This document discusses endogenous and exogenous growth theories. Endogenous growth theory views technological progress as endogenous to the economic system and driven by factors like investment in human capital and ideas. Exogenous growth theory sees technology as an external factor determined outside the economic system. The Harrod and Domar models emphasize the role of capital accumulation in driving growth, and define actual, warranted, and natural growth rates. Steady growth requires the actual and warranted rates to be equal, and the natural rate puts an upper limit on growth. Disequilibriums can cause inflation or overproduction.

1. Growth Theories

2. Endogenous and Exogenous Growth
• Endogenous Growth Theory
 Emerged in early 1980s
 Romer (1986, 1990); Lucas (1988)
 Endogenous growth theory is an economic theory which focuses
that economic prosperity is generated from within a system as a direct
result of internal processes.
 More particularly, investment in human capital within the system will lead
to economic growth of a nation.
 Rich country may follow an ever increasing growth path while poor
economy grows at much slower path leading to divergence to the world
economy
 It is found that similar rate of investment and growth of technology may
not result in similar pattern of growth among economies.
 Technological progess--------------------------Economic growth
 Technological progess takes place through innovation in the form of new
product, market and places.
 It consider technical progress as endogenous factor.
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3. Endogenous Growth Theory
 Endogenous growth theory takes two important points
First, It views technological progress as a product of economic
activity.
Second, knowledge and technology are characterized by
increasing returns, and these increasing returns drive the
process of growth.
 The endogeneous growth theory attempts to explain the
sources of technological progress. Three important candidates
for the source of such progress are
A. Ideas (Profit-seeking research)
B. International openness
C. Human capital formation
So, crucial point of this theory is that knowledge drives growth.
New knowledge or technology Increasing return
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4. Exogenous growth model
 Developed by Solow
 Technology is exogenous factor that contribute to economic
growth
 Capita accumulation and labor force improvement as sources
of growth
 The three central assumptions
 Constant return to scale
 Perfect competition
 Exogenous technological change
Growth is determined by accumulation of capital and labour
along with technical change
Technology can be discovered outside the nation and can be
transferred into the nation.
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6. Harrod Growth Model
• This model is based on the capital factor as the crucial factor of
economic growth.
• Harrod and Domar assign a crucial role to capital accumulation in
the process of growth. In fact, they emphasize the dual role of
capital accumulation.
• On the one hand, new investment generates income ,on the other
hand, it increases productive capacity (through productivity effect)
of the economy by expanding its capital stock

7. Assumptions
• The main assumptions of the Harrod-Domar models
are as follows:
• (i) A full-employment level of income already exists.
• (ii) There is no government interference in the
functioning of the economy.
• (iii) The model is based on the assumption of “closed
economy
• (iv) The average propensity to save (APS) and marginal
propensity to save (MPS) are equal to each other.
• S/Y= ∆S/∆Y
• (v) Both propensity to save and “capital coefficient” (i.e.,
capital-output ratio) are given constant.
• (vii) Income, investment, savings are all defined in the
net sense, i.e., they are considered over and above the
depreciation.
• (viii) Saving and investment are equal.

8. Harrod’s growth model raised three issues:
• (i) How can steady growth be achieved for an
economy with a fixed (capital- output ratio)
(capital-coefficient) and a fixed saving-income
ratio?
• (ii) How can the steady growth rate be
maintained? Or what are the conditions for
maintaining steady uninterrupted growth?
• (iii) How do the natural factors put a ceiling on
the growth rate of the economy?
• In order to discuss these issues, Harrod had
adopted three different concepts of growth rates:
(i) the actual growth rate, G, (ii) the warranted
growth rate, Gw (iii) the natural growth rate, Gn.

9. The Actual Growth Rate
• The Actual Growth Rate is the growth rate determined by the
actual rate of savings and investment in the country. In other
words, it can be defined as the ratio of change in income (AT)
to the total income (Y) in the given period. If actual growth
rate is denoted by G, then
• G = ∆Y/Y
• The actual growth rate (G) is determined by saving-income
ratio and capital- output ratio. Both the factors have been
taken as fixed in the given period. The relationship between
the actual growth rate and its determinants is expressed as:
• GC = s …(1)

10. Warranted growth
• “Warranted growth” refers to that growth rate of the economy when it
is working at full capacity. It is also known as Full-capacity growth rate.
This growth rate denoted by Gw is interpreted as the rate of income
growth required for full utilisation of a growing stock of capital, so that
entrepreneurs would be satisfied with the amount of investment
actually made.
• Warranted growth rate (Gw) is determined by capital-output ratio and
saving- income ratio. The relationship between the warranted growth
rate and its determinants can be expressed as
• Gw Cr = s
• where Cr shows the needed C to maintain the warranted growth rate
and s is the saving-income ratio.
• Let us now discuss the issue: how to achieve steady growth? According
to Harrod, the economy can achieve steady growth when
• G = Gw and C = Cr

11. Instability of Growth
• If G > Gwthen C < Cr and If G <Gw then C > Cr
• it can be concluded that steady growth implies a balance
between G and Gw.
• Natural Growth rate
Thus, the natural growth rate is the maximum growth rate which
an economy can achieve with its available natural resources. The
third fundamental relation in Harrod’s model showing the
determinants of natural growth rate is

12. The Domar Model:
• The aggregate model assumes that net
increase in capital stock (new investment )
would generate dual effect in the economy.
• 1) It would help increase in outcome
• 2) it enhances the productive capacity of the
economy which is instrumental for future
production.

13. Assumptions and Calculation
• The basic Harrod-Domar model assumes that
• National output is proportional to the capital stock of the
economy. i.e
• Y=σK------------------1
• where Y=national output
• σ= outut-capital ratio (Y/K), constant
• K=total capital stock
• and any change in K would lead to change in Y by σ times
change in K.
• ∆Y=σ∆ K
• or, ∆Y=σI, where I=∆ K= new investment
• in equilibrium Saving=Investment
• S=I

14. • or, ∆Y=σS
• As, saving is S=sY
• or, ∆Y=σsY
• Dividing both side by Y,
• or, ∆Y/Y=σsY/Y
• or, ∆Y/Y=σs---------------(3)
• which implies that growth rate of national
income depends on output-capital ratio (σ) and
marginal propensity to save.

15. Disequilibrium
If ∆Y/Y>σs
• Under the first situation, long-term inflation would appear in
the economy because the higher growth rate of income will
provide greater purchasing power to the people and the
productive capacity (σs) would not be able to cope with the
increased level of income. The first situation of disequilibrium
will, therefore, create inflation in the economy

16. • If ∆Y/Y<σs
• The second situation, under which growth rate of
income or investment is lagging behind the
productive capacity, will result in over production.
The reduced growth rate of income will put a
constraint on the purchasing power of the people,
thereby reducing the level of demand and resulting
in over-production