Discussion
Consider the following statements.
The knife-edge problem in the Harrod-Domar growth model implies a constant
(i) Rate of population growth
(ii) Output
(iii) Rate of saving
(iv) Capital-output ratio
Of the statements :
Answer: A
The key's answer is (iv) alone is correct: the knife-edge problem implies a constant capital-output ratio.
In the Harrod-Domar model the economy grows steadily only if the warranted rate of growth, \(s/v\) (the saving rate over the capital-output ratio), exactly equals the natural rate set by labour-force growth. Because the model fixes the capital-output ratio, technology allows no substitution between capital and labour, so nothing pulls the economy back once the two rates differ. Any deviation grows, which is the knife-edge.
Solow's growth model removed the problem precisely by letting the capital-output ratio vary. The key therefore singles out (iv). Output (ii) is not constant in a growth model at all, and the options that add population growth and the saving rate treat parameters of the model as the source of the instability, which the key does not accept.
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