Business Cycles

Question 1

What is a Business Cycle?

Answer 1

Periodic Fluctuations in macroeconomic variables, particularly GDP. Mainly, fluctuations in output around its trend (potential output)

Question 2

Formula: Output Gap (%)

Answer 2

Real GDP – Natural GDP (or trend) / Natural GDP

Question 3

What if the Output Gap is Negative

Answer 3

all factors of production are not used efficiently/intensively

Question 4

What if the Output Gap is Positive

Answer 4

overtime of workers and machines are working at full capacity

Question 5

A business cycle is not a GDP’s growth rate curve. Why not?

Answer 5

A business cycle is fluctuations above and below the trend level so two elements are needed: GDP Value and GDP Trend

Question 6

Define: Expansion/Boom

Answer 6

output above trend

Question 7

Define: Recession

Answer 7

output below trend… more specifically two successive quarters of negative growth

Question 8

Define: Growth Recession or economic downturn

Answer 8

the growth rate is positive but is lower than the economy’s long run trend rate

Question 9

Define: Depression

Answer 9

does not have a precise definition. Loosely speaking, a long-lasting recession and in which output declines substantially

Question 10

True/False: Expansions are longer than recessions

Answer 10

True

Question 11

True/False: Recessions are sharper than expansions

Answer 11

True

Question 12

True/False: Cycles are not correlated across regions and across countries

Answer 12

False: They ARE correlated across regions and across countries

Question 13

True/False: GDP is more volatile in more industrialized countries

Answer 13

False: It is less volatile

Question 14

True/False: All sectors rise and fall together over the business cycle, but volatility is most pronounced in manufacturing and consumption

Answer 14

True

Question 15

Rising GDP can be contributed by:

Answer 15

• Rising Investment
• Rising Consumption
• Rising Employment

(Rising C+I+G+Net X), etc.

Question 16

Define: Procyclical

Answer 16

Deviations from the trend go in the same direction as deviations of GDP:

o Consumption
o Investment
o Employment

Question 17

Define: Countercyclical

Answer 17

Deviations from the trend go in the OPPOSITE directions as deviations of GDP:

o Unemployment (Okun’s Law)

Question 18

What is Okun’s Law

Answer 18

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*)

Question 19

Comparisons of business cycles before and after World War II show that

Answer 19

• 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.

Question 20

During a recession, the consumption of individuals is reduced unevenly depending on:

Answer 20

• 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

Question 21

Name a theory that supports that business cycles are bad

Answer 21

It generates vicious circles

Lower Y –> Lower I –> Lower Y

Lower Y –> Higher u –> lower skills –> Lower Y/L (Productivity) –> Lower Y

Question 22

Name a theory that supports that business cycles are good

Answer 22

• 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

Question 23

Two Economic Theories try to explain the propagation of Business Cycles

Answer 23

• 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)

Question 24

Name the factors that happen as a result of an Increase in Demand (Fiscal policy and monetary policy)

Answer 24

• Increase in Consumption
• Increase in Investment
• Increase in Government Expenditure
• Decrease in Saving

Question 25

Name the factors that happen as a result of an Increase in Supply (Labour market and technology endowment)

Answer 25

• 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

Question 26

Explanation to business cycles: Real Business Cycle Theory

Answer 26

• 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

Question 27

Explanation to Business Cycles: Keynesian Theory

Answer 27

• 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