Use AD/AS model to show effects on GDP and price level of an increase in capital stock.

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pohnpei397 eNotes educator| Certified Educator

In the long run, an increase in capital stock in an economy will lead (all other things being equal) to an increase in the gross domestic product and to a decrease in the price level.  This is because such an increase will cause an increase in aggregate supply.

When capital stocks increase, what is happening is that the capacity of the economy to create things is increasing.  As firms buy more machinery, or more sophisticated machinery, the productivity of the economy increases.  This means that the economy will be able to produce more goods using fewer resources (particularly, using less labor).  When this happens, aggregate supply rises.

When aggregate supply rises, all other things being equal, prices go down and GDP goes up.