AP Macroeconomics Unit 5: Long–Run Consequences of Stabilization

5.1 - Fiscal and Monetary Policy Actions in the Short Run

  • Putting Fiscal and Monetary Policy Together

    • Economic policies don’t exist in a vacuum

    • Policymakers need to work together to achieve economic goals


5.2 - The Phillips Curve

  • The Phillips Curve

    • Shows the trade off between inflation and unemployment

    • An inverse relationship between unemployment and inflation

    • A change in aggregate demand corresponds to a movement along the short-run Phillips Curve

    • A change in aggregate supply corresponds to a shift in the short-run Phillips Curve

    • Label equilibrium on the axis, not at the actual point of intersection

      • Tip: draw the AD AS curves first, then draw the Phillips Curve

    • Changing the natural rate of unemployment shifts Long-run Phillips Curve (LRPC)

5.3 - Money Growth and Inflation

  • Quantity Theory of Money

    • M X V = P X Y

      • M = Money Supply

      • V = Velocity

      • P = Price Level

      • Y = Quantity of output

    • Notice that P x Y = Nominal GDP

  • When velocity of money (V) is fixed and real output (Y) is limited to full employment -> Increase in money supply (M) causes increase in Price Level

  • Short- run spending leads to higher resources prices and inflation 

    • If inflation is bad enough, banks won’t lend and the economy tanks

  • Numerous economists support expansionary policy due to the increase of output in short-run

  • Long run will raise everything

  • James “Downtown” Green

5.4 - Government Deficits and the National Debt

  • All Policies have Tradeoffs

    • Deficit Spending

      • Budget Deficit - annual government spending and transfer payments are greater than tax revenue

      • Budget Surplus - annual government spending and transfer payments are less than tax revenue

      • The National Debt - the accumulation of all the budget deficits over time

  • Entitlements - federal program that requires payments to any eligible person or unit of government. This mandatory spending must be paid (Social Security)



5.5 - Crowding Out

  • Crowding out - Government deficit spending and borrowing to pay off deficit spending, leads to higher real interest rates and less investment spending

    • Adverse effect of government borrowing on interest-sensitive private sector spending

    • Crowds out private investment and consumption


5.6 - Economic Growth

  • Measuring Economic Growth

    • What do economists use to measure economic growth and standard of living?

      • NOT Nominal GDP

        • Doesn't account for inflation

      • NOT Real GDP

        • Doesn't account for population

      • Real GDP per Capita is used

        • The Real GDP divided by the population

  • Why Do Some Countries Have More Growth?

    • Economic System

      • Capitalism promotes innovation and provides incentives to improve productivity

    • Rule of Law

      • Countries with solid institutions and political stability have historically had more economic growth

    • Capital Stock

      • Countries that have more machines and tools are more productive

    • Human Capital

      • Countries that have better education and training are more productive

    • Natural Resources

      • In general, countries that have access to more natural resources are more productive

  • Productivity

    • Output per Unit

  • Aggregate Production Function Graph

    • Will likely not be asked to draw on the AP Macro Exam

5.7 - Public Policy and Economic Growth

  • What government policies most likely result in long-run economic growth?

    • Education/Training Spending

      • Increases human capital

    • Infrastructure Spending

      • Public works like roads, bridges, and harbors

        • Increases physical capital

    • Production/Investment Incentive Programs

      • E.g. Investment Tax Credits

        • Increases physical capital 

      • “Supply-Side Policies”

  • Supply-Side Fiscal Policy

    • Federal government policies designed to increase production by reducing business taxes and/or regulations

    • Why Is This Controversial?

      • Providing tax breaks to businesses might disproportionately benefit the wealthy

      • It assumes corporations will spend their tax cuts on investment rather than payout shareholders through stock