Question

QUESTION 13 What are diminishing returns to capital (or any factor of productivity)? Explain the relationship between diminishing returns to productivity, the catch-up effect, and economic growth Specifically address the reasons why some smaller and less advanced countries can grow at faster rates than more developed countries. TTT Arial 3 (12pt) TEE. Words:0 Patho

Answer 1

I)The Law of Diminishing Returns to a Factor (say capital or labour or technology) is fundamental in Economics.

In order to understand it, let us begin by imagining a small farm with 10 acres of land.

It employs both labour (say, 3 men and 3 women) and capital (say, tractors and ploughs).

For the optimum level of production to be achieved, we require a certain combination of labour and capital. But we must bear in mind that both these factors are scarce.

So imagine further that the capital available to us is limited (or fixed)In such a case, we will have to employ more labour to increase output. One can imagine this in three stages, as follows:

1. Initially, the farmer would employ 2 more men. This would cause a great increase in output per unit of additional labour. There would be more men to work the fields while experienced workers run the tractors.
2. Later, if the farmer chooses to employ 2 more women, Now the work gets done more quickly, but the increase in output because of the extra labourers is not significant.
3. But If the farmer chooses to engage any more labour on the farm, then there will be idle labour on the farm. There isn't enough capital to absorb the labourers. In this case, the increase in output per additional labour unit will actually fall.

The increase in output per unit of additional labour refers to the Marginal Product. The law of diminishing returns implies that after a point, output diminishes with every additional unit of a variable factor (in this case, labour) or in technical terms, the marginal product falls.

This happens because the fruits of 'division of labour' and 'specialisation' have already been used up. Additionally, there is an imperfect substitutability between factors. So after the point, the farmer, in this case, will also need more tractors to increase productivity.

II)The catch-up effect is named so with reference to less-developed countries (LDC's) which have the ability to 'catch-up' with the developed countries because they face increasing returns to factors of production. As LDC's are predominantly labour intensive, an additional boost of capital investment leads to higher returns as compared to the same level of investment in developed countries.

For example: If a country like India invests in agriculture, by introducing better quality seeds or in irrigation, the returns would be far greater than in the US where farmers already have good systems in place.

This implies that economic growth in LDC's will be higher than in developed countries, leading to a sort of convergence in their level of development