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CLEP Principles of Macroeconomics study materials
CLEP Principles of Macroeconomics study resources

CLEP Principles of Macroeconomics: Inflation, Unemployment, and Stabilization Policies

CLEP Principles of Macroeconomics · Work through your exam, one topic at a time.

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Inflation, Unemployment, and Stabilization Policies

This domain tests the measurement and causes of unemployment and inflation, the short-run and long-run Phillips curve, Okun's law, and the use of fiscal and monetary policy to stabilize the economy. Expect questions on the natural rate, cyclical unemployment, demand-pull versus cost-push inflation, and policy lags.

Unemployment and inflation

  • Frictional, structural, and cyclical unemployment; the natural rate equals frictional plus structural unemployment.
  • Okun's law: roughly a 2% output gap for each 1 percentage point of excess unemployment.
  • Demand-pull inflation comes from aggregate demand growth; cost-push inflation comes from input or supply shocks.
  • CPI inflation = (CPI_t − CPI_{t−1}) / CPI_{t−1} × 100. Unanticipated inflation redistributes from lenders to borrowers.

Phillips curve

  • The short-run Phillips curve shows a downward tradeoff between inflation and unemployment.
  • The long-run Phillips curve is vertical at the natural rate; expected inflation shifts the short-run curve.
  • Disinflation typically costs output and raises unemployment in the short run.

Stabilization policy

  • Expansionary fiscal policy: government spending up or taxes down. Expansionary monetary policy: money supply up, interest rates down.
  • Contractionary policy fights inflation. Automatic stabilizers and lags (recognition, implementation, impact) matter.
  • Supply-side policies shift LRAS rather than just AD.

Worked example

Potential GDP is growing at 3% and actual GDP at 1%. With an Okun coefficient of 2, the unemployment rate rises by (3 − 1) / 2 = 1 percentage point above the natural rate. If actual growth had been 5%, unemployment would fall by (5 − 3) / 2 = 1 point. This illustrates why weak growth raises cyclical unemployment.

Traps that cost marks

  • The long-run Phillips curve is vertical; there is no permanent inflation-unemployment tradeoff.
  • Structural unemployment is not cyclical and is not cured by demand stimulus alone.
  • Expected inflation changes wage and price setting, shifting the short-run Phillips curve.
  • Fiscal policy has lags and may be offset by crowding out.
  • Do not treat a one-time price-level increase as ongoing inflation.