(17) Understanding Business Cycles Flashcards
LOS 17. a: Describe the business cycle and its phases.
The business cycle has four phases:
Expansion: Real GDP is increasing.
Peak: Real GDP stops increasing and begins decreasing
Contraction: Real GDP is decreasing.
Trough: Real GDP stops decreasing and begins increasing.
Expansions feature increasing output, employment, consumption, investment, and inflation. Contractions are characterized by decreases in these indicators.
Business cycles are recurring but do not occur at regular intervals, can differ in strength or severity, and do not persist for specific lengths of time
LOS 17. b: Describe how resource use, housing sector activity, and external trade sector activity vary as an economy moves through the business cycle.
Inventory to sales ratios typically increase late in expansions when sales slow and decrease near the end of contractions when sales begin to accelerate. Firms decrease or increase production to restore their inventory-sales ratios to their desired levels.
Because hiring and laying off employees have high costs, firms prefer to adjust their utilization of current employees. As a result, firms are slow to lay off employees early in contractions and slow to add employees early in expansions.
Firms use their physical capital more intensively during expansions, investing in new capacity only if they believe the expansion is likely to continue. They use physical capital less intensively during contractions, but they are more likely to reduce capacity bey deferring maintenance and not replacing equipment than by selling their physical capital.
The level of activity in the housing sector is affected by mortgage rates, demographic changes, the ratio of income to housing prices, and investment or speculative demand for homes resulting from recent price trends.
Domestic imports tend to rise with increase in GDP growth and domestic currency appreciation, while increasing in foreign incomes and domestic currency depreciation tend to increase domestic export volumes.
LOS 17. c: Describe theories of the business cycle. List four.
Neoclassical economics
Keynesian economics
Monetarists
Real business cycle theory
LOS 17. c: Describe theories of the business cycle. Describe Neoclassical economists;
Neoclassical economists believe business cycles are temporary and driven by changes in technology, and that rapid adjustments of wages and other input prices cause the economy to move to full-employment equilibrium.
LOS 17. c: Describe theories of the business cycle. Describe Keynesian economics;
Keynesian economists believe excessive optimism or pessimism among business managers causes business cycles and that contractions can persist because wages are slow to move downward. New Keynesians believe input prices other than wages are also slow to move downward.
LOS 17. c: Describe theories of the business cycle. Describe Monetarists economics;
Monetarists believe inappropriate changes in the rate of money supply growth cause business cycles, and the money supply growth should be maintained at a moderate and predictable rate to support the growth of real GDP.
LOS 17. c: Describe theories of the business cycle. Describe real business cycle theory;
Real business cycle theory hold that business cycles can be explained by utility-maximizing actors responding to real economic forces such as external shocks and changes in technology, and that policy makers should not intervene in business cycles.
LOS 17. d: Describe types of unemployment and compare measures of unemployment. List three.
Frictional unemployment
Structural unemployment
Cyclical unemployment
LOS 17. d: Describe types of unemployment and compare measures of unemployment. Describe frictional unemployment.
Frictional unemployment results from the time it takes for employers looking to fill jobs and employees seeking those jobs to find each other.
LOS 17. d: Describe types of unemployment and compare measures of unemployment. Describe structural unemployment.
Structural unemployment results from long-term economic changes that require workers to learn new skills to fill available jobs.
LOS 17. d: Describe types of unemployment and compare measures of unemployment. Describe cyclical unemployment.
Cyclical unemployment is positive (negative) when the economy is producing less (more) than its potential real GDP.
LOS 17. d: Describe types of unemployment and compare measures of unemployment. Describe unemployment, the labor force, and the unemployment rate.
A person is considered unemployed if he is not working, is available for work, and is actively seeking work. The labor force includes all people who are either employed or unemployed. The unemployment rate is the percentage of labor force participants who are unemployed.
LOS 17. e: Explain inflation, hyperinflation, disinflation, and deflation.
Inflation is the persistent increase in the price level over time. An inflation rate is percentage increase in the price form one period to the next.
Disinflation is a decrease in the inflation rate over time. Deflation refers to a persistent decrease in the price level (i.e., a negative inflation rate)
Hyperinflation is an economic term describing rapid, uncontrolled price increases. During periods of hyperinflation, the real value of domestic currency erodes at a rapid rate. Prices increase as people who hold the currency seek to get rid of it as quickly as possible because they know that the cash will not purchase as many goods tomorrow as it does today.
LOS 17. f: Explain the construction of indices used to measure inflation.
A price index measures the cost of a specific basket of goods and services relative to its cost in a prior (base) period. The inflation rate is most often calculated as the annual percentage change in a price index.
The most widely followed price index is the consumer price index (CPI), which is based on purchasing patterns of a typical household. The GDP deflator and the producer or wholesale price index are also used as measures of inflation.
Headline inflation is a percentage change in a price index for all goods. Core inflation is calculated by excluding food and energy prices from a price index because of their high short-term volatility.
LOS 17. g: Compare inflation measures, including their uses and limitations.
A Laspeyres price index is based on the cost of a specific basket of goods and services that represents actual consumption in a base period. New goods, quality improvements, and consumers’ substitution of lower-priced goods for higher-priced goods over time cause a Laspeyres index to be biased upward.
A Paasche price index uses current consumption weights for the basket of goods and services for both periods and thereby reduces substation bias.
A fisher price index is the geometric mean of the Laspeyres and a Paasche index.
