We previously discussed how economic growth depends on the combination of ideas, human and physical capital, and good institutions. The fundamental factors, at

We previously discussed how economic growth depends on the combination of ideas, human and physical capital, and good institutions. The fundamental factors, at least in the long run, are not dependent on inflation. The long-run aggregate supply curve, part of the AD-AS model we’ve been discussing, can show us an economy’s potential growth rate when all is going well.

The long-run aggregate supply curve is actually pretty simple: it’s a vertical line showing an economy’s potential growth rates. Combining the long-run aggregate supply curve with the aggregate demand curve can help us understand business fluctuations.

For example, while the U.S. economy grows at about 3% per year on average, it does tend to fluctuate quite a bit. What causes these fluctuations? One cause is “real shocks” that affect the fundamental factors of production. Droughts, changes to the oil supply, hurricanes, wars, technological changes, etc. can all have big and potentially far-reaching consequences.

Shocks are not all bad though! For instance, new technology can help boost economic growth. The key takeaway about real shocks is that economic growth, even in stable economies, is not smooth sailing.

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