5 Harrod’s growth model

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

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  • Thanks for the site
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  • If you are interested in the Chinese economy, then the answer is much more complicated. I suggest you read online, I found this site giving a good explanation of the downturn. //www.quora.com/What-is-the-reason-for-the-slowdown-of-the-Chinese-economy,
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  • Thanks for the answer. I am reading a few of the books on macroeconomics to understand the processes involved. The interest was triggered by the recent downturn in the Chinese economy. However, while going through your slides to understand the growth model I found them hazy and at best confusing. It is perhaps owing to my academic background. But when I read some of the foreign authors especially Fisher and Abel. et. al I find them transparent and easy to understand. I dont know why. I would certainly try to read your book, but I must confess: if it's loaded with mathematical redundancy at the cost of economic argument then your work is not my cup of tea. So would you let me know the nature of your work at least briefly. Thanks again for the answer.
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  • @Mukund Giri . As you know, Harrod was a Post Keynesian. I think you are under some misunderstanding. The entrepreneurs do not try to increase K/O ratio, because the Post Keynesians reject the homogeneous and malleable capital model of the Neo-classical economists. In Harrod's model, the rigidly given GW can be adjusted by changing the savings ratio. When growth is taking place, Income increases, and when Income increases both Consumption and Savings increase. Ex Post Savings become equal to Investment. So in the Keynesian framework, Investment is the prime mover, and savings becomes equal to investment ex post. Please check up your Keynesian theory. Your first question - the entrepreneurs do not increase the K/O ratio as it is given by technology. As K/O is fixed by technology, and S/Y by savings behaviour of the public, Harrod points out that it is not possible to achieve steady growth in the capitalist system. If it occurs than it is by fluke. The explanation is too lengthy to include here. I recommend that you read our book on "Models of Steady Growth" which I have written with Prof. Kamala Subramaniam, and published by Himalaya Publishers. You may find the answers there. If not you are welcome to contact me again.
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  • How does the investment of the entrepreneurs increase when they try to increase capital output ratio. The answer is not clear. Would you please explain the slides clearly? Besides, why dont you proceed from s/a to show S=I you do just the opposite? I dont understand the logic.
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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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