Skip to content
Marlbridge
Free trial

Flashcards · AP® Macroeconomics · Unit 5

Unit 5: Long-Run Consequences of Stabilization Policies flashcards

47 cards on topics 5.1 to 5.7. Pick a topic or study the whole unit.

Study mode needs JavaScript. Every card is listed below, so you can still cover the answers and test yourself.

All 47 cards

For a quick read-through or printing. Cover the right-hand side to test yourself.

5.1 Fiscal and Monetary Policy Actions in the Short Run

Which policy mix closes each output gap?
Recessionary gap: expansionary fiscal and monetary policy. Inflationary gap: contractionary fiscal and monetary policy.
What happens to the interest rate when fiscal and monetary policy are both expansionary?
It is uncertain. Monetary expansion lowers it, but higher income from fiscal expansion raises money demand and pushes it up. AD, real output and the price level rise.
What happens with expansionary fiscal and contractionary monetary policy?
The nominal interest rate rises, but the effect on AD, real output and the price level is uncertain. With contractionary fiscal and expansionary monetary policy, the rate falls and output is uncertain.
The MPC is 0.8 and there is a recessionary gap of VD 50 billion. What is the minimum rise in G that closes it alone?
The spending multiplier is 5, so 50 ÷ 5 = VD 10 billion.
G rises by VD 5 billion and a rate rise cuts investment by VD 5 billion (MPC 0.75). What is the net AD shift?
Zero: both use the spending multiplier of 4 (+20 and −20). The interest rate rises. Equal opposite actions cancel only when they use the same multiplier.
Graph: which graphs do you use to show a combined policy?
AD–AS (price level and real GDP) for output and the price level. A money market graph (nominal interest rate and quantity of money), or a reserve market graph, for the nominal interest rate.

5.2 The Phillips Curve

What does the short-run Phillips curve show?
Inflation rate on the vertical axis against unemployment rate on the horizontal. The SRPC slopes down: in the short run, lower unemployment comes with higher inflation. The economy is always on its current SRPC.
What is the long-run Phillips curve?
A vertical line at the natural rate of unemployment: no long-run trade-off. Long-run equilibrium is where the SRPC crosses the LRPC.
How does a change in AD appear on the Phillips curve graph?
As a movement along the SRPC, not a shift. AD up: move up and to the left. AD down: move down and to the right.
How does a supply shock appear on the Phillips curve graph?
The SRPC shifts the opposite way to SRAS. An adverse shock (SRAS left) shifts the SRPC right: stagflation. A favourable shock (SRAS right) shifts it left.
Graph: describe the long-run adjustment after AD rises, on the Phillips curve.
Inflation rate on the vertical axis, unemployment rate on the horizontal. First the economy moves up and left along SRPC₁, left of the LRPC. As SRAS shifts left, the SRPC shifts right until the economy is back on the LRPC at the natural rate, with inflation higher than at the start.
What shifts the LRPC?
A change in the natural rate. Better job-matching that cuts frictional unemployment lowers the natural rate: the LRPC shifts left and LRAS shifts right.
The natural rate is 4.5% and unemployment is 3.8%. Where is the economy?
Left of the LRPC: an inflationary gap.

5.3 Money Growth and Inflation

What causes inflation that lasts?
The money supply growing too fast for too long. A sustained fall in the money supply causes deflation. A one-time price rise is not continuing inflation.
What is the equation of exchange?
M × V = P × Y. It is always true, because velocity is defined as nominal GDP ÷ M. P is a price level (index ÷ 100), not an inflation rate.
What does the quantity theory of money say?
Velocity is stable and real output is fixed at full employment by real resources, so in the long run money growth sets the inflation rate. Money is neutral in the long run: it changes nominal values only.
Money grows 8% a year, V is constant and real GDP grows 3%. About what is long-run inflation?
About 8 − 3 = 5%, from %ΔM + %ΔV ≈ %ΔP + %ΔY. Not 8%: real growth must be subtracted.
M = 300, V = 3 and Y = 750. What is P?
P = (M × V) ÷ Y = 900 ÷ 750 = 1.2, a price index of 120.
Graph: describe a rise in the money supply in the AD–AS model.
Price level on the vertical axis, real GDP on the horizontal. AD shifts right and output rises above Yf in the short run. Nominal wages then rise and SRAS shifts left, so output returns to Yf on LRAS at a higher price level.
M = VD 150 billion and nominal GDP = VD 900 billion. What is velocity?
V = 900 ÷ 150 = 6: on average each valda is spent on final output 6 times a year. Velocity is a number of times, not an amount of money.

5.4 Government Deficits and the National Debt

What is the difference between a budget deficit and the national debt?
A deficit is a flow: in one year, tax revenue is less than government purchases plus transfers. The national debt is a stock: the total the government owes, equal to past deficits minus past surpluses.
Does a falling deficit lower the national debt?
No. Any deficit adds to the debt; only a surplus reduces it. A deficit falling from VD 50 billion to VD 20 billion still raises the debt by VD 20 billion.
How do you calculate the budget balance?
T − (G + transfers + interest). With T = 250, G = 200, transfers 60 and interest 15 (VD billion), the balance is −25: a deficit of VD 25 billion.
How is a budget deficit financed?
By borrowing: the government sells bonds.
What are the burdens of the national debt?
Interest must be paid every year; that money has other uses (opportunity cost); borrowing to pay interest makes the debt grow faster; future taxpayers bear the cost; and borrowing may crowd out private investment.
A debt of VD 300 billion carries 4% interest, all of it borrowed. What is the debt a year later?
300 × 1.04 = VD 312 billion.
Is interest on the debt part of G?
No, because it buys no goods or services. But it is government spending in the budget, so include it on the spending side.

5.5 Crowding Out

What is crowding out?
Extra government borrowing raises the real interest rate, which reduces interest-sensitive private spending: business investment, new housing and goods bought on credit.
Graph: the government borrows more. Describe the loanable funds graph.
Real interest rate on the vertical axis, quantity of loanable funds on the horizontal. Demand shifts right (or, as the other method, supply shifts left; use one only). The real interest rate rises; the total quantity rises, but private borrowing falls.
What are the short-run and long-run effects of crowding out?
Short run: the fall in investment offsets part of the stimulus, so AD rises by less than the simple multiplier suggests. Long run: less physical capital and slower productivity growth, so LRAS shifts right by less.
Private demand Qd = 240 − 10r and supply Qs = 60 + 20r. The government borrows VD 30 billion more. How much investment is crowded out?
Before: r = 6% and VD 180 billion. After: 270 − 10r = 60 + 20r gives r = 7%, and private investment = 240 − 70 = VD 170 billion. VD 10 billion is crowded out; the other VD 20 billion comes from extra saving.
Does crowding out make fiscal policy useless?
No. Private investment falls by less than the amount borrowed, so AD still rises, by less. Crowding out slows long-run growth; it does not stop it.
What makes crowding out larger?
Saving that responds little to the interest rate (a steeper supply curve) gives bigger crowding out.

5.6 Economic Growth

How is economic growth measured?
By the growth rate of real GDP per capita: a long-run rise in the economy's capacity to produce. Growth rate = (new − old) ÷ old × 100. Never use nominal GDP.
What determines labour productivity?
Productivity = real GDP ÷ employed workers. It rises with physical capital per worker, human capital per worker and better technology.
Graph: how is economic growth shown on the PPC and in the AD–AS model?
PPC: the curve shifts outward. AD–AS: the vertical LRAS shifts right to a higher full-employment output. Both show the same rise in capacity. A rightward shift of AD alone is not growth.
Real GDP grows from VD 720 billion to VD 756 billion while population grows from 36 million to 36.9 million. What is per capita growth?
Per capita real GDP rises from VD 20,000 to about VD 20,487.80: growth of 2.44%. The shortcut 5% − 2.5% = 2.5% is only approximate.
Real GDP is VD 450 billion and 18 million people are employed. What is labour productivity?
450 ÷ 18 = VD 25,000 per worker. Divide by employment, not by population.
Is recovery from a recession economic growth?
No. Moving from inside the PPC back onto it is not long-run growth; growth means capacity itself rises.
How does a bigger population with the same capital affect productivity?
It means less capital per worker, which lowers labour productivity, other things equal.

5.7 Public Policy and Economic Growth

How can public policy raise economic growth?
By raising productivity (more physical capital, human capital and better technology per worker) or labour force participation. Growth of real GDP per capita ≈ productivity growth + growth of the employed share of the population.
What are supply-side fiscal policies?
Taxes, spending and benefit rules that change incentives to work, save, invest and innovate, raising aggregate supply and potential output.
Graph: a government builds new infrastructure. Describe the short-run and long-run effects.
Price level on the vertical axis, real GDP on the horizontal. Short run: G rises, so AD shifts right. Long run: once the roads or networks are in use, productivity rises and LRAS shifts right. The change in the price level depends on the relative sizes of the shifts.
Does a one-off cash payment to households raise long-run growth?
No. It shifts AD right but does not change capacity, so LRAS is unchanged. At full employment, the long-run result is a higher price level.
Output per worker is VD 60,000 and 45% of the population is employed. What is real GDP per capita?
60,000 × 0.45 = VD 27,000.
What is the opportunity cost of policies that build capital?
More capital goods now means fewer consumer goods now. Borrowing to pay for a policy can also crowd out private investment.
Must a supply-side tax cut lower the price level?
No. Real output rises, but the price level depends on the relative sizes of the AD and AS shifts.

Study Unit 5 further

AP® and Advanced Placement® are trademarks registered by the College Board, which is not affiliated with, and does not endorse, this website. Marlbridge is an independent tuition provider. It is not an authorized AP course provider, an AP school or an exam centre, and these resources are not official College Board materials. Reading them or doing simulations does not meet the laboratory requirement of an AP science course.