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# 5 Harrod’s growth model

Post Keynesian theory of growth. Meaning of steady growth, instability problem, knife edge problem

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### 5 Harrod’s growth model

1. 1. HARROD’S GROWTH MODEL LECTURE 6
2. 2. OBJECTIVES To determine:  What are the conditions necessary for Steady Growth?  Is there stability of Steady Growth? Assumptions:  Post Keynesian model, S/Y = S/ Y = s  I = ( Y), I is Induced investment, function of increase in Y.  Keynesian causation, I = S  Capital is durable and produces C goods,
3. 3. 5) = incremental K/O ratio, constant, given the technology. I = ( Y), or = I/ Y = K/ Y, 6) No capital depreciation, I = K, 7) Aggregate analysis, Y, C, S, and I in aggregate, 8) Growth of labour is given exogenously I) The Actual Rate of Growth (Ga) The economy has some rate of growth = Ga, But this rate may not be steady growth, S = sY0 ------- (1) I = a(Y1 – Y0) ------ (2) At Equilibrium I = S, a(Y1 – Y0) = sY0
4. 4. Ga ≡ s/ a -------- (3) This equation of growth is a truism Ex post savings in period t is equal to addition to stock of K, S = I. But Ga need not be steady growth. It is the rate at which the economy is actually growing. or (Y1 – Y0) = s = Ga = Y Y0 a Y
5. 5. 2. Warranted Rate of Growth: Gw. • Entrepreneurs take independent investment decisions, • May or may not be satisfied with the present rate of growth, Ga. • They wish for a Desired or Warranted Rate of growth, which satisfies them. • If they are satisfied, they will continue investment at the same rate in future. Warranted rate of growth Gw = s/ d Where d is the desired K/O ratio
6. 6. Features of Gw: 1) Rigidly given only one d can achieve steady growth. 2) Equality of I and S: the ex ante S should be exactly equal to the ex post I. Gw I Y = C , S
7. 7. Instability  Ga Gw, the actual rate of growth may not be equal to warranted rate of growth.  If Ga Gw = instability, and they can never become equal. Instability continues.  If Ga = Gw, then there is steady growth, but this is difficult to achieve.  Instability occurs because entrepreneurs do not properly understand the signals in the economy.  Harrod explains how entrepreneurs react to the inequality of Ga and Gw.
8. 8. 1. Explosive Situation: a) In the first case: Ga > Gw, then s/ a > s/ d Assuming s is same for both, a < d , i.e. the actual K/O is less than the desired K/O. Example: • Ga = 5% > s = 10%, s/ a = 10/2 = 5% • Gw = 2.5%, s = 10%. s/ d = 10/4 = 2.5% Entrepreneurs want K/O to be 4, but actually it is 2. So to increase K/O they increase Investment. But increase in Investment, leads to Ga increase, Gap between Ga and Gw increases. This leads to a BOOM or Inflationary situation.
9. 9. 2. Contraction:  If Ga < Gw, then a > d, given s.  E.g. If Ga = 2%, s = 10%, then a = 5.  Gw = 5%, then d= 2, i.e. a > d  Entrepreneurs think they have over invested, and reduce their investment.  When investment falls, actual rate of growth falls.  This leads to recession and unemployment.
10. 10. Instability Gth % Time Gw = Steady growth Ga Expansion Ga Contraction 0
11. 11. Conundrum  Thus when entrepreneurs think they are producing more they are actually producing less. Gw > Ga,  When they are think they are producing less, they are producing more. Gw < Ga.  Therefore Harrod concludes that because of wrong reasoning by entrepreneurs, it is not possible to achieve Steady Growth.  Thus growth in a capitalist economy is basically unstable.  No self correcting mechanism to achieve steady growth, as s, and I are rigidly given.
12. 12. Natural Rate of Growth (Gn)  Will there be full employment also with steady growth?  Will there be full utilisation of productive capacity? Gn = GL + GT  GL= long term growth of population,  GT = neutral technical progress (K/O constant)  GN is the maximum rate of growth of the economy, the ceiling rate of growth.
13. 13. Full employment, steady growth If GA = GW = GN = Full employment, steady gth. = s/ a = s/ d = GL = GT But s, a, d, population growth, technical progress are all given exogenously. Therefore this equality can never be achieved. So full employment, steady growth is impossible, according to Harrod.
14. 14. The Knife Edge To show the instability and uniqueness of full employment, steady growth. GA GW GN 1) GA > GW > GN : Actual growth is above the ceiling growth, but this cannot be sustained by population and technical progress. Labour shortages develop and prevent further growth. GA falls. 2) GA < GW < GN : deflationary conditions, with rising unemployment.
15. 15. • s and rigidity is unreasonable, can change. • Does not show how steady growth is achieved, only deviations from it. • Entrepreneurs are myopic, and do not learn from their mistakes. • No policy prescriptions • No role of autonomous investment, main Keynesian principle. CRITICISM:

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Post Keynesian theory of growth. Meaning of steady growth, instability problem, knife edge problem

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