A developing country targets an annual economic growth rate of 8\%. The economy's Incremen… — JAMB UTME

A developing country targets an annual economic growth rate of $8\%$ . The economy's Incremental Capital-Output Ratio (ICOR) is estimated at $3.5$ , and its current domestic savings rate is $21\%$ of national income. According to the Harrod-Domar growth model, what is the foreign savings gap (as a percentage of national income) that must be filled to achieve this growth target?

$7.0\%$ Answer
B
$28.0\%$
C
$2.29\%$
D
$4.5\%$

Answer

7.0\%

of national income

According to the Harrod-Domar development planning model, the rate of economic growth (

g

) equals the savings ratio (

s

) divided by the Incremental Capital-Output Ratio (

k

), expressed as

g = \frac{s}{k}

. Rearranging this gives the total required savings rate

s^* = g \times k = 8\% \times 3.5 = 28\%

. Given that domestic savings currently provide

21\%

of national income, the remaining savings gap to be financed via external capital or foreign aid is

28\% - 21\% = 7.0\%

Step-by-Step Solution

Identify the basic Harrod-Domar growth equation relating growth rate (

g

), savings rate (

s

), and Incremental Capital-Output Ratio (

k

Formula:

g = \frac{s}{k}

The Harrod-Domar model establishes that economic growth depends directly on the savings rate and inversely on the capital-output ratio.

Rearrange the equation to determine the total required domestic savings rate (

s^*

) needed to achieve the target growth rate (

g = 8\%

0.08

) with an ICOR (

k = 3.5

s^* = g \times k = 8\% \times 3.5 = 28\%

To achieve an

8\%

growth rate with an ICOR of

3.5

, the country must allocate

28\%

of its national income to capital investment.

Calculate the savings gap by subtracting the current domestic savings rate (

s = 21\%

) from the total required savings rate (

s^* = 28\%

Savings Gap

= s^* - s = 28\% - 21\% = 7.0\%

The difference between required investment resources and available domestic savings defines the external financing requirement.

Key Concept

Harrod-Domar Growth Model and Savings Gap Analysis

Question

Answer

Step-by-Step Solution

Key Concept

Common Mistakes

Topics

More questions from this topic