Business Cycle and AE model Flashcards
What is the Business Cycle?
a macroeconomic model which illustrates the pattern of economic activity overtime
Three economic indicators and describe?
Leading: considered to point toward future events eg share prices, housing
Co incident: occurs in real time, snapshot of current state of economy eg GDP, ue rates
Lagging: confirm or validate past economic trends, eg personal income, retail sales
What two trends does the business cycle identify in econ activity?
- the economy experiences long term growth over time. this is indicated by the positive slope of the long -term growth trend
- the pattern of the economy is cyclical in nature as the model illustrates four phases
What are the four phases of the business cycle?
Expansion
Peak
Contraction
Trough
7 Characteristics of expansion phase
- increase in labour/wages
- increase in consumer spending
- 3 aggregates increases
- econ growth increases (rising GDP)
- cyclical UE decreases -> structural UE increases
- demand pull inflation increases
- IR increase
8 Characteristics of contraction phase
- three aggregates decrease
- economic growth decreases (falling GDP)
- cyclical UE increases
- demand pull inflation decreases
- IR decreases
- less demand = less prod of g/s
- productive input falls
- h/h income falls - spending falls
6 Characteristics of trough phase
- marks start of new growth period
- three agreggates reach its lowest point ie bottoming out
- economic growth reaches its lowest point (real GDP)
- cyclical ue is high
- demand pull inflation increases
- IR is low
5 Characteristics of peak phase
- three agreggates reach its lowest point ie bottoming out
-econ growth reaches its highest point(high GDP) - cyclical ue is low- structural ue is high
- demand pull inflation increases
- IR are high
5 Recent economic cycles in aus economy in 2014-19
- slow growth
- low inflation
- UE fell from 6.2% in 2014 to 5.1% in 2019
- low wage growth
- mining investment down
7 Recent economic cycles in aus economy in 2020-22
due to pandemic:
- supply chain interruptions
- businesses shut down
- fall in consumption; increase in savings rate
- ukraine war increased econ uncertainty
- flooding in east aus
- rapid rise In inflation 2022- due to higher prices for food and energy
- upward pressure on IR
2 Recent economic cycles in aus economy in 2023-25
- inflation should moderate
- demand for commodity may prevent downturn in aus
2 Causes of business cycle flunctuations
Endogenous cycles: they have an internal cause
- therefore some types of spending In the economy are likely to rise and fall themselves overtime
Exogenous cycles: outside influence
can be;
- positive(increase in econ aactiivty) eg mining boom
- negative (decrease in econ activity) eg covid 19 pandemic
- random (occurs spontaneously) eg natural disasters/supply shocks
What is Aggregate expenditure?
is the sum of all expenditure on final goods and services undertaken in the economy during a specific time period
What are the 4 major components of AE
- consumption expenditure
- private sector investment
- government expenditure
- net exports
How much does consumption expenditue account for and what it consists of
- largest component of AE (53%)
- consists of:
- expenditure on non-durable goods
- expenditure on durable goods
- expenditure on services
What is expenditure on non-durable goods, examples, and how much it accounts for
- consumed shortly after purchase
- eg food,drink,fuel,clothing
- could be regarded as essential spending
- accounting for abt 35% of total consumption expenditure
What is expenditure on durable goods, examples and how much it accounts for
- last a longer period of time
- eg white goods(fridges,ovens), furniture, motor vehicles
- often discretionary spending (can be postponed or brought forward)
- accounts for 15% of consumption exp
What is expenditure on services, examples and how much it accounts for
-intangible and provide transitory satisfaction of want
- eg education, transport, health
- accounts for 50% of consumption exp
- some essential, some discretionary
What is private sector investment, how much does it account for and what it consists of
- spending on new captial goods and additions to inventories
- spending in national accounts
- accounts for 18% of ae
- consists of:
- business investment: privately funded business spending on capital goods used in production - equipment , machinery, buildings
- housing investment: private expenditure on new hosuin
- inventories - unsold goods, sometimes described as ‘stock’
What is the government expenditure, how much it accounts for what what is it made up of, examples
accounts for 27% of ae
made up of:
- current spending (G1)
- finances business of govt,
-eg wages, salaries, purchasing g/s
- capital spending (G2)
- spending on public infrastructure such as power, and water supply, school, roads
- provide for future needs
What are net exports, how much it account for
- exports of overseas purhcasing aus g/s adds to ae,
- imports are a withdrawal from circular flow of income, reducing ae
- often accounts for negative % of ae
- recent years, up to 6% of GDP(Ae) due to less demand for imports(covid)
What is the Keynesian aggregate expenditure model
illustrates the relationship between AE, AO, AY (AO=AY) this refers to the concept of macroeconomic equilibrium where AO = AY=AE
7 characteristics when AE >AO, AY
- spending is greater than output
- stock rundown
- increase in production (AE)
- increase in demand for resources, including labour ( decrease in cyclical UE)
- increase in income
- increase in spending
- econ expands and will continue to so until AE = AO = AY and the economy is at equilirbium
6 characteristics when AE<AO,AY
- spending is less than outpiut
- stock buildup
- decrease in prod (AE)
- decrease in demand for resources, including labour ( increase in cyclical UE)
- decrease in income, spending
- econ contracts and will continue to so until AE = AO = AY and the economy is at equilirbium
What is the AE model - 6 characterics
- AE is the key determinant in the level of econ activity
- 45 line represents Ao (=AY) - a point crosses the 45 line at equilibrium
- AE line above zero due to survival spending
- the ae line positively sloped as spending increases as income increases
- economy is EQ, when the ae line intersects 45 line (AO)
- demand model only
What is consumption function? and equation
- illustrates the amount of consumption spending at each level of income
C=a+bY
What is autonomous consumption?
'’a’’
- the amount of spending when y = 0, represents survival spending
What is marginal propensity to consume(MPC) and equation?
'’b’’
- the amount of spending from every additional dollar earned
-change in C/ change in Y
What is savings function and equation?
illustrates the amount of savings at each level of income
- S = a + bY
What is autonomous savings?
'’a’’
- the amount of saving when y = 0
what is marginal propensity to save (MPS) and equation
- amount of saving from every additional dollar earned
- change in S/ change in Y
What is autonomous investment
unaffected by changes in the level of income
equation for income equilibrium
a(Auto C+I)/1-b
finding equilibrium in table
when Y,O = C+I(AE)
- S=I, leakages = injections
Adding savings to AE model
- savings line below zero
- Goes through point of x- axis where C line intersects with 45 line, and through point on Investment line where C+I line interests 45 line
adding C + investment to AE model
- C+I(AE) line above C line the same amount I line above zero
- Equilibirum is where C+I meets 45 line
AE model - government sector
- govt expenditure -> autonomous
- therefore, it is unaffected by changes in income
- Taxation -> positively sloped, it will increase as income increases
MPT and equation
Marginal propensity to tax
- the amount of tax from every additional dollar earned
- change in T/change in Y
AE model - overseas sector
- exports -> autonomous
- unaffecting by changes in income
- Imports -> positively sloped
MPM equation
Marginal propensity to import
- the amount of imports from every additional dollar earned
- change in M/ change in Y
5 charactertics when Increase in AE
- the AE model can illustrate the effect of changes in AE on the economy
- an increase in aggregate expenditure from AE to AE1 causes economy to be a disequilibrium where AE exceeds AO
- this creates a stock rundown which causes an increase in production which increases the demand for resources and therefore increasing income
- the economy continues to expand until it reaches a higher equilibrium level of income at YE1
- AE increases to AE 1, YE increases to YE1
4 characterics when Decrease in AE
- a decrease in AE from AE to AE1 causes the economy to be at disequilibrium where AO exceeds AE
- creates stock buildup which causes decrease in production which decrease the demand for resources and therefore decrease in income
- economy continues to contract until it reaches a lower equilibrium level of income at YE1
- AE decreases to AE1, YE decreases to YE1
Relationship between The MPC and the slope of AE - 4
- the size of the MPC will affect the slope of AE, which will then impact he lvl of economic activity in the economy
- the more steep the AE line, the higher the MPC level of income
- the slope of the AE is determined by the MPC
- a more steep AE will determine a higher equilibrium level of income
What is the multiplier effect?
- describes how an autonomous change in a component of aggregate expenditure will result in a greater change (multiple effect) in aggregate income and therefore economic activity
- due to the portion of extra income that is spent which generates further changes in aggregate income,
- '’one mans spending is another mans income’’
What is postive vs negative multiplier
positive multiple -> component on AE increases
negative multiple -> component of AE decreases
Simple vs complex multiplier
- simple multiplier (3 sectors)
- complex multipliers (5 sectors)
What are the 4 types of multiplier effect?
- investment multiple (change in I)
- govt multiple ( change in G)
-trade multiple (change in X-M) - consumption multipier (change in C)
How to calculate the size of the multiplier
k=1/1-MPC
Explaining the mupltiplier process on AE model- positive investment multiplier -7
- ae model ilustrates the multipleir process for an autonomous increase in I
- the increase in investment caused AE to shift from AE to AE+, ‘‘ab’’
- the increase in I led to an increase in AY shown at ‘‘bc’’
- increase in Y leads to induced C as a portion of the extra Y is spent, shown at ‘‘cd’’
- the extra Y spent generates urhter increase in Y shown at ‘‘de’’ as one mans spending is another mans income
- multiplier process continues to increase both Y and C until it reaches a higher EQ lvl of Y, output at YE1
- initial increase in I led toa multiplier effect on AY as YE increase by a greater amount (YE-YE1) than the total increase (AE TO AE+)
THE RELATIONSHIP BETWEEN THE SIZE OF THE MULTIPLIER AND THE MPC. -3
-The size of the multiplier effect is determined by the size of the MPC
- Therefore, the higher the MPC the greater the multiplier effect.
- This is because a greater portion of extra income is spent generating further increases in income.
