12 BTC, AD/AS Flashcards
What is the business trade cycle?
The business trade cycle is a model that depicts fluctuations in real output produced by an economy around the long term average growth trend. During the business trade cycle, there is a rise and fall in the economy’s output gap (potential level of output - real level of output)
What are the typical phases that make up the business trade cycle?
- peak
- contractions
- troughs
- expansions
Explain why peaks occur in the business trade cycle.
Peaks occur when actual output is close to the level of potential output. They occur because the economy can’t continue to expand indefinitely, as after a while all the spare capacity and resources is used up and thus the economy can’t continue to grow unless the potential output is increased. As actual output reaches full capacity, shortages of resources start to become evident. Excess aggregate demand leads to demand pull inflation which is met by macroeconomic policy such as the RBA increasing cash rates to keep inflation within target levels. This discourages consumption and eventually real output decreases.
Explain why contractions in the BTC occur.
Downtowns occurs when the output gap increases. This occurs because aggregate demand falls due to AD determinants. As AD falls, AS falls and then demand for labour falls too. Unemployment increases.
Explain why troughs in the BTC occur.
Troughs occur when output gap is very big. Rather than the economy collapsing, troughs occur because of survival consumption in consumers who try to maintain a standard of living by buying essential products, even when income is reduced. Replacement investment still occurs. There is a social security safety net in Australia, resulting in a rise in injections into the economy through welfare benefits. Macroeconomic policy may also help like the RBA reduced cash rates to encourage consumption.
Explain why expansions in the BTC occur.
Expansions occur when the output gap decreases. During this phase, aggregate demand rises due to an increase in any of its determinants. Aggregate supply rises along its curve to meet AD. Output increases, demand for labour increases. Employment rises
List leading indicators of the BTC.
- Share prices
- Levels of stock held by firms.
- Business/Consumer confidence.
- Building approvals
- consumer expectations
- new business start-ups
- new employment vacancies.
- Manufacturers new orders
List coincident indicators of BTC.
- GDP
- Manufacturing output
- Retail sales.
- Job advertisements
- Capacity utilization
- Production of building materials
- motor vehicle sales
- Money supply
- Sales of consumer durables
List lagging indicators of BTC.
- Interest rates
- Unemployment rate
- Inflation rate
- Consumer debt
- Bankruptcies.
Define aggregate demand.
Aggregate demand is the total amount of real output that consumers, firms, the government, and foreigners are willing and able to buy at each possible price level, over a particular period of time.
What factors affect consumption expenditure?
- Changes in consumer confidence
- changes in interest rates
- changes in wealth
- changes in personal income taxes
- changes in the level of household indebtedness
What factors affect investment?
- changes in business confidence
- changes in interest rates
- improvements in technology
- changes in corporate taxes
- level of corporate indebtedness
- legal/institutional changes
What factors affect government expenditure?
- changes in political priorities
- changes in economic priorities
What factors affect net exports?
- changes in national income abroad
- changes in exchange rates
- changes in the level of trade protection
Define aggregate supply.
Aggregate supply is the total supply of goods and services produced within an economy at a given overall price in a given period of time.
