Economics for Today 9th Edition by Irvin Tucker

Exercise 40

HOW DOES PUBLIC CAPITAL AFFECT A NATION'S CURVE?
Applicable Concept: economic growth
The discussion of low-investment country Alpha versus high-investment country Beta explained that sacrificing production of consumer goods for an increase in capital goods output can result in economic growth and a higher standard of living. Stated differently, there was a long-run benefit from the accumulation of capital that offset the short-run opportunity cost in terms of consumer goods. Here the analysis was in terms of investment in private capital such as factories, machines, and inventories. However, public or government capital can also influence the production of both capital goods and consumption goods. For example, the government provides infrastructure such as roads, schools, bridges, ports, dams, and sanitation that makes the accumulation process for private capital more efficient, and in turn, an economy grows at a greater rate.
Using data from 21 high-investment countries, a recent study by economists investigated how government investment policy affected the productivity of new private capital goods. Countries included in the research were, for example, Canada, Japan, New Zealand, Spain, and the United States. A key finding was that a 1 percent increase in public investment increased the productivity of private investment by 27 percent. As a result, public capital caused the stock of private capital to rise more quickly over time.
Finally, economic growth and development is a major goal of countries throughout the world, and there are numerous factors that cause some countries to experience greater economic growth compared to other countries. Note that this topic is discussed in more depth in the last chapter of the text.
Construct a production possibilities curve for a hypothetical country. Put public capital goods per year on the vertical axis and consumer goods per year on the horizontal axis. Not shown directly in your graph, assume that this country produces just enough private capital per year to replace its depreciated capital. Assume further that this country is without public capital and is operating at point A, where consumer goods are at a maximum. Based on the above research and using a production possibilities curve, show and explain what happens to this country's private capital, production possibilities curve, and standard of living if it increases its output of public capital.