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, than the other. Suppose that the saving rate in both countries increases from 5 percent to 6 percent. What would we expect over the next 10 years?
A) The growth rate will not change in either country.
B) The country with less capital will grow faster.
C) The country with more capital will grow faster.
D) Both countries will grow at the same rate.

Question

Quizplus · Accepted Answer

Since there are diminishing returns to capital, the country with less capital will experience a higher growth rate as the increase in saving rate will lead to a larger increase in capital stock in that country. The country with more capital already has a higher capital stock, and so the increase in saving rate will result in a smaller increase in capital stock and therefore a lower growth rate.

Suppose That There Are Diminishing Returns to Capital