Question

It is found that the real GDP per capita of developing countries grows faster than developed countries at the same period. Explain this phenomenon in the light of diminishing returns to capital.

Answer 1

Real GDP of developing countries grows faster than developed as going by the phenomenon of diminishing return which states that with an increase in human or even physical capital the gains to economic growth tend to diminish. If we take capital- then an increase in the capital will definitely increase the output and an additional increase in the capital will again increase the output but the marginal increase would have become smaller in size. Hence countries like India have a lower level of human and physical capital hence an investment in these areas would have a much larger effect on growth when compared to that of the US who is already operating in high levels of physical and human capital. Therefore the diminishing returns conclude that developing economies will converge to the growth levels of that of the developed and we can substantiate it by the growth of economies like India and China.