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Question 3 (12 marks) a. It is found that the real GDP per capita of developing...

Question 3

  1. 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.
  2. 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.
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Answer #1

Ans a) A developing country has a lower capital than the developed country, so, investment in capital stock in a developing country will add more to output than in developed country because of diminishing returns to capital which is as the quantity of capital employed increases, the additional production by each additional unit of capital falls.

b) Government saving = Taxes - Government Expenditure = 17600 - 30000 = -$12400

National Saving = Private saving + Government savings

=> Private saving = National Saving - Government savings = 20000 - (-12400) = $32400

Also, Private saving = GDP - Consumption

=> GDP = Private saving + consumption = 32400 + 80000 = $112400

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