# Domar Model - DOMAR GROWTH MODEL DOMAR The Framework The...

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DOMAR GROWTH MODEL DOMAR GROWTH MODEL The Framework The Framework The basic premises of the Domar model are as follows: 1. Any change in the rate of investment flow per year I(t) will produce a dual effect: it will affect the aggregate demand as well as the productive capacity of the economy. 2. The demand effect of a change in I(t) operates through the multiplier process, assumed to work instantaneously. Thus an increase in I(t) will raise the rate of income flow per year Y(t) by a multiple of the increment in I(t) . The multiplier is k=1/s , where s stands for the given (constant) marginal propensity to save. On the assumption that I(t) is the only (parametric) expenditure flow that influences the rate of income flow, we can then state that

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s dt dI dt dY 1 = ( 1 ) 3. The capacity effect of investment is to be measured by the change in the rate of potential output the economy is capable of producing. Assuming a constant capacity-capital ratio, we can write ρ κ K ( = a constant ) where (the Greek letter kappa) stands for capacity or potential output flow per year, and (the Greek letter rho) denotes the given capacity-capital ratio. This implies, of course, that with a capital stock K(t) the economy is potentially capable of producing an annual product, or income, amounting to dollars. Note that, from K κ≡ K
(the production function), it follows that , and dK d ρ κ= I dt dK dt d κ = = ( 2 ) In Domar's model, equilibrium is defined to be a situation in which productive capacity is fully utilized. To have equilibrium is, therefore, to require the aggregate demand to

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## This note was uploaded on 11/30/2011 for the course BUSINESS Finance taught by Professor Xiaoyun during the Spring '10 term at Nankai University.

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Domar Model - DOMAR GROWTH MODEL DOMAR The Framework The...

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