L11 - Cycles in Economic Acitivity Flashcards
What are the types of Cycles?
- Long Cycles
- Short Cycles
What did Long Cycles identify?
50 Year Cycles identified by Kondratief
-Identified 3 phases in cycle:
Expansion,Stagnation,Recession
- Affects all sectors of an economy
- Focused on prices and interest rates.
Also has innovation theory
• Kondratiev’s ideas were taken up by Schumpeter in the 1930s. The theory suggested very long-run output and price cycles, originally estimated to last 50–54 years
What is the Expansion (Ascendant) phase characterised as?
• Ascendant phase (expansion) as characterized by an increase in prices and low interest rates
What is the Recession phase characterised as?
• Other phase (recession) consists of a decrease in prices and high interest rates. Subsequent analysis concentrated on output.
What is the Innovation theory commonly associated with Long Cycles?
Business waves arise from the bunching of basic innovations that cause technological revolutions in turn create leading industrial or commercial sectors
What is the Short Cycle characterised as?
- Clement Juglar in 1862 first identified short cycles – 7 to 11 years
- Looking at data on prices, interest rates and central bank balances
Why does GDP Fluctuate?
- Fluctuations in AD primary causes of trade (or short) cycles
- Sources of these demand shocks come from any component of AD (C, I, G, NX or monetary policy shocks through interest rate changes)
- Most important change is Private Investment. Investment more volatile and major source of fluctuations of AD
What is the Accelerator process?
An Exogenous rise in AD cause multiple increase in GDP
- GDP stop rising when injections= withdrawals
- Assumes only one permanent rise in I. But other ways to raise I
- If investment rose along with GDP could go upwards for a while
What are the reasons for the growth in Investment along with GDP? (Accelerator Process)
- The Accelerator Process
- Availability of funds
- Expectations
What is the Accelerator Model?
K=aY
-Linking Investment with GDP
Where:
- a is the amount of capital needed per GDP
- K is capital
- Y GDP
- Recession: ΔY<0 I falls and AD falls
- Boom: ΔY>0 I rises
Clearly linked to Multiplier (since I cause bigger causes in GDP which in turn leads to further increases in I)
What is Samuelson’s Multiplier-Accelerator model?
In the 1950’s
Proposed Equations:
- Yt = Ct + It + Gt
- Ct = aYt-1
- It = b(Ct – Ct-1) = ab(Yt-1 – Yt-2)
Together, form 2nd dif equation to give dynamic time path for GDP:
Yt = a(1 + b)Yt-1 – abYt-2 + Gt
OR
Yt= ayt-1+ abyt-1-abyt-2+Gt (Same thing)
What are the differing cycle pattern?
- Damping Cycle Pattern
( Stability over time)
(GDP returning to equilibrium) - Explosive Cycle
No return to equilibrium and the fluctuations become larger over time.
Rarely observed
What are the problems with Samuelson’s Model?
- When economy goes up firms more concerned with putting existing idle capital to work rather than investing in capital goods
- Firms concerned with “capital–widening” and not “capital-deepening” i.e. more of the same type of capital and not with new more productive machinery
- Different production lines require different amounts of capital so the amount of capital required to meet a cyclical rise in demand will vary over time and industry
Whats meant by Availability of Funds?
- Innovations and Inventions are taken up by firms from retained profits
- Typically low at the trough of the cycle and so firms maybe financially constrained; such constraints are loosened as the upswing continues
- Firms may borrow from the markets to finance new machinery– which may be cheaper in recession when interest rates are low, although borrowing costs are likely to rise as the upswing develops
What’s meant by Expectations?
- Time lag factor. So business decisions on production etc. influenced by business expectation
- Expectations can be volatile or self-fulfilling. (Brexit) can drive cycle over SR
- Banks and other lending institutions cautious in lending and so restrain investment
