Question

A DVC's population is growing 2 percent per year and output is growing 3 percent per year. If the government wants to improve living standards over coming decades, which of the following would probably be the best savings rate for the economy? a. 0 percent. b. 2 percent. c. 5 percent. d. 10 percent.

Short answer

The best savings rate for improving living standards is 10 percent.

Step-by-step solution

Understanding Growth Rates

The problem states that the population growth rate is 2 percent per year and the output growth rate is 3 percent per year. Living standards can be thought of as output per capita, which is the output per person. To improve living standards, output must grow faster than the population.

Calculating Improvement in Living Standards

The improvement in living standards can be estimated by the difference between the output growth rate and the population growth rate. The output is growing by 3 percent per year, while the population is growing by 2 percent per year, so the current improvement in living standards is: \\[3\% - 2\% = 1\%\].

Evaluating the Savings Rate Options

Higher savings rates can boost investment in capital, which could lead to higher output growth. Among the given options, increasing the savings rate increases the potential for economic growth to exceed population growth more significantly. A higher savings rate means more money available for productive investments that can drive output growth.

Determining the Most Suitable Savings Rate

Given that the gap between output growth and population growth reflects improvements in living standards, and the aim is to maximize this improvement, the highest savings rate (10 percent) should be chosen. This rate maximizes potential output growth, which, when assuming the savings lead to effective investments, can lead to a larger gap between output growth and population growth.

Key concepts

Population Growth

Population growth refers to the increase in the number of people in a country or region over time. In this exercise, the population is increasing at a rate of 2 percent per year. This is an important factor because, as the population grows, more resources are needed to maintain or improve the quality of life. The key is to ensure that the economic output, or the goods and services produced in the economy, grows at an equal or greater pace to support the additional people. If the output does not grow as fast as the population, it could lead to a decrease in living standards because there will be less wealth available per person.

Output Growth

Output growth measures the rate at which an economy increases its production of goods and services over time. In the provided exercise, the output is increasing by 3 percent each year. This is a critical metric because it directly impacts the standard of living for the population. When output grows faster than the population, it means each individual could potentially have access to more goods and services, thus improving their standard of living. To achieve sustained improvements in living standards, the output growth should always surpass or at least match population growth.

Savings Rate

The savings rate is the proportion of income that a nation or an individual saves rather than spends immediately. A higher savings rate can be beneficial since those savings can be used to fund investments that lead to higher productivity and output growth. In the exercise, increasing the savings rate to 10 percent is suggested to maximize economic growth. This is because higher savings can facilitate investments in capital goods, infrastructure, and technology. Such investments are necessary as they enhance the production capacity of an economy, potentially leading to faster output growth and improved living standards.

Living Standards

Living standards refer to the wealth, comfort, and material goods available to individuals or societies. Improving living standards is a primary goal of economic growth. It involves increasing the output per person or output per capita. In the original problem, living standards can improve if the rate of output growth surpasses the rate of population growth. This results in more resources being available for each individual, thereby raising overall well-being. For policymakers, the challenge is to find optimal strategies, such as adjusting the savings rate, that can enhance living standards sustainably over time.