Question

Country A has 100 machines (physical capital) and a population of 100 (out which 80 are in the labour force). Discuss the effect on real GDP per capita if a. Population doubles (keeping machines constant at 100) b. Machines double (keeping the population constant at 100)

Answer 1

Answer:

1. If the population doubles, let's say it is now 200. However, physical capital remains the same. Thus the capital per capita is K/L, where L is the population size and K is the physical capital. Inputting the values, we get 100/200 = 1/2 whereas, prior to the change, the ratio was 1:1. It seems that there are more people than the physical capital available and thus there is a scarcity of capital, this will cause per capita GDP to fall because there will be a fall in productivity.
2. Now let's say that capital increases to double, 200. However, the population remains the same, then K/L= 200/100 =2, as opposed to the initial ratio being 1:1. Now there is more capital than the population and therefore some of the capital is unused and turns obsolete. This is known as the underutilization of capital. This also causes the real GDP per capita to fall, because resources are not being used efficiently.