Short-Run Economic Fluctuations

Question 1

Definition of Business cycle:

Answer 1

• short-run (year-to-year) fluctuations in an economy’s output and unemployment

Question 2

Definition of Unemployment rate (U):

Answer 2

• percentage of the labor force without jobs

Question 3

Potential output (Y*)

Answer 3

• the normal or average level of output, as determined by resources and technology

Question 4

Definition of Natural rate of unemployment (U*)

Answer 4

• normal or average level of unemployment

Question 5

Definition of Economic boom:

Answer 5

• period when actual output exceeds potential output

Question 6

Definition of Recession:

Answer 6

• period when actual output falls below potential output

Question 7

Output gap (Y~)

Answer 7

• percentage difference between actual and potential output;

(Y -􏰅 Y*)/Y* = Ý

Question 8

Definition of Okun’s law: (Unemployment Fluctuations)

Answer 8

• Relation between output and unemployment over the business cycle:

the output gap falls by 2 percentage points when unemployment rises 1 point above the natural rate;

(Y -􏰅 Y*)/Y* 􏰀= 􏰅2(U -􏰅 U*)

Question 9

Effects of aggregate expendeture :

Answer 9

Question 10

Definition of Aggregate expenditure (AE):

Answer 10

• total spending on an economy’s goods and services by people, firms, and governments.
• These ideas were developed by the British economist John Maynard Keynes in his 1936 book The General Theory of Employment, Interest, and Money.

Question 11

Equilibrium output: (graph)

Answer 11

Question 12

A shift in monetary policy : (graph)

Answer 12

Question 13

what is “Expenditure shock”?

Answer 13

• event that changes aggregate expenditure for a given interest rate, shifting the AE curve

Question 14

Types of Expenditure Shocks:

Answer 14

1. Government spending
2. Taxes
3. Consumer confidence
4. New technologies
5. Changes in bank lending
6. Foreign business cycles

Question 15

what is the meaning of Credit crunch

Answer 15

• a sharp reduction in bank lending

Question 16

how government spending affect the economy ? ( Expenditure Shocks)

Answer 16

• The goverment can create an Expenditure Shocks when it start consuming more and increasing its share of aggregate consume

Question 17

what is “Countercyclical monetary policy”?

Answer 17

• adjustments of the real interest rate by the central bank to offset expenditure shocks and thereby stabilize output

Question 18

Expected inflation formula:

Answer 18

pi 􏰀= pi^e

where “pi” is actual inflation and “pi^e” is expected inflation.

Question 19

Is adaptive expectations a reasonable assumption?

Answer 19

Supporters make two points:

• For the firm managers who set prices, forecasting that inflation will equal past inflation is an easy shortcut.
• Although adaptive expectations are not the best possible forecasts, they are fairly good ones, adaptive forecasts of inflation have not been far off.

Question 20

Phillips curve (PC)

Answer 20

• the positive short-run relationship between output and inflation; also, the negative short-run relationship between unemployment and inflation
• inflation equals expected inflation when output is at potential
• The key idea behind the Phillips curve is that an economic boom raises inflation and a recession reduces​

Question 21

Phillips curve (PC) graph

Answer 21

Question 22

Why can we draw the Phillips curve in two different ways?

Answer 22

• Okun’s law
• which tells us that output and unemploy- ment move in opposite directions over the business cycle

Question 23

Output Phillips Curve (formula)

Answer 23

pi =􏰀 pi^e +􏰁 X . (Y - Y*)/ Y* ; (X 􏰄> 0)

• pi mean inflation
• pi^e mean expected inflation
• X is a positive constant that measures how strongly output affects inflation.
• Y mean output
• Y* is potential output

Question 24

Unemployment Phillips Curve: (formula)

Answer 24

pi = 􏰀pi^e - 􏰅2X (U􏰅 - U*)

• pi mean inflation
• pi^emean expected inflation
• X is a positive constant that measures how strongly output affects inflation.
• U is the deviation of unemployment from the natural rate.

Question 25

Output Phillips Curve with Adaptive Expectations (formula)

Answer 25

p - pi(-􏰅1) =􏰀 X . (Y - Y*)/Y*

• “pi” mean inflation
• “pi^e “ mean expected inflation
• “X” is a positive constant that measures how strongly output affects inflation.
• Y* is potential output

Question 26

Unemployment Phillips Curve with Adaptive Expectations (formula)

Answer 26

pi -􏰅 pi(􏰅-1) =􏰀 􏰅2X . (U 􏰅- U*)

• “pi” mean inflation
• “pi^e“ mean expected inflation
• “X” is a positive constant that measures how strongly output affects inflation.
• “U” is the deviation of unemployment from the natural rate.

Question 27

what is NAIRU ?

Answer 27

• Acronym for nonaccelerating inflation rate of unemployment, the unemployment rate that produces a constant inflation rate; another name for the natural rate of unemployment, U*

Question 28

The definition of Supply shock (v): (with inflation)

Answer 28

• event that causes a major change in firms’ production costs, which in turn causes a short-run change in the inflation rate
• An adverse supply shockraises costs
• a beneficial supply shock reduces costs

Question 29

Output Phillips Curve with Supply Shocks (formula)

Answer 29

pi =􏰀 pi^e +􏰁 X . (Y - Y*)/ Y* + v

• pi mean inflation
• pi^e mean expected inflation
• X is a positive constant that measures how strongly output affects inflation.
• Y mean output
• Y* mean potential output
• V mean supply shock

Question 30

Output Phillips Curve with Adaptive Expectations and supply shock (formula)

Answer 30

p - pi(-􏰅1) =􏰀 X . (Y - Y*)/Y* + v

• “pi” mean inflation
• “pi^e “ mean expected inflation
• “X” is a positive constant that measures how strongly output affects inflation.
• “v” mean supply shock

Question 31

Aggregate expenditure/ Phillips curve (AE/PC) model

Answer 31

• theory of short-run economic fluctuations that assumes a negative relationship between the interest rate and output (the AE curve) and a positive relationship between output and inflation (the Phillips curve)

Question 32

The Complete Economy:graph

Answer 32

Question 33

what is “Accommodative monetary policy”?

Answer 33

• decision by the central bank to keep the real interest rate constant when a supply shock occurs, allowing inflation to change.
• An accommodative monetary policy allows a supply shock to raise inflation permanently.

Question 34

what is “Nonaccommodative monetary policy”?

Answer 34

• decision by the central bank to adjust the interest rate to offset a supply shock and keep inflation constant.

Question 35

what is “Disinflation” to the central bank ?

Answer 35

• monetary policy of reducing inflation by temporarily raising the real interest rate.
• a temporary fall in output reduces inflation permanently

Question 36

Definition of “Long-run monetary neutrality” ?

Answer 36

• principle that monetary policy cannot permanently affect real variables (variables adjusted for inflation)

Question 37

what is the Neutral real interest rate (rⁿ)?

Answer 37

• the real interest rate that makes output equal potential output, given the aggregate expenditure curve

Question 38

what is the meaning of Hysteresis?

Answer 38

• theory that the short-run path of a variable, such as unemployment, affects its long-run level, such as the natural rate of unemployment