GROWTH AND DEVELOPMENT

Growth and Development

Concepts of growth and development-Indicators of

Economic Development: National Income, Per
capita Income, PQLI, Human Development Index,
Gender Development Index, Human Poverty Index
and Deprivation Index. Measures of Inequality:
Kuznets Inverted U hypothesis, Lorenz Curve and
Gini
coefficient, Atkinson, Theil, Palma ratio.

Module II: Theories of Economic Growth

Harrod-Domar Growth Model- Contributions of

Kaldor Mirrlees and Joan Robbinson, Hirofumi
Uzawa model, Solow’s Growth Model and the
Convergence Hypothesis, Endogenous Growth
Theory and the role of Human Capital; Indian Plan
Models of Mahalanobis and Wage-goods model.
Module III: Partial Theories of Economic Growth
and Development
Basic Features of Underdeveloped Countries,
Population Growth and the Theory of Low-Level
Equilibrium Trap, Critical Minimum Effort Thesis,
Theory of Big-Push; Balanced Versus Unbalanced
Growth Theories
Concepts of linkages.

Module IV: Stage Theories

Marxian Stage theory, Rostow’s Stage Theory.

Theory of Growth and Structural Change. Concept
of Dualism: Technological, Social, Geographical and
Financial. Myrdal and Circular Causation,
Backwash and Spread Effect. Institutions and
Economic Growth.

Module V: Financing Economic Development

Domestic Resource Mobilisation: Prior-Savings

Approach, The Keynesian and Quantity Theory
Approaches to the Financing of Economic
Development. Foreign Resource: Dual Gap
Analysis.
Module I

Concepts and Measurements of Economic

Growth and Development

Concepts of Growth and Development

For a common man, the term economic

development and economic growth are synonyms.
For a long time – till sixties—the term economic
development and economic growth were often
interchangeably used – it is not so any more.
Economic development is more extensive and
comprehensive in meaning than economic growth.
Economic growth is referred to the increase of per
capita real gross domestic product over a period of
time. Real GDP is a quantitative concept since it
involves increased productive capacity in an
economy, which leads to rising national output,
incomes and living standards over time.
Economic growth can occur from two main factors:
1. The increased use of resources such as land,
labour, capital and entrepreneurial resources due to
improvements in technology.
2. The increased productivity of existing resources
use through increased labour and capital
productivity.

In contrast, economic development is a qualitative

process and refers to structural change of economic
and social infrastructure in an economy, which
allows an increase in the standard of living in a
nation’s population.

Economic development is a broader concept than

economic growth. Development reflects social and
economic progress and requires economic growth.
Growth is a vital and necessary condition for
development, but it is not a sufficient condition as it
cannot guarantee development. One of the most
compelling definitions of development is that
proposed by Amartya Sen.
According to Amartya Sen, development is about
creating freedom for people and removing obstacles
to greater freedom. Greater freedom enables
people to choose their own destiny. Obstacles to
freedom, and hence to development, include
poverty, lack of economic
opportunities, corruption, poor governance, lack of
education and lack of health. Some leading
economists have drawn a line of demarcation
between economic development and economic
growth.

According to Kindle Berger, “economic growth

means more output and economic development
implies more output and changes in the technical
and institutional arrangements, by which it is
produced”. According to Prof. Schumpeter,
“development is a discontinuous and spontaneous
change in the stationary state, which forever alters
and displaces the equilibrium state previously
existing; while growth is a gradual and steady
change in the long run, which comes about by a
general increase in the rate of saving and
population.

According to Dr. Bright Singh “Economic

development is a multi-dimensional phenomenon, it
involves not only increase in money income, but
also improvement in real habits, education, public
health, greater leisure and in fact all the social and
economic circumstances that makes for a fuller and
happier life. On the contrary, in case of economic
growth, here is increase in national
income alone. There are no structural changes in
the economy.

Amartya Sen points out: “economic growth is one

aspect of the process of economic development.”
Economic growth and development can vary from
different countries, depending on their level of
income, quality of life, environmental quality and the
government’s involvement within the economy.
Thus, economic growth is related to a quantitative
sustained increase in the country’s national income
or output. On the other hand, economic
development is a wider concept than economic
growth “It is taken to mean growth plus change.” It
describes the underlying determinants of growth
such as technological and structural change. An
economy can grow but it may not develop because
poverty, unemployment and inequalities may to
persist due to the absence of technological and
structural changes. But it is difficult to imagine
development without economic growth.
Development is not possible in the absence of
increase per capita output, particularly when
population is growing rapidly. Despite
these differences, some economists use these terms
as synonyms. Arthur Lewis in his The Theory of
Economic growth writes that “most often we shall
refer only to growth but occasionally for the sake
variety, to progress or development.” Economic
growth is a necessary but not sufficient condition of
economic development.
In sum, growth and development complement each
other. There can be no sustained economic growth
without extensive changes through the economy and
it is difficult to see how there could be any
substantial development without any increase in the
economy’s ability to produce welfare- enhancing
goods and services.

Indicators of Economic Development

Economic development is a long process in which
several forces or factors work together to bring
about an economic change for the betterment.
Hence no single method of measurement of
economic development can be adopted. That is why
different methods of measurement of economic
development have been floated by different
economists.
I. Gross Domestic Product
Gross domestic product (GDP) is the most popular
and simple method of measuring economic
development of a country. GDP per capita is widely
assumed to be a good indicator of a country’s level
of development. Several leading economists have
supported this method, such as Meir and Baldwin,
Simon Kuznets, Mrs. Ursula Hicks, Samuelson and
A C Pigou. According to A C Pigou “the economic
development can be measured in terms of changes
in national income over time”. In the words of Prof.
Samuelson “GNP is the best measure of economic
development”. In the words of Mrs. Ursula Hicks “the
best way of measuring economic development of a
country is to covert national income in terms of real
goods. Increase in real national income leads to
increase in per capita income. Thus, economic
development can be measured only in terms of
changes in national income.”

Criticism:
As merely a gross measure of market activity, GDP
only counts money transactions in the economy.
GDP ignores
everything that happens outside the realm of
monetized exchange, regardless of the importance
to well-being. The World Bank itself recognizes
many of these problems: Although they reflect the
average incomes in a country, GNP per capita and
GDP per capita have numerous limitations when it
comes to measuring people’s actual well-being.
They do not show how equitably a country’s income
is distributed. They do not account for pollution,
environmental degradation, and resource depletion.
They do not register unpaid work done.

II. Per Capita Income

Another popular measure of economic development
relates to an increase in the per capita real income
of the economy over a period of time. Economists
are one in defining economic development in terms
of an increase in per capita real income or output.
Mier defines economic development as “the
process whereby the real per capita income of a
country increases over a long period of time subject
to the stipulation that the number of people below
an ‘absolute poverty line’ does not
increase, and the distribution of income does not
become more unequal.” This indicator of economic
development emphasizes that for economic
development the rate of increase in real per capita
income should be higher than the growth rate of
population.

Criticisms of PCI:
Per capita income is not a good indication of a
country’s development is that it does not account for
improving the longevity of human life nor the quality
of the environment such as pollution, environmental
degradation, health, education, etc., particularly in
underdeveloped countries. So, in order for income
and welfare increases to be sustainable, the growth
process must not lead to serious environment
damage nor lead to any sort of its own destruction
in any other way.

1. An increase in PCI may not raise the real

standard of living of the masses.
2. There is another possibility of the masses
remaining poor despite an increase in the real PCI if
the increased income goes to the few rich instead of
going to the many poor.
3. The real PCI fails to take in to account problems
associated with basic needs like nutrition, health,
sanitation, housing, water and education. The
improvement in living standard by providing basic
needs cannot be measured by increase in real PCI.

4. The real PCI estimates fail to measure adequately

changes in output due to changes in the price level.
5. International comparison of the real PCI an
inaccurate due to exchange rate conversion of
different countries into a common currency i.e., US
Dollars, through the use of official exchange rate.
6. PCI fails to measure changes in output due to
changes in price level.
7. Does not show whether any increase in income
goes to the rich or the poor.
8. International comparisons of real GNP per capita
are inaccurate due to exchange rate considerations
of different currencies into one standard currency.
The concern of development economists in recent
years has shifted from economic growth to human
development. The main reason for this shift is the
growing recognition that the real objective of
development is to enlarge people’s option. Income is
one of the options—and an extremely important
one. But it is not the sum total of human life.
Education and literacy, health, physical
environment, equality of opportunity to all people
irrespective of sex, caste and creed, political
freedom, etc., may be just as important as income.
Economic development has traditionally been
measured in terms of GDP, GNP, PCI. But it is
difficult to decide how human development is to be
measured particularly in view of its various
dimensions as pointed out earlier. The search for
comprehensive measures that could capture the
various dimensions of human development led to
the formulation of some measures like PQLI, HDI,
GEM, HPI, GDI. According to Paul Streeten, the
strong argument in favour of these indexes is that
they show up the inadequacies of other indexes
such as GNP.

III. Physical Quality of Life Index

The Physical Quality of Life Index was developed for

the Overseas Development Council in the
mid-1970s by Morris David Morris, as one of a
number of measures
created due to dissatisfaction with the use of GNP
as an indicator of development. PQLI might be
regarded as an improvement but shares the general
problems of measuring quality of life in a
quantitative way. According to Morris: Physical
Quality of Life Index (PQLI) is a measurement of the
most basic needs of the people. As per this
approach, development should be reflected in the
improved economic status or the higher Physical
Quality of Life of the people.
The Physical Quality of Life Index is an attempt to
measure the quality of life or well-being of a country.
The value is the average of three statistics: basic
literacy rate, infant mortality, and life expectancy at
age one, all equally weighted on a 0 to 100 scale.
For each indicator, the performance of individual
country is ranked on a scale of 1 to 100 were 1
represent the worst performance and 100 as the
best performance by any country. A composite
index calculated by averaging these three indices
and if the index shows a rising tendency, it does
means that the Physical Quality of Life of the people
is improving and hence the country concerned is
developing. PQLI does not measure economic
development and total welfare. It is only an attempt
to measure the quality of life or well-being of a
country.

Criticisms:

1. Morris admit that PQLI is a limited measure of

basic needs. It does not measure economic growth.
Further it does not explain the changing structure of
economic and social organization. It therefore, does
not measure economic development.
2. Similarly, it does not measure total welfare.
However, it measures the qualities of life, which are
essential for poor.
3. Many societal and psychological factors like
security, justice, human rights, etc. are excluded.
4. Does not explain the changing structure of
economics and societal development.
5. Arbitrary weights are given to each determining
factors.
Despite these limitations, the PQLI can be used to
identify particular region of underdevelopment and
groups of society suffering from the neglect or failure
of
social policy. The state can take up such policies
which increase the PQLI rapidly along with
economic growth.

IV. The Human Development Index (HDI)

The HDI was introduced in 1990 as part of the

United Nations Development Programme (UNDP)
to provide a means of measuring economic
development in three broad areas - per capita
income, health and education. HDI was devised and
launched by Pakistani economist Muhabul ul Haq,
followed by Indian economist Amartya Sen in 1990.
The HDI tracks changes in the level of development
of countries over time. Each year, the UNDP
produces a development report, which provides an
update of changes during the year, along with a
report on a special theme, such as global warming
and development, and migration and development.
The introduction of the index was an explicit
acceptance that development is a considerably
broader concept than growth, and should include a
range of social and economic factors.
The HDI has two main features:
A scale from 0 (no development) to 1 (complete
development).
An index, which is based on three equally, weighted
components:
1. Longevity, measured by life expectancy at birth

2. Knowledge, measured by adult literacy and

number of years children are enrolled at school
3. Standard of living, measured by real GDP per
capita at purchasing power parity.
HDI is used to distinguished whether the country is
developed, developing and under developed. On
the basis of HDI values, countries are classified into
three groups, namely,

a) High human development countries with HDI 0.80

and above,
b) Medium human development countries with HDI
0.500to 0.799
c) Low human development countries with HDI
value below0.50.
As per human development report 2019 Norway with
HDI value of 0.957 ranks first and Ireland with a
value
of 0.955 ranks second. India with a HDI value of
0.645 ranks positioned 131thin terms of human
development out of 189 countries for which Human
Development Report 2019. Niger with HDI value of
0.394 occupies the last place in HDI ranking.

The HDI is a very useful means of comparing the

level of development of countries. GDP per capita
alone is clearly too narrow an indicator of economic
development and fails to indicate other aspects of
development, such as enrolment in school and
longevity. Hence, the HDI is a broader and more
encompassing indicator of development than GDP,
though GDP still provides one third of the index.

HDI as a measure of human development has

following advantages

1. Besides income, the HDI measure education and

health and is the multidimensional rather than one
dimensional.
2. It focuses the attention of the policymakers on the
ultimate objective of development not just the
means.
3. It is more meaning as a national average than
GDP because there are much greater extremes in
income distribution than in the distribution of life
expectancy and literacy.
4. The HDI can be disaggregated by gender, ethnic
group or geographical region and in many other
ways – to present relevant policy measures.

5. An upward movement in HDI can be regarded as

an improvement.

Despite the widespread use of the HDI there are a

number of criticisms that can be made, including:

1. The HDI index is for a single country, and as

such does not distinguish between different rates of
development within a country, such as between
urban and traditional rural communities.
2. Critics argue that the equal weighting between the
three main components is rather arbitrary.
3. Development is largely about freedom, but the
index does not directly measure this. For example,
access to
the internet might be regarded by many as a
freedom which improves the quality of people's
lives. 4. As with the narrow measure of living
standards, GDP per capita, there is no indication of
the distribution of income.
5. In addition, the HDI excludes many aspects of
economic and social life that could be regarded as
contributing to or constraining development, such as
crime, corruption, poverty, deprivation, and negative
externalities.

V. Human Poverty Index

The Human Poverty Index (HPI) is an indication of

the standard of living in a country, developed by the
United Nations (UN) to complement the Human
Development Index (HDI) and was first reported as
part of the Human Development Report in 1997. It
was considered to better reflect the extent of
deprivation in developed countries compared to the
HDI. It tries to arrive at an aggregate judgment on
the extend of poverty in an economy. The HPI
concentrates on the deprivation in the three
essential elements of human life already reflected in
the HDI:
longevity, knowledge and a decent standard of
living. Human Development Report 2009 used the
following variables for calculating HPI: probability at
birth of not surviving to age 40 (times 100); adult
literacy rate; and unweighted average of population.
The HPI is derived separately for developing
countries (HPI-1) and a group of select high-income
OECD countries (HPI-2) to reflect socio- economic
differences and the widely different measures of
deprivation in the two groups.

In 2010 it was supplanted by the UN’s

Multidimensional Poverty Index. The MPI is the
product of the multidimensional poverty headcount
(the share of people who are multi- dimensionally
poor) and the average number of deprivations each
multi-dimensionally poor household experiences.
HDR 2011 estimates MPI for 109 countries. The
estimate shows that condition in countries falling in
medium human development countries and low
human development countries are particularly bad.
In most of these countries more than 1/3 of the
population suffers from multidimensional poverty. In
India 53.7% of the population i.e., as many as 61.22
crore people suffer from multidimensional poverty.
Not only this, 28.6 % of the population lives under
condition of severe poverty.

VI. Gender-related Development Index

The Gender-related Development Index (GDI) was

introduced in 1995 in the Human Development
Report written by the United Nations Development
Program. The aim of these measurements is to add
a gender
sensitive dimension to the Human Development
Index (HDI). The first measurement that they
created as a result was the Gender-related
Development Index (GDI). The GDI is defined as a
“distribution-sensitive measure that accounts for the
human development impact of existing gender gaps
in the three components of the HDI”. Distribution
sensitive means that the GDI takes into account not
only the average or general level of well-being and
wealth within a given country, but focuses also on
how this wealth and well-being is distributed
between different groups within society. It measures
economic development as HDI does, but take into
account the ‘inequality between men and women’.
Definition and calculation

The UNDP in its HDR 1995 has introduced GDI as a

measure of economic development. The GDI is
often considered a “gender-sensitive extension of
the HDI”. It addresses gender-gaps in life
expectancy, education, and incomes. GDI attempt
to capture achievements through the same set of
basic capabilities as included in the HDI – life
expectancy, educational attainment and income –
but adjusted the HDI for gender inequality. In terms
of life expectancy, the GDI assumes that women will
live an average of five years longer than men.
Additionally, in terms of income, the GDI considers
income-gaps in terms of actual earned income.

The GDI cannot be used independently from the

Human Development Index (HDI) score and so, it
cannot be used on its own as an indicator of
gender-gaps. Only the gap between the HDI and
the GDI can actually be accurately considered; the
GDI on its own is not an independent measure of
gender-gaps. Greater the gender disparity in basic
human development, lower is the country’s GDI
compared with its HDI. If there is no
gender inequality in a country, its GDI coincides with
its HDI.

VII. Deprivation Index

Studying the social inequalities in health and

wellness has long been a challenge due to the lack
of socioeconomic information in administrative
databases. In order to track changes in social
inequality related to certain significant health
phenomena, such as mortality, hospitalization, and
use of services, it became necessary to implement
a measure based on the socioeconomic
characteristics of the local community rather than on
those specific to the individual.

This measure took the form of a deprivation index.

As outlined here and based on the suggestions of
British researcher Peter Townsend, deprivation
takes two forms: material and social. While material
deprivation reflects the lack of everyday goods and
commodities, social deprivation refers to the fragility
of an individual’s social network, from the family to
the community. The index measures six indicators
chosen for their known
connection to health and one of the two forms of
deprivation.

The index is intended to support health and wellness

planning. It could be used to monitor social
inequality, evaluate services, develop policies and
programs, and allocate resources. Human
deprivation index is a composite index based on the
income, health and educational deprivations. For
the analysis human deprivation index gives equal
weightage for these three deprivations. There is lot
of indicators for measuring these deprivations. For
example, per capita income, percentage of
population living below poverty line, unemployment,
anaemia among children and mother, under
nourished children, infant mortality rate, maternal
mortality rate, birth rate, death rate, immunisation
achievement, availability of health facilities, illiteracy,
drop out, student teacher ratio, availability of
educational facilities etc.

But among these, very prominent, sensitive and

effective indicators are selected for human
deprivation index
construction. Poverty has traditionally been
measured using “means” indicators recently
analysis poverty with “end” indicators is getting
interest support and importance. Human deprivation
index is one of such an index analysing poverty with
the help of both means and end indicators such as
poverty line, infant mortality rate and illiteracy rate.
It is a composite index of three components, they
are, percentage of population living below the
poverty line i.e., head count index, which is used as
a measure of income deprivation, illiteracy which is
used as a measure of educational deprivation and
infant mortality rate is used as a measure of health
deprivation.

The income approaches of poverty view the poverty

as income or consumption deprivation. Income
poverty, which measures people’s deprivation in
income or consumption related to some standard of
poverty line. The poverty line specifies the society’s
minimum standard of living to which everybody
should be entitled. A person is identified as poor if
he or she cannot enjoy this minimum. When
estimating monetary measured of
poverty, one may have a choice between using
income or consumption as the indicator of
well-being. Human wellbeing not only includes
consumption of goods and services but also the
accessibility of people to the basic needs like
health, education, water and sanitation, etc. Human
deprivation index is a composite index and it is used
for measuring the multidimensions of deprivation. It
also shows the limitations in distributing the fruits of
development among people and achievements in
three most important basic human needs viz.,
income, health and education. To represent the
dimensions of human deprivation important
variables are chosen from these aspects because
income, health and education are important for
human development.

According to the World Bank, there are five core

dimensions of poverty reflect the deprivation of
human capabilities: economic (income, livelihoods,
decent work), human (health, education), political
(empowerment, rights, voice), sociocultural (status,
dignity) and protective (insecurity, risk, vulnerability).
Among these deprivations’ income, health,
education
deprivations are taken for this analysis. Because,
the data of these are the most sensitive,
predominant, easily assessable and available for
any kind of research and analysis. Income poverty
is the main cause for ill health and illiteracy. Like
that ill health and illiteracy leads to poverty. Low
income, ill health, illiteracy are the key dimensions
of poverty. Raising the income of the poor alone
might not be enough to reduce poverty without
improvements in the health and education of the
poor. So, with income, health and education
determines human development. Like that
deprivation in income, health and education suffers
people severely. Hence, these deprivations are
getting priority in this analysis. Human deprivation
Index is more comprehensive for evaluating the
deprivation even within subnational level. It is an
appropriate index for cross country analysis also.
Since, poverty is a multi-dimensional phenomenon,
indicators which are used to analyse it, should also
be multidimensional. Hence in assessing poverty,
non income aspects of poverty, such as deprivations
in health, education have also to be included.
Measures of Inequality

Comprehending the impact of policy changes on the

distribution of income first requires a good portrayal
of that distribution. There are various ways to
accomplish this, including graphical and
mathematical approaches that range from simplistic
to more intricate methods. All of these can be used
to provide a complete picture of the concentration of
income, to compare and rank different income
distributions, and to examine the implications of
alternative policy options. An inequality measure is
often a function that ascribes a value to a specific
distribution of income in a way that allows direct and
objective comparisons across different distributions.
To do this, inequality measures should have certain
properties and behave in a certain way given
certain events. For example, moving Rs.1 from a
richer person to a poorer person should lead to a
lower level of inequality. No single measure can
satisfy all properties though, so the choice of one
measure over others involves trade-offs. The
following measures differ with regards to the
properties they satisfy and information they present.
None can be considered superior, as all are useful
given certain contexts. A well-balanced inequality
analysis should look at several of these measures.

1. Kuznets Inverted U hypothesis

Prof. Kuznets is the first economist to study the

relationship between economic growth and income
distribution empirically. There has been much
controversy among economists over the issue
whether economic growth increases or decreases
income distribution. Kuznets observes that in the
early stages of economic growth relative income
inequality increases, stabilizes for a time and then
decline in the latter stages. This is known as the
inverted U- shaped hypothesis of income
distribution.

It was in his 1963 study that Kuznet developed his

inverted U-shaped hypothesis by taking the data of
18
 Figure 1.1:Kuznets Curve

countries. He got Nobel Prize for this work in 1971.

countries. He got Nobel Prize for this work in 1971.
Kuznet suggested on the experience of the
developed Kuznet suggested on the experience of
the developed countries that historically there was a
tendency for countries that historically there was a
tendency for income inequality to increase first, and
then to be income inequality to increase first, and
then to be reduced as countries developed from a
low leve
reduced as countries developed from a low level. On
the basis, he constructed different Lorenz curve for
basis, he constructed different Lorenz curve for
developed and under developed countries and
derived developed and under developed countries
and derived their Gini coefficient. It showed that
income inequalities their Gini coefficient. It showed
that income inequalities were higher in under
developed countries than in were higher in under
developed countries than in developed countries.

Gini coefficient is the best measure of the degree of

t is the best measure of the degree of

inequality. It varies from 0 (complete equality) to 1

inequality. It varies from 0 (complete equality) to 1
(complete inequality). The larger the coefficient, the
(complete inequality). The larger the coefficient, the
greater the inequality. The Kuznets inverted U shape
greater the inequality. The Kuznets inverted U shape
curve explains the changes in the income
distribution as measured by the Gini coefficient in
relation to the increase in per capita income. More
portion of the Kuznets curve lies to the right: income
inequality falls with an increase in per capita income
at higher levels of development. The inverted U
shape curve hypothesis applies to the present
developed and developing countries but the degree
of inequality in the latter is greater than in the
former.

Causes of increase in inequality with development

There are many factors, which led to increase

relative income inequality in the early stages of
development in LDC’s. When the process transition
from a traditional agricultural society to modern
industrial economy begins, it increases inequalities
in income distribution. There are structural changes,
which lead increasing employment opportunities,
exploitation of new resources, and improvements of
technology. All these leads to increase in per capita
income in the industrial sector. The income of
workers, managers, entrepreneurs etc, in urban
areas increase more rapidly. But income per
capita of workers agricultural and non- agricultural
occupations in rural areas does not rise due to
subsistence agriculture, defective land tenure
system and rural backwardness. The workers in
industrial sector have high income and employers
earn large profit. Thus, the modern industrial sector
grows faster than the rural subsistent sector. As a
result, the relative share of income and profit in
national income of this sector rises, more than in
the rural sector.

The migration of rural population to urban areas

does not provide gainful employment opportunities
to unskilled and uneducated people in town and
cities. Govt.in LDC’s find it difficult to pass and
implement legislation and other economic measures
relating to concentration of income and wealth
among the rich due to political reason.
Consequently, the income inequalities increase.
Above all, higher growth rate of population among
the masses in LDCs increases the absolute number
of people and hence relative inequality.
Causes for reduction in inequality with development
Kuznets give two reasons for decrease in inequality
of income distribution when the country reaches
high income level in the latter stages of
development. First, the per capita income of the
highest income groups falls because their share of
income from property decreases. Second, the per
capita income of lowest income groups rises when
the government takes legislative decisions with
respect to education and health services, inheritance
and income taxation, social security, full employment
and economic relief to either whole group or
individuals.

As development proceeds, per capita income of the

industrial sector increases. This, in turn, increases
the demand for farm products and other products of
rural and backward areas, which raise the per
capita income of the people of these areas. This is
what Hirchman calls “trickle-down effect” and
Myrdal calls “spread effect” of development. Above
all, as development gain momentum the growth rate
of population declines which increase per capita
income.

Critical Appraisal
Kuznets inverted U hypothesis has been empirically
tested and confirmed by some economists while
others find it in other way. Karvis in his study of 11
developing countries and developed countries,
Adelman and Morris in their study of 43 developing
and 13 developed countries confirm the Kuznets
hypothesis that the degree of inequality first
increases at low level of development and decline
at higher level of development. Montek S Ahluwalia
in his analysis of the data for 60 countries finds that
income inequality increases substantially in the
early stages of development with reversal of this
tendency in the latter stages. Despite these the
validity of the Kuznets inverted U shape –
hypothesis has been questioned on the basis of the
data taken by Kuznets and other for their studies.
Kuznets taken a very small sample of developing
and developed countries. Critics pointed out that his
analysis is based on 5 percent empirical information
and 95 per cent speculation.
2. Lorenz Curve
Lorenz curve is one of the simplest representations
of inequality. On the horizontal axis the cumulative
number of income recipients ranked from the
poorest to the
richest individual or household. The vertical axis
displays the cumulative percentage of total income.
The Lorenz curve reveals the percentage of income
owned by x per cent of

Figure 1.2:Lorenz Curve

the population. It is usually shown in relation to a 45-
degree line that represents perfect equality where
each x percentile of the population receives the
same x percentile of income. Thus, the farther the
Lorenz curve is in relation to the 45-degree line, the
more unequal the distribution of income.
3. Gini-coefficient
It is the most widely cited measure of inequality; it
measures the extent to which the distribution within
an economy deviates from a perfectly equal
distribution. The index is computed as the ratio of
the area between the two curves (Lorenz curve and
45-degree line) to the area beneath the 45-degree
line. In the figure above, it is equal to A/(A+B). A
higher Gini coefficient represents a more unequal
distribution. According to World Bank data, between
1981 and 2013, the Gini index ranged between 0.3
and 0.6 worldwide. The coefficient allows direct
comparison of two populations’ income distribution,
regardless of their sizes. The Gini’s main limitation
is that it is not easily decomposable or additive.
Also, it does not respond in the same way to
income transfers between people in opposite tails of
the income distribution as it does to transfers in the
middle of the distribution. Furthermore, very
different income distributions can present the same
Gini coefficient.

4. Atkinson Index
This is the most popular welfare-based measure of
inequality. It presents the percentage of total income
that a given society would have to forego in order to
have more equal shares of income between its
citizens. This measure depends on the degree of
society aversion to inequality (a theoretical
parameter decided by the researcher), where a
higher value entails greater social utility or
willingness by individuals to accept smaller incomes
in exchange for a more equal distribution. An
important feature of the Atkinson index is that it can
be decomposed into within and between-group
inequality. Moreover, unlike other indices, it can
provide welfare implications of alternative policies
and allows the researcher to include some
normative content to the analysis.

5. Theil Index
The values of the GE class of measures vary
between zero (perfect equality) and infinity (or one,
if normalized). A key feature of these measures is
that they are fully decomposable, i.e., inequality
may be broken down by population groups or
income sources or using
other dimensions, which can prove useful to policy
makers. Another key feature is that researchers can
choose a parameter α that assigns a weight to
distances between incomes in different parts of the
income distribution. For lower values of α, the
measure is more sensitive to changes in the lower
tail of the distribution and, for higher values, it is
more sensitive to changes that affect the upper tail.
The most common values for α are 0, 1, and 2.
When α=0, the index is called “Theil’s L” or the
“mean log deviation” measure. When α=1, the index
is called “Theil’s T” index or, more commonly, “Theil
index”. When α=2, the index is called “coefficient of
variation”. Similarly, to the Gini coefficient, when
income redistribution happens, change in the indices
depends on the level of individual incomes involved
in the redistribution and the population size.

6. Palma ratio
It is the ratio of national income shares of the top 10
per cent of households to the bottom 40 per cent. It
is based on economist José Gabriel Palma’s
empirical observation that difference in the income
distribution of
different countries (or over time) is largely the result
of changes in the ‘tails’ of the distribution (the
poorest and the richest) as there tends to be
relative stability in the share of income that goes to
the ‘middle’.

Module II
 Theories of Economic Growth
Harrod-Domar Growth Model

Roy Harrod and Evsey Domar worked separately to

develop their highly similar models of economic
growth and business cycles. The two economists
expanded the short-run Keynesian framework to
analyse the growth process in the developed
economies. Both of them criticized the basic
Keynesian framework of income determination in
the short run for ignoring the role of investment to
create more capacity for the production of output.
The investment in physical capital, according to
these economists, has a dual role. Dual role of
investment here means that investment spending
generates income on one hand and also increases
the productive capacity of the economy on the other
hand. Increase in the income as a result of increase
in investment is called the demand side effect while
the increase in the productive capacity of economy
due to investment is called the supply side effect.
Both the economists were interested in finding out
an equilibrium growth path which would guarantee a
full employment in some sense. Although the two
models of Harrod and
Domar are similar in many respects but they have
some crucial differences as well. Let us investigate
the two models below in turns:

Harrod’s Model

The model was first given by Harrod in his 1939

paper in the ‘Economic Journal’. His first concern
was to find that does there exist an equilibrium
growth rate of output which if the economy grows at
then it will continue to grow at the same rate moving
over time? His second concern was to investigate
that whether such an equilibrium growth path is
stable in the sense that if ever the economy grew at
some different rate then would it automatically move
towards equilibrium growth rate in due time?

Basic assumptions of the Harrod’s Model

1. Savings and investment refer to income of the
same period. Both Saving and Investment are
net, i.e., over and above the depreciation.
2. The economy saves a constant proportion of its
income, which implies that the marginal
propensity to
save (MPS) i.e., ���� /���� is equal to
average propensity to save (APS) i.e., ��/��.
Since if MPS ≠ APS, then the latter could not
stay constant.
3. Income is determined by investment through the
multiplier process while investment is determined
through the process of accelerator.
4. If plans of investment are realized then the firms
don’t change the rate of desired investment
whereas if plans are under realized i.e., actual
investment is less than planned investment or
over realized i.e., actual investment is more than
planned then firms increase or decrease
respectively the rate of desired investment.
5. The economy is assumed to begin with full
employment of capital.
6. There are no lags in the adjustment between
demand and supply, especially between
investment and creation of productive capacity.
7. Aggregate output in the economy can be written
as a function of aggregate physical capital and
aggregate labour measured in suitable units
respectively i.e., �� = �� (��, ��). It is
further assumed that there are constant
returns to scale in the aggregate production
function which means that if both the factors are
changed by some equal proportion then output
also gets by same proportion.
8. General Price level and the rate of interest
remains fixed. It means that the relative prices of
capital and labour remain constant as the
economy grows. This assumption has a very
crucial implication for the Harrod model. A
constant relative factor price implies a constant
capital-labour ratio i.e., ���� in the economy
over time. Some authors like Branson formulate
the requirement of fixed ���� in the Harrod
model using an L shaped fixed proportion
production function of the form �� = Min
(����, ����) as shown figure 2.1.
9. If the production function is conceived to be of
a perfectly complementary form as above
then a change in relative factor prices from
say (w/r) to (w/r)’will not change the ratio
��/�� in which the factors are used.
Although there is no need to assume such a
functional form of aggregate production
provided, we assume constant relative price
of factors.
Figure 2.1
 10. The implication of constant returns to scale
along with fixed proportion of factors implies
constant capital-output ratio as well as
constant labour output ratio overtime. The
constancy of capital output ratio is a very
important assumption of the Harrod’s model.
11. There is no role of government in influencing
aggregate demand and supply.

Structure and working of the Harrod’s Model

Harrod wanted to find out that rate of growth of
investment or output which will sustain itself
overtime. In order to find that out Harrod does the
marriage of multiplier and accelerator to arrive at his
most fundamental growth equation.

Keynesian multiplier can be written says

that ∆�� = ∆��/��…….. (1)

Here Y stands for the aggregate output, I for net

investment and s for the savings ratio in the
economy. The accelerator theory of investment tells
us that the net investment planned or desired in any
period in an economy is a fixed multiple of the
expected change in output during that period i.e.,

�� = ����∆Y …… (2)
Here ���� = ∆���� /∆�� stands for the
desired change in capital stock per unit increment in
output.
���� is also known as desired incremental
capital-output ratio. If we combine equations 1 and
2 above by eliminating ∆Y then we get that rate of
growth of planned investment
∆�� /�� = ��/ ���� ……. (3)
We know that in any short run equilibrium of the
economy, planned net savings must equal planned
net investment i.e., �� = �� which implies that in
a short run equilibrium �� = �� = ���� or
��/�� = ��. In other words, to keep their ratio
fixed, planned investment and output must grow at
the same rate i.e., ∆��/ �� = ∆��/ �� if the
economy has to always remain in short run
equilibrium at all points in time while growing.
Substituting ∆��/ �� in place of ∆��/ �� in
equation 3 above, we get
∆��/ �� = ��/ ���� …… (4)
Equation 4 is the most fundamental equation in
Harrod’s model since it says that if economy is
growing at the rate given in the right-hand side of
equation 4, then planned investment is always
equal to planned savings along the moving growth
path. To see why this happens we can rewrite the
equation 4 as ����∆�� = ���� where the
right-hand side is nothing but the planned savings
and the left-hand side is nothing but the planned
investment. Since we generally assume in
Keynesian framework that savings are always
realized and by truism, we know that actual
savings must always equal actual investment
therefore equation 4 can be understood to give us
that growth path where planned investment must
equal actual investment. The assumption number 7
above tells us that if the plans of firms are met, then
there is no reason for them to change their rate of
investment which through multiplier would ensure
an unchanged rate of growth.

Therefore, if the economy grows at the rate ��

/���� then there is no force to deviate it from this
constant growth path. Such an equilibrium growth
rate is defined as Warranted (Required) rate of
growth by Harrod and denoted as ����. In his
own words, it is “that rate of growth which, if occurs,
will leave all the parties satisfied that they have
produced neither more nor less than the right
amount. It will put them into a frame of mind which
will cause them to give such orders as will maintain
the same rate of growth”. Therefore, we may write
���� = ��/ ����…… (5)
In fact, he defines the following three different types
of rate of growth for an economy.
1. Warranted (Required) rate of growth denoted as
����. 2. Actual rate of growth denoted as
����.
3. Natural rate of growth denoted as ����.

Using a similar terminology as in case of warranted

rate of growth we may write that

���� =∆௒௒= ቀ∆௒ூ×ூ௒ቁ = ቀ∆௒

ூ ௦
∆௄× ௒ቁ = ௖ …… (6)

Here S is the saving ratio and C is the actual (not

desired) ratio of actual change in capital i.e., actual
net investment to the change in output i.e.
�� = ∆�� /∆�� = �� /∆��.
Thus, C is the actual incremental capital-output
ratio. Natural rate of growth is defined by Domar as
that rate of growth of output which is required to
fully employ the entire growing labour force. Since
labour-output ratio is assumed to be constant,
therefore the natural rate of growth of output must
be equal to the rate of growth of labour. Suppose if
the rate of growth of population is given by ��
then the natural rate of growth must be equal to
��.
���� = �� ……... (7)
You may think of growth of labour force as not just
an increase in number of labour but an increase in
number of effective labours to incorporate the
increases in labour productivity. We know that in the
short run disequilibrium occurs whenever actual
investment is not equal to planned investment i.e.,
there is either an unplanned positive or an
unplanned negative addition to stock of inventories.
This equilibrium is restored by the firms in
subsequent periods through increase or decrease in
output in case of unplanned removal or unplanned
addition to inventories respectively. Does a similar
response mechanism also bring the economy back
to required equilibrium growth path in case of any
deviation from it? After deriving the warranted or
equilibrium rate of growth, Harrod’s next concern
was to check if the equilibrium is stable i.e., is any
deviation from the equilibrium path self-correcting
over time?
Amartya Sen in his introduction to Harrod in the
book ‘Growth Economics’ has formulated the
following adaptive expectation response model of
the firms wherein
��௧ = ��௥(��௧௘

− ��௧ିଵ) ௘ =

λ(��௧ିଵ −

��௧ିଵ

��௧௘ − ௘
)
��௧ିଵ

The first equation says the investment in any period

is a function of the increase in output expected in
this period over the previous period’s output. The
second equation says that the expected rate of
growth of output increases by a constant positive
multiple of the difference between actual and
expected rate of growth of output in the previous
observed period. For example, if actual output in
previous period was more than expected output i.e.,
actual growth was more than expected growth in
previous period then the firms will revise their
expectations of growth of output upwards in the
current period implying a larger expected output in
the current period and therefore a larger investment
given by the first equation of Sen. The reverse will
hold true whenever actual will be less than
expected.

Let us consider the following two

scenarios: 1. ����>����

2. ����<����
Using equations 5 and 6 above, we may write that if
����>����⟹��<����⟹ ∆��<
∆����⟹����������������������
������������������������
����
 ⟹����������������������
����<����⟹��>����⟹ ∆��>
∆����⟹����������������������
������������������������
����
⟹����������������������
The first implication above considers the situation
when for some reason the actual rate of growth in
the economy happens to be more than the
warranted rate of growth. Under such a situation,
the actual incremental capital per unit of
incremental output will be less than the desired
incremental capital per unit of incremental output. A
shortfall in actual capital vis-à-vis planned capital will
take either the form of unplanned shortfall in the
stock of inventories or an excess demand for the
equipment. Both the situations will be inflationary
and responded by the firms through increase in the
rate of planned investment according to assumption
4. Such an increase will cause a further increase in
the actual rate of growth of output through the
multiplier mechanism. It means that whenever the
actual growth rate of output is more than
the warranted rate of growth, the response by the
firms will make the actual growth rate even larger
than the warranted growth rate. Therefore, the
response mechanism which worked to create
equilibrium in the short run will create further
disequilibrium in the long run and take the economy
further away from the equilibrium growth path
towards a boom.

The second implication above considers the

situation when the actual rate of growth in the
economy happens to be less than the warranted
rate of growth. Under such a situation, the actual
incremental capital per unit of incremental output
will be more than the desired incremental capital
per unit of incremental output.

A shortfall in actual capital vis-à-vis planned capital

will again take either the form of unplanned addition
to the stock of inventories or an excess capacity of
the equipment. Both the situations will be
deflationary and responded by the firms through
decrease in the rate of planned investment
according to assumption 4. Such a decrease will
cause a further decrease in the actual rate of
growth of output through the multiplier. It means that
whenever the actual growth rate of output is less
than the warranted rate of growth, the response by
the firms will make the actual growth rate even
smaller than the warranted growth rate. Therefore,
the response mechanism will create further
disequilibrium in the long run and take the economy
further away from the equilibrium growth path
towards a depression. The above analysis
concludes that the equilibrium growth path of
Harrod is completely unstable and any deviation is
further aggravating rather than self-correcting. For
this reason, the equilibrium growth is said to have a
Knife
Edge Stability. If you make a slip on either side, you
keep falling.
The instability of equilibrium in the Harrod model
was used by him to explain the business cycles
above and below the trend path of warranted
growth. But we know that business cycles always
have peaks and troughs. Harrod explained these
through the use of natural rate of growth of output.
Remember from equation 7 that ���� = ��.
Harrod argues that in an economy with constant
capital-labour ratio, the actual growth rate of output
can
never be more than the natural rate of growth of
output i.e., ���� ≤ ���� = ��. In other
words, growth is constrained by labour.

Here again we consider two possible

scenarios: 1. ���� ≤
����<����
2. ����>����.

In the first situation, natural rate is less than the

warranted rate which implies that the actual rate
which has to be less than or equal to the former will
also be less than the warranted rate. Such a
situation as we have seen above will push the
actual rate further below and bring a deflationary
gap in the economy. During this gap, neither the
labour nor the capital will be fully employed. The
less than full employment of capital is obvious since
at all rates of growth below the warranted, actual
capital stock must be more than planned capital
stock. Correction will only be possible if the
warranted rate of growth falls below to become
equal to the actual.

A fall in warranted rate requires a fall in savings or

an increase in����. But an increase in latter is
not profitable
and thus possible under conditions of deflation. In
fact, ���� is bound to fall. But Harrod argues that
the savings rate in the economy will fall during the
deflation due to redistribution in income against the
capitalists and will fall more in proportion to fall in
���� thereby decreasing the warranted rate.
When it has fallen enough, then actual will once
again become greater than warranted and begin to
recover thereafter. In the second situation, natural
rate is more than the warranted rate. In this
situation, if actual is equal to warranted then there
the economy will move along a constant growth
path where there will full employment but persistent
growing unemployment of labour. However, if actual
is more than warranted, then actual rate will keep
growing till it reaches its bounds of natural rate of
growth.

Although the unemployment will keep on reducing

but the capital will be in excess demand putting
inflationary pressures. But this rate high rate of
growth will not be sustained forever since dueto
inflation there will be a redistribution of income in
favour of capitalists implying an increase in savings
rate faster than the increase in
desired incremental capital output ratio. On the other
hand, if actual is less than warranted, then the
economy will move further in depression with high
labour unemployment levels and also unused
capacity. This will keep happening unless the
warranted rate falls below through the mechanism
discussed in the above paragraph. Note that
although warranted growth rate changes, but the
warranted growth path does not which requires that
actual rate of growth must be equal to warranted
rate of growth.

The only situation in the Harrod’s model where there

is full employment of both capital and labour under
equilibrium is when
���� = ���� = ����

This is so improbable a situation that Mrs. Joan

Robinson has termed it ‘Golden Age’

Domar’s Model of Economic growth

Domar’s starting point was to criticize Keynesian

framework for its incompleteness in addressing two
important issues related to the long-run
1. Keynesian analysis considers investment only to
be an income generating (i.e., demand side)
instrument through the multiplier while ignoring the
essential productive capacity changing (i.e., supply
side) role of investment. It is precisely because of
this reason that Keynes assumed that employment
of labour is a function of national income. But
Domar points out that this is true only in the short
run. He assumes that overtime employment of
labour is a function of ‘ratio of national income to
productive capacity’.

2. Keynesian analysis, while giving over importance

to the need of full employment of labour, almost
ignores the issue of unemployment of capital, which
in turn becomes the source of labour
unemployment. According to Domar, it is the
premature obsolescence of capital equipment that
discourages investment and growth, thereby
causing the labour unemployment.

Main Assumptions of Domar’s model

1. Savings and investment refer to income of the

same period.
2. Both Saving and Investment are net, i.e., over
and above the depreciation.
3. Depreciation is measured not in respect to
historical costs of the depreciated equipment but in
respect to the cost of replacement of the
depreciated asset by another one of same
productive capacity. The latter cost may be different
from the former owing to technological progress.
4. There is a constant general level of prices. 5. No
adjustment lags are present in any market. 6.
Productive capacity of an asset or of the entire
economy can be measured. This assumption is very
strong since the productive capacity of a given
physical stock of capital does not depend just upon
the technical factors but economic and institutional
factors as well, for example distribution of income,
preferences of consumers’, wage rates, relative
prices, and structure of industry, etc.
7. Average and marginal propensities to save are
equal for the economy.
8. The ratio of productive capacity of capital to the
size of capital for the entire economy is equal to
that of the
new investment projects. It means nothing but that
average potential output to capital ratio is equal to
marginal potential output capital ratio.
9. Employment rate depends upon the ratio of actual
output and productive capacity, also known as the
utilization ratio.

Structure of Domar’s Model

1. National Income (output) is determined by

investment through the multiplier as per the
following relation ���� = ����/ �� …… (1)
Where �� (assumed to be constant) is the
marginal propensity to save.
2. Productive capacity of an economy (or capital
stock) is defined by Domar as its output when
the entire labour force is fully employed in some
conventional sense.
3. For the new investment projects, the ratio of
potential productive capacity created by these
 new investment projects to the size of capital
invested in them (i.e., ��), is denoted by ��.
Domar in his original work had used a different
symbol though.
�� = ����/ ���� …….. (2)
Using assumption 8, we can write
�� = ��/ �� = ����/ ����.
4. The addition in potential productive capacity of the
entire economy’s capital stock may be less than
the potential productive capacity of just the new
investment projects. This is because operation of
new projects may involve transfer of scarce
labour from older projects making the latter less
productive and thereby increasing the overall
productive capacity of the economy due to new
investment less than the potential. The ratio of
change in productive capacity of the economy
(due to new investment) to the amount of
investment is termed by Domar as the “potential
social average investment productivity” and is
denoted by ��. Therefore
 �� =ௗ௉⁄ௗ௧
ூ …….. (3)
where �� stands for the productive capacity of
the economy.
5. Domar assigns the following characteristics to
��:
a. Its magnitude depends on the technological
progress (as embodied in new investment
projects). Thus, we can say that �� refers
to increase in capacity which accompanies
rather than caused by investment.
b. �� refers to increase in potential capacity
to supply. Its realization depends upon the
presence of adequate demand for it.
c. The maximum value which �� can attain is
equal to ��. The shortfall would depend
upon the magnitude of the rate of
investment, growth of labour force and
natural resources, technological progress,
misdirection of investment etc. Therefore
�� ≤ ��
 d. It is assumed by Domar that ��&��
remain constant.
6. When ��<�� then following an investment
�� new projects with productive capacity of
���� are built. The productive capacity of
entire economy however increases only by
���� (<����). This implies that
somewhere in the economy (not excluding new
projects because of misdirection of investment),
productive capacity must be reduced by ����
− ����. But since Domar has assumed in
assumption number 8 above that the ratio of
productive capacity of capital to the size of
capital for the entire economy is constant at ��,
therefore every year an amount of capital (or
capital value) equal to ��(��−��) ��
becomes useless. Such an untimely (unintended)
demise of capital equipment (over and above
depreciation) is termed by Domar as “Junking”.
Junking of capital is a result of unprofitability of
old type of capital assets which in turn may be
 caused by either shortage in supply of labour or
loss of demand of produce because of lower
costs and better quality of newer products.
7. The incentives for investment are provided by the
rate of growth of output and hurt by the amount of
junking. We may write that
ା ି

��,��ᇩᇭ − ᇪᇭᇫ��

��= �� ൮����ฏ
����

��൲
The increase in proportion of capital junked
negatively affects the business confidence
thereby reducing the rate of investment.

Working of Domar’s Model

The Question Harrod asks is that what must be the

rate of growth of investment if the increase in
productive capacity (due to change in capital stock)
is to be exactly matched by the increase in output
(due to change in demand for investment), so that
the economy always remains in full employment (of
labour) equilibrium over time.

Rewriting equation (2) above as follows gives us the

rate of change of productive capacity.
���� /���� = ���� ……. (4)
Note that productive capacity increases so long as
net investment and potential social average
investment productivity are positive.
The rate of growth of output is obtained by
differentiating equation (1) with respect to time as
given below
ௗ௒
ௗூ ଵ
ௗ௧= ௗ௧× ௦ …..… (5)

For simplification, Domar assumes that the economy

is in equilibrium to begin with i.e.

��0 = ��0 ….… (6)

The equilibrium condition then is that change in
productive capacity equals change in output, i.e.
����/ ���� = ����/ ���� …..… (7)
Substituting from (3) and (4), we obtain the
equilibrium condition as follows
1 /�� × ����/ ���� = ���� ….… (8)
The above condition implies that equilibrium over
time requires investment to grow at a constant
continuous rate equal to ����. Equation (1), (5)
and (6) together imply that 1/ �� × ����/
���� = 1 /�� × ����/ ���� ….… (9)
This implies that output grows as the same rate as
investment, i.e., ����. If the economy fails to
grow at this warranted rate, then the capacity will be
under-utilized implying less than full employment of
labour as well as capital.
Notice the similarity between the expression of the
warranted (required) rate of growth of Domar and
that of Harrod. The warranted rate of Harrod is ��/
����, where ����
is reciprocal of the marginal output-capital ratio. The
consequences of an economy to grow at a rate
different from the warranted rate i.e., ���� are
demonstrated by Domar under the following two
conditions:
1. �� = �� (no junking)
This is a situation in which no junking of
capital equipment occurs. Under such
situation, suppose the investment and
output grow at a constant rate of ��, i.e.,

�� = ��0������
Now since ����/���� = ��,
therefore capital stock at any point of time is
nothing but the continuous sum of all net
investments, we can therefore write
௧
�� = ��଴ + න �� ଴��௥௧���� = ��଴
଴ ௥௧
+�� ��(�� − 1)
଴
As ��⟶ ∞, ��0 + (��଴��௥௧ −
1)⟶ூబ௥(��௥௧) , as the other terms
become relatively insignificant. This implies
that the capital will also grow at the rate
approaching ��.
Since �� = �� /�� and �� = �� =
��/ ��,
���
��� �� ��=
 ��� ��� ௧→ஶ
��� ��� ��଴
��଴ ��௥
௥ =
�� ௧
௧ ���
௧→ஶ
���
− 1)ቃ ௧→ஶ
���� =
������
ቂ��଴

+ூబ௥(��௥௧ 1
ି௥௧
ூబ−
1ቁ �� +ଵ௥ቃ
���� ቂቀ௄బ
௧→ஶ

௥
= ௦ఙ
௥
The expression ௦ఙ is termed by Domar as
the coefficient of utilization and denoted by
��. When
i. ��< 1 ⟺��<����
The economy fails to utilize its
capacity i.e., ��<��. The proportion
of capital stock unutilized is given
by (1 − ��). This not only creates
 unused capital but unused labour
force as well.
ii. �� = 1 ⟺�� = ����
Only under this situation wherein
actual growth rate is equal to the
warranted growth rate, full
capacity is utilized and the
economy is in equilibrium.
2. ��<�� (junking)
As seen above, whenever ��<��, the amount
୍(஗ି஢)

஗of capital is junked every year.

This implies that ୢ୏
୍(஗ି஢)
ୢ୲ ≠ �� but rather = �� −

஗
ଵ஢
= ஗.
୰୲
୰஗(e − 1)
୍
Therefore �� = ��0 + బಚ

&
��଴
��� ��= ௥
��� ��� ��
௧
�� ���
 ������
௧→ஶ ௧→ஶ
௥௧
௥ఎ(�� −
=
1)ቃ
������
��଴��௥௧
���� ቂ��଴
+ூబ഑
௧→ஶ 1
ூబ− 1ቁ �� ି௥௧
= ������ +ఙ௥ఎቃ
���� ቂቀ௄బ
௧→ஶ

=௥௦ఙ
Thus, Domar demonstrates that even under the
case of junking, the capacity will be fully utilized so
long as the rate of growth is equal to the warranted
rate of growth. Under this case, although there is full
employment of labour but less than full employment
of capital owing to premature death of capital.
Entrepreneurs are discouraged for further
investments in such case.

Stability of Equilibrium in Domar’s model

Domar only considers the question of downward
stability of his equilibrium, although not explicitly.

According to Domar, even in the situation of no

junking, if the investment ever fails to grow at the
warranted rate then the economy would progress
towards
depression because investors would further reduce
the rate of investment following developed unused
capacity due to fall of output below productive
capacity.

The situation becomes even grimmer in the case of

junking. Under this situation, the business
confidence would be negatively affected despite the
fact the economy is on the equilibrium path i.e., ��
= ��. This owes to the junking of capital following
new investments. Junking (i.e., unused capital stock
due to shortfall in labour force or demand or both)
leads to lack of desire to invest further and thereby
a reduction in rate of invest below the warranted
rate of growth even when the economy started with
the latter rate of growth. One
way Domar points out that in which entrepreneurs
will react to a high unused capacity would be by
decreasing the real wage rates and thereby
increasing their share of profits. However, this
moves, since capitalists have a higher savings rate
than the rest, would leads to increase in the savings
rate of the economy as a whole and thus the
warranted rate of growth, making it even more
difficult to achieve the warranted rate and therefore
further building of the excess capacity.

Conclusions of Domar’s model

1. Without Junking or unwanted scrapping of capital,

the income, investment, productive capacity and
capital stock can grow at the warranted rate of
growth ���� ensuring the full employment of
both labour and capital.

2. With junking of capital every year, the economy

would move towards acute depression.
3. It is the unused capital equipment that endangers
the attainment of full employment equilibrium in the
economy.

Comparison between Harrod’s and Domar Model

As noted above, the two models are similar in the

following ways:

1. For both the economists, the started point to

make the Keynesian framework dynamic.
2. Both have assumed, to some extent, constancy of
capital-output ratio ���� in case of Harrod and its
inverse, the related output-capital ratio �� in case
of Domar.

3. Both obtain constant growth paths.

4. Both assume that output follows demand thereby

implying that output can fall below potential leading
to entrepreneurial reaction of change in rate of
investment.

5. Both conclude a grimmer future if ever the

economy diverges from its unstable equilibrium
path.

Issue Domar Harrod

Key concept Rate of growth than full employment
which equate output to of capital.
Equilibrium rate of growth for
productive capacity,
entrepreneurs, which requires
ensuring full
full employment of capital but
employment of
is compatible with less than
labour but if junking
full employment of labour.
is present, it is
possible with less

Long-run Junking of capital Labour shortage not

problem decreasing the rate ofFeature of economy

investment below the Unused capacity Less than full
warranted employment of labour.
allowing economy to reach
warranted rate of growth
Role of Labour Shortages leads to
junking of capital
and thus negatively
Cause of instability affects rate of
 investment Determines the adjustment which
Continuously natural rate of results in expected
decreasing growth which is a rate of growth
investment cap on the rate of diverge further and
incentive due to growth an economy further from the
increasing unused can achieve warranted rate of
capacity growth
The process of

Causes of Simplification Fixed relative rate of

fixed assumption interest and thus
capital fixed capital-labour
output ratio combined with
ratio CRS

Although similar on many broad counts, the two

differences in models can be summarized as below:

Contributions of Kaldor
Unlike other neo-classical growth models such as
the Harrod-Domar model and Solow model,
Kaldor’s model of economic growth (Kaldor, 1957)
considers the causation of technical progress as
endogenous and provides a framework that relates
the genesis of technical progress to capital
accumulation. The model is based on Keynesian
techniques of analysis and the well
known dynamic approach of Harrod in regarding the
rates of changes in income and capital as the
dependent variables of the system. Pasinetti’s
model has made a correction to the Kaldor’s theory
of distribution and points out that in any type of
society, when any individual saves a part of his
income, he must also be allowed to own it,
otherwise he would not save at all.

Kaldor’s Model of Economic Growth

Kaldor’s growth model is based on certain

assumptions. The basic assumptions of the model
are the following:

Assumptions

1. The model assumes that in a growing economy

the general level of output at any point of time is
limited by
the availability of resources and not by effective
demand. In other words, the model assumes full
employment in the strictly Keynesian sense – a state
of affairs in which the short-run supply of aggregate
goods and services is inelastic and irresponsive to
further increase in monetary demand.

2. Technical progress depends on the rate of capital

accumulation and technical invention.

3. The variables of the model such as income,

capital, profits, wages, savings and investment are
expressed in real terms i.e., values are expressed
at constant prices.

4. The model assumes an investment function which

makes investment of any period partly a function of
the change in output and partly of the change in the
rate of profit on capital in the previous period.

5. Monetary policy is assumed to play a passive role

– which means that interest rates follow the
standard set by the rate of profit on investment in
the long-run. The model is consistent with continued
price-inflation (with money wages rising faster than
productivity) or with a
constant price level. It is also consistent with
constant money wages.

6. It is assumed that there are no effects of a

change in the share of profits and wages, and of a
change in rate of profit on capital (or of interest
rates) on the choice of techniques adopted.

Framework of the model

Kaldor postulates the following three relationships:

(i) Given savings propensities for profit-earners and

wage-earners.

(ii) Investment decisions in any period are governed

by the desire to maintain the capital stock in a given
relationship to turnover, modified by any change in
the rate of profit on capital.

(iii)A given technical relationship between the rate of

growth in productivity per person and the rate of
growth in capital per person.

Let,Yt, Kt, Pt, St and Lt denote respectively real

income, capital, profits, savings and investment at
time. Income
is divided into two categories, wages and profits,
where wages comprise salaries as well as the
earnings of manual labour, and profits comprise
entrepreneurial incomes and also incomes accruing
to property owners. The familiar saving-investment
identity is represented in the following equation
St≡ Lt≡ Kt+1-Kt