B5-Economic Concepts

Question 1

Economic Concepts

Changes in Economic and Business Cycles

Business Cycles

Answer 1

Business cycles refer to the rise and fall of economic activity relative to its long-term growth trend.

Question 2

Economic Concepts

Changes in Economic and Business Cycles

Business Cycles

Macroeconomics

Answer 2

Macroeconomics is the study of the economy as a whole. It examines the determinants of national income, unemployment, inflation, and how monetary and fiscal policies affect eocnomic activity.

Question 3

Economic Concepts

Changes in Economic and Business Cycles

Business Cycles

Measuring Econ Activity-Gross Domestic Product

Answer 3

GDP is the total market value of all final goods and services produced within the borders of a nation in a particular period.

Note that GDP includes all final goods and services produced by resources within a country regardless of who owns the resources. Thus, US GDP includes the output of foreign owned factories in the US but excludes the output of US owned factories operating abroad-(GNP includes this)

Question 4

Economic Concepts

Nominal GDP vs Real GDP

Answer 4

Nominal GDP

Not adjusted for inflation. Measures value of all goods and services in prices prevailing at the time of production. Current prices.

Real GDP

Adjusted for inflation. Measures the value of all goods and services in constant prices. Real GDP is adjusted to account for changes in the price level. Most commonly used measure of economic activty and national output.

Question 5

Economic Concepts

Price Index (GDP Deflator)

Answer 5

Removes the impact of inflation. it is the price index used to calculate real GDP. It is a price index for all goods and servcies included in GDP.

Real GDP = Nominal GDP x 100

GDP Deflator

Question 6

Economic Concepts

Changes in Economic and Business Cycles

Summary Composition of Business cycles

• Expansionary Phase*
• Peak*
• Contractionary Phase*
• Trough*
• Recovery Phase*

Answer 6

Expansionary Phase

Characterized by rising economic acitivity (Real GDP) and growth. Econ activity rising above its L-T growth trend.

“GDP increases, Profits Increase, Unemployment Decreases, Prices Increase”

Peak

High point of econ activity. It marks the end of an expansionary phase and the beginning of a contractionary phase in econ activity. Profis are at their highest levels. Firms also are likely to face capacity constraints and input shortages.

Contractionary Phase

Falling economic activity and growth and follows a peak.

GDP decreases, profits decrease, unemployment increases.

Trough

Low point of econ activity. Profits at lowest levels. Firms experience significant excess production capacity, leading them to reduce workforce and cut costs.

Recovery Phase

Follows a trough. Econ activity begins to increase and return to its long term trend. Firm’s profits typically begin to stabilize as demand for goods and services begins to rise.

Question 7

Economic Concepts

Recession

Answer 7

Contractionary phase: GDP decreases, profits decrease, and unemployment increases.

A recession occurs when the economy experiences negative real economic growth (declines in national output). Economists define a recession as two consecutive quarters of falling national output.

Question 8

Economic Concepts

Depressesion

Answer 8

Depression is a very severe recession. It is characterized by a relatively long period of stagnation in business activity and high unemployment rates. Many businesses go out of business during this period.

Question 9

Economic Concepts

Economic Indicators

• Leading Indicators*
• Lagging Indicators*
• Coincident Indicator*

Answer 9

are statistics that historically have been highly correlated with economic activity.

Leading Indicators

tend to predict economic activity.

Lagging Indicators

tend to follow economic activity. Economists measure lagging indicators to confirm or dispute previous forecasts and the effectiveness of policy directives.

Coincident Indicators (Industrial production is an example)

change at approx the same time as the whole economy, thereby proving info about the current state of the economy.

Question 10

Economic Concepts

Reasons for Fluctuations

Answer 10

Economists generally agree that business cycles result from shifts in aggregate demand and or aggregate supply.

Aggregate demand and supply curves can be used to illustrate the relationship between a country’s output (real GDP) and price level (GDP deflator). They are also used to examine the causes of economic fluctuations.

Question 12

Economic Concepts

Aggregate Demand Curve

Answer 12

Illustrates the maximum quantity of all goods and services that households, firms, and the government are willing and able to purchase at any given price level. Shows relationship between total output (real GDP) of the economy and the price level.

X axis-real GDP

y-axis is the price level

Question 13

Economic Concepts

• Aggregate Supply Curve*
• Short Run*
• Long Run*

Answer 13

• Agg. Supply Curve*-maximum quantity of all goods and services producers are willing and able to produce at any given price level.
• Short Run Agg. Supply Curve-*upward sloping, illustrating that as the price level rises, firms are willing to produce more goods and services
• Long-Run Agg. Supply Curve-*vertical, illustrating that in the long run, if all resources are fully utilized, output is determined solely by the factors of production.

Question 14

Economic Concepts

Potential GDP

Answer 14

Potential GDP-level of real GDP (national output) that the economy would produce if its resources (capital and labor) were fully employed.

When Real GDP is below potential level of output, typically experiening a recession and when above, typically economy experiencing expansion.

Question 15

Economic Concepts

Y*

Answer 15

Intersection of short-run aggregate supply curve (SRAS), aggregate demand (AD) curve and long-run aggregate supply curve (LRAS).

Question 16

Economic Concepts

Aggregate Demand, Aggregate Supply, and Economic Fluctuations

Reduction in Demand

Increase in Demand

Reduction of Supply

Increase in Supply

Answer 16

Reduction in Demand-GDP decreases, profits decrease, unemployment inc, prices decrease

Increase in Demand-GDP inc, Profits inc, unemployment dec, and prices inc.

Reduction of Supply-GDP dec, profits dec, unemployment inc, and prices inc

Increase in Supply-GDP inc, profits inc, unemployment dec, prices dec

Question 17

Economic Concepts

Factors that cause shifts in Aggregate Demand

(TWICEG)

Taxes, Wealth, Interest Rates, Consumer Confidence, Exchange Rates, and Gov’t Spending

Answer 17

1. Changes in Wealth
   
   • increase in wealth(right shift)-AD inc, GDP inc, unemployment dec, and prices inc
   • decrease in wealth(left shift)-AD dec, GDP dec, unemployment inc, and prices dec
2. Changes in Real Interest Rates
   
   • Increase in Real Int Rates-save more and borrow less, thus aggregate demand is going to go down bc less cash on hand to spend. AD dec, GDP dec, unemployment inc, and prices dec (bad for overall economy)
   • Decrease in Real Int Rates-(positive for economy)-people tend to save less and consumers borrow more and spend more. AD inc, GDP inc, unemployment dec, and prices inc
3. Changes in expectations about the Future Economic Outlook (consumer confidence)
   
   • confident econ outlook-AD inc, GDP inc, unemployemnt dec, prices inc
   • uncertain ““-AD dec, GDP dec, unemploy-inc, prices dec
4. Exchange Rates
   
   • Appreciated Currencies (strong currencies-$ becomes more expensive relative to foreign currencies)-its good will become relatively more expensive for foreigners(less exports), while foreign goods will become relatively less expensive for its residents (more imports). AD dec, GDP dec, unemployment inc, prices dec. Negative for economy as a whole.
   • Depreciated Currencies (weak currencies- $ less expensive relative to foreign currencies)-its goods will become relatively less expensive for foreigners (more exports), while foreign goods will become more expensive for its residents (less imports). AD inc, GDP inc, unemployment dec, prices inc.
5. ​Changes in Government Spending
   
   • Inc in Gov’t spending-AD inc, GDP inc, unemploy dec, prices inc
   • Dec in Gov’t spending-AD dec, GDP dec, unemploy inc, prices dec
6. Changes in Consumer Taxes
   
   • Inc in consumer taxes-AD dec, GDP dec, unemployment inc, prices dec
   • Dec in consumer taxes-AD inc, GDP inc, unemployment dec, prices inc

Question 18

Economic Concepts

Graphs

When economy is in a recession what does the gov’t do?

Answer 18

Gov’t can stimulate the economy by increasing gov’t spending or decreasing taxes (or both), shifting the aggregate demand curve to the right and causing national output (real GDP) to rise.

The goal is to push the economy back to LR potential output.

Question 19

Economic Concepts

Graphs

When economy is in a expansionary phase and the gov’t wants to contract the economy, what does the gov’t do?

Answer 19

the gov’t can contract the economy by decreasing gov’t spending or increasing taxes (or both)., shifting the agg demand curve to the left and causing national output to fall.

Question 20

Economic Concepts

Multiplier Effect

What is it and whats the formula?

Answer 20

refers to the fact that an increase in consumer, firm, or gov’t spending produces a multiplied increase in the level of economic activity. For example, a $1 inc in gov’t spending results in agreater than $1 increase in GDP.

The multiplier effect results from the marginal propensity to consume (MPC). The MPC is the change in consumption due to an $1 increase in income. B/c people tend to save part of their income, the MPC is typically less than one.

Formula

multiplier = 1 / (1 - MPC) = 1 / MPS (save)

Question 21

Economic Concepts

Factors that Shift Short-Run Aggregate Supply (SRAS)

Answer 21

1. Changes in Input (Resource) Prices
   
   • Increase in Input Prices-AS dec, GDP dec, unemployment inc, prices inc-bad for economy
   • Decrease in Input Prices-AS inc, GDP inc, unemployment dec, prices dec-good for economy
2. Supply Shocks
   
   • Supplies are plentiful-AS inc, GDP Inc, unemployment dec, prices dec-good for economy
   • Supplies are curtailed-AS dec, GDP dec, unemployment inc, and prices inc-bad for economy