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The Harrod-Domar model explains how the income of today affects the income of tomorrow in a simple equation where the data entries are minimal Although the Harrod-Domar model is easy to use there are a few limitations The economy only enters equilibrium when there is a full employment of both labor and capital Using the fixed-coefficient production function the capital-labor ratio must remain constant On a graph with capital on the y-axis and labor on the x-axis we can illustrate all the different combinations of capital and labor that equal the same income through L-shaped isoquants In order to be at full employment capital and labor must grow at the same rate which is unlikely First capital stock must grow at the same rate as output which implies constant growth at full employment of capital The capital stock to output ratio v is capital stock divided by output where the variables grow at the same rate Output grows at a rate of g therefore capital stock must be growing at the same rate If we apply the above logic to labor the population must be growing at same growth rate g Now what if the labor force is growing too fast where ng we move off the isoquant where resources are under-utilized There are new workers but the machinery is not being used which implies labor unemployment What if the opposite was true what if the labor force was not growing fast enough In this case there are too many machines and not enough workers or unemployed capital This characteristic has come to be known as the knife-edge problem In the Harrod-Domar model the savings rate s the growth rate of the population n and the capital output ratio v were taken as constants or exogenous variables Solow understood that all these variables were capable of changing from time to time but sporadically and more or less independently Oct 15 Solow realized that the
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