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The Harrod-Domar model

Calculate growth and a savings gap with the Harrod-Domar model, and explain its limitations

Saving pays for the investment that builds new capital

In a low-income country most income is spent at once on necessities such as food. Lack of saving means a lack of loanable funds for investment, so the capital stock grows slowly.

The capital-output ratio sets how much extra output new capital brings

The model assumes each extra pound of output needs a fixed amount of capital: the capital-output ratio. With a ratio of four, £4 of new capital adds £1 a year to output. A lower ratio means capital is used more productively, so each pound invested brings more output.