Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

The ‘really long run’

Here we consider what effect the increase in consumer spending has on the natural level of output in the really long run: the answer may surprise you!

Output can increase in the long run in two main ways:


Improved technology: Innovations that allow firms to make more/better goods and services from the same quantity of inputs.


Increased factors of production: Examples include capital and labour. Increases in the capital stock are especially important for increasing living standards.

Although increased consumer confidence may not affect firms’ technological advances, it does impact indirectly on capital accumulation. Every year, some part of the existing capital stock depreciates, that is, wears away. Investment as economists use the term refers to the purchase of capital goods, which adds to the capital stock. Consumer confidence has quite a lot to do with investment.

In the long run, increased consumption due to increased consumer confidence actually reduces investment and may reduce living standards. Think about it this way. Firms produce two types of goods:


Consumption goods: Made to be consumed – almost all goods that households purchase fall into this category.


Capital goods: Made to produce other goods in the future.

At one extreme, firms could produce only consumption goods, which would mean very high levels of consumption now but would reduce future consumption due to the lack of new capital goods. Every year that this continued, the capital stock would depreciate further and the country’s productive capacity would be further impaired. In other words, the natural

level of output would fall because of the reduced amount of capital (K).

At the other extreme, firms could produce only capital goods, which would mean no consumption today (!) but higher output in the future due to the large amount of new capital goods. Over time the capital stock would grow

substantially and the natural level of output would increase. (Whether anyone would be around to enjoy all that output after not consuming anything for years is another matter!)

Clearly, neither of these extreme options is likely to be optimal. Instead, the optimum policy involves devoting some proportion of output to consumption goods and some proportion to capital goods.

The more of a nation’s output that’s devoted to consumption goods, the less capital goods it produces, and this reduction is one-for-one. This reduces living standards in the long run – compared to the case where consumption is lower and investment (new capital goods) is higher.