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While do this multiple choice question, I am stuck.

Which of the following is LEAST likely to be associated with a higher rate of economic growth? Choose 1 answer:

A. strong protection of property rights

B. taxes on savings and investment

C. policies that discourage immigration

D. encouraging the replenishment of natural resources

E. higher consumption

I choose C, but the actual answer is E. I am kindly confused. WHY?

For me, the C will leastly increase economic growth because by having more immigrations, the labor force increase which increase the output (real GDP) in long run (at natural rate of unemployment). This increase the aggregate supply and economic growth . So by having policies that discourage immigration, we have lower labor force which have inverse bad effect.

For answer E, I have some hesitations for it when doing the question.It is true that higher comsumption leads to lower saving and high interest rates which decrease company captial investment, but more consumptions means more aggregate demand and more aggregate demands leads to higher ouput???

So what I am I missing and what I did wrong?

Thanks for any suggestions and answer!

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There are two ways of looking at this answer.

  1. Of the five options only the last one is endogenous to a growth model, everything else would be either a parameter or a policy variable for someone who is not the agent. Since level or per capita consumption is a solution to the model, it will not by itself cause a growth effect.

  2. Changes in consumption, if it is just a temporary adjustment or a long run adjustment would not be growth effects. While it is true that if consumption tomorrow rises relative to consumption today, we would say that consumption has grown, this is a short run effect. Growth, in macroeconomics, these days, unless otherwise defined, is assumed to be long run growth.

If long run consumption rises, that would be a steady state level effect and not a growth effect.

In either case, short run or long run change, a rise in consumption is always due to changes to model parameters. There is no reason why these parameters should also affect the growth rate. Thus, change in consumption being an endogenous change to the system is not something that would cause growth - and we move back to point 1.

An example of parameter could be the rate of time preference - it would affect short run fluctuations and long run level, but not growth rate in a neoclassical model.

Finally, just because we have growth effect does not necessarily mean there will be a consumption change. For example, in a Hicks Neutral neoclassical model, a rise in technology growth rate could affect long run growth rates, but would keep per capita consumption same. Growth and consumption are not associated here.

By the way, I do not think this is a well designed question - especially if the responder does not know the difference between level and growth effects and about neoclassical models.

About immigration:

There is some literature about immigration and growth. The basic idea is that immigration changes the stock of human capital, which in turn causes growth effects.

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  • $\begingroup$ Thanks for the answer and sorry for the late reply, I am still a little bit confused, don't changes in aggregate demand affect our economic growth? For example, government could use fiscal policy (change government spending which is part of aggregate demand) to control the economic growth (either contrationary or expansionary) $\endgroup$
    – James
    Apr 17 at 4:24
  • $\begingroup$ Reviewing your answer agagin, does you mean that the higher consumption is only short-term affect, but economic growth rate is often long-term effect??? If so, why the higher consumption could not be long term? Thanks! $\endgroup$
    – James
    Apr 17 at 4:27

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