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Credit Sprint's Guide to Macroeconomics Unit 5: Long-Run Consequences of Stabilization Policies

AP® weight 20–30%CLEP® weight 20–25% + 5–10% growth

The Phillips curve shows a short-run tradeoff between inflation and unemployment that disappears in the long run. Deficit spending can crowd out private investment through the loanable funds market. Long-run growth comes from more and better resources and technology.

What you need to know

  • The short-run Phillips curve (SRPC) slopes down; the long-run Phillips curve (LRPC) is vertical at the natural rate.
  • AD shifts move along the SRPC. SRAS shifts and expected inflation shift the SRPC.
  • Government borrowing increases demand for loanable funds, raises the real interest rate and reduces private investment.
  • Quantity theory: MV = PQ. If V and Q are fixed, money growth equals inflation.
  • Growth comes from physical capital, human capital, technology and good institutions.
  • Growth shows as an outward PPC shift and a rightward LRAS shift.
  • Rule of 70: years to double ≈ 70 ÷ growth rate.

Formulas

M × V = P × Q
Growth rate = (GDP₂ − GDP₁) ÷ GDP₁ × 100
Years to double ≈ 70 ÷ growth rate (%)

Exam traps

Watch forMovements along the SRPC mirror AD shifts; SRAS shifts move the SRPC itself.
Watch forCrowding out works through the real interest rate in the loanable funds market.
Watch forDisinflation (slower inflation) is not deflation (falling prices).

Key terms

  • Short-run Phillips curve: Downward-sloping curve showing a short-run tradeoff between inflation and unemployment.
  • Long-run Phillips curve: Vertical at the natural rate of unemployment. No long-run tradeoff.
  • SRPC shifters: Expected inflation and supply shocks shift the SRPC. AD changes move along it.
  • Crowding out: Government borrowing raises the real interest rate, reducing private investment.
  • Quantity theory of money: MV = PQ. With V and Q constant, money growth causes equal inflation.
  • Velocity of money: How many times a dollar is spent in a year. V = nominal GDP ÷ money supply.
  • Budget deficit vs. debt: The deficit is one year's shortfall; the debt is the accumulated total.
  • Economic growth: A sustained rise in real GDP per person. Shown by LRAS and PPC shifting out.
  • Productivity: Real output per worker or per hour. The main driver of living standards.
  • Human capital: Knowledge and skills workers gain through education and training.
  • Rule of 70: Years for a value to double ≈ 70 ÷ annual growth rate.
  • Disinflation: A fall in the inflation rate while prices are still rising.

Practice questions

Five of the 45 Unit 5 questions in Credit Sprint. Every choice is explained in the app.

1. The short-run Phillips curve shows:
  1. That unemployment always returns to zero
  2. A vertical line at the natural rate
  3. The relationship between money and output
  4. An inverse relationship between inflation and unemployment
  5. A positive relationship between inflation and unemployment
Show answer

An inverse relationship between inflation and unemployment. Lower unemployment comes with higher inflation in the short run.

2. Persistent deficit spending can slow long-run growth because:
  1. It raises the natural rate of unemployment immediately
  2. It raises net exports
  3. It lowers real interest rates
  4. It shifts LRAS right
  5. Crowding out reduces private investment in capital
Show answer

Crowding out reduces private investment in capital. Higher real interest rates mean less new capital.

3. Disinflation means:
  1. The inflation rate falls but stays positive
  2. The price level falls
  3. Inflation equals zero
  4. Unemployment falls to zero
  5. The inflation rate rises
Show answer

The inflation rate falls but stays positive. Prices still rise, just more slowly.

4. Velocity is constant, the money supply grows 8% and real output grows 3%. Inflation will be about:
  1. 5%
  2. 8%
  3. 11%
  4. 24%
  5. 3%
Show answer

5%. 8% − 3% = 5%.

5. The labor force grows because of immigration of working-age adults. LRAS:
  1. Doesn't change
  2. Only AD shifts
  3. Shifts right
  4. Shifts left
  5. LRAS becomes horizontal
Show answer

Shifts right. More labor raises potential output.