>> We've talked about how in the short-run GDP can fluctuate above or below potential. But what determines that long-run potential? Potential GDP which shows up as long-run aggregate supply in our graphs depends on two basic components. Inputs and the efficiency of those inputs in producing output. The inputs are further broken into two categories. Workers, which we call labour, and things like infrastructure, factories, computers, and office buildings, which we call capital. Think of the efficiency of those inputs as good ideas for how to combine the same capital and labour to produce more output. An example of this is shipping containers. By putting cargo in identical metal boxes, the same port workers and the same cranes can load and unload cargo ships in hours rather than days. So, an increase in the labour force, the construction of more capital like warehouses or delivery trucks or MRI machines or better ideas about how to organize production can all increase our potential output. That's the long-run trend that GDP fluctuates around in the short-run. We think that increasing any of these inputs in isolation runs into diminishing returns. If you add more workers without adding more capital or vice versa, output won't grow very much. However, increase in capital, labour and productivity simultaneously gives us huge increases in potential output. But if we're concerned with living standards, we need to look at consumption per person. Ultimately, that means looking at output per person. After all, if you doubled your production by simply doubling your number of workers, we aren't better off on a per person basis. When we look at everything on a per person basis, output per worker depends on productivity and capital per worker. In the long run, those are the factors that make Thailand richer than Tanzania and Denmark richer than both of them. On a per worker basis, Denmark has more capital per worker. And it combines those inputs more efficiently. Those factors are also how countries raise their income per person over time. The living standard in the U.S. is about eight times higher than it was 100 years ago. That's because each worker today has more equipment, technology, and skills to work with than 100 years ago. And we've organized our production more efficiently. As it turns out, increasing capital per worker is necessary but costly. First, we have to turn some of today's workers and factories over to producing more capital goods like computers and delivery trucks rather than consumption goods like phones and t-shirts. Second, once we have that initial capital, we have to devote resources to replacing it as it wears out. On the other hand, there is no upper limit to good ideas on new ways to combine capital and labour. Ultimately, while the level of capital per worker gives us the level of output per worker, the growth rate in productivity gives us the growth rate of output per worker. So, in the long run, potential output is determined by the amount of capital and labour we have and how efficiently they're combined to produce output. Trends and living standards and the differences between rich and poor nations boil down to changes in capital per worker and efficiency.