Ten Principles of Economics - Part 53. Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by a single central planner but through the combined actions of millions of households and firms. Economists therefore study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. Economists also study how people interact with one another. | CHAPTER 24 PRODUCTION AND GROWTH 539 investment. Or perhaps high growth and high investment are both caused by a third variable that has been omitted from the analysis. The data by themselves cannot tell us the direction of causation. Nonetheless because capital accumulation affects productivity so clearly and directly many economists interpret these data as showing that high investment leads to more rapid economic growth. DIMINISHING RETURNS AND THE CATCH-UP EFFECT Suppose that a government convinced by the evidence in Figure 24-1 pursues policies that raise the nation s saving rate the percentage of GDP devoted to saving rather than consumption. What happens With the nation saving more fewer resources are needed to make consumption goods and more resources are available to make capital goods. As a result the capital stock increases leading to rising productivity and more rapid growth in GDP. But how long does this higher rate of growth last Assuming that the saving rate remains at its new higher level does the growth rate of GDP stay high indefinitely or only for a period of time The traditional view of the production process is that capital is subject to diminishing returns As the stock of capital rises the extra output produced from an additional unit of capital falls. In other words when workers already have a large quantity of capital to use in producing goods and services giving them an additional unit of capital increases their productivity only slightly. Because of diminishing returns an increase in the saving rate leads to higher growth only for a while. As the higher saving rate allows more capital to be accumulated the benefits from additional capital become smaller over time and so growth slows down. In the long run the higher saving rate leads to a higher level of productivity and income but not to higher growth in these variables. Reaching this long run however can take quite a while. According to studies of international data on economic growth .
