Question

Explain the effect of an increase in (physical) capital on economic growth. (10marks)

In your answer, carefully explain the effect of increase in capital on real GDP, real GDP per capita and average labour productivity.

Answer 1

Physical capital & Economic growth
Physical capital in economics is the factors of production such as machinery, building etc. The inputs for the production process can also be defined as physical capital. It constitutes one of the important factors of the production function. The increase in the amount of physical capital can make huge impact in the actual economic growth. Nominal growth can be developed through the change in the price level, but the growth in real terms can only be increased by the expansion of factors including physical capital.
The increase in real GDP is after the increase in the total output of the goods and services produced in an economy. An increase in the capital can lead to increasing the ability of the production process. Expansion of machinery, building and all can increase the productivity of the firm or the industry. Increased capital installments can increase the level of output, improving level of employment, affecting shift in demand and supply, thus leading to economic growth. The increase in the level of total output through increasing the physical capital by utilizing more resources helps the per capita to rise which is a sign of economic growth. The capital expansion can also increase the average productivity of labor and increasing the efficiency of both capital and labor. The amount of labor to produce per unit of output will be reduced doe to the increase in the physical capital. These are how the physical capital can make impact on the real terms of growth.