Page 443 - Krugmans Economics for AP Text Book_Neat

capital depreciating and its production possibilities curve would shift in-
ward over time, indicating a decrease in production possibilities. Points B
and C represent a mix of consumer and investment goods for the economy.
While we can see that points A and D would not be acceptable choices over
a long period of time, the choice between points B and C would depend on
the values, politics, and other details related to the economy and people of
Kyland. What we do know is that the choice made by Kyland each year will
affect the position of the production possibilities curve in the future. An Section 7 Economic Growth and Productivity
emphasis on the production of consumer goods will make consumers bet-
ter off in the short run but will prevent the production possibilities curve
from moving farther out in the future. An emphasis on investment goods
will lead the production possibilities curve to shift out farther in the future
but will decrease the quantity of consumer goods available in the short run.
So what does the production possibilities curve tell us about economic
growth? Since long-run economic growth depends almost entirely on rising
productivity, a country’s decision regarding investment in physical capital,
human capital, and technology affects its long-run economic growth. Gov- © Rosenfeld/Corbis
ernments can promote long-run economic growth, shifting the country’s
production possibilities curve outward over time, by investing in physical
capital such as infrastructure. They can also encourage high rates of private Investments in capital help the economy
investment in physical capital by promoting a well-functioning financial reach new heights of productivity.
system, property rights, and political stability.

Long-run Economic Growth and the Aggregate
Demand-Aggregate Supply Model

The aggregate demand and supply model we developed in Section 4 is another useful
tool for understanding long-run economic growth. Recall that in the aggregate
demand-aggregate supply model, the long-run aggregate supply curve shows the rela-
tionship between the aggregate price level and the quantity of aggregate output sup-
plied when all prices, including nominal wages, are flexible. As shown in Figure 40.4, the

figure 40.4

The Long-run Aggregate Aggregate Long-run aggregate
Supply Curve price level supply curve, LRAS
The long run aggregate supply curve
P 1
shows the quantity of aggregate output
…leaves the quantity
supplied when all prices, including
A fall in the of aggregate output
nominal wages, are flexible. It is vertical aggregate supplied unchanged
at potential output, Y P , because in the price level… in the long run.
long run a change in the aggregate
price level has no effect on the quantity
of aggregate supplied. P 2

Potential Y P Real GDP
output

module 40 Economic Growth in Macroeconomic Models 401