Week 7 - Pacing Guide and Lesson Plans Unit 6 – Economic Growth and Productivity

Unit 65-10% of AP Economic Growth and Productivity

I. Economic Growth and Productivity *A. Investment in human capitalB. Investment in physical capitalC. Research and development, and technological progressD. Growth policy

* Taken from the AP Economics Course Description 2010

II. Student ObjectivesA. Define economic growth and list the factors that stimulate growthB. Assess the role of productivity in raising real output and standard of livingC. Suggest how public policies stimulate economic growth

III. Graphs and Diagrams to be masteredA. Trade-off Between Investment and Consumer GoodsB. Short Run movements along Long Run Aggregate SupplyC. Long Run Aggregate Supply Curve and Economic Growth

IV. Formulas to be masteredA. Real GDP per CapitaB. Rule of 70C. Aggregate Production Function

V. Key Terms Section 7 p. 45 (Textbook)VI. Key Concepts: Ingredients of growth, production possibilities, growth in aggregate

demand and supply, accounting for growth, acceleration of productivity VII. Supplemental Activity

A. Economics by Example: David AndersonChapter 28: Why Are Some Nations Rich and Others Poor?

B. Strive for a 5: Ray and MayerModule 37 Activities p. 260-262Module 38 Activities p. 263-265Module 39 Activities p. 266-268Module 40 Activities p. 269-270Section 7 Before You Take the Test

Featured Graph: Long run Growth-PPC and AD/AS p. 271Problems p. 271-275 Review Questions p. 275-277

Section 7 Textbook pagesOpening Section 7 p. 367Module 37: Long Run Economic Growth p. 368-375Module 38: Productivity and Growth p. 376-386Module 39: Growth Policy: Why Economic Growth Rates Differ p. 387-397Module 40: Economic Growth in Macroeconomic Models p. 398-404Section 7 Summary p. 404-408

MODULE 37: LONG-RUN ECONOMIC GROWTH

The purpose of this module is to introduce the concept of long -run economic growth. Once growth is defined and broadly explained as the product of national gains in productivity, upcoming modules can explore the role of productivity in more detail.

Student learning objectives:• How we measure long-run economic growth.

• How real GDP has changed over time. • How real GDP varies across countries. • The sources of long-run economic growth. • How productivity is driven by physical capital, human capital, and progress in

technology.

Key Economic Concepts For This Module:• The most common measure to track long-run economic growth over time and between

nations is real GDP per capita. • Economic growth is not simply the recovery from a recession. Economic growth

fundamentally increases the nation’s ability to produce goods and services. • One way to think about economic growth is to think back to the model of production

possibilities. Short-run recovery is a movement from a point inside the PPC to the limits of the PPC. Long-run economic growth is an outward shift of the entire PPC.

• The “rule of 70” approximates how many years it takes for a nation’s economy to double in size.

• The most important factor in a nation’s long-run economic growth is average labor productivity.

• Labor productivity is enhanced by more physical capital, more human capital, and faster progress in technology.

Common Student Difficulties:• Students usually assume that the U.S. is a “rich” nation, but rarely know how much

wealthier the average American is when compared to the average citizen around the world. Use the cross-country comparisons in the text to impress upon the students just how much wealthier the U.S. is to other nations students might hear about in the news.

• Students can mistake physical capital with technology. You might stress that the capital is the tool itself, the technology is the improvement in the tool.

In-Class Presentation of Module and Sample Lecture

Suggested time: This module can be covered in an hour-long class session with part of a second hour used to discuss the Household Production activity if it is assigned.

I. Comparing Economies Across Time and Space A. Real GDP per Capita B. Growth Rates

II. The Sources of Long-Run Growth A. The Crucial Importance of Productivity B. Explaining Growth in Productivity

1. Physical Capital 2. Human Capital 3. Technology

I. Comparing Economies Across Time and Space Note: it might be helpful to ask the students how they would design a statistic to measure the growth of a nation’s economy. The instructor might get several responses that we could describe as “short-run” measurements like, “a lower unemployment rate”. Is it lower this month, or is it permanently lower? The measure must be trackable over time, and must be applicable across nations, not just ours.

A. Real GDP per Capita The key statistic used to track economic growth is real GDP per capita—real GDP divided by the population size.

• GDP because, as we have learned, GDP measures the total value of an economy’s production of final goods and services as well as the income earned in that economy in a given year. Think of this as the total size of the economic pie.

• Real GDP because we want to separate changes in the quantity of goods and services from the effects of a rising price level. This is the size of the pie after adjusting for inflation.

• Real GDP per capita because we want to isolate the effect of changes in the population. This gives us the size of each person’s slice of the pie, if it were shared equally.

For example, other things equal, an increase in the population lowers the standard of living for the average person—there are now more people to share a given amount of real GDP. An increase in real GDP that only matches an increase in population leaves the average standard of living unchanged.

Note: the instructor may wish to discuss the differences between the real GDP per capita in the U.S. and some of our main trading partners. The graphs and charts in the text can be the foundation for these comparisons.

B. Growth Rates Growth rates are like compounded interest.If the annual interest rate is 10% at the bank, and you are saving $100, after year 1 you will have $110, an increase of $10. After year two, you will have $121, an additional increase of $11.

If the economy grows by 2% one year, and another 2% the following year, and another 2% the year after that, these annual growth rates are compounded into larger and larger increases in per capital real GDP.

Rule of 70 approximates how many years it will take for the economy to double at a given rate of economic growth.

# of years for a number to double = (70/annual growth rate of that number)

Example If annual per capita real GDP increases at 5% every year, it will take approximately 14 years for it to double.

The million dollar question is why some nations have faster long-run economic growth than others.

II. The Sources of Long-Run Economic GrowthThree words: Productivity, productivity, productivity.

A. The Crucial Importance of Productivity The authors stress: Sustained growth in real GDP per capita occurs only when the amount of output produced by the average worker increases steadily.

Labor productivity = (real GDP/# of people working)

If workers are creating more output, on average, the size of the economic pie will be rising and the average person’s slice will also be rising.

What factors lead to higher productivity?

1. Physical Capital If you give a worker more physical capital (tools) with which to do the work, he/she will almost always be more productive.A carpenter with a hydraulic nail gun will build more houses in a year, than a carpenter with a claw hammer.A book keeper with a laptop computer and software will create more financial statements in year than a book keeper with a hand-held calculator.

2. Human Capital If a worker has more education and training, human capital, he/she tends to be more productive.

As jobs and the global economy become more complex, nations with a more highly educated workforce will be able to produce more output per worker than nations with a lower level of education.

Today nearly 30% of American workers have a college degree. In 1910, only 3% had college degrees. This significantly contributed to the growth of the U.S. economy.

3. Technology We can think of technology as our collective body of knowledge. How do we know how to build a satellite that will orbit the earth and tell me how to get from my hotel in Washington,

DC to the Lincoln Memorial? It takes years and years of collective learning to build such useful devices as GPS systems. These innovations, and many others large and small, are major factors in allowing an average worker to increase his/her output in a given year.

So, if you give a worker more tools, better tools, and the education and training to know what to do with them, that worker will be more productive.

In-Class Activities and Demonstrations

Household Production:

Ask the students to go home and make a list of the production that happens in the home or community. For example, meals are cooked, clothes are washed, children are bathed, dishes are cleaned, teams are coached, etc.

Observe household members engaged in these activities in a typical night. The student may watch Dad cook dinner, Mom coach soccer, and the teenager might be doing laundry.

Ask the student to make a list of the physical capital and technology that allows the household to be more productive. The microwave allows Dad to cook more quickly, which gives him time to check on Junior’s homework. The washer and dryer allow the teenager to get the laundry done, while still allowing time to study for economics class. The cell phone allows Mom to coach soccer and order pizza from the car on the way home.

If the student can see that the physical capital and technology in the household increases each member’s productivity, it will be clear that the same is true of the increased productivity in the workplace and nation.

MODULE 38: PRODUCTIVITY AND GROWTH

The purpose of this module is to further explore the relationship between productivity and growth. Economists estimate aggregate production functions to empirically measure the impact of additional investments in physical capital, human capital, and technology on long-term economic growth.

Student learning objectives:• How changes in productivity are illustrated using an aggregate production function. • How growth has varied among several important regions of the world and why the

convergence hypothesis applies to economically advanced countries.

Key Economic Concepts For This Module:• The aggregate production function is a graphical way of measuring how physical

capital per worker, human capital per worker, and technology are combined to produce real GDP per worker.

• There are diminishing returns to increasing physical capital per worker. • The importance of natural resources has diminished in a nation’s economic

growth, though destruction of the natural resources is widely accepted as not conducive to strong growth.

• History tells us that the formula for a nation’s economic success is complicated and not easy for economists to predict.

Common Student Difficulties:• If students have not had microeconomics, the concept of diminishing returns is

foreign to them. Use an example that is familiar to them. Does the first hour of studying for an exam produce more or less additional benefit (a higher test score) than the 10th hour of studying for the same exam?

• Students can get bogged down in multiple case-studies. If you fear that the class will overlook the key points while trying to memorize what has happened in Argentina, then skip this section and focus on the material that will be tested on the AP Macro exam. While the details are not testable, the case studies are used to illustrate the important (and testable) concepts presented in this module.

In-Class Presentation of Module and Sample Lecture

Suggested time: This module can be covered in one one-hour class session.

I. Productivity and Growth A. Accounting for Growth: The Aggregate Production Function B. What About Natural Resources?

II. Success, Disappointment, and Failure

A. East Asia’s Miracle B. Latin America’s Disappointment C. Africa’s Troubles

I. Productivity and Growth

A. Accounting for Growth: The Aggregate Production Function We saw from the previous module that productivity is higher, other things equal, when workers are equipped with more physical capital, more human capital, better technology, or any combination of the three.

Economists make use of tons of macroeconomic data to statistically estimate the nation’s aggregate production function, which shows how productivity depends on the quantities of physical capital per worker and human capital per worker as well as the state of technology.

Example Barry Bosworth and Susan Collins of the Brookings Institution estimated (using data from China and India) the following aggregate production function:

GDP per worker = T ×(Physical capital per worker)0.4×(Human capital per

worker)0.6

T: an estimated level of technology

There is an important microeconomic concept that also applies to the aggregate production function.

Diminishing returns to physical capital: all else equal, as physical capital is increased, aggregate output increases by a smaller amount.

Example Office typists are given better and better laptop computers.

Physical Capital per Worker

Real Output per Typist

$0 $0$1000 $4000$2000 $7000$3000 $9000$4000 $10,000

The increase in real output per typist is initially high, an increase of $4000.But if better computers are provided, a doubling of physical capital per worker, real output increases but not by double.The pattern continues. Another $1000 of physical capital per worker is added to the office, but real output per typist rises at a slower and slower rate.

340 Section 7: Economic Growth and Productivity

Note: Have the students plot these five points from the table in a graph that shows the aggregate production function rising at a slower rate. The graph shows the diminishing returns as a flattening of the upward sloping curve.

It is very important to stress the “all else equal” assumption above. If the typists also were given training to increase their average words per minute, then a doubling of the physical capital per worker may indeed provide a doubling of the real output per worker. We have to hold technology and human capital constant to see the impact of a change in physical capital on aggregate output.

Note: This may be where the instructor decides to stop in-depth coverage of this module. The AP Macroeconomics exam will not cover growth accounting or the specific growth rates of Asia, South America and Africa. The ideas presented below can be useful for understanding the testable material.

In reality, everything is changing at once. Economists try to estimate the impact different factors have on growth with a technique called growth accounting.

When other important factors, like human capital or technology, increase, the aggregate production function shifts upward. This tells us that, for any given level of physical capital per worker, total production has increased. Economists try to measure higher total factor productivity: the amount of output that can be produced with a given amount of factor inputs. So when total factor productivity increases, the economy can produce more output with the same quantity of physical capital, human capital, and labor.

B. What About Natural Resources? Other things equal, countries with abundant natural resources, such as highly fertile land or rich mineral deposits, have higher real GDP per capita than less fortunate countries. For example, oil rich nations like Kuwait. Yet some nations with huge oil reserves (Nigeria) are not wealthy.

Natural resources were very important for economic growth when there were vast territories that remained undeveloped. As North America became more populous, the fertile farmland and timber and mineral resources played a huge role in the growth of the U.S. and Canada.

However, once the arable land was planted and the natural resources were harvested, the role of natural resources diminished and the role of physical capital, human capital and technology increased.

Clearly, a nation that overexploits or pollutes its natural resources cannot enjoy much long-run growth, but the actual possession of many natural resources has become less important in the aggregate production function.

II. Success, Disappointment, and Failure Growth rates differ widely across the regions of the globe. Why? The authors present three case-studies.

A. East Asia’s Miracle Since 1975, the whole region of East Asia has increased real GDP per capita by 6% per year, three times America’s historical rate of growth.

How have the Asian countries achieved such high growth rates?The answer is that all of the sources of productivity growth have been firing on all cylinders.• Very high savings rates. The percentage of GDP that is saved nationally in any given

year, have allowed the countries to significantly increase the amount of physical capital per worker.

• Very good basic education has permitted a rapid improvement in human capital. • And these countries have experienced substantial technological progress.

The East Asian experience demonstrates that economic growth can be especially fast in countries that are playing catch - up to other countries with higher GDP per capita.On this basis, many economists have suggested a general principle known as the convergence hypothesis. It says that differences in real GDP per capita among countries tend to narrow over time because countries that start with lower real GDP per capita tend to have higher growth rates.

B. Latin America’s Disappointment Since about 1920, growth in Latin America has been disappointing.The fact that South Korea is now much richer than Argentina would have seemed inconceivable a few generations ago.Why has Latin America stagnated?

Comparisons with East Asian success stories suggest several factors.• The rates of savings and investment spending in Latin America have been much

lower than in East Asia, partly as a result of irresponsible government policy that has eroded savings through high inflation, bank failures, and other disruptions.

• Education—especially broad basic education—has been underemphasized: even Latin American nations rich in natural resources often failed to channel that wealth into their educational systems.

• And political instability, leading to irresponsible economic policies, has taken a toll.

C. Africa’s Troubles Real GDP per capita in sub-Saharan Africa actually fell 13 percent from 1980 to 1994, although it has recovered since then. The consequence of this poor growth performance has been intense and continuing poverty.

What explains it?Several factors are probably crucial.• Perhaps first and foremost is the problem of political instability. In the years since 1975,

large parts of Africa have experienced savage civil wars (often with outside powers backing rival sides) that have killed millions of people and made productive investment spending impossible.

• The threat of war and general anarchy has also inhibited other important preconditions for growth, such as education and provision of necessary infrastructure.

• Property rights are also a problem. The lack of legal safeguards means that property owners are often subject to extortion because of government corruption, making them averse to owning property or improving it. This is especially damaging in a country that is very poor.

While many economists see political instability and government corruption as the leading causes of underdevelopment in Africa, some—most notably Jeffrey Sachs of Columbia University and the United Nations—believe the opposite. They argue that Africa is politically unstable because Africa is poor. And Africa’s poverty, they go on to claim, stems from its extremely unfavorable geographic conditions— much of the continent is landlocked, hot, infested with tropical diseases, and cursed with poor soil.• In poor countries, worker productivity is often severely hampered by malnutrition and

disease. In particular, tropical diseases such as malaria can only be controlled with an effective public health infrastructure, something that is lacking in much of Africa.

• Economists are studying certain regions of Africa to determine whether modest amounts of aid given directly to residents for the purposes of increasing crop yields, reducing malaria, and increasing school attendance can produce self - sustaining gains in living standards.

In-Class Activities and Demonstrations

At this point in the semester, the students might enjoy a video segment or two that discusses economic growth in one nation or another. The instructor can search the PBS NewsHour website for phrases like “economic growth” and many video reports are found in the search.

http://www.pbs.org/newshour/video/

The instructor can also search for specific developing nations like Brazil, Nigeria, Peru or even members of the European Union.

Before, there was no change in technological progress.

MODULE 39: GROWTH POLICY: WHY ECONOMIC GROWTHRATES DIFFER

The purpose of this module is to demonstrate that there are ways for the government to encourage investment in physical capital, human capital, and technological progress.

Student learning objectives:• The factors that explain why long-run growth rates differ so much among countries • The challenges to growth posed by scarcity of natural resources, environmental

degradation, and the concern for sustainability

Key Economic Concepts For This Module:• If a nation’s government puts a high priority on investment in physical capital,

human capital and/or technological progress, that nation is more likely to experience long-term economic growth.

• Economists believe in the power of incentives to change human behavior. If natural resources (oil for example) become more scarce, prices will rise, and consumers will seek less expensive alternatives.

• Economists also believe that negative externalities (like pollution or climate change) can be remedied with economic incentives. For example, if the emission of carbon dioxide is causing global economic damage, tax each ton of carbon that is burned, and people will burn less of it.

Common Student Difficulties:• Students might believe that some nations just happen to be poor or rich. How the nation

got there was just some sort of random coincidence. It is important to stress that nations can make decisions today that have long-term consequences, both good and bad, on economic growth.

In-Class Presentation of Module and Sample Lecture

Suggested time: This module can be covered in one hour-class session.

I. Why Growth Rates Differ A. Capital, Technology, and Growth Differences

1. Adding to Physical Capital 2. Adding to Human Capital 3. Technological Progress

B. The Role of Government in Promoting Economic Growth 1. Governments and Physical Capital 2. Governments and Human Capital 3. Governments and Technology 4. Political Stability, Property Rights, and Excessive Government

Intervention

II. Is World Growth Sustainable? A. Natural Resources and Growth, Revisited B. Economic Growth and the Environment

I. Why Growth Rates Differ Some nations have had more rapid economic growth than other nations. How does this happen, and does government policy have a role?Small differences in growth rates matter.

Example Jamal and Angelina both have $10,000 and they want to save that money for retirement in 30 years.Jamal can invest his money at an annual rate of 3%.Angelina can invest her money at a slightly smaller annual rate of 2.5%.

Jamal’s money in 30 years grows to: $10,000*(1.03)30 = $24,272.62Angelina’s money in 30 years grows to: $10,000*(1.025)30 = $20,975.69

The ratio of Angelina’s nest egg divided by Jamal’s is equal to .86. In other words, after 30 years Angelina’s money is 14% below the level of Jamal’s.

A. Capital, Technology, and Growth Differences Countries that have been able to achieve faster rates of growth have been able to rapidly add to their physical capital, upgrade their educational level, and make fast technological progress.

1. Adding to Physical CapitalToday, China is the fastest-growing major economy.In 2007, investment spending was 41% of China’s GDP, compared with only 15% in the United States.

Where does investment spending come from? From national savings and foreign capital inflow. So nations that have a high saving rate will have a high capital investment rate and faster economic growth.

2. Adding to Human CapitalNations with higher rates of educational attainment have enjoyed faster rates of economic growth.

Note: refer the class to Table 39-1 to compare Latin American and East Asia.

A. Technological ProgressNew technologies, like semiconductors, DNA testing and stuffed-crust pizza are the result of scientific research, or research and development (R & D).Nations that invest in R & D should experience more economic growth than nations that do not.

B. The Role of Government in Promoting Economic Growth Governments can play an important role in promoting—or blocking—all three sources of long-term economic growth: physical capital, human capital, and technological progress.

1. Governments and Physical CapitalGovernments provide infrastructure by building roads, airports, seaports, electrical grids and many others. These systems help consumers and firms engage in economic activity that promotes economic growth.

Private firms also invest in physical capital like building new factories, shopping malls, and housing developments. Firms also purchase computer systems, delivery trucks, forklifts and many other pieces of physical capital.

If the government can provide infrastructure and maintain a financial system that provides for the saving and borrowing that is required for private investment, a nation’s physical capital will grow.

2. Governments and Human CapitalGovernments pay for the vast share of primary and secondary education. Any American child can complete high school at very little out-of-pocket expense.When nations make education a higher priority, they subsidize it. More people acquire the education and the nation prospers with long-run economic growth.

3. Governments and TechnologyWhile much R & D is done by private companies, the government subsidizes this research with grants. The government also provides direct support and grant money to professors at public and private universities and that research helps to drive technological progress.

4. Political Stability, Property Rights, and Excessive Government InterventionSuppose a firm wants to build a factory that produces gadgets in a foreign nation Kreblakistan. Firms are going to be very hesitant to invest in Kreblakistan if the government might be radically overthrown, or if the government could just claim the factory as government property.

Or maybe Kreblakistan’s courts and government bureaucracies are corrupt so that day-to-day business transactions require bribes or hush money. Firms are not going to want to invest in nations such as this.

At the other extreme, a nation’s government could excessively intervene in markets with high taxes, tariffs, or other anti-competitive policies. This can also slow down economic growth.

II. Is World Growth Sustainable? Some skeptics have expressed doubt about whether long-run economic growth is sustainable—whether it can continue in the face of the limited supply of natural resources and the impact of growth on the environment.

A. Natural Resources and Growth, Revisited Most people believe that there is a finite amount of oil and minerals (non-renewable resources) on the planet. But this understanding leads to important questions.

Differing views about the impact of limited natural resources on long-run economic growth turn on the answers to three questions:

Question 1: How large are the supplies of key natural resources?

We need to ask geologists or officials in the oil, gas, and mining industries. Some believe that there are vast untapped resources “out there” and others believe that we are close to a plateau of oil and mineral extraction.

Question 2: How effective will technology be at finding alternatives to natural resources?Engineers will determine the answer to this question. Scientists around the world are already developing renewable ways to generate electricity on a large scale.

Question 3: Can long-run economic growth continue in the face of resource scarcity?This is a question for the economists, and most economists are optimistic because they believe in human nature to respond to incentives. When prices are high, people consume less and find better (cheaper) alternatives. So if oil is becoming more and more scarce, oil prices will rise. There will be a huge incentive to consume less oil and entrepreneurs will emerge, responding to a profit incentive, to offer products that use less oil.

B. Economic Growth and the Environment Human societies have usually placed economic growth ahead of the environment. We tend to expand our local economy to the point where pollution becomes deadly and then we adopt laws and regulations to lessen the local pollution, without harming the local economy. What environmental price do we pay for a strong economy?

But what if the environmental impact is global, not local? Climate change is a result of excessive emissions of greenhouse gases like carbon dioxide and methane. Science tells us that these emissions have dramatically spiked with human use of fossil fuels and deforestation. And these emissions spikes correlate to warming temperatures and changing weather patterns around the world.

If we are concerned about this issue, can we curb emissions without crippling the global economy at the same time?

Economists believe in the usefulness of gradual implementation of policies such as carbon taxes and cap-and-trade legislation that will reduce emissions without major damage to the economy. Pollution is a negative externality that imposes costs on all of us. If we can mitigate these damaging costs, such policies actually improve social welfare, not diminish it.

In-Class Activities and Demonstrations

If the instructor has time, it might be interesting for the students to look at one measure of a nation’s level of development, the Human Development Index from the United Nations.

Ask the students what factors might identify a nation as more developed than another. If a student says “a higher standard of living”, press the student on what exactly is meant by that phrase. Since this is an economics class, the students might gravitate toward economic data but the instructor can also steer them to issues like a woman’s right to vote, or laws against child labor, as indicators of a developed nation.

Another project might be for small groups of students to be randomly assigned a nation and the students must look at that nation’s HDI statistic and present to the class why their nation ranked where it ranked.

http://hdr.undp.org/en/statistics/

MODULE 40: ECONOMIC GROWTH IN MACROECONOMICMODELS

The purpose of this module is to incorporate the concept of economic growth in the models that have been developed throughout the course.

Student learning objectives:• How long-run economic growth is represented in macroeconomic models. • How to model the effects of economic growth policies.

Key Economic Concepts For This Module:• Long-run economic growth is seen as either an outward shift of the nation’s PPC, or an

outward shift in the LRAS curve. • Nations that invest in more physical capital, human capital, or technological R & D

should see the PPC shift outward faster than a nation that invests primarily in consumer goods.

• Short-run economic fluctuations in the business cycle are seen as movements from within a fixed PPC, or as shifts in either the AD or SRAS curves.

• Key graphs are seen below.

Common Student Difficulties:• If real GDP is increasing the AD/AS model, students assume that the economy has

experienced growth. This is only true of the LRAS curve shifted outward.

In-Class Presentation of Module and Sample Lecture

Suggested time: This module can be covered in one hour-long class session. Much of this module is good review of previous models and highlighting the role of growth in those models so the instructor may even cover this material out of class in a review homework assignment.

I. Long-run Economic Growth and the Production Possibilities Curve II. Long-run Economic Growth and the Aggregate Demand and Supply Model III. Distinguishing Between Long-run Growth and Short-run Fluctuations

I. Long-run Economic Growth and the Production Possibilities Curve Long-run economic growth is the sustained rise in the quantity of goods and services the economy produces, as opposed to the short-run ups and downs of the business cycle.

One of the earlier models discussed in the course was the PPC.

Note: as a quick review, ask the students to choose any two goods/services and draw a PPC that illustrates increasing opportunity costs. They should be able to draw a concave PPC.Then ask them to identify a point in the graph that is currently unattainable. How would this economy ever hope to reach this unattainable combination of your two products?

Create an example similar to the one given in the text. An economy can choose to produce consumption goods (food, clothing, entertainment) or investment goods (physical capital).

Example Two nations, nation X and nation Y, have the same PPC in 2010.Suppose nation X chooses a point like A, where most of the resources are used to produce consumption goods.

Nation Y chooses a point like B, where most of the resources are used to produce investment goods. Where will these PPC’s lie in 20 years?

Both nations will experience growth in the PPC, but Nation Y experiences more growth over time because investments in physical capital goods produce other goods.

In fact, if a nation like Nation X focuses solely on consumption goods, their current stock of physical capital will begin to depreciate. Machinery used to produce other goods eventually wears out and becomes useless. If this were to happen the PPC could even shift inward.

II. Long-run Economic Growth and the Aggregate Demand and Supply Model In the aggregate demand and aggregate supply model, the long -run aggregate supply curve shows the relationship between the aggregate price level and the quantity of aggregate output supplied when all prices including nominal wages are flexible.

The long-run aggregate supply curve is vertical at the level of potential output.

While actual real GDP is almost always above or below potential output, reflecting the current phase of the business cycle, potential output is the level of output around which actual aggregate output fluctuates.

III. Distinguishing Between Long-run Growth and Short-run Fluctuations Remember: Long-run economic growth is the sustained rise in the quantity of goods and services the economy produces, as opposed to the short-run ups and downs of the business cycle.

In the model of Production Possibilities, a short-run fluctuation is described as a movement along, or within the PPC.As we showed above, long-run growth is a fundamental shift outward of the PPC.

In the AD/AS model, a short-run fluctuation of the business cycle would be seen as a shift of the AD curve or SRAS curve. For example, a recessionary gap is the result of a decrease in AD or a decrease in SRAS. The model predicts that in the long run the economy will adjust to full employment, which is identified by the vertical LRAS curve.

In-Class Activities and Demonstrations

Below are two teaching tips that may help students to remember the role of human capital and growth.

• Human Capital – Many students have a difficult time grasping what human capital is. Generally students understand that the purchase of a machine will add to the production of a firm, but have a more difficult time grasping that improvement in the knowledge or skills of a workforce will have the same effect. This is rather simple, but you can help your students better understand the term human capital if you use it frequently. Ask students why they are in school. Most will respond “To get an education,” or “To get a diploma.” Relate these answers to human capital.

Ask “Why do you want an education/diploma?” Typical responses will include “To go to college” or “To make more money.” A diploma and a college degree are certificates of human capital. As students near graduation (and near the AP Macroeconomics exam), frequently congratulating them on almost achieving their certificates of human capital will help them make this connection. If students do not do well on a particular test, suggest to them that they need to increase their human capital for the next test. The familiarity of the term will grow if you use it in contexts that the students already understand.

• Connecting Investment to Production Possibilities to Growth to LRAS – Students need to make a connection between long-term growth and LRAS. Remind students that any change in production possibilities will result in a change in LRAS. Investment in physical or human capital will result in production possibilities increasing, thus LRAS shifting to the right. Although a little simplistic, you might write on the board “Growth = PPF = LRAS” when covering this material. When students see the word “growth” on the test, they will immediately look for things that make production possibilities expand (or shrink).