A country's potential output rises persistently over 20 years after firms increase investment spending on factories and equipment, and workers use the new capital to produce more output per hour. Short-run recessions still occur, but the long-run trend of real GDP per capita is upward. Based on the information shown, which factor is the primary driver of the long-run growth described?
- An increase in aggregate demand that temporarily raises real GDP above potential output.
- A rise in the price level that increases nominal GDP and therefore raises living standards.
- Physical capital accumulation that raises labor productivity and potential output over time. (correct answer)
- A decrease in unemployment during a recovery that returns real GDP to its prior level.
- An increase in total spending that raises output even if productive capacity is unchanged.
Explanation: Economic growth occurs when an economy's productive capacity expands, allowing it to produce more goods and services per person over time. The scenario describes physical capital accumulation through increased investment in factories and equipment, which raises labor productivity (output per hour worked) and shifts the production possibilities curve outward. This capital deepening (choice C) is a fundamental driver of long-run growth because it permanently enhances workers' ability to produce, unlike temporary demand increases that only affect short-run output. A key misconception is thinking that any increase in spending or GDP represents growth—true economic growth requires expanding potential output through supply-side factors. To identify growth drivers, look for factors that increase productivity or productive capacity: physical capital, human capital, technology, or institutions.