Question

Because investment and capital goods are paid for with savings, higher savings rates reflect a decision to consume fewer goods in the present to invest in more goods for the future. Households in China save 40 percent of their annual incomes each year, whereas U.S. households save less than 5 percent. At the same time, production possibilities are growing at roughly 7 percent per year in China but only about 3.0 percent per year in the United States. Use graphical analysis of ‘present goods’ versus ‘future goods’ to explain the difference between China's growth rate and the U.S. growth rate.

Short answer

The growth rate of China is higher than that of the U.S., as shown in the graph below.

Step-by-step solution

Consumption in China and in the U.S. at present

A nation spends its income on consumption and savings. Whatever a nation saves is used as investment by it in the future. As China holds 40% of its income, it is consuming 60% and keeping the remaining 40% for the future.

$$\begin{gathered} Y=C+S \\ =0.6Y+0.4Y \end{gathered}$$

As the production possibilities for China are increasing by 7% each year, the amount saved for the future increases by 7%, and the present consumption decreases by the same. Therefore, the curve is negatively sloped.

Similarly, the U.S. consumes approximately 97% and saves 3% for the future. The future goods for the U.S. progress by 3% every year.So, the graph for the growth of the U.S. is negatively sloped, declining by 3% constantly.

Comparing the growth rate of China and that of the U.S.

In the above graph, the pink curve represents the growth rate of China, and the blue curve represents that of the U.S. China consumes 60% of its income at present and saves 40% for future goods, and the U.S. consumes 97% in the present goods and saves 3% for future goods, as shown in the graph.

China will consume 100% income in the future after some years, growing by a rate of 7%, while the U.S. will achieve 100% consumption in the future, growing by 3%. As the graph for China's growth rate is steeper compared to the U.S., China will reach 100% consumption in the future in less time.

On the other hand, the present consumption in the U.S. is very high, while the curve is flatter. So, the U.S. will take more time to reach the full consumption level in the future. Therefore, the growth rate of China is higher than that of the U.S.