Business Cycle And Aggregate Expentiture - Jackson

Question 1

The Concept of the Business Cycle

Answer 1

Business Cycle shows a typical short run growth path for an economy with total output moving above and below the long term average or trend path. There is rise and fall in the economy’s output gap.

Question 2

Output Gap

Answer 2

The output gap is the difference between the actual level of output and the maximum possible or potential level of output.

Question 3

Characteristics of the phases, and causes, of the business cycle

Answer 3

Boom - Actual output is close to the level of potential output
Downturn - The gap between actual output and potential output increases
Slump/Trough - Actual output is well below potential output
Recovery/Upswing - The gap between actual output and potential output decreases

Question 4

Relationship between business cycle and economic indicators

Leading Indicators:

Answer 4

Most important indicator is GDP.

• reflect expectations by predicting trends before they become evident in the rest of the economy
• Building approvals, share prices, new employment vacancies, levels of inventory held by retail firms, consumer expectations and level of business and consumer confidence

Question 5

Relationship between business cycle and economic indicators

Coincident indicators:

Answer 5

• Don’t usually show any change until after trends in the rest of the economy have occurred
• New car registrations, manufacturing output, production of building materials, sales of consumer durables (last more than 3 years eg. furniture and cars), retail sales, job advertisements, consumer prices, money supply

Question 6

Relationship between business cycle and economic indicators

Lagging indicators:

Answer 6

• Are not expected to show any change until after trends in the economy have been confirmed
• Interest rates, consumer debt, duration of unemployment, bankruptcies, unemployment rates/levels, inflation rate

Question 7

Characteristics of a Boom:

Answer 7

Unemployment is lowest
Inflation is highest
Growth is highest
Actual output is closest to potential output

Question 8

Characteristics of a Downturn:

Answer 8

Employment falls
Inflation falls
Growth falls
Aggregate demand decreases - there is a fall in the level of one or more of the components of AD causing a leakage of expenditure from circular flow
Negative multiplier effect occurs - cut backs in one area of the economy cause cut backs in other areas, confidence falls
Output gap increases

Question 9

Characteristics of a Trough

Answer 9

Unemployment is highest
Inflation is lowest
Growth is lowest

Question 10

Characteristics of an upswing

Answer 10

Unemployment falls
Inflation rises
Growth increases
Aggregate demand increases - one or more of the components (consumption, planned investment, government spending or net exports) causes injection into the economy
Multiplier effect occurs - initial investment causes a flow on effect with increased income in different sectors
Output gap decreases

Question 11

Components of Aggregate Expenditure: Consumption

Answer 11

Spending by households on goods and services
- makes up 55% of aggregate expenditure and is relatively stable
- Autonomous consumption is necessary to satisfy basic needs like food and clothing. Not directly related or influenced by income
- Discretionary consumption is luxury spending and reflects the level of disposable income
Factors affecting consumption: disposable income, interest rates, inflation, wealth and debt, consumer confidence and expectations
C = a + bY (consumption = autonomous spending + marginal propensity to consume x disposable income)

Question 12

Components of Aggregate Expenditure: Investment

Answer 12

Planned Investment expenditure occurs when firms buy capital goods and households buy new houses.
Unstable component of AE and makes up 15-20%
Factors determining level of planned investment:
- Real interest rates, profitability, expectations and business confidence, government policies
- GDP is an indicator as to whether investment will increase or decrease. Increase in GDP = increase in investment

Question 13

Components of Aggregate Expenditure: Government (G1 and G2)

Answer 13

• G1 (structural spending) - current expenditure (consumption) which provides for day to day factories, buildings and tools. Relatively stable.
• G2 (cyclical spending) - capital expenditure (investment) to provide for future needs such as schools, roads, power and communication.
• Influenced by business cycle, hence cyclical and unstable.
• Relatively stable component of AE and makes up 25%
• Subject to non economic shocks like politics, natural disasters, population, health care, level of tax revenue and governments attitude to borrow.

Question 14

Components of Aggregate Expenditure: Net Exports (X-M)

Answer 14

The purchase of Australian produced good and services by foreigners add to total demand.
Exports are considered an injection into the economy as it creates incomes for Aus firms
Imports are subtracted because they are a leakage as Aus money is leaving the country.
Relatively unstable component of AE and -1% of AE
Factors affect level of net exports:
- Structural factors - are those affecting our international competitiveness: inflation levels, exchange rate value of AUD, wage rates and productivity plus quality, design and delivery.
- Cyclical factors: Aus growth rate affects the level of imports purchased in Australia. Growth in overseas markets affects demand for Aus products
- Shocks: natural disasters affect transport and shipping (floods, droughts)