Assalamu Alikum All,

I asked Dr. Rasha about what she gave us at the last section regarding H-D & the 2 Gap Model and I requested from her to write us something to organize them and make it easier to understand them. She replied me with the following notes which I think will be of much benefit for you all:

Concerning the H-D model.

Well, it is an aggregate model (covering the whole economic performance reflected in GNP equation and its variables).

The model main assumptions are:*Saving fixed proportion of output, **This saving ratio is the main constraint to growth if it is insuffecient to finance the desired level of investment required to achieve the desired rate of growth.

The model proceeds as folllows;

1. In a closed economy; equilibruim is when I=S and I is only addition to new capital (change in k), we get the following relation:g=s/k -previously discussed. i.e. for an economy to grow it must save more and invest in new capital.

2. In a closed economy; I is not only addition to capital, but also replacement of worn out capital (change in K and depreciation). So S at equilibruim (S=I) now is required to cover both.

3. In the short-run, output (GNP) is dependent mainly on labor force and productivity of labor.(Do u remeber the assumption that production function is dependent on labor productivity while both capital and technology are constant in the short-run? here we apply it on aggregate level).  At this level, saving is required to  create the suitable number of job opportunities in proportion to labor force growth and labor productivity. This is shown in the equation: s=k(g+deprectaion)…where g=n+p….PLZ revise the symboles from the lecture.

4. Now, we are speaking about labor and productivity. At this level we specialize more to divide saving into *saving out of wages and *saving out of profit. Proceeding through the mathematical manupilation covered well in the lecture, we can determine the desired saving rates out of profits and wages and design the best economic policies to encourage both workers and enterpreuers to save.

So, the main goal of the model is to dtermine the desired saving rates at all the previously mentioned levels…

Concerning the 2-gap model; the main idea is that;

GDP= C+I+X-M (where G is included in C(private and government) and I(private and government).

*To reach the desired GDP growth rate (g), I and net exports must reach certain levels. S is required to finance I, and M is required to make certain imported capital goods availabe to produce and export. Here comes the S-I and M-X gaps.

These gaps aren’t additive, i.e., the government should do its best to cover the largest of the two gaps (whether the domestic or foreign gap), once the largest gap is covered, the other will not form a problem.

If the government succefully determined the largest gap and the required amounts to cover it, means to finance must be found. The most commenly used are foreign borrowing and foreign direct investment.