C.9 The Short Run and the Long Run in Macroeconomics

Question 1

Potential GDP

Answer 1

The level of real GDP attained when firms are producing at capacity and labour is fully employed

Question 2

Expansion

Answer 2

The period of a business cycle during which real GDP and employment are increasing

Question 3

Keynesian economics

Answer 3

The perspective that business cycles represent disequilibrium, or non-market clearing behaviour

Question 4

Classical economics

Answer 4

The perspective that business cycles can be explained using equilibrium analysis

Question 5

Macroeconomic shock

Answer 5

An exogenous, positive or negative event that has a significant event on an important sector of the economy or on the economy as a whole

Question 6

In the short run nominal prices and wages are _____ while in the long run are ______

Answer 6

sticky

flexible

Question 7

What does it mean for a firm to compete in imperfectly competitive markets?

Answer 7

They have some control over prices

Question 8

Reasons for price stickiness

Answer 8

• imperfectly competitive markets
• menu costs
• customers can get mad over increased costs
• information is costly

Question 9

menu costs

Answer 9

costs in changing prices

Question 10

how often to firms change prices

Answer 10

retailers just once or twice a year

Question 11

Efficiency wages

Answer 11

Higher than equilibrium real wages to motivate employees to be more productive

Question 12

The Great Moderation

Answer 12

The increased stability of real GDP after the early 1980s

Question 13

Reasons for stabilized real GDP after 1950s

Answer 13

• The increasing importance of services and the declining importance of goods
• The establishment of E.I. and other gov’t transfers that provide funds to the unemployed
• Active fiscal and monetization policy

Question 14

Real GDP eq’n

Answer 14

Y = Y^P + (Y-Y^P)
where,
Y^P = potential GDP
Y = real GDP

Question 15

Output gap

Answer 15

The % deviation of real GDP from potential GDP

Question 16

Output gap eq’n

Answer 16

Y~ = (Y-Y^P)/Y^P

Question 17

What does the output gap measure

Answer 17

How fully the economy is employing its resources, such as labour, natural resources, and physical and human capital

Question 18

When the output gap equals zero

Answer 18

The economy is producing at its long-run capacity and so its producing the max sustainable level of goods and services

Question 19

When the output gap is greater than zer0

Answer 19

Economy is operating at a level greater than it can sustain in the long run

Question 20

Cyclical unemployment rate

Answer 20

The difference between the unemployment rate and the natural unemployment rate

Question 21

Okun’s Law

Answer 21

A statistical relationship between the cyclical unemployment rate and the output gap

Question 22

Cyclical unemployment _____ during a recession

Answer 22

rises

Question 23

Cyclical unemployment eq’n

Answer 23

u - u^N = -h*[(Y-Y^P)/Y^P] = -h*Y~
where,
u = unemployment rate
u^N = natural unemployment rate
h = Okun's law coefficient

Question 24

What does Okun’s law coefficient, h, represent

Answer 24

the effect a 1% drop in output on unemployment

Question 25

Why is the Okun coefficient typically less than 1

Answer 25

labour hoarding: in recessions, firms do not reduce employment in line with the decline in output

Question 26

Costs of the business cycle to workers

Answer 26

1. Recessions do not necessarily have the same magnitude as expansions
2. long periods of unemployment lead to lost skills
3. lower income workers are hit harder
4. negative effects of recessions on workers can last many years

Question 27

A link between business cycles and growth

Answer 27

The uncertainty of business cycles can reduce investment spending

Question 28

Procyclical variable

Answer 28

An economic variable that moves in the same direction as real GDP - increasing during expansions and decreasing during recessions

Question 29

Examples of procyclical variables

Answer 29

• employment
• investment spending
• spending on durable goods

Question 30

Examples of countercyclical variables

Answer 30

• unemployment rate

Question 31

Hysteresis

Answer 31

Even when output returns to potential, employment does not

Question 32

Leading indicators

Answer 32

Variables that reliably indicate a future recession or expansion

Question 33

Examples of leading indicators

Answer 33

• avg work week hours, manufacturing
• housing index
• US leading index
• money supply
• new orders, durable goods
• stock price index
• retail trade, furniture and appliances
• business and personal services employment

Question 34

Multiplier effect

Answer 34

A series of induced increases (or decreases) in consumption spending that results from an initial increase (or decrease) in autonomous expenditure; this effect amplifies the effect of economic shocks on real GDP

Question 35

Autonomous expenditure

Answer 35

Spending that is independent of income

Question 36

Multiplier

Answer 36

The change in equilibrium GDP divided by the change in autonomous expenditure

Question 37

Autonomous expenditure multiplier eq’n

Answer 37

(Change in GDP/Change in autonomous expenditure) = 1/(1-m)
where,
m = the proportion of an increase in income that is spent on domestic goods and services