggregate Demand .
(b)Investment leads to increase in K, and
productive capacity . Aggregate Supply
It is not necessary that these two will exactly
match, i.e. Increase in D increase in S. Also
there is a time gap between the two.
Only if these two are equal, then there will
be steady growth. There is only one unique
rate of growth that can equate them.
Asymmetrical effects of Investment
• I ∆Y at a constant rate, and is determined by
the multiplier (∆Y = I × 1/mps).
• Aggregate D increases at a constant rate.
• But I ∆ K, more and more addition to capacity
or to capital each year with Investment .
• Aggregate S increases at a faster rate.
• Therefore growth in Y has to be faster to keep up
with growth in capacity.
• Otherwise there will be unused capacity in the
Example of asymmetrical effects of
Let s = 0.2, = 0.5, initial capacity = 100
Year 1 2 3 4
∆I 200 200 200 200
Y = ∆I .1/s =200 × 1/0.2 1000 1000 1000 1000
Capacity= 1000 +
∆I . = 1000 + (200 ×
1100 1200 1300 1400
in Y is
there is a
S and D
How to achieve steady growth
• In the above example, ∆I is constant each year.
• Domar points out that ∆I should increase each
year for D to catch up with S.
• The steady growth of this investment should be
equal to: G = ∆I/I = s ×
• ∆I should increase at a steady rate every year.
• In this example = s × = 1/5 × ½ = 1/10 = 10%.
• If this economy grows at 10%, then it is possible
for demand to catch up with supply,
– There is steady growth.
– But it takes place after one year’s time lag.
Taking s = 0.2, = 0.5, initial capacity = 100, G = 10%
Year 1 2 3 4
∆I 200 220 242 266.2
∆Y = ∆I .1/s 1000 1100 1210 1331
Capacity = ∆I . 1100↗ 1210↗ 1331↗ 1464↗
By increasing Investment by 10% each year, it is
possible to increase effective demand ∆Y, and make
it equal to increase in capacity or Supply. This
ensures steady growth, but after a time lag.
• Domar showed that if the economy is not having
steady growth, it leads to junking of extra capital.
• Hundreds of entrepreneurs invest independently.
• So actual capital stock > required capital stock for
• Therefore the extra capital will be “junked”
• It may also lead to fall in investment, and to
disequilibrium situation again (recession).
1) Domar does not have an Investment
function, on what factors does investment
2) O/K or is constant, no technical progress.
3) Full employment is not discussed, but assumed.
4) Aggregate analysis,
5) Does not show how to make G = s × if the
system is not in steady growth.
6) Does not discuss inflationary situation, only over
production and recession.