Question

Using the figure depicting the Solow model equilibrium and no more than 4 sentences, explain why long-run economic growth must be driven by improvements in total factor productivity and NOT by capital accumulation?

Answer 1

Long-run economic growth is sustained by productivity improvements rather than capital accumulation due to the impact of diminishing returns on capital, highlighting the significance of total factor productivity in enhancing economic output efficiently.

Step-by-step explanation:

In the Solow model equilibrium, long-run economic growth must be driven by improvements in total factor productivity, as capital accumulation alone will eventually lead to diminishing returns.

While capital deepening, which involves increasing the amount of capital per worker, can boost output, there is a limit to how much capital can contribute to growth before each additional unit of capital leads to less and less extra output.

Instead, growth in productivity, defined as the output per worker or GDP per capita, is crucial because it represents the efficiency with which both labor and capital are used, and it can continue to increase without being subject to diminishing returns.

Therefore, increases in total factor productivity are essential for sustained long-term economic growth and shifts of the aggregate supply (AS) curve to the right in the AD/AS diagram.