5. Balanced growth and convergence The economy of Amandier conforms to the Solow

Question

5. Balanced growth and convergence The economy of Amandier conforms to the Solow model with population growth and technological progress, so it is on a balanced-growth path. What does this imply about the relationship between output per worker and capital stock per worker in the steady state? O The capital stock per worker remains constant as output per worker grows O Output per worker remains constant as capital stock per worker grows. O Output per worker and capital stock per worker grow at the same rate. If the rate of technological progress in Amander is 890 per year and the population grows at 5% per year, then the economy's capital-output ratio will True or False: If the economies of Amandier and Buglosse are conditionally converging, income per person in the two countries will eventually be the same level. O False O True

Explanation / Answer

The concept of capital output ratio shows the relationship between the value of capital invested and the value of output.

Capital output ratio is equal to the amount of capital needed to produce one unit of output.

For instance, suppose that investment is 8% (of GDP), and the economic growth corresponding to this level of investment is 5%.

Here, a Rs.8 investment produces an output of Rs.5. Thus, Capital output ratio = 8/5 or 1.6 or 2.

In other words, We can say that in order to produce one unit of output, 2 unit of capital is required. But we cannot forget that the Rs 32 invested in the form of machinery will remain there for around ten or twelve years. Such a machinery will be giving Rs 1 output in every year.

If we talk about the relevance of capital output ratio in economic planning

Capital output ratio has very good use in economic planning. Suppose the government targets an economic growth of 6% for next year. planners know that the capital output ratio in India is 2. Here, to realize 12% growth, investment should be increased to 2% (9 x4).

Capital output ratio thus explain the relationship between level of investment and the corresponding economic growth. There is a simple equation in economics that shows the relationship between investment, capital output ratio and economic growth.

G = S/V

Here, G is economic growth, S is saving as a percentage of GDP and V is capital output ratio.

A lower capital output ratio shows that only low level of investment is needed to produce a given growth rate in the economy which is considered as a desirable situation.

Thus, we can say that the Lower capital output ratio shows that capital is very productive or efficiency.

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