Chapter 11 · Macroeconomic objectives II: Economic growth, sustainable level of debt
Long-run economic growth: Keynesian
Show long-run economic growth as an outward shift of Keynesian AS. Explain how greater productive capacity raises potential real GDP.
The economic idea
Long-run economic growth is an increase in productive capacity or potential output. It differs from actual growth that merely brings idle resources back into use.
The Keynesian aggregate-supply curve has a horizontal range with extensive spare capacity, a rising range as bottlenecks emerge and a vertical section at full-employment output. Long-run growth shifts the whole boundary right, including the vertical section.
Investment, education, health, infrastructure, technology and institutional improvement can increase both the quantity and productivity of resources. Yet if aggregate demand remains weak, the economy may continue to operate inside the new capacity boundary.
Borrowing for productive public investment can expand capacity and may crowd in private investment. Debt remains sustainable only when future growth and revenues support debt service; project quality, interest costs, implementation lags and fiscal credibility therefore matter.
Reading the capacity shift from AS₁ to AS₂
“Price level” is on the vertical axis and “Real GDP” is on the horizontal axis.
“AS₁” and “AS₂” are Keynesian aggregate-supply boundaries. Their vertical sections mark the original and current full-employment output.
“AD” is held fixed. “E₁” and “E₂” show where that same planned expenditure meets the two supply conditions.
Original equilibrium: E₁
“E₁” is the intersection of “AD” and “AS₁”, giving actual output “Y₁” and price level “Pl₁”. The vertical section of “AS₁”, projected to “Yp₁”, marks potential output; the two outputs coincide only when demand reaches capacity.
Capacity change: AS₁ to AS₂
“AS₂” lies to the right of “AS₁”. Potential output rises from “Yp₁” to “Yp₂”. The current state shows long-run potential growth.
New equilibrium: E₂
“AD” meets “AS₂” at “E₂”, giving actual output “Y₂” and price level “Pl₂”. Actual output rises from “Y₁” to “Y₂”, while potential output is marked separately by “Yp₂”. The new capacity is not fully used: equilibrium remains on the non-vertical section of AS.
More capacity still needs customers
A rightward shift of Keynesian AS raises the output that could be produced. If AD is weak, firms may have little reason to use the additional capacity, so potential growth need not become an equal increase in actual real GDP.
Explain how the policy or change improves resources, productivity or technology, then read the new AD–AS intersection. Assess the cost and time needed for that capacity improvement rather than assume it is immediate.
From productive investment to a new full-employment boundary
Investment, skills, technology, labour-force growth or institutional improvement increases the quantity, quality or productivity of resources.
The Keynesian supply boundary moves from “AS₁” to “AS₂”, including a rightward shift of the vertical full-employment section.
The larger capacity can be fully used only if “AD” is strong enough to reach the new full-employment boundary.
Common mistakes to avoid
- A shift from “AS₁” to “AS₂” is potential growth; it is not merely movement toward unchanged capacity.
- Do not assume that creating capacity automatically creates the aggregate demand required to use it.
- Higher total real GDP does not necessarily mean higher real GDP per capita or improved welfare.
- The diagram does not plot debt, interest payments or fiscal balances and cannot by itself prove debt sustainability.
How to draw this diagram
- Title the diagram “Long-run economic growth: Keynesian”. Label the horizontal axis “Real GDP” and the vertical axis “Price level”.
- Draw AD first and label it clearly.
- Draw AS₁ next and label it clearly.
- Draw AS₂ next and label it clearly.
- Mark each relevant intersection and distinguish the initial, market and socially optimum or policy outcomes where applicable.
- Project important intersections to the axes with dashed guide lines and label the outcomes.
- Check that every symbol used in the explanation appears on the diagram and add arrows showing the direction of change.
Assumptions and limitations
- The diagram does not show the time lags or uncertainty surrounding productivity and investment.
- Aggregate potential output is estimated rather than directly observed.
- Higher real GDP may coexist with inequality, environmental damage or slower per-capita growth.
- The stylised Keynesian AS shape compresses many sectoral bottlenecks into one boundary.
- Public debt and debt service are not axes or curves in this model; they require separate fiscal analysis.