Business Cycles Flashcards
What is a Business Cycle?
Periodic Fluctuations in macroeconomic variables, particularly GDP. Mainly, fluctuations in output around its trend (potential output)
Formula: Output Gap (%)
Real GDP – Natural GDP (or trend) / Natural GDP
What if the Output Gap is Negative
all factors of production are not used efficiently/intensively
What if the Output Gap is Positive
overtime of workers and machines are working at full capacity
A business cycle is not a GDP’s growth rate curve. Why not?
A business cycle is fluctuations above and below the trend level so two elements are needed: GDP Value and GDP Trend
Define: Expansion/Boom
output above trend
Define: Recession
output below trend… more specifically two successive quarters of negative growth
Define: Growth Recession or economic downturn
the growth rate is positive but is lower than the economy’s long run trend rate
Define: Depression
does not have a precise definition. Loosely speaking, a long-lasting recession and in which output declines substantially
True/False: Expansions are longer than recessions
True
True/False: Recessions are sharper than expansions
True
True/False: Cycles are not correlated across regions and across countries
False: They ARE correlated across regions and across countries
True/False: GDP is more volatile in more industrialized countries
False: It is less volatile
True/False: All sectors rise and fall together over the business cycle, but volatility is most pronounced in manufacturing and consumption
True
Rising GDP can be contributed by:
- Rising Investment
- Rising Consumption
- Rising Employment
(Rising C+I+G+Net X), etc.
Define: Procyclical
Deviations from the trend go in the same direction as deviations of GDP:
o Consumption
o Investment
o Employment
Define: Countercyclical
Deviations from the trend go in the OPPOSITE directions as deviations of GDP:
o Unemployment (Okun’s Law)
What is Okun’s Law
Okun’s Law is an empirically observed relationship between unemployment and losses in a country’s production.
As an example: It predicts that a 1% increase in unemployment will usually be associated with a 2% drop in gross domestic product (GDP).
Formula: (Y-Y)/Y =-β(u-u*)
Comparisons of business cycles before and after World War II show that
- Expansions have lengthened
- Contractions have shortened
This is because of fact 4: GDP is less volatile in more industrialized countries. Industrialization has taken part in many countries over time causing the fluctuations to be less severe.
During a recession, the consumption of individuals is reduced unevenly depending on:
- Consumption by age
- Consumption by occupation
The impact of a recession is most by the young and the least by those of prime working age
Name a theory that supports that business cycles are bad
It generates vicious circles
Lower Y –> Lower I –> Lower Y
Lower Y –> Higher u –> lower skills –> Lower Y/L (Productivity) –> Lower Y
Name a theory that supports that business cycles are good
- It lowers opportunity cost
- So called economic pit stops causes
o Reconstructing costs
o Boosting productivity costs
o Improving skills costs - Are lower in recessions and enhance expansions
Two Economic Theories try to explain the propagation of Business Cycles
- Real B.C Theory (classical): Business Cycles are the response to an efficient behaviour of the economy (SUPPLY SHOCKS)
- Keynesian Theory: Business Cycles are a sign that the market is failing to operate (DEMAND SHOCKS)
Name the factors that happen as a result of an Increase in Demand (Fiscal policy and monetary policy)
- Increase in Consumption
- Increase in Investment
- Increase in Government Expenditure
- Decrease in Saving
Name the factors that happen as a result of an Increase in Supply (Labour market and technology endowment)
- Decrease in Labour (L), in Capital (K), Technology or Total Factor Production (A=TFP)
- Increase in Oil prices
- Increase in Indirect taxes that affect production
- Decreases in the power of workers, new legislation
- Credit crunches and lower physical investment
Explanation to business cycles: Real Business Cycle Theory
- Aggregate supply determines output
- Recessions are caused by supply shocks
- Business cycles are an outcome of market mechanism
- They are a part of the game, natural
- They are good
Explanation to Business Cycles: Keynesian Theory
- Aggregate demand determines output
- Recessions are caused by low demand
- Business Cycles are the negative response to a failed economy, working below its potential
- Market mechanisms may not work so governments must step in to shore up demand… economic policy can alter the business cycle
