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. What 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

Since there are diminishing returns to capital, an increase in the saving rate will lead to a temporary increase in growth in the level of real GDP per person, but eventually the growth rate will return to its previous level due to diminishing returns. The country with less capital will experience a greater temporary increase in growth in the level of real GDP per person because it has farther to move along the diminishing returns curve. Therefore, both countries will have higher levels of real GDP per person, but the temporary increase in growth in the level of real GDP per person will have been greater in the country with less capital.

Suppose That There Are Diminishing Returns to Capital