Which policy would most directly increase a country's potential output in the long run?

Which policy would most directly increase a country's potential output in the long run?

• A. Increase government spending.
• B. Tax incentives for investment and deregulation.
• C. Import restrictions.
• D. Increase tariffs.

Answer: (B)

Long-run potential output is driven by the economy’s capacity to produce: capital stock, technology, and efficiency. Policies that directly expand this capacity—like encouraging more investment and reducing unnecessary regulatory obstacles—shift the economy’s long-run supply outward. Tax incentives for investment spur firms to add to capital and adopt new technologies, while deregulation lowers the costs and delays of productive activity. Over time, these effects build the capital base and improve productivity, raising potential output. In contrast, increasing government spending mainly stimulates demand and can boost short-run output without reliably raising future capacity; and import restrictions or higher tariffs typically reduce efficiency and hamper long-run growth by limiting trade and the spread of ideas and technologies.

Long-run potential output is driven by the economy’s capacity to produce: capital stock, technology, and efficiency. Policies that directly expand this capacity—like encouraging more investment and reducing unnecessary regulatory obstacles—shift the economy’s long-run supply outward. Tax incentives for investment spur firms to add to capital and adopt new technologies, while deregulation lowers the costs and delays of productive activity. Over time, these effects build the capital base and improve productivity, raising potential output.

In contrast, increasing government spending mainly stimulates demand and can boost short-run output without reliably raising future capacity; and import restrictions or higher tariffs typically reduce efficiency and hamper long-run growth by limiting trade and the spread of ideas and technologies.