IS-LM

Question 1

What are business cycles?

Answer 1

Fluctuations about the trend in real GDP

Question 2

4 phases of business cycles?

Answer 2

Expansion
Peak
Contraction
Trough

Question 3

What is the frequency of business cycles?

Answer 3

The number of peaks per year

Question 4

Define recession?

Answer 4

Decline in GDP >= 2 consecutive quarters

Question 5

Define depression?

Answer 5

Severe and prolonged recession

Question 6

Define boom?

Answer 6

Prolonged expansion in economic activity

Question 7

How does the classical model assume an economy will respond to exogenous shocks? Why?

Answer 7

Assumes fluctuations are caused by productivity and supply shocks, tf shocks will be absorbed and tf equilibrium will be restored via the market mechanism

Question 8

Idea behind Keynesian planning?

Answer 8

In the SR the economy’s income is largely determined by the spending plans of households, firms and the government

Question 9

Define actual expenditure(AE^A)?

Answer 9

Amount households firms and gov. spend on G+S

Question 10

Define planned expenditure(AE^P)?

Answer 10

Amount households firms and gov. plan to spend on G+S

Question 11

What happens if a firm sells less than planned? (Keynes)

Answer 11

Sells less than planned -> increase stock of inventories (=increase unplanned investment) -> less production -> increase U and decrease GDP

Question 12

What happens if a firm sells more than planned? (Keynes)

Answer 12

Sells more than planned -> decrease stock of inventories(=decrease unplanned investment) -> increase production -> decrease U and increase GDP

Question 13

Why is AE^A not equal to AE^P?

Answer 13

Unplanned investment

Question 14

Why is the line on the AE^A against Y line at 45 degrees?

Answer 14

Because AE^E = Y

Question 15

Why does the slope of the AE^P line equal MPC?

Answer 15

AE^P = C + I^P(fixed) + G^P(fixed)

Since C=C(Y-T)
Consumption is the only variable affected by income tf gradient = MPC

Question 16

See page 8

Answer 16

Now

Question 17

Draw the Keynesian cross diagram?

Answer 17

Now

Question 18

Why is the AE^E curve always steeper than the AE^P curve?

Answer 18

Because MPC is = (0,1)

Question 19

How is the economy driven towards AE^A=AE^P?

Answer 19

The actions of firms when they have either an unplanned rise or fall in inventories

Question 20

What does the gap between AE^A and AE^P represent BEYOND the point where they cross?

Answer 20

Unplanned inventory accumulation (not selling enough)

Vice versa for before the point where they cross