LM4: Understanding Business Cycles

Question 1

Describe the stages of the business cycle

Answer 1

Question 2

Describe credit cycles and are they longer or shorter than Business cycles?

Answer 2

During an improving economy, lenders are more willing to extend credit at favourable terms. In contrast, lenders tighten their lending standards in a weak economy by increasing rates and making loans harder to obtain. These factors often lead to the decline of assets such as real estate, resulting in further declines in the economy and higher default rates. Credit plays a large role in financing property acquisition and construction.

Studies suggest that credit cycles coincide with stronger expansions and longer contractions. Credit cycles and business cycles do not always coincide, as historical data suggests the former has lasted on average longer than the latter.

Question 3

Describe the 5 different business cycles theories with recommended policies

Answer 3

Question 4

What are the three types of unemployment and describe them

Answer 4

• Frictional: Temporary position changes -> between jobs
• Structural: Caused by long-run changes in the economy -> demand for blacksmiths has decreased and demand for technicians has gone up
• Cyclical: Depends on the stage of the business cycle which affects economic activity and hence employment

Question 5

What is the equation for Unemployment rate / Participation ratio / Labor force?

Answer 5

Question 6

Define inflation

Answer 6

a sustained rise in overall prices in the economy

Question 7

Define deflation

Answer 7

• Deflation = a sustained decrease in aggregate price level, i.e. negative inflation rate or prices are falling.

Question 8

Define Disinflation

Answer 8

Disinflation = declining inflation rate. Note that prices are still rising in disinflation, but at a slower rate than before.

Question 9

Define Hyperinflation

Answer 9

Hyperinflation = an extremely high inflation rate. If over a 3 year period the aggregate price level doubles, this is a hyperinflation

Question 10

Define cost-push inflation

Answer 10

Cost-push inflation = inflation caused by a decrease in aggregate supply (AS)

Question 11

Define demand-pull inflation

Answer 11

Demand-pull inflation = inflation caused by an increase in aggregate demand (AD)

Question 12

What is the Laspreyes index and what are its negatives?

Answer 12

uses base consumption basket to measure inflation

Question 13

What is the Paasche index and what are its positives and negatives?

Answer 13

Paasche index: uses current consumption basket to measure inflation

Question 14

What is the equation for the GDP Deflator Formula?

Answer 14

Question 15

What is the Fischer Index?

Answer 15

Fischer index: is the geometric mean of Laspeyres and Paasche index

It is deemed the “ideal” price index as it corrects the positive price bias in the Laspeyres Price Index and the negative price bias in the Paasche Price Index

Question 16

What is stagflation?

Answer 16

Stagflation: persistent high inflation combined with high unemployment and stagnant demand in a country’s economy

Question 17

What are the equations for the price indexes?

Answer 17

Question 18

What are Leading indicators and some examples?

Answer 18

Leading indicators include share prices, average weekly hours worked in the manufacturing sector, or new orders for capital goods. The function of leading indicators is to predict the future movements of the economy.

Question 19

What are Lagging indicators and some examples?

Answer 19

Lagging indicators only change when the economy has started following a certain pattern. Even though they are more precise than leading indicators, they can only be seen after a large economic shift has occurred. They include unemployment rates, interest rates, gross national product (GNP), the balance of trade, consumer price index (CPI), and gross debt.

Question 20

What are Coincident indicators and some examples?

Answer 20

Coincident indicators constitute elements such as gross domestic product (GDP), retail sales, and employment levels. They can be seen simultaneously as the size of the economy either expands or contracts.

Question 21

What are the main uses of economic indicators?

Answer 21

• They have a unique release schedule. As a result, investors can prepare and plan to access certain
  information at a specific time.
• They indicate the direction of the economy.
• Analysts use them to predict the possibility of investing in the future.

Question 22

What are the main limitations of Economic indicators?

Answer 22

• They need to be correctly interpreted.
• Most of the data is somewhat inaccurate.
• Measuring gross domestic product (GDP) is almost impossible.