Question

1.Suppose Zusanna's current GDP is $400 billion and that it has a savings rate of .3, a depreciation rate is .1, and a capital to output ratio of 3. If the World Bank wants Zusanna to grow at 7% next year, and believes in the Harrod-Domar, then it should give $__________ of financial aid (to the nearest billion).

2.For the Harrod-Domar model to work it must be the case that dollars of development aid increase (consumption, savings, trade) _____,, and this leads to an increase in (investment, consumption, trade)_____, and this leads to (consumption, growth, capital to output ratio) _____

3.Economists criticized the Harrod-Domar because it assumes that the marginal product of capital is (positive, constant, diminishing)______, and that is should be replaced with a production function that has a(n) (increasing, diminishing, constant) _______, marginal product of capital with (constant, increasing, decreasing)_______ returns to scale in its rival inputs.

Answer 1

SOLUTION :

1) Harrod Domer equation

( s / k) - d = g

where s is the savings rate , k is the capital to output ratio , d is the depreciation rate, g is the expected growth rate for next year.

thus at s= 0.3, d = 0.1 , k = 3; g = ( 0.3 /3) - 0.1 = 0.1 - 0.1 implying growth rate will be 0% next year , but the world bank wants Zussana to grow at 7% next year ,

At output of 400, k was 3 meaning Capital (K) must be = output × k = 400 × 3 = 1200

They with growth rate of 7%

0.07 should be = (0.3 / k') -0.1 ;

0.17 = 0.3/k'

Where k' is new capital output ratio , and k' = K/Y' ; K=1200

0.17 = 0.3/(1200/Y')

0.17 = (0.3 *Y') / 1200

Y' = (0.17 * 1200)/0.3

Y' = 0.5667 ×1200

Y' = 680.04 billion

This the financial aid required is Y' - Y =

680.04 - 400

= 280.04 billion

or

280 billion.