On a new set of axes, re-graph the production function from part (A), for values of K/L from 0 to 10,000
(increasing 1,000 at a time), assuming E = 1,000. Label it On the same axes, graph the production function
for values of K/L from 0 to 10,000 (increasing 1,000 at a time), assuming E = 1,000. Label it
In which case, when
= 1/3 or when
= 0.6, are the returns to investment greater?
The returns to investment are greater when
= 0.6. Returns to investment refer to how much more
output per worker we get from adding more capital per worker to the existing stock of capital per worker.
When we add more capital per worker to the existing stock of capital per worker, we get a greater increase
in output per worker the higher the value of
For example, consider what happens to Y/L when K/L increases from 1,000 to 2,000. When
= 1/3, Y/
L increases by 260 (from 1,000 to 1,260), whereas when
=0.6, Y/L increases by 516 (from 1,000 to
1,516). Since 516 > 260, the increase in Y/L is greater when
Explain, in words that would make sense to someone who doesn’t yet understand, what it means for the returns
to investment to be greater. (When someone doesn’t understand, an example is often the best way to start.)
Suppose you have two different economies: one that is very developed and one that is still developing.
Now suppose each economy experiences the net investment in capital that increases each economy’s
capital stock per worker (machines and buildings per worker) by the same dollar amount. Will both enjoy
the same increase in output?
Probably not. Probably the developed economy, which already has lots of capital (machines) for each of