The Democratic Republic of the Congo’s current GDP is close to 35 billion USD. S
ID: 1141264 • Letter: T
Question
The Democratic Republic of the Congo’s current GDP is close to 35 billion USD. Suppose the gross national savings rate is 10%, the capital-output ratio is 5, and the rate of depreciation is 1%.
a) (5 points) The DRC’s target GDP ve years from now is 45 billion USD. What is the growth rate needed to achieve this (calculate the numerical target), if growth occurs according to the Harrod-Domar model?
b) (5 points) The DRC plans to achieve the targeted growth rate, calculated in part(a) by increasing savings. What is the necessary savings rate? [Assume that the capital-output ratio and depreciation rate does not change]
Explanation / Answer
The Harrod Domar growth model is a model, that explains how growth has occured and how it may occur again in the future. Growth strategies are the things a government might introduce to replicate the outcome suggested by the model.
Basically the model suggests that the economy's rate of growth depends on:
1) the level of national savings (S)
2) the productivity of capital investment (known as the capital output ratio).
a) According to Harrod Domar Model rate of growth of GDP is given by:
Rate of growth of GDP= Savings Ratio/Capital Output Ratio
In the question, we are given that, the savings ratio is 10% and the capital output ratio is 5.
Using the above values to calculate the numerical target of growth rate, we get,
Rate of growth of GDP= 10%/5 = 2%
Therefore, the rate of growth of GDP is given by 2%, which means that the Democratic Republic of Congo would grow at the rate of 2% per year.
b) Given the capital output ratio as 5 and growth rate as we calculated above as 2%, the savings rate can be determined using the same analysis.
The Effect of savings rate can be understood as the increase in savings rate would increase the growth rate. The size of the increase will be inversely propotional to the size of incremental output ratio. In our question, the incremental capital output ratio is 5, a 10% increase in savings rate would be needed to increase growth rate by 2% assuming that both the capital output ratio and the rate of gdp growth remained constant.
Therefore, using the above formula:
Rate of growth of GDP= Savings rate/Capital output ratio
Savings rate=Rate of Growth of GDP*Capital output ratio
Savings rate=2%*5
Savings rate = 10%.
Therefore a savings rate of 10% would be needed to acheive the target growth rate of 2% per annum by the DRC.
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