Question

Suppose that every additional 3 percentage points in the investment rate boosts GDP growth by 1 percentage point. Assume also that all investment must be financed with consumer saving. The economy is now characterized by consumption: $6 trillion, saving (= investment): $1 trillion, GDP: $7 trillion. If the goal is to raise the growth rate by 2 percentage points, by how much must investment increase? $ billion. By how much must consumption decline? $ billion.

Answer 1

To raise the GDP growth rate by 2 percentage points, investment must increase by $2 trillion. Consequently, consumption must decline by $2 trillion as the increase in investment is financed by consumer saving.

Step-by-step explanation:

The question is asking how much investment needs to increase to raise the GDP growth rate by 2 percentage points, given that every additional 3 percentage points in the investment rate boosts GDP growth by 1 percentage point. The current economy has a consumption of $6 trillion and investment (which equals savings) of $1 trillion with a total GDP of $7 trillion. To achieve a 2 percentage point increase in growth, investment needs to increase by 6 percentage points, which, according to the given information, necessitates an additional $2 trillion investment (or saving).

Since all investment is financed by consumer saving, and the total GDP remains unchanged, this additional investment will come at the expense of consumption. Therefore, consumption must decline by the same amount that investment increases, which is $2 trillion.

Compound growth and compound interest have similar effects on economic variables, magnifying the impact of changes in rates over time. This is relevant to understanding the transformative power of investment on GDP growth.