Question

a. It is found that the real GDP per capita of developing countries grows faster than developed countries at the same period. Explain this phenomenon in the light of diminishing returns to capital.

b. In a closed economy, consumption is $80,000, taxes are $17,600, government purchases are $30,000 and national saving amounts to $20,000. Compute the level of GDP and private saving.

Answer 1

(a)

Developing countries have lower capital stock that developed countries. So they experience increasing returns to capital, which increases growth rate of per capita GDP, while developed countries experience diminishing returns to capital, which decreases growth rate of per capita GDP over time.

(b)

Y = C - T + I + G

(Y - C) + (T - G) = I

National saving = I = 20,000

GDP = C + I + G

= 80,000 + 20,000 + 30,000

= 130,000

Private saving = Y - C

= 130,000 - 80,000

= 50,000