Question

Q1:

1. Explain the concept of diminishing returns to physical capital. What does it predict about economic growth of different countries over time? Give real world examples of countries that are in line with this prediction, as well as those that contradict this prediction.

2. Howistheconceptofdiminishingreturnstoaninput(suchasphysicalcapital)similarto,and how is it different from, the concept of decreasing returns to scale? Which one of these is more likely to be observed in real-world economies, and why?

3. What is your view on GDP as a measure of wellbeing? Carefully discuss and also try to connect the debate to the COVID-19 pandemic and the lockdown.

Answer 1

The diminishing returns to physical capital mean that the initial usage of physical units yield higher output but when we keep on increasing the physical capital, the output will not increase in a similar manner rather will grow at a diminishing rate. This phenomenon has to do with marginal product of capital which means additions to the output with additional unit of capital. This marginal product declines when we add more physical capital to the production process. The prediction made by this concept is that for a country growing from a base, the increase in physical capital can lead to growth, but because of diminishing returns, the same addition to capital stock decreases the output over the period of time.
This phenomenon of countries in line and contradicting can be best explained using the convergence effect to the catch up effect which shows that poorer countries-per capita will grow with diminishing returns to capital as compared to rich economies and both will converge after a point of time as developing economies imitate or transfer the technology from developed nations.The developing economies face weak diminishing returns to scale as compared to the developed nations. Example Germany and Japan contradict this prediction as after World War II there situation was worse. In U.S.A this phenomenon is applicable as most of the machines and equipments are lying ideal or are imported from the nation.

The decreasing returns to scale means increase in all inputs causing less proportionate increase in output. Here, the focus is not on single factor rather all the factors are considered and is usually a long run concept.
It is similar to the diminishing returns to physical capital in the sense that the output growth is lowered with a change in the inputs used. It is different from the diminishing returns to physical capital as in the latter the focus is only on one factor of production rather than all the factors.

In the real world scenario, the concept of diminishing returns to physical capital is more prevalent as economies hardly make changes in all the inputs simultaneously. With the requirement of the industries the changes are made in the short run.