Capital Accumulation - Harrod–Domar Model

Harrod–Domar Model

In macroeconomics, following the Harrod–Domar model, the savings ratio and the capital coefficient are regarded as critical factors for accumulation and growth, assuming that all saving is used to finance fixed investment. The rate of growth of the real stock of fixed capital is:

where is the real national income. If the capital-output ratio or capital coefficient is constant, the rate of growth of is equal to the rate of growth of . This is determined by (the ratio of net fixed investment or saving to ) and .

A country might for example save and invest 12% of its national income, and then if the capital coefficient is 4:1 (i.e. $4 billion must be invested to increase the national income by 1 billion) the rate of growth of the national income might be 3% annually. However, as Keynesian economics points out, savings do not automatically mean investment (as liquid funds may be hoarded for example). Investment may also not be investment in fixed capital (see above).

Assuming that the turnover of total production capital invested remains constant, the proportion of total investment which just maintains the stock of total capital, rather than enlarging it, will typically increase as the total stock increases. The growth rate of incomes and net new investments must then also increase, in order to accelerate the growth of the capital stock. Simply put, the bigger capital grows, the more capital it takes to keep it growing and the more markets must expand.