Question

Question 5

a) Let’s assume that the total investment (% of GDP) and saving rates are the same for two hypothetical countries in Asia. Aruba had a 4% growth rate of average annual income per capita and Smalland had a 1% growth rate. Based on the economic concept/s you have learned, explain what would have caused the growth rates to be different? Diagram/s are required.

b) Due to high levels of inflation, the Central Bank in Country A decides to sell government bonds. Using the Phillips curve framework, explain and analyse how this will impact unemployment in the short run and long run. Diagram/s are required.

Answer 1

( a ) As we know according to neoclasical growth model there are four determinants of economic growth for a country:-

( ) Savings rate, Investment rate, labor, and knowledge or technology.

As we can see that both the countries are keeping all the three variables constant, except knowledge or technology, therefore, we can say that a better technology would have increased productivity of labor or capital, thereby leading to higher growth growth rate of average annual income per capita despite having having same level of other variables.

( b ) According to the Phillips curve, there is a trade off between inflation rate and unemployment rate in the short run. Therefore, as the Central Bank in Country A decides to sell government bonds there would be a decrease in supply of money which would lead to fall in inflation rate. However, unemployment will increase in the short run, while adjusting back to equilibrium level in the long run.