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Chapter 22: Problem 2

What are the consequences for growth of diminishing returns to capital? How are some economies able to maintain high growth rates despite diminishing returns to capital?

Short Answer

Expert verified
Diminishing returns to capital can slow down economic growth by reducing the productivity of new investments. Some economies, however, are able to maintain high growth rates despite diminishing returns by diversifying their sources of growth and focusing on increasing the productivity of all inputs, not just capital.

Step by step solution

01

Understanding Diminishing Returns to Capital

Diminishing returns to capital is an economic theory stating that if the amount of one factor of production is increased while keeping other factors constant, at some point, additional increases in the productive factor do not increase output proportionately. In other words, after a certain point, each additional unit of capital results in less output than the previous unit.
02

Effect on Economic Growth

When an economy relies heavily on capital accumulation for growth, the phenomenon of diminishing returns to capital means that every new investment of capital will yield less 'bang for the buck'. This can significantly slow down an economy's growth rate over time if additional measures to stimulate productivity are not implemented.
03

Overcoming Diminishing Returns

Economies can overcome diminishing returns to capital and maintain high growth rates by diversifying their sources of economic growth. In other words, economies should not rely solely on capital accumulation. Other sources of growth include technology improvements, human capital development, infrastructure investment, and institutional reforms. Economies that focus on these areas are able to sustain high growth rates despite diminishing returns to capital because these factors increase the productivity of all inputs, including capital.

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