AP Macroeconomics Unit 5 Cheatsheet: Long-Run Consequences of Stabilization Policies

Fiscal + Monetary Policy Combinations

• Both can shift aggregate demand to close output gaps
• Expansionary: increase AD when in recession (negative gap)
• Contractionary: decrease AD when overheating (positive gap)
• Joint effects on real output, price level, interest rates

Phillips Curve Framework

• SRPC: downward-sloping; shows inflation-unemployment trade-off
• Economy always operates on the SRPC in short run
• LRPC: vertical at natural rate of unemployment (NRU)
• Long-run equilibrium = SRPC ∩ LRPC intersection

Gaps & Shocks

• Left of equilibrium = inflationary gap (low unemployment)
• Right of equilibrium = recessionary gap (high unemployment)
• Demand shocks: movement along SRPC
• Supply shocks: shift the SRPC itself
• Changes to NRU shift the LRPC horizontally

Key Relationships

• Inflation is a monetary phenomenon—caused by money supply growing too fast for sustained period
• At full employment: changes in M do not affect real output in long run
• Long-run (quantity theory, V constant): growth rate of M ≈ inflation + growth rate of real output Q, so inflation ≈ money growth − real GDP growth (money growth equals inflation only if Q is constant)

Solving Quantity Theory Problems

• Rearrange MV = PQ to isolate unknown variable
• If M increases 10% and V constant, P increases 10% (at full employment)
• Real output Q is fixed at full-employment output only for a given LRAS; Q can still change with no output gap if LRAS shifts (economic growth), while short-run output gaps move Q away from full employment
• Velocity V often assumed constant in long-run analysis