Give a simple explanation of the mechanism of the Harrod-Domar growth model.

The Harrod-Domar growth model is an economic model that was developed independently by Roy Harrod and Evsey Domar in the 1930s. It was one of the first models that attempted to explain long-term economic growth by focusing on the roles of investment, savings, and capital output. The primary purpose of the model is to determine the growth rate of an economy that is necessary to maintain full employment and a stable price level.

There are three main components of the Harrod-Domar model: 1. Savings, denoted as S: This refers to the total amount of income that is saved, rather than consumed, in an economy. 2. The Marginal Propensity to Save (MPS), denoted as s: This is the proportion of each additional unit of income that is saved, rather than consumed. 3. Incremental Capital Output Ratio (ICOR), denoted as k: This is the additional amount of capital required to produce one additional unit of output or income.

The Harrod-Domar model is expressed using the following equation: Growth Rate (g) = \( \frac {S} {k} \) Where: - Growth Rate (g) is the rate of economic growth needed to maintain full employment and stable prices. - Savings (S) represents the total amount of income saved in the economy. - Incremental Capital Output Ratio (ICOR), (k) is the additional capital needed to produce one more unit of output.

The Harrod-Domar model simplifies the complex process of economic growth into the relationship between savings, investment, and output. According to the model, an increase in savings leads to higher investment, which in turn increases capital stock and thus contributes to economic growth. The growth rate of an economy (g) is determined by two factors: the marginal propensity to save (s) and the incremental capital-output ratio (k). If any of these two factors change, it affects the overall growth rate. For example, if the marginal propensity to save increases, this means that people are saving more money and therefore, investment in the economy can increase. This leads to higher capital accumulation, which can ultimately lead to higher economic growth. Similarly, if the incremental capital-output ratio decreases, it means that the economy becomes more efficient in using capital to produce output. This will also result in higher economic growth as less capital investment is required to achieve the same increase in output. While the Harrod-Domar model simplifies the economic growth process, it has its limitations. The model does not consider factors such as technology, human capital, and productivity that play significant roles in explaining modern economic growth. However, the model has been an important starting point for the development of more advanced economic growth theories.