AP_Krugman_Textbook

module 40 Economic Growth in Macroeconomic Models 403

YP Y 1 Real GDP

P 1

Aggregate

price

level

LRAS SRAS 2

SRAS 1

AD

E 1

E 2

A rise in

nominal

wages

shifts SRAS

leftward.

Y 1 YP Real GDP

P 1

Aggregate

price

level

LRAS SRAS 1

SRAS 2

E 1

A fall in

nominal

wages

shifts SRAS

rightward.

E 2

AD

figure 40.6 From the Short Run to the Long Run

In panel (a), the initial equilibrium is E 1. At the aggregate price level,

P 1 , the quantity of aggregate output supplied, Y 1 , exceeds potential

output, YP.Eventually, low unemployment will cause nominal wages

to rise, leading to a leftward shift of the short-run aggregate supply

curve from SRAS 1 toSRAS 2 and a long-run equilibrium at E 2. In

panel (b), the reverse happens: at the short-run equilibrium, E 1 , the

quantity of aggregate output supplied is less than potential output.

High unemployment eventually leads to a fall in nominal wages over

time and a rightward shift of the short-run aggregate supply curve.

The end result is long-run equilibrium at E 2.

Module 40 AP Review

Check Your Understanding

1. How are long-run economic growth and short-run fluctuations
   during a business cycle represented using the production
   possibilities curve model?

Solutions appear at the back of the book.

2. How are long-run economic growth and short-run fluctuations
   during a business cycle represented using the aggregate
   demand-aggregate supply model?

Tackle the Test: Multiple-Choice Questions

1. Which of the following will shift the production possibilities
   curve outward?
   I. an increase in the production of investment goods
   II. an increase in the production of consumer goods
   III. technological progress
   a. I only
   b. II only
   c. III only
   d. I and III only
   e. I, II, and III


2. In the production possibilities curve (PPC) model, long-run
   economic growth is shown by a(n)
   a. outward shift of the PPC.
   b. inward shift of the PPC.

c. movement from a point below the PPC to a point on

the PPC.

d. movement from a point on the PPC to a point below

the PPC.

e. movement from a point on the PPC to a point beyond

the PPC.

3. The reduction in the value of an asset due to wear and tear is
   known as
   a. depreciation.
   b. negative investment.
   c. economic decline.
   d. disinvestment.
   e. net investment.