Question

The Harrod–Domar model exhibits the knife-edge property that growth is consistent with continuously full employment only if (s/k)-d just happens to equal n. This knife-edge property is eliminated in the simple neoclassical model, which is characterized by continuously full employment. Discuss the importance of assuming variable rather than fixed proportions production technology for working this change

Answer 1

the neoclassical model which was given by Solow emphasised on capital accumulation and related saving as a determinant of growth. Its production function had two factors of production capital and labor. There were two ways of inheriting technological advancement, one was to introduce an exogeneously determined level of technology and second was to assume labour augmentation.

In contrast to the fixed proportionate assumpion in Harrod Domar model, neo classical model preferred variable proportion production function which implies that there are enumerous ways to substitute capital and labor in the production process. Another assumption was that investment and ssavings are always equal given price flexibility to adjust immediately. This indicates that neo classical growth focuses on supply side factors as determinants of growth and didnot rely on aggregate demand like Harrod domar model.

The instability problem in the Harrod Domar model which was due to fixed proportion assumption was avoided by the variable proportion introduced in the Neo classical model. The emphasis was on the ease of substitution between the factors of production to ensure that the steady state growth is achieved.