In a small Asian country, it is estimated that changing the level of capital from $8 million to $12 million will increase real GDP from $4 million to $6 million. What level of GDP would you expect the economy to be able to reach if spending on capital continued to rise to $16 million, assuming no technological change and no change in the hours of work?

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Business

Kristopher Koch

11 May, 00:30

In a small Asian country, it is estimated that changing the level of capital from $8 million to $12 million will increase real GDP from $4 million to $6 million. What level of GDP would you expect the economy to be able to reach if spending on capital continued to rise to $16 million, assuming no technological change and no change in the hours of work?

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Nathan Huynh · Answer 1

If increasing the level of capital from $8 million to $12 million increases real GDP from $4 to $6 million, then a further increase of the level of capital from $12 to $16 million should increase the real GDP but not in the same proportion, i. e. it will not increase the real GDP from $6 million to $8 million.

An increase in the level of capital will increase investment in the economy, but unless productivity or technological progress increases, then the gains will tend to be smaller every time.

Investment is the greatest driver of economic growth, but it cannot do it all by itself. Productivity must increase, and generally when investment increases, productivity increases due to technological progress. E. g. You deliver packages on a bicycle and are able to deliver 10 packages per day. If the company gives you a delivery truck (increase in investment and technology) then you will be able to deliver 30 packages per day and your productivity will have increased by 200%.