AP_Krugman_Textbook

capital depreciating and its production possibilities curve would shift in-
ward over time, indicating a decrease in production possibilities. Points B
andCrepresent a mix of consumer and investment goods for the economy.
While we can see that points AandDwould not be acceptable choices over
a long period of time, the choice between points BandCwould 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
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-
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
investment in physical capital by promoting a well-functioning financial
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

module 40 Economic Growth in Macroeconomic Models 401

Section 7 Economic Growth and Productivity

Investments in capital help the economy

reach new heights of productivity.

© Rosenfeld/Corbis

figure 40.4

The Long-run Aggregate

Supply Curve

The long run aggregate supply curve

shows the quantity of aggregate output

supplied when all prices, including

nominal wages, are flexible. It is vertical

at potential output, YP,because in the

long run a change in the aggregate

price level has no effect on the quantity

of aggregate supplied.

Aggregate

price level Long-run aggregate

supply curve, LRAS

...leaves the quantity

of aggregate output

supplied unchanged

in the long run.

A fall in the

aggregate

price level...

Potential

output

YP Real GDP

P 1

P 2