L5 - Aggregate Spending and Business Cycles Flashcards
What are Trade/Business Cycles?
Periodic fluctuations in the rate of economic activity, as measured by levels of employment, prices and production.
First used in 1919
What are the differing periods of business cycles?
- UK: 1800-1860: 14 cycles averaging 4.3 years
* 1860-1914: 7 cycles averaging 7.5 years
Why was there a greater regularity and length in cycles after 1860?
Due to the increased importance of the investment cycle relative to the trade cycle.
Also shifts in employment: From Agricultural to Industrial (Seasonal to Full-time)
What are the differing business phases?
- Peak
- Recession
- Trough
- Recovery
What is a Peak?
The top of the cycle – productive capacity fully utilised shortages may start to develop
What is a Recession?
Downturn in activity. Defined as a fall in real GDP for two successive quarters.
Typically incomes and employment levels fall. Profits may also decline as some firms experience financial difficulties. A recession that is deep and long lasting is called a depression.
What is a Recovery?
Characterised by rising incomes, employment and consumption.
Business expectations become more optimistic and new investment projects are begun.
What is a Trough?
Characterised by high unemployment and low demand in relation to the capacity to produce. Business confidence is low
What was the unemployment rate in the Great Depression?
-Reaching 2 million in 1922 and peaking at around 3 million (22%) in 1932
1931-2: 34.5% of coal miners,
36.3% of pottery workers, 43.2% of cotton operatives, 43.8% of pig-iron workers, 47.9% of steelworkers and 62% of shipbuilders and ship-repairers were unemployed
Marx was first to realise that recessions led to unemployment.
What was Hobson’s (1896) interpretation for the Great Depression?
Identified cause as ‘Over-production’
- Poor people spend more than rich
- Rich people save too much
- Due to savings being too high and consumption too low (due to the unequal distribution of incomes, as the rich spent less than the poor)
What was the economic response to the Great Depression?
- Economy as fundamentally sound.
- Lionel Robbins at the LSE and Joseph Schumpeter at Harvard both said that nothing should be done
Schumpeter:
“this is not all: our analysis leads us to believe that recovery is sound only if it does come of itself.”
Churchill (representing treasury view):
“It is the orthodox treasury dogma, … that whatever might be the political and social advantages, very little additional employment can in fact… be created by state borrowing and expenditure.”
Keynes (1929):
“I know of no British economist of reputation who supports the proposition that schemes of National Development are incapable of curing unemployment.”
What was Keyne’s view into his general theory?
- Effective demand key to full employment
- Model based on short run over which excess of supply of output which would not be eliminated automatically
- In Long Run all dead
- SR traditionally defined as a period over which there is a negative output gap. i.e. the level of demand is less than potential productive potential of the economy (Y
What are the temporary assumptions behind Keyne’s theory?
Given SR assumptions of model. Assumptions made.
- The industrial structure of the economy is fixed
- Firms’ output is aggregated into a single productive sector producing output which is homogenous
- The price level is fixed: i.e. real and nominal values are identical, or alternatively, all variables are measured in real terms (constant prices)
What determines the level of Aggregate Expenditure?
- Divided production to Consumption Goods purchased by household goods (C) & Capital Goods purchased by firms (I)
- C & I divided into autonomous and induced spending
- Autonomous (Exogenous) spending is that spending independent of current income
- Spending which rises with income is referred as Induced spending
What is the Consumption Function?
The amount of aggregate consumption mainly depends upon the amount of aggregate income: More money, the more you spend
