Definitions
Define the natural rate of unemployment
The unemployment rate at full employment including ONLY frictional and structural unemployment
Looking at this graph, identify what could have caused this shift and what happens to the price level and real GDP. (AD-AS graph; AD shifting right).
Increased consumer confidence, tax cuts, or increased government spending; price level rises, real GDP increases
Is cutting taxes an example of expansionary or contractionary fiscal policy
Expansionary
What happens to borrowing and spending when the Federal Reserve raises the federal funds rate?
Borrowing becomes more expensive, so investment and consumption fall, reducing AD
According to this graph, what happens to inflation when unemployment decreases? (standard downward-sloping Phillips curve).
Inflation increases
A country experiences rising oil prices globally. Identify whether this causes demand-pull or cost-push inflation and explain why
Cost-push because rising oil prices increase production costs, shifting SRAS left, raising price levels while reducing real GDP
Identify the type of output gap shown and describe what will happen in the long run without government intervention. (AD-AS graph; real GDP is to the right of potential GDP).
Inflationary gap; in the long run wages rise, SRAS shifts left, returning to potential GDP at a higher price level
During a recession, Congress passes a $300 billion infrastructure spending bill. Using the concept of the multiplier, explain why the total economic impact will likely exceed $300 billion
Each dollar spent becomes income for another person who spends a portion of it, creating numerous rounds of spending
The Fed is concerned about rising inflation. Describe the sequence of actions it would take using open market operations, and what happens to the AD
Fed sells bonds → money supply decreases → interest rates rise → investment falls → AD shifts left
In 2021, the U.S. experienced both low unemployment and high inflation simultaneously. Using the Phillips Curve, explain how this makes sense
Low unemployment equals high inflation on the SRPC
The MPC in an economy is 0.8. The government increases spending by $200 billion. Calculate the total change in GDP
Multiplier = 1/(1-0.8) = 5. Total change = $1 trillion
Describe the economic event that could cause this and name the term. (AD-AS graph; SRAS shifting left, AD remains constant).
Supply shock; stagflation
Compare the effectiveness of a tax cut versus direct government spending as tools of expansionary fiscal policy. Why do tax cuts have a smaller multiplier effect?
Tax cuts depend on MPC. Some portion is saved rather than spent, reducing the multiplier effect
Identify what Fed action caused this shift and what is the effect on aggregate demand. (Money Market graph; money supply shifting left).
Fed sold bonds, raised reserve requirement, or raised discount rate; AD shifts left
Explain what caused this shift and connect it to what was simultaneously happening on the AD-AS model. (short-run Phillips curve shifting outward to the right).
Caused by rising inflation expectations or a supply shock
Explain why the real interest rate matters more than the nominal interest rate for investment decisions
Real interest rate accounts for inflation
The government decides to use fiscal policy to close this gap. Explain what happens to the AD-AS model. (AD-AS graph; reveals recessionary gap).
AD shifts to the right closing the gap
The economy is booming and unemployment is at its lowest in decades. Should the government be running a budget deficit or a surplus right now, and why?
A surplus. During a boom the government should save money and pay down debt so it has room to spend during a future recession
Explain why monetary policy is generally considered more flexible than fiscal policy.
The Fed can meet and act quickly without approval; fiscal policy requires Congress to pass bills, creating implementation lags
If the government uses expansionary policy to push unemployment below the natural rate, what happens to inflation in the short runs
Inflation rises
What does the shape of the long-run Phillips curve tell us about the relationship between inflation and unemployment
The LRPC is vertical at the NAIRU, showing no long-run tradeoff. In the long run, workers adjust expectations and unemployment returns to its natural rate regardless of inflation
An economy is simultaneously experiencing a recessionary gap and rising inflation due to a supply shock. Using the AD-AS model, explain why both expansionary fiscal policy AND contractionary fiscal policy would each only solve half the problem.
Expansionary policy closes the output gap but worsens inflation; contractionary reduces inflation but worsens the recession
Congress passes a stimulus bill during a recession, but by the time the money reaches the economy the recession is already over. What problem does this illustrate?
Implementation lag, which means fiscal policies can take time to pass through Congress and deploy
A student argues that the Fed should simply print money to pay off the national debt. Explain the long run consequence of this action
Severe inflation/hyperinflation as price level rises, SRAS shifts left, economy returns to potential GDP but at a drastically higher price level
The short-run Phillips Curve shifts upward. What caused this shift
Rising inflation expectations or a supply shock caused the shift