Chapter 3
Classic Theories
of Economic
Growth and
Development
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3.1 Classic Theories of Economic
Development: Four Approaches
• Linear stages of growth model
• Theories and Patterns of structural change
• International-dependence revolution
• Neoclassical, free market counterrevolution
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3.2 Development as Growth and
Linear-Stages Theories
• A Classic Statement: Rostow’s Stages of
Growth
• Harrod-Domar Growth Model (sometimes
referred to as the AK model)
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Rostow’s Stages of Economic
Growth
Walt Rostow proposed a five-stage model of economic development,
emphasizing a linear progression from traditional to modern
economies.
Traditional Society
Subsistence agriculture, barter economy
Limited technology, low productivity
Rigid social structure, resistance to change
Preconditions for Take-off
Emergence of external influence (trade, investment)
Development of infrastructure (transport, education)
Growth in savings and investments
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Rostow’s Stages of Economic
Growth
Take-off
Rapid industrialization, rising investment rates
Shift from agriculture to manufacturing
Institutional changes to support growth
Drive to Maturity
Diversification of industries
Technological advancement, increased incomes
Expansion of global trade
Age of High Mass Consumption
Shift to consumer-oriented economy
Rise in service sector dominance
Social welfare improvements
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Rostow’s Stages of Economic
Growth
Criticism & Relevance
Too simplistic, ignores structural constraints
Assumes all countries follow the same path
Useful for understanding historical development
trends
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Harrod-Domar Growth Model
(AK Model)
• A Keynesian-based economic growth model explaining how savings
and investment drive economic expansion.
• Higher Savings → More Investment → Capital Accumulation → Higher
Output → Economic Growth
Key Assumptions
Growth depends on savings rate (S) and capital-output ratio (C).
Economic stability requires a balance between actual, warranted,
and natural growth rates.
Investment leads to both income generation (demand-side) and
productive capacity (supply-side).
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The Harrod-Domar Growth Model
Every economy must save a certain proportion of its national
income, if only to replace worn-out or impaired capital goods
(buildings, equipment, and materials). However, in order to
grow, new investments representing net additions to the capital
stock are necessary. If we assume that there is some direct
economic relationship between the size of the total capital stock,
K, and total GDP, Y—for example, if $3 of capital is always
necessary to produce an annual $1 stream of GDP—it follows
that any net additions to the capital stock in the form of new
investment will bring about corresponding increases in the flow
of national out put, GDP.
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The Harrod-Domar Growth Model
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The Harrod-Domar Growth Model
Note: Eq 3.7 is simplified version of Harrod-Domar Growth Model
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The Harrod-Domar Model –
Incorporating Capital Depreciation
• Equation 3.7 is also often expressed in terms of gross savings,
in which case the growth rate is given by
(3.7’)
where δ is the rate of capital depreciation
• But there is now growing evidence of “per capita income convergence,”
weighting changes in per capita income by population size
• (Also, in chapter 3, we return to examine the concept of conditional
convergence when we study the Solow model)
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Actual rate at which economies can grow?
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Implications
Higher savings lead to faster growth, but excessive savings
without investment can cause unemployment.
Capital-output ratio (efficiency of investment) plays a crucial
role in sustaining growth.
Explains why developing countries face a "savings gap",
requiring external financing (loans, aid).
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Criticism & Limitations
Assumes a fixed capital-output ratio and ignores technological
change.
Does not account for institutional and structural constraints in
developing economies.
Overemphasizes savings and investment, neglecting other
growth factors (e.g., human capital).
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