This chapter analyzes economic growth by examining the aggregate production function. Sources of economic growth are identified and growth rates of different countries are compared.
Growth and the Long-Run Aggregate Supply Curve
- Explain and illustrate graphically the concept of the aggregate production function. Explain how its shape relates to the concept of diminishing marginal returns.
- Derive the long-run aggregate supply curve from the model of the labor market and the aggregate production function.
- Explain how the long-run aggregate supply curve shifts in responses to shifts in the aggregate production function or to shifts in the demand for or supply of labor.
Economic growth means the economy's potential output is rising. Because the long-run aggregate supply curve is a vertical line at the economy's potential, we can depict the process of economic growth as one in which the long-run aggregate supply curve shifts to the right.
Figure 8.4 Economic Growth and the Long-Run Aggregate Supply Curve
Because economic growth is the process through which the economy's potential output is increased, we can depict it as a series of rightward shifts in the long-run aggregate supply curve. Notice that with exponential growth, each successive shift in LRAS is larger and larger.
Figure 8.4 "Economic Growth and the Long-Run Aggregate Supply Curve" illustrates the process of economic growth. If the economy begins at potential output of Y1, growth increases this potential. The figure shows a succession of increases in potential to Y2, then Y3, and Y4. If the economy is growing at a particular percentage rate, and if the levels shown represent successive years, then the size of the increases will become larger and larger, as indicated in the figure.
Because economic growth can be considered as a process in which the long-run aggregate supply curve shifts to the right, and because output tends to remain close to this curve, it is important to gain a deeper understanding of what determines long-run aggregate supply (LRAS). We shall examine the derivation of LRAS and then see what factors shift the curve. We shall begin our work by defining an aggregate production function.