An economy operating under a medium-term development plan targets an annual real GDP growt… — JAMB UTME

An economy operating under a medium-term development plan targets an annual real GDP growth rate of $8\%$ . If the country's incremental capital-output ratio (ICOR) is estimated at $4$ and the current domestic savings rate is $18\%$ of GDP, what is the domestic savings gap (additional savings rate required) to achieve the target growth rate according to the Harrod-Domar growth model?

$14\%$ Answer
B
$2\%$
C
$32\%$
D
$50\%$

Answer

The domestic savings gap required to achieve the targeted growth rate is

14\%

According to the Harrod-Domar growth model, economic growth (

g

) is determined by the savings ratio (

s

) divided by the incremental capital-output ratio (

k

), expressed as

g = \frac{s}{k}

. Rearranging to find total required savings gives

s = g \times k = 8\% \times 4 = 32\%

. Since the economy currently saves

18\%

of GDP, the additional savings required to fulfill the plan (the savings gap) is

32\% - 18\% = 14\%

Step-by-Step Solution

Identify the given variables in the Harrod-Domar growth model formula.

Target growth rate (

g

) =

8\%

, Incremental Capital-Output Ratio (

k

) =

4

, Current domestic savings rate (

s_{current}

) =

18\%

The Harrod-Domar model states that the economic growth rate

g = \frac{s}{k}

, where

s

is the total required national savings rate and

k

is the ICOR.

Calculate the total required savings rate (

s_{required}

s_{required} = g \times k = 8\% \times 4 = 32\%

To generate an

8\%

growth rate given that

4

units of capital produce

1

unit of output, total savings must equal

32\%

of GDP.

Compute the domestic savings gap.

Savings Gap =

s_{required} - s_{current} = 32\% - 18\% = 14\%

The savings gap measures the shortfall between total required investment/savings and currently available domestic savings.

Key Concept

Harrod-Domar Growth Model and Savings Gap Calculation

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