AP Macroeconomics Unit 5: Long-Run Consequences of Stabilization Policies | Notes and practice

Notes

The short-run Phillips curve (SRPC) shows a trade-off: lower unemployment comes with higher inflation, and vice versa. Moving along it corresponds to AD shifting.
The long-run Phillips curve (LRPC) is vertical at the natural rate of unemployment. In the long run, there's no trade-off.
A shift in SRAS shifts the SRPC (a negative supply shock shifts SRPC right: higher inflation and unemployment).
Inflation expectations shift the SRPC: if people expect more inflation, SRPC shifts up.

In the short run there's a trade-off; in the long run, unemployment returns to its natural rate.

Quantity theory of money: $MV = PQ$ (money supply × velocity = price level × real output). If $V$ and $Q$ are stable, increasing $M$ raises $P$.
In the long run, money is neutral: changes in the money supply affect prices but not real output.
Printing money too fast can cause hyperinflation.

A budget deficit happens when spending exceeds tax revenue in a year. The national debt is the total of past deficits.
Large deficits can raise interest rates (crowding out), reducing investment and long-run growth.

Long-run growth comes from more physical capital, human capital (education and skills), technology, and natural resources. Growth shifts LRAS and the PPC outward.
Productivity (output per worker) is the key to rising living standards.
Supply-side policies (tax incentives for investment, education, research) aim to increase long-run aggregate supply.

The short-run Phillips curve shows:

The long-run Phillips curve is vertical at:

A sudden increase in oil prices causes the short-run Phillips curve to:

According to $MV = PQ$, if velocity and real output are constant, doubling the money supply will:

The national debt is:

Which policy would most likely increase long-run economic growth?

Long-run economic growth is shown by:

If people come to expect higher inflation, the short-run Phillips curve:

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Free-response question

The government increases spending, financed by borrowing.

(a) Show the effect on the loanable funds market (describe it).

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Demand for loanable funds shifts right, so the real interest rate rises.

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(b) Explain how this could affect private investment.

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Higher real interest rates make borrowing more expensive, so businesses invest less (crowding out).

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(c) Explain how reduced private investment could affect long-run economic growth.

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Less investment means less new physical capital, so productivity grows more slowly, and LRAS shifts out less than it otherwise would.

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