Business Cycle Flashcards
What is potential output?
The amount the economy would produce if all inputs were utilised at their long run sustainable levels (could be different from the steady state output), determined in the long run by the factors of production for the long run aggregate supply independent of price levels and inflation
What is actual output?
The actual amount produced at a given point in time Y = potential output Ȳ + short term fluctuation Ŷ
What is Ỹ?
The percentage deviation of actual output from predicted output = (Y - Ȳ)/Ȳ
How can output be graphically be represented?
On a graph of output against time Ȳ is a positive straight line and Y varies cyclically around it, with the difference between the lines being Ŷ
On a graph of SR output against time, Ỹ is a sinusoidal line around 0
What is the business cycle?
The short run fluctuations of real GDP around the potential output estimated from growth trends, it is characterised by recessions of low GDP and booms of high GDP
What is a recession?
When actual output falls below potential output (SR output negative) until it starts to rise
Practical definition (for policymakers) usually two consecutive quarters of negative GDP growth
What is the short run?
A complete cycle of fluctuation of the business cycle (not directly observable so this is not precise)
What does business cycle theory do?
Describes the short run fluctuations of an economy, assuming that the economy is constantly being hit by short run nominal and real shocks
The model is that shocks get amplified then propagate then cause fluctuations in real GDP
What are the variables in the aggregate demand and supply model?
Y = real GDP (or employment)
r = real interest rate
P = price level (or inflation)
What is the Aggregate Demand curve?
Combinations of P and Y at which the market for goods and the money market are in equilibrium
What is the Short-run Aggregate Supply curve?
Combinations of P and Y at which the production factor markets are in equilibrium
What is the difference between the aggregate supply and demand model and the circular flow diagram?
The former adds the money market to the latter
What happens graphically when money supply increases?
On a plot of P against Y, an increase in M shifts the AD curve (convex downwards sloping line) to the right, the LRAS curve is a vertical line so the LR price level increases but output doesn’t, the SRAS is a horizontal (or shallow positive) line due to sticky prices so the SR price stays the same and output sold increases (but over time the price will increase as prices are flexible in the long run)
How is credit crunch and related intervention shown graphically?
On a plot of P against Y, LRAS is a vertical line, SRAS0 is a shallow positive line, in a credit crunch (contractionary monetary policy) aggregate demand and supply fall (curves shift left) which decreases output (effect on price depends on level of shifts)
QE and fiscal expansion increase AD (shift curve right) so output increases
Why did the Great Recession spread globally?
Global interdependencies which eventually led to the European sovereign debt crisis
