Chapter 9 - Business cycles, macroeconomic goals & measurement

Question 1

What is gross domestic product?

Answer 1

It is the total market value of all final goods and services produced in the economy during a specified period.

Question 2

How is it measured?

Answer 2

In money terms and not in physical units. It is usually measured over a year.

Question 3

What is the purpose of national accounts (to measure the economy)?

Answer 3

1) measure the level of production in the economy
2) explain the immediate causes of the level of performance of the economy
3) uncover underlying problems in the economy
4) plot the long-run course of the economy over time
5) provide foundations for public policies

Question 4

What is the balance of payments account?

Answer 4

It is a statement recording all the transactions that take place between a country’s residents and the residents of all foreign nations.

Question 5

What are the two basic subcategories of balance of payments accounts?

Answer 5

The current account - reflecting current transactions
The capital and financial account - capital account reflects transactions of a non-current and non-financial nature and the financial account captures transactions including the exchange of financial assets.

Question 6

Do the accounts balance?

Answer 6

The current account balance and the capital and financial account balances are essentially reflections of each other and tush in a sense there will always be a ‘balance’ in the balance of payments.

Question 7

What is the external balance?

Answer 7

It is a level of the current account consistent with the maintenance of existing (or growing) levels of consumption, employment and national output over the long term

Question 8

What is the business cycle?

Answer 8

the recurrent, somewhat cyclical increases and decreases in the level or rate of growth in economic activity that typify the pattern of progress of our economy’s real GDP over time.

Question 9

Is the long run economic growth of Australia steady?

Answer 9

No there have been ups and downs

Question 10

What are the phases of the business cycle?

Answer 10

Peak - temporary maximum economic activity
Recession - decline in output and employment to a low or negative level
Trough - output bottoms out at their lowest levels
Recovery - output and employment expand toward full employment levels

Question 11

What is a depression?

Answer 11

A severe and prolonged recession

Question 12

What is full employment?

Answer 12

A situation of labour market balance consistent with output at the economy’s potential output level. In this state cyclical unemployment is absent.

Question 13

What are the types of unemployment?

Answer 13

Frictional unemployment
Structural unemployment
Cyclical unemploymnet

Question 14

What is frictional unemployment?

Answer 14

Includes new entrants and workers leaving voluntarily / or being laid off due to seasonality. This is inevitable and partly desirable.

Question 15

What is structural unemployment?

Answer 15

It is unemployment resulting from mismatches in the skills and geographic location of labour due to changes in the composition of the total demand for labour. They are not employable without additional training, education and/or geographical movement.

Question 16

What is cyclical unemployment?

Answer 16

It is unemployment caused by the business cycle or due to insufficient aggregate demand or total spending.

Question 17

Does full employment mean zero unemployment?

Answer 17

No, full employment is also known as the natural rate of unemployment, this equals the sum of frictional and structural unemployment but not cyclical unemployment (which is zero in the natural rate of unemployment)

Question 18

What is the economy’s potential output?

Answer 18

The real level of domestic output that is associated with the natural rate of unemployment.

Question 19

Who tracks unemployment and why is it not accurate?

Answer 19

The ABS, and it is not accurate because:

• It is not an entire view and is just a sample
• all part time workers are included as employed people
• the person must be actively seeking work to be included.

Question 20

What is not captured in the unemployment figures?

Answer 20

• Part time workers who want to work more hours but are unable to do so
• Discouraged workers - those who after unsuccessfully seeking employment for a time become discouraged and drop out of the labour force.

Question 21

What is the participation rate?

Answer 21

Those in the specified labour force group expressed as the percentage of the civilian population aged 15 and over in that specified group

Question 22

What is the basic economic cost of unemployment?

Answer 22

It is forgone output and is measured in terms of GDP Gap.

Question 23

What is GDP gap?

Answer 23

It is the amount by which the actual level of GDP falls short of the potential level of GDP.

Question 24

How is unemployment and GDP related?

Answer 24

They increase together

Question 25

What does Okun’s law show?

Answer 25

The quantified relationship between the unemployment rate and the GDP gap. For every 1% of unemployment above the natural rate, a GDP gap of more than 3.5% is generated.

Question 26

What is inflation?

Answer 26

It is a continuous rise in the general price level and is measured as ‘inflation rate = ((current year index - previous year index)/previous year index) x 100

Question 27

What is the 70’s rule?

Answer 27

It allows a quantitative appreciation and shows the number of years required for a doubling of the price rule. Approx Number of years required for price level to double = 70/annual rate of increase %.

Question 28

What does the 70’s rule show?

Answer 28

It allows estimation of how long it will take for GDP (or savings) to double

Question 29

What are the two general causes/theories of inflation?

Answer 29

• Demand-pull inflation

* Cost-push or supply-side inflation.

Question 30

What causes demand-pull inflation and what is it?

Answer 30

Caused by excess demand for output. In this case the economy attempts to spend beyond its capacity to produces (ie beyond its potential level of output)

Question 31

What is cost-push or supply-side inflation?

Answer 31

Inflation that arises on the supply or cost side of the market and is often explained in terms of the market power of unions and businesses. It can be due to wage push or profit push.

Question 32

What are the stages of demand pull inflation?

Answer 32

Range 1 - total spending is very low and domestic output is far short of full employment and a substantial GDP gap exists.
Range 2 - Demand continues to rise and the economy moves closer to fully utilising its available resources, prices may also begin to rise.
Range 3 - Full employment is achieved. Output is at a maximum and further increases in demand will cause demand pull inflation.

Question 33

How is demand-pull inflation drawn on a graph?

Answer 33

From P, horizontally starting to tip up, then in range 2, it is a corner curve, then in range 3 it is vertical. Full employment output is the point on Q where the line goes vertical.

Question 34

Explain demand-pull inflation in regards to GDP

Answer 34

Range 1 - Increases in money and GDP are identical
Range 2 - Money GDP is rising faster than real GDP, so money GDP must be deflated to measure changes in physical output.
Range 3 - Money GDP is rising, but real GDP is constant.

Question 35

What is another name for Range 2?

Answer 35

Premature inflation.

Question 36

What is nominal income?

Answer 36

The number of dollars received as wages, rent, interest or profits

Question 37

What is real income?

Answer 37

The amount of goods and services that can be purchased with money income.

Question 38

When does a decline in real income occur?

Answer 38

When nominal income fails to keep pace with inflation.

Question 39

How may a person react to expected inflation?

Answer 39

They may try to negotiate an income increase so as to protect their real income.

Question 40

Who is detrimentally affected by unexpected inflation?

Answer 40

• Fixed money-income receivers (eg pensioners)
• Savers - if interest is less than inflation
• Creditors - the amount repaid may not be worth in real terms the amount borrowed.

Question 41

Who is positively affected by unexpected inflation?

Answer 41

Borrowers as they are paying back less than what they borrowed in real terms.

Question 42

What is the output effect of demand-pull inflation?

Answer 42

It can provide real stimulus. Range 2 shows there is a trade off between output and employment on one hand and inflation on the other so some moderate levels of inflation must be accepted if we are to realise higher levels of output and employment.

Question 43

What is the output effect of cost-push inflation and unemployment?

Answer 43

Cost push inflation means people can buy less with the money they have, so output will fall and unemployment rises. Also hyperinflation may occur.

Question 44

What is hyper inflation?

Answer 44

Hyperinflation is sustained and very rapid increases in the level of prices (high inflation) leading to a rapid erosion in the value of the monetary unit. It can be devastating and can even cause economic collapse.