6 Business Cycles AD-AS Flashcards
Business cycles
Periods of expansion and slowdown of economic activity
Recession
Negative growth for two consecutive quarters
Contraction
When real output is lower than the previous time period
Expansion
When real output is higher than the previous time period
Time series data
Records observations of a variable over time
Stationary data
Time series data that has a constant mean value over time
Non stationary data
Time series data where the mean can either rise or fall over time
Deterministic trends
Are constant independent of time
Stochastic trends
Vary by some random amount each time period
Pro cyclical variable
A variable that is above trend when GDP is above trend (real wages)
Countercyclical variable
A variable that is below trend when GDP is above trend (unemployment)
Leading indicator
Can be used to foretell future changes
Lagging indicator
Used to show past changes
Coincident indicator
Occurs at the same time as the changes
Real business cycle model assumptions
No market imperfections
Optimal behaviour
Market clearing
How does the real business cycle model predict a negative shock will impact the market?
A negative technology shock reduces labour productivity and therefore the demand for labour falls. Output falls because supply falls. Prices rise and there is a rise in interest rates which decreases investment.
Who uses Dynamic stochastic general equilibrium models?
Often used by central banks
What are disadvantages of models
They are approximations so are never perfectly accurate. Until recently they were under used or used poorly
When does the classical dichotomy and money neutrality occur?
In the long run
When are real variables affected by changes in the money supply?
In the short run
What does the AS curve show?
The quantity of goods and services that households, firms, the government and customers abroad want to buy at each price
What does the AS curve show?
The quantity of goods snd services that forms are willing to sell at each price level.
What are the 3 effects which make the AD curve downward sloping?
Wealth effect (c) Interest rate effect (I) Exchange rate effect (NX)
What is the wealth effect?
A decrease in price, increases the real value of money. Consumers feel wealthier and increase their spending
What is the interest rate effect?
Decrease in price level, real money balances are in excess supply. Households buy illiquid assets which makes the interest rate drop. Stimulates spending on investment goods
What is the exchange rate effect?
Decrease in UK price level, reduces interest rate. UK pound depreciated as Net Capital Outflows increase and supply of pounds on FX market increases. Stimulates UK exports and suppresses UK imports so NX increases
What causes a shift in the AD curve?
Consumption
Investment
Government spending
Net exports
What is the LRAS curve determined and shifted by?
Capital
Labour
Natural resources
Technology
When is the LR output level achieved?
When all existing factors of production are fully utilised and unemployment is at its natural rate.
What are the theories for why the SRAS curve is upward sloping
Sticky wage theory
Sticky price theory
Misperceptions theory
What happens to output when the actual price rises above the expected price?
The output rises above its natural rate
Sticky wage theory
Nominal wages are based on expected prices but are slow to adjust. If price is lower than expected, then real wages are higher and so workers are sacked and less is produced
Sticky price theory
Prices are slow to adjust. Prices are the firms’ marginal revenue. If actual prices are lower than expected so is revenue so firms might be forced to cut production
Misperceptions theory
Changed in overall price level can temporarily mislead suppliers. Suppliers see a drop in prices below the expected level, the firms see this a fall in their prices and so drop production when actually all prices have fallen
In the long run what is true of prices?
Actual prices equals expected prices
What shifts the SRAS curve?
Labour Capital Natural resources Technological change Changes in expectation
