Business Cycles

Question 1

Definition: business cycles

Answer 1

•a business cycle is defined as the recurrent but not periodic pattern of expansion and contraction in the level of economic activity that occurs within a county

Question 2

Nature of business cycles

Answer 2

•changes in economic activity are recurring but never exactly the same
•different circumstances and expectations cause consumers and producers to respond differently to initiating forces
•the duration and amplitude of every business cycle will be different

Question 3

Business cycles are recognised by the following :

Answer 3

•two periods : contraction and expansion
•two turning points: trough and peak
•four phases: recovery, prosperity, recession and depression

Question 4

Phases of business cycles
•Recovery phase

Answer 4

•there is greater demand for goods and services
•this leads to an increase in production
•more jobs are created
•business confidence rises and there is an increased spending by firms
•there is increased economic activity and the country enters into a period of prosperity

Question 5

•Expansion phase

Answer 5

•there is a great degree of optimism in the economy
•entrepreneurs borrow money to buy machines and equipment (investment)
•Employment levels rise and this gives rise to a rise in salaries and wages and spending increases
•a peak is reached
•there is a larger amount of money in circulation and this leads to an inflationary situation in the economy and lead to a recession

Question 6

•Recession phase

Answer 6

•when there is negative economic growth rate for two consecutive quarters
•it is introduced by a decrease in profits of businesses that is the result of inflation and over production
•there is a decrease in production that lead to a drop in employment
•unemployment increase and this gives rise to a feeling of pessimism
•there is a decrease in economic activity and the economy slows down

Question 7

•Depression phase

Answer 7

•during a depression, money is short in supply, leading to a further decline in spending
•there is a negative impact on investment spending
•economic activity is at its lowest and a trough is reached
•cost of production decreases
•this encourages foreign trade and leads to a recovery

Question 8

Real (actual) business cycle

Answer 8

•an actual business cycle is obtained when the effects of irregular events, seasons and long term growth trend are removed from the time series data
•the length or duration of the cycle is measured from trough to trough or peak to peak.
•the distance of the peaks and troughs from the trend line is known as the amplitude and shows the severity of cyclical fluctuations

Question 9

Explanations/ Causes
•Exogenous explanation (monetarist explanation/ reason)

Answer 9

•also called sunspot theory/ exogenous approach
•believe markets are inherently stable
•departures from the equilibrium state are caused by exogenous factors (factors outside the market system)
•when disequilibrium exists in the economy, market forces (supply and demand) kick in and bring the economy back to its natural state
•gov interference are not part of the normal forces operating in the market
•gov should not interfere in the markets
•the straight bold line indicates natural growth in the economy
(Figure 2.3)

Question 10

Causes of economic fluctuations

Answer 10

•inappropriate gov policies
•undesirable increases and decreases in money and supply
•weather conditions
•shocks (September 11) severe increases in the price of fuel and wars
•structural changes

Question 11

•endogenous explanation (keynesian explanation)