Unit 5: Long-Run Consequences of Stabilization Policies (Princeton Review AP Macroeconomics 2023 [21st Edition])

Currency Exchange shows inflation as…

the value of one nation’s currency dropping relative to another nation’s currency

Monetary Inflation

oversupply in one nation’s currency leading to decreases in purchasing power and increased prices

As the AD curve shifts to the right, the price level increases and unemployment…

dcereases

As the AD curve shifts to the left, the price level decreases and unemployment…

increases

As inflation increases, unemployment…

decreases due to increased demand for goods and services

As inflation decreases, unemployment…

increases as demand for goods and services declines

Short-Run Phillips Curve

describes the inverse relationship between inflation and unemployment

The Short-Run Phillips Curve Shape

downward sloping (inflation rate on Y, unemployment rate on X)

The Long-Run Phillips Curve Shape

vertical as the natural rate of unemployment (inflation rate on Y, unemployment rate on X)

Natural Rate of Unemployment

sum of frictional and structural unemployment

Stagflation is caused by shocks that shift AS…

leftward, which shifts the the Phillips Curve rightward

Supply shocks are caused by…

natural disasters, technological issues, or restrictions on resources

Structural Shocks

when the composition of AD changes and results in inflation and unemployment due to firms’ decisions

Expansionary policies can make AD increase and unemployment…

decrease

Contractionary policies can make AD decrease and unemployment…

increase

Firms respond to inflationary expectations with…

higher prices and higher wages

Expectations of inflation cause the Phillips Curve to shift…

rightward

Expectations of decreased nflation cause the Phillips Curve to shift…

leftward

Theory of Rational Expectations

people learn to anticipate government policies designed to influence the economy, thereby making the policies ineffectual

According to the theory of rational expectations, when the government increases spending, shifting the AD right…

people will anticipate higher future inflation and adjust their wages and price demand (shifting AS left), making the policy ineffective

Similar to classical theory, rational expectations theory assumes…

wgaes, prices. and interest rates adjust quickly to keep real GDP at full employment level

Rational Expectations Theory states the government…

should not intervene in the economy because it is not necessary, useful, or effective in stabilization

Budget Deficit

the difference between federal government spending and tax collections

National Debt

the accumulation of past deficits (the total amount the federal government owes at a given time)

Keynesian reasoning states that deficit spending during recession is good because…

it can be balanced with budget surpluses during booms

The government finances deficits by…

selling Treasury bonds, bills, and notes on the open market

Ricardian Equivalence Theory

suggests that consumers anticipate future taxes from government debt and tend to save more to repay their debt (states deficit financing is no different that tax financing)

By creating money, the government can spend money without raising interest rates, but…

this likely causes inflation

Those who wish to pay off debt sooner state…

benefits recieved by present generations are paid for by future generations and that the Ricardian Theory is invalid because most people wouldn’t be able to pay off their debt

Crowding Out

the decrease in real investment due to higher interest rates due to government purchases

Partial Crowding Out

the effect of crowded-out investment on real GDP is most likely smaller than the initial increase in real GDP due to purchases

Complete Crowding Out

decrease in investment eliminates the entire boost in real GDP from increased purchases

Economic growth is measured in…

annual increases in real GDP or real GDP per capita

Economic growth on a graph is shown by…

the LRAS curve shifting right or the PPC curve shifting out

Government policies to promote economic growth…

support for education, vocational training, research grants, development programs

The Fed’s policies to promote economic growth…

actions that lower interest rates and increase investment in capital

Sources of Economic Growth

Increased investments in human capital, increased investments in physical capital, improvements in technology, and enhanced resource utilization

Thomas Malthus worried…

food would grow at an arithmetic rate while population would grow at a geometric rate, resulting in population imbalance