Unit 5 Test: Long-Run Consequences of Stabilization Policies
Test AP Macroeconomics Unit 5 skills. Practice Phillips curve shifts, stagflation, crowding out, long-run self-correction, and supply-side economics with AP-style questions.
Long-Run Macro Analysis in AP Macroeconomics
Unit 5 extends the analysis of fiscal and monetary policy into the long run and introduces the Phillips curve as a key analytical tool. The College Board-style exam tests your ability to connect short-run policy effects to long-run outcomes, evaluate the effectiveness and limitations of stabilization policies, and analyze the unemployment-inflation trade-off under various economic conditions.
The Phillips Curve
The short-run Phillips curve (SRPC) shows an inverse relationship between the unemployment rate and the inflation rate. When unemployment is low, inflation tends to be high, and vice versa. On AP FRQs, the SRPC is drawn with the inflation rate on the vertical axis and the unemployment rate on the horizontal axis.
Shifting the Short-Run Phillips Curve
- A positive supply shock (lower input costs) shifts the SRPC downward and to the left, allowing lower inflation at every unemployment rate.
- A negative supply shock (higher input costs, such as an oil price spike) shifts the SRPC upward and to the right, causing stagflation — higher inflation and higher unemployment simultaneously.
- Changes in inflation expectations also shift the SRPC: higher expected inflation shifts it upward.
The Long-Run Phillips Curve
The long-run Phillips curve (LRPC) is vertical at the natural rate of unemployment (NRU). In the long run, there is no trade-off between inflation and unemployment because the economy self-corrects to the NRU. Attempts to hold unemployment below the NRU through expansionary policy lead to accelerating inflation over time.
Long-Run Self-Correction
In the AD-AS model, if the economy is in a recessionary gap, wages and input prices eventually fall, shifting SRAS to the right until output returns to potential GDP. If the economy is in an inflationary gap, wages and input prices rise, shifting SRAS to the left. This self-correction mechanism means that in the long run, the economy returns to full employment without government intervention — though the process can be slow and painful.
Crowding Out
Expansionary fiscal policy financed by government borrowing increases the demand for loanable funds, raising the real interest rate. Higher real interest rates reduce private investment — a process called crowding out. Crowding out weakens or offsets the initial stimulus effect of fiscal policy, particularly in the long run.
Supply-Side Economics
Supply-side policies aim to increase long-run aggregate supply (shift LRAS right) by improving productivity, reducing regulations, cutting marginal tax rates to incentivize work and investment, and investing in infrastructure or education. Unlike demand-side fiscal policy, supply-side policies target the productive capacity of the economy rather than short-run aggregate demand.