Suppose that there are diminishing returns to capital. Suppose also that two countries are the same except one has less capital and so less real GDP per person. Suppose that both increase their saving rate from 3 percent to 4 percent. Which of the following will happen in the long run?
A)Both countries will have permanently higher growth rates of real GDP per person, and the growth rate will be higher in the country with more capital.
B)Both countries will have permanently higher growth rates of real GDP per person, and the growth rate will be higher in the country with less capital.
C)Both countries will have higher levels of real GDP per person, and the temporary increase in growth in the level of real GDP per person will have been greater in the country with more capital.
D)Both countries will have higher levels of real GDP per person, and the temporary increase in growth in the level of real GDP per person will have been greater in the country with less capital.

Question

Quizplus · Accepted Answer

The country with less capital will experience a greater temporary increase in the growth rate of real GDP per person because it has more room to increase its capital stock. However, both countries will eventually reach a new steady state level of capital and real GDP per person, with both experiencing a permanent increase in their growth rates. The growth rate will be higher in the country with less capital because it has more potential for growth due to the initial lower level of capital.

Suppose That There Are Diminishing Returns to Capital