In the Solow framework, long-run growth comes from three forces that expand what the economy can produce: more physical capital, a larger labor force, and improvements in technology that raise overall productivity. Building up physical capital increases the stock of capital available for production, raising output. But because capital has diminishing returns, simply piling on more capital doesn’t sustain growth forever without other factors. A growing labor force adds more workers, which raises total output as the economy can employ more people. Per-capita growth, however, depends on how efficiently those workers combine with capital, which brings us to technology. Technological progress—total factor productivity—shifts the production function outward, meaning the same amounts of capital and labor produce more output. This is the key to sustained long-run growth in per-capita terms, because it raises the efficiency with which both capital and labor are used. The other options don’t capture the model’s mechanism: policy tools like government spending or money supply don’t by themselves drive long-run growth in the Solow model; inflation and unemployment are not the drivers of long-run output growth here; and focusing only on capital per worker ignores the roles of labor and technology.

The balanced-budget multiplier asks how output responds when the government raises spending and taxes by the same amount. In the simplest Keynesian model with lump-sum taxes, let consumption depend on disposable income as C = a + b(Y − T) and let investment be fixed. The equilibrium is Y = C + I + G, so Y = a + b(Y − T) + I + G. Rearranging gives (1 − b)Y = a − bT + I + G. Now if G rises by ΔG andTaxes rise by the same amount ΔT = ΔG, the new Y satisfies Y′ − Y = [ΔG − bΔT] / (1 − b) = [ΔG − bΔG] / (1 − b) = ΔG. So output increases by exactly ΔG. The direct boost from higher government spending is offset by higher taxes reducing disposable income through consumption, and in this setup those effects cancel in such a way that the total change in GDP equals the change in G. This is why the multiplier in this simple framework is one.

Inflation targeting works by the central bank committing to achieving a specified inflation rate over time, using policy instruments and clear communication to guide expectations. The framework emphasizes price stability but also recognizes that policy choices to keep inflation on target can affect real activity in the short run, so there’s a trade-off between inflation stability, output stability, and the credibility of the central bank. It’s not about fixing the exchange rate, not about enforcing a fixed inflation cap, and not about maximizing long-run growth regardless of inflation.

Okun's law describes a link between the unemployment rate and how far actual output is from what the economy could sustainably produce. The key idea is that these two move in opposite directions. The output gap is the difference between actual output and potential output (the level the economy can produce with full employment). When actual output is below potential, the economy has a negative output gap, and SAMPLEunemployment tends to be higher because weaker demand means firms hire fewer workers. When actual output is above potential, the economy has a positive output gap, and unemployment tends to be lower as stronger demand leads to more hiring. This is an empirical pattern, not a precise rule, and the exact strength can vary, but the sign of the relationship is consistently negative.