Consider two economies with the same GDP per capita: Barylia and Litha

Consider two economies with the same GDP per capita: Barylia and Lithasia. The savings rate in Barylia is 20% while the savings rate in Lithasia is 60%.

a. Which of these two countries is likely to accumulate capital faster?
b. The government in Barylia decides to provide incentive to its citizens to increase the savings rate further to 80% as a means to improve standards of living. Will the increase in savings and thus investment and output translate into improvements in the standard of living?

ANSWER

a. The amount of capital accumulation in an economy is equal to the capital stock of last year, minus depreciated capital, plus the level of investment in an economy. Hence, as the level of investment increases, the amount of capital accumulation increases.
The investment in an economy equals I = savings rate × GDP per capita.
Therefore, it can be inferred that higher the savings rate in an economy, higher is the investment in the economy. Hence, higher the savings rate in an economy, higher is the capital accumulation in the economy. Lithasia is likely to accumulate capital faster compared to Barylia.
b. The total amount of income in an economy is either consumed or saved. The standard of living in any country is dependent on consumption and not on savings. Hence, if the government encourages households to save more, increase in investment and output may not translate into improvements in living standards of the people in the country.