Harrod–Domar Model

Origins and basic structure

Keynes's General Theory (1936) focused on investment as a determinant of short-run aggregate demand, but it did not address the fact that investment also expands productive capacity. Roy Harrod, in his 1939 “Essay in Dynamic Theory,” and Evsey Domar, in his papers of 1946 and 1947 on capital expansion and employment, analyzed this dual character. The model's central equation is g = s / v, where s is the saving rate and v is the capital–output ratio. If an economy saves 20 percent of income and needs four units of capital per unit of output, for example, it can grow at 5 percent a year. Domar stressed that full employment can be sustained only if demand grows fast enough to absorb the capacity that investment creates.

Warranted and natural growth and the knife edge

Harrod distinguished the warranted rate of growth, at which firms are satisfied with the investment they have undertaken, from the natural rate, which is permitted by labor force growth and technical progress. Steady growth with full employment is possible only when the two coincide, yet because the saving rate, the capital–output ratio and population growth are set independently, such a coincidence would be largely accidental. Moreover, because a small departure of actual growth from the warranted rate leads expectations and investment to widen the gap, the equilibrium was described as balanced on a knife edge. Besomi (2001) argued that this reading partly simplifies Harrod's own intentions. The problem became the starting point for later debates in growth theory.

From Harrod–Domar to Solow and development economics

Solow (1956) and Swan (1956) showed that allowing substitution between capital and labor, and thus a variable capital–output ratio, makes the economy converge to a stable balanced growth path, laying the foundation of the Solow model. Cambridge economists such as Kaldor (1956) instead argued that the saving rate adjusts through the distribution of income. Meanwhile, the Harrod–Domar equation was widely used in development economics in the 1950s and 1960s to calculate the investment and external finance needed to reach a target growth rate, alongside the ideas of Lewis (1954) and Rostow (1960). Easterly (1999) criticized this financing gap model, still used by international financial institutions, for predicting the actual relationship between investment and growth poorly. Today the model is treated as the starting point of a history of growth theory that leads to endogenous growth theory.

FAQ

What is the Harrod–Domar model in simple terms?

It is a simple growth model in which the growth rate depends on how much an economy saves and invests and on how efficiently that investment raises output.

What is the knife-edge problem?

It is the idea that if actual growth departs even slightly from the equilibrium rate, firms' expectations and investment widen the gap, so the economy moves away from equilibrium instead of returning to it.

Sources reviewed: 2026-10-26

References

1. Harrod, R. F. (1939). An essay in dynamic theory. Economic Journal, 49(193), 14–33.
2. Harrod, R. F. (1948). Towards a Dynamic Economics. London: Macmillan.
3. Domar, E. D. (1946). Capital expansion, rate of growth, and employment. Econometrica, 14(2), 137–147.
4. Domar, E. D. (1947). Expansion and employment. American Economic Review, 37(1), 34–55.
5. Keynes, J. M. (1936). The General Theory of Employment, Interest and Money. London: Macmillan.
6. Solow, R. M. (1956). A contribution to the theory of economic growth. Quarterly Journal of Economics, 70(1), 65–94.
7. Swan, T. W. (1956). Economic growth and capital accumulation. Economic Record, 32(2), 334–361.
8. Kaldor, N. (1956). Alternative theories of distribution. Review of Economic Studies, 23(2), 83–100.
9. Lewis, W. A. (1954). Economic development with unlimited supplies of labour. Manchester School, 22(2), 139–191.
10. Rostow, W. W. (1960). The Stages of Economic Growth: A Non-Communist Manifesto. Cambridge: Cambridge University Press.
11. Sen, A. (Ed.). (1970). Growth Economics. Harmondsworth: Penguin.
12. Easterly, W. (1999). The ghost of financing gap: Testing the growth model used in the international financial institutions. Journal of Development Economics, 60(2), 423–438.
13. Besomi, D. (2001). Harrod's dynamics and the theory of growth: The story of a mistaken attribution. Cambridge Journal of Economics, 25(1), 79–96.