Question 1

What are expansionary policies?

Accepted Answer

Expansionary policies refer to a set of fiscal and monetary policies that increase aggregate demand, leading to the growth of the economy

(fiscal: increase govt. spending, decrease taxes; monetary: decrease RR, decrease DR, buy bonds)

Question 2

What are contractionary policies?

Accepted Answer

Contractionary policies are a set of fiscal and monetary policies that decrease aggregate demand, leading to a decrease in the growth of the economy

(fiscal: decrease govt. spending, increase taxes; monetary: increase RR, increase DR, sell bonds)

Question 3

What is an output gap?

Accepted Answer

The difference between the current level of real output and potential output

(inflationary/positive, recessionary/negative, or full employment)

Question 4

What will happen in a recession if no policy action is taken?

Accepted Answer

Aggregate supply will increase as a result of low wages and low costs

This will restore full employment

Question 5

What fiscal policies can be used in a recessionary gap?

Accepted Answer

Increase government spending or decrease taxes

Question 6

What monetary policies can be used in a recessionary gap?

Accepted Answer

Decrease the RR

Decrease the DR

Buy bonds

Question 7

What is the short-run Phillips curve (SRPC)?

Accepted Answer

A downward-sloping curve that illustrates the short-run trade-off between inflation and unemployment

Question 8

What is the long-run Phillips curve (LRPC)?

Accepted Answer

A vertical line illustrating the long-run relationship between inflation and unemployment at the natural rate of unemployment

There is no tradeoff between unemployment and inflation in the long run, so the LRPC is vertical at the natural rate of unemployment

Question 9

What is long-run equilibrium on the Phillips curve graph?

Accepted Answer

Long-run equilibrium is the intersection of the SRPC and the LRPC

(full employment is at the NRU)

Question 10

What do points to the left or right of the LRPC represent on the Phillips curve graph?

Accepted Answer

Left of LRPC: inflationary gaps

Right of LRPC: recessionary gaps

An economy is always operating somewhere along the SRPC

Question 11

How do demand shocks affect the Phillips curve?

Accepted Answer

Positive shock: move the dot left on the curve

Negative shock: move the dot right on the curve

Question 12

How do supply shocks affect the Phillips curve?

Accepted Answer

Positive shock: the SRPC shifts left

Negative shock: the SRPC shifts right

Question 13

What causes shifts in the LRPC?

Accepted Answer

Anything that changes NRU (changes in structural or frictional unemployment)

Question 14

What is the equation for the quantity theory of money?

Accepted Answer

Money supply times velocity of money = price level times real GDP (Q)

Question 15

Why is the LRAS vertical?

Accepted Answer

Because changes in the money supply have no effect on real output in the long run when the economy is in equilibrium

Question 16

According to the quantity theory of money, what determines the inflation rate?

Accepted Answer

The growth rate of the money supply

Question 17

What is a government budget deficit?

Accepted Answer

When the government spends more money than it collects in revenue

(opposite of a budget surplus)

Question 18

What happens to the national debt when the government runs a budget deficit?

Accepted Answer

The national debt increases over time

Question 19

What happens to a government's interest payments as its accumulated debt increases?

Accepted Answer

The interest payments also increase, making it increasingly difficult for the government to use those funds for alternative uses

Question 20

Why can it be beneficial not to balance the national budget?

Accepted Answer

It may be beneficial to run a budget deficit (expansionary) during recessionary gaps and run a budget surplus (contractionary) during inflationary gaps to help restore full employment

Question 21

What does a government do when it is in budget deficit?

Accepted Answer

Borrows to finance its spending

Question 22

What does the loanable funds market model demonstrate?

Accepted Answer

The effect of government borrowing on the equilibrium real interest rate and the resulting crowding out of private investment

Question 23

What is crowding out?

Accepted Answer

The theory that increased government borrowing can lessen or eliminate private sector spending due to budget deficits increasing demand for loanable funds

Increasing demand for loanable funds decreases the amount available for private investors and increases interest rates, leading to less private investment and potentially a recessionary gap

Question 24

Why does crowding out occur?

Accepted Answer

Government borrowing leads to higher demand for loans, which increases interest rates

This makes it harder for private corporations to get loans and reduces economic growth

Question 25

What is the potential long-run impact of crowding out?

Accepted Answer

A lower rate of physical capital accumulation and less economic growth as a result

Question 26

What is the impact of crowding out on an expansionary fiscal policy?

Accepted Answer

It can partially cancel out the effects of the policy, making it less effective in correcting a recessionary gap

Question 27

How can we measure economic growth?

Accepted Answer

The growth rate in real GDP per capita over time

Question 28

What is the relationship between aggregate employment and output?

Accepted Answer

Aggregate employment and aggregate output are directly related, as firms need to employ more workers in order to produce more output

Question 29

What does output per employed worker measure?

Accepted Answer

Output per employed worker is a measure of average labor productivity

Question 30

What determines productivity?

Accepted Answer

The level of technology, physical capital, and human capital per worker

Question 31

What does the aggregate production function measure?

Accepted Answer

How much is produced overall in an economy, given factors such as total labor in the economy

Question 32

How can the government increase real GDP per capita and economic growth?

Accepted Answer

By enacting public policies that increase productivity and labor force participation

(investments in education & infrastructure, production incentive programs)

Question 33

What is supply-side fiscal policy?

Accepted Answer

Policies that emphasize tax cuts and deregulation to increase the production of goods and services

Based on the idea that reducing taxes and regulations will incentivize businesses to invest more, leading to increased economic activity and job creation

Question 34

What is the goal of supply-side fiscal policies?

Accepted Answer

To create incentives for businesses and households to increase economic activity and improve efficiency in the long run

(this does not always work in reality)

Question 35

Why is supply-side fiscal policy controversial?

Accepted Answer

Providing tax breaks will disproportionately benefit the wealthy

It assumes corporations will spend money from tax cuts on new investments rather than paying shareholders

Question 36

Does all government spending lead to economic growth?

Accepted Answer

No, only spending that increases productivity or technology leads to growth

Question 37

What are investment tax credits?

Accepted Answer

Tax incentives offered by the governments to encourage businesses to invest in certain areas or industries

(allows businesses to pay less tax if they invest in some technology, such as renewable energy)

Unit 5 - Long-Run Consequences of Stabilization Policies, AP Macroeconomics Flashcards