BUSINESS CYCLE / POLICIES Flashcards
What are the 7 macroeconomic objectives
inflation rate of 2% plus or minus 1%.
economic growth as measured by an increase in real GDP.
achieve full employment.
a current account equilibrium, whereby the inflows are equal to the outflows.
government spending equals tax revenue.
reduce inequality.
protect the environment.
Describe the shape of the business cycle diagram
real gdp on y axis
time on x axis
Graph starts with a upward slope before shooting downwards, this cycle repeats as time increases
What is the area between the Boom and following bust known as
Slowdown/slump
What is the area between the bust and following boom known as
Recovery
What is the definition of a recession
Two or more consecutive quarters of negative economic growth
definition of: Boom
part of the business cycle where real GDP is at its highest.
What does the trend line (potential trend gdp) of the boom bust cycle show
In the long run despite downward and upward spirals, real gdp is overall increasing
What is a positive output gap
When actual gdp is above trend potential gdp, economy is producing above its potential
What is a negative output gap
when actual gdp is below trend potential gdp, economy is producing below its potential
the definition of: Potential Trend GDP
The sustainable rate of GDP growth caused by improvements in productive capacity overtime.
what is meant by the business cycle?
Fluctuations in real GDP over time
How do you represent an neoclassical output gap on an ad-as diagram
Using neoclassical lras, sras and ad, for negative output gap intersection of lras and ad leads to a greater real gdp than intersection of sras and ad
What do neoclassical economists believe about long term and short term output gaps
Short run output gaps are possible but long run output gaps are impossible.
how do you represent a long run output gap
keynesian lras curve + ad curve, on the horizontal part of the lras curve, draw arrow to show difference in maximum potential output and actual output
What are the characteristics of a boom (5)
High animal spirits.
High economic growth
demand pull inflation
low unemployment
reduced budget deficit
Why might a boom lead to reduced budget deficit
Less unemployed people, more income tax revenue, less benefits spending
Gov revenue increases while gov spending falls
What are the characteristics of a bust (5)
Low animal spirits decrease consumption and investment.
Low economic growth measured by a decrease in real GDP.
Low inflation or deflation as the price level decreases.
High unemployment as firms demand fewer workers.
A worsened budget as government spending increases and tax revenue decreases.
What are the two types of economic policy
demand side policy
supply side policy
main impact of a decrease in income tax?
Increase in AD
what is meant by supply side policies
Government policies which aim to influence aggregate supply.
What is meant by demand side policies
Government policies which aim to influence aggregate demand.
Who manages supply side policies?
The government
What are the two types of demand side policies
fiscal policy - managed by government
monetary policy - managed by bank of england
What fiscal policy options would the government choose to pursue to get the economy out of a recession
Decrease taxes and increase government spending, worsening the budget deficit
What is expansionary/loose fiscal policy
when the government reduces taxes and increases government spending expanding the circular flow of income
What is contractionary fiscal policy
when the government increases taxes and reduced government spending in order to improve budget deficit contracting the circular flow of income
what is fiscal policy
When the government changes its taxes and spendings to influence the economy
What are benefits
payments made by the governments to low income or unemployed people
one disadvantage and one advantage of increasing benefits.
Increasing benefits means more money is transferred to unemployed workers. This will increase their consumption, which will increase AD. Also, increasing benefits will help to reduce income inequality.
benefits trap.
What is meant by the benefits trap
if benefits are too high, there is a significant disincentive for unemployed people to find a job, because they may earn more by claiming benefits.
one disadvantage and one advantage of the government reducing spending on benefits.
budget deficit will improve as the government is paying out less.
poor households will have less to spend, so consumption will fall, which will decrease AD. Also, income inequality will worsen as the poor get poorer.
What is meant by crowding out
When the government increases its spending, to build a hospital or railway, it needs to borrow money and also needs more land, labour and capital.
This increases costs for firms reducing their supply shifting sras to the left
Why might interest rates rise as the government increases its demand for borrowed money, land, labour and capital?
When the government competes with businesses for resources (land, labor, and capital), wages and prices for these inputs rise.
Higher costs lead to inflationary pressures, which central banks may counteract by raising interest rates to control inflation.
what is meant by infrastructure
Items needed for businesses to operate such as roads and telecommunications networks.
What is contractionary monetary policy
Contractionary monetary policy is a type of economic policy used by central banks to reduce inflation and slow down an overheating economy.
It involves decreasing the money supply and increasing interest rates to curb excessive spending and borrowing.
What is expansionary monetary policy
Expansionary monetary policy is a type of economic policy used by central banks to stimulate economic growth,
especially during periods of recession or economic slowdown.
It aims to increase the money supply and encourage borrowing and spending.
typically involves lowering interest rates
What are the tools the bank of england can use in monetary policy
Changing base interest rates
Quantitative easing
What is the impact of an increase in the interest rate on investment.
An increase in the interest rate means that firms will have more re- payments when they borrow. This will lead to a reduction in investment which is a components of aggregate demand. A reduction in AD should decrease the price level and reduce the rate of inflation
What is quantitative easing
Quantitative easing is when the central bank buys financial assets such as bonds from high street banks. This increases the money supply for high street banks, which increases the amount of money that banks can lend.
disadvantage of qe
high levels of qe shoot up the money supply may lead to hyperinflation
what mistakes did the us government make that cause the crash of the stock market to led to teh great depression
Restrictive trade policy
contractionary fiscal policy
What 3 policies did roosevelt use to lift usa out of the great depression
new deal - expansionary fiscal policy
removed trade restrictions cheaper imports
got rid of gold standard allowing interest rate manipulation and changing money supply
What are the two types of supply side policies
there is interventionist policy where the government is actively involved in increasing aggregate supply
Second, there is market based where the government allows the market to operate freely.
Which type of policy is infrastructure spending an example of?
interventionist ssp
What type of supply-side policy is reducing corporation tax an example of?
Market based ssp
one advantage and one disadvantage of reducing the national minimum wage.
a decrease in wage costs will decrease the cost of production for firms, which will increase short run aggregate supply.
a reduction in the minimum wage will reduce disposable income for many households. This will reduce consumption and decrease aggregate demand, which will lead to a reduction in real GDP.
What is meant by deregulation
When regulations are removed to lower barriers to entry
Explain the impact of a reduction in income tax on aggregate supply.
reducing income tax means that workers get to keep more of their earnings and so disposable income increases. This is likely to increase the number of hours they choose to work
However, an increase in disposable income could cause some workers to decrease their labour supply as they now need to work less to earn the same amount of money
What is monetary policy
When the central bank changes the base interest rate or the money supply in order to influence aggregate demand within an economy.
What is the base interest rate
The interest rate, set by the Bank of England, showing the rate at which they will lend money to highstreet banks.
What does the phillips curve show
Tradeoff between inflation and unemployment
Describe the tradeoff between unemployment and inflation
When unemployment is low, firms compete to hire the few remaining workers, increasing the wage that they are willing to pay.
So wages increase, and firms will then increase their prices, so that they can make a profit
as unemployment decreases, the price level increases, which, as we know, is inflation
Describe the shape of the phillips curve
downward sloping, starting very steep and then becoming much flatter:
X axis is unemployment%
Y axis is inflation rate
What can be said about the relationship between contractionary fiscal policy and supply side policies
Contractionary fiscal policy is required to fund supply side policies
There is a conflict between contractionary fiscal policy and supply side policies
How can monetary policy limit the effectiveness of fiscal policy in boosting economic growth?
Expansionary fiscal policy creates inflationary pressure in the economy.
Therefore, policy makers respond by using monetary policy to increase interest rates.
This holds back economic growth and creates a policy conflict between fiscal and monetary policies.
What is meant by policy paralysis
