Critically examine the basic formulations of the Harrod-Domar model of economic growth. How does the Harrod model explain the occurrence of trade cycles?

The basic formulations of the Harood-Domar Model of economic growth are summarized as follows: -

(i)Investment is the central theme of the HDM. It plays a dual role. On the one hand it generates income and on the other it creates productive capacity.

(ii)The increased capacity results in greater output and greater employment, depending on the behavior of the income.

(iii)Condition regarding the behavior of income can be expressed in terms of growth-rates i.e , G, Gw and Gn. The equality between these growth rates would ensure full employment of labour and full utilization of capital stock.

(iv)These conditions, however, designate only a steady-line of growth. The actual growth rate may differ iron the warranted growth rate. If the actual growth rate is higher than the warranted rate of growth, the economy will experience cumulative inflation. If the actual growth rate is lower than the warranted growth rate, the economy will hurtle towards cumulative deflation.

(v)The business-cycles are viewed as the deviations from the path of steady growth. These deviations cannot go on indefinitely. There are constraints on upper and lower limits. The “full employment ceiling” acts an upper limit and autonomous investment and consumption act as a lower limit. The actual growth-rate fluctuates between these two limits.

Harrod has used his model to explain trade cycles. In the recovery phase, because of the existence of unemployed resources, G>Gn. When full employment is reached G = Gn. If Gw exceeds Gn at the full employment, slump is inevitable. Since G had to fall below Gw, it will, for the time being, be driven progressively downwards. Further, G itself fluctuated during the course of the business cycle. Savings as a fraction of income, though fairly steady in the long run, fluctuate in the short run. In the short run, savings tend to be residual between the earning and normal consumption. Companies, also, are likely to save large portion of their short-period increased in net receipts. Thus, even if Gw is normally below Gn, it is likely to ride above Gn in the later stages of advance, and, if it so happens, a vicious spiral of depression is inevitable when full employment is reached. If Gw does not ride above Gn in the course of advance, there would be continued pressure to advance when full employment is reached; this would lead to inflation and consequently, sooner or later, to a rise of Gw above Gn, resulting ultimately into a vicious spiral of depression. Actually, G may be reduced before the employment is reached because of immobilities, frictions, and bottlenecks and, if it so happens, depression may come before full employment is reached. If Gw is far above Gn, G may never rise far above Gw during the revival and the depression may result long before full employment is reached.