BSA 2-3

ECONOMIC DEVELOPMENT

Please discuss the following Theories on Economic Development

1. Theory of Development Stages

1. Traditional Society: During this period, most countries rely largely on
agriculture as their primary source of revenue and employment. They have minimal
technological progress, which leads to limited economic growth. This stage is
distinguished by high birth and death rates, as well as a lack of critical infrastructural
and educational resources.
2. Prerequisites for Take-Off: As countries enter the second stage, they begin
to make critical investments in sectors such as infrastructure, education, and
technology. This change allows their economies to diversify beyond agriculture, with
some improvement in industry and trade being witnessed. Savings and investment
are increasing, and the creation of essential institutions and enhanced infrastructure
are important elements.
3. Take-off: The third stage is characterized by fast industrialization and significant
economic expansion. Manufacturing and industrial sectors gain dominance, resulting
in higher productivity and urbanization. This stage is distinguished by increased
investment, technical innovation, and the rise of new industries that fuel economic
growth.
4. Drive to Maturity: As countries go to the fourth stage, they continue to experience
economic expansion and industry diversification. The emphasis moves to improving
living conditions and developing service sectors. This stage is distinguished by stable
institutions, improved education and healthcare systems, and a growing middle
class.
5. Age of Mass Consumption: In the final stage, countries have evolved into
advanced economies with high living standards. The service sector overtakes
manufacturing as the leading contributor to economic activity. People in these
countries consume a much, thanks to a well-developed infrastructure and a strong
emphasis on enhancing their quality of life.

2. Harrod-Domar Model of Economic Growth

The Harrod-Domar Model of Economic Growth, developed by Sir Roy Harrod and
Evsey Domar independently in the 1930s, is an early macroeconomic model that
focuses on the relationship between investment and economic growth. This model
seeks to explain how changes in investment levels can influence a country's overall
economic output or Gross Domestic Product (GDP).

2. Basic Assumptions:
The model is based on several key assumptions:

There are two main sectors in the economy: the consumption sector and the
investment sector.
Investment is the key driver of economic growth.
There is a fixed capital-output ratio, which means that a certain amount of capital
(machines, factories, infrastructure) is required to produce a given level of output
(goods and services).
The economy is closed, meaning it doesn't engage in international trade.
3. The Harrod-Domar Equation:
The central idea of the Harrod-Domar Model is summarized by the following
equation:

ΔY = (I / S) * ΔS

ΔY represents the change in national income or GDP.

I represents investment.
S represents savings.
ΔS represents the change in savings.
The equation suggests that an increase in investment (I) will lead to a proportional
increase in national income (ΔY), provided that the economy's savings rate (S)
remains constant.

4. Understanding the Model:

If the rate of investment (I) is greater than the rate of savings (S), then the economy
will experience positive economic growth (ΔY will be positive).
If the rate of investment (I) is less than the rate of savings (S), then the economy will
experience negative or reduced economic growth (ΔY will be negative or smaller).
5. Implications and Critiques:
The Harrod-Domar Model highlights the importance of investment in stimulating
economic growth. It implies that to achieve higher economic growth rates, a country
should aim to increase its rate of investment, which can be done through public or
private spending on capital projects.
Critics of the model argue that it oversimplifies the complex process of economic
growth by assuming a fixed capital-output ratio, which may not hold true in the real
world. In reality, the efficiency of capital can vary and change over time.
The model also doesn't account for factors like technological progress, changes in
the labor force, or the impact of government policies on growth.
Additionally, it assumes a closed economy, which limits its applicability to open
economies that engage in international trade.
6. Modern Relevance:
While the Harrod-Domar Model has limitations, it laid the foundation for later
growth theories and models. Contemporary economic models have built upon these
ideas by incorporating more realistic assumptions, such as endogenous growth
theory, which emphasizes the role of factors like technological advancement and
human capital in driving economic growth.

In summary, the Harrod-Domar Model is a foundational concept in economics that

highlights the relationship between investment and economic growth. While it
provides valuable insights, it should be viewed as a simplified representation of
economic reality and considered alongside other models and theories for a
comprehensive understanding of economic development.

3. The Neoclassical Theory

4. The Newgrowth Theory
5. Solow Growth Model