Term 2 Week 1: Business Cycles Flashcards
What causes the business cycle (2)
-Shifts in Aggregate spending decisions
-Short-run Supply shifts
Why do policy makers worry about AD fluctuations, and how can they impact AD (1,2)
-Policymakers worry about AD fluctuations due to their impacts on unemployment and inflation
-Fiscal policy can impact AD both directly (G) and indirectly (can impact C and I)
-Monetary policy aims to stabilize AD through changing IR
What is a the business cycle (2)
-The business cycle model shows how a countries GDP fluctuates over time, including expansions, peaks, recessions, troughts
-Unemployment rates vary over the business cucle, due to its countercyclical nature
What is an output gap (2)
-Output gap = actual output - potential output
-Output gap % = (y - ye/ye) x 100
What is potential output, and how can it be estimated (1,3)
-Potential output is how fast an economy can grow over the long term
The three main estimation methods are:
-statistical trend (working out the long term GDP trend)
-Estimating a production function (cobb-douglas)
-Estimating the OG directly (realtime data on capacity utilisation or labour market slack)
How do households consumption smooth, and what does this show (2,2)
-Households cope with fluctuations through self insurance (save in good, spend in bad) and co insurance (tax/charity to those who need)
-Co-insurance is less effective when a bad shock hits everyone, but is even more necessary
-A basic source of stabilization in any economy comes from a desire to smooth consumption
-This is because there are diminishing marginal returns to consumption at any given time
Why may households consumption smoothing be constrained (4)
-Lack of information when future planning
-Credit constraints
-Weakness of will
-Limited co-insurance
Why is investment volatile (3,2)
-Unlike households, there is no incentive for firms to smooth investment spending
-When firms innovate, the firms that produce the machines may need their own production facilities
-Investment occurs in waves, since new innovation means other firms have to follow suit, or risk losing market share
-Investment in new technology can lead to a stock market bubble and overinvestment in machinery/equipment
-This could lead to the bubble bursting as share prices rise to unsustainable levels
How does investment impact aggregate demand (2)
-Investment leads to higher spending by workers and firms, leading to higher demand, and thus higher future investment
-As consumption spending is smooth and investment spending more volatile, the change in GDP will usually be in between changes in C and I
What is Okun’s law (2,1,4)
-Δut = α + β(GDP growth)
-The change in unemployment at time t = intercept value + real GDP growth rate x Okun’s coefficient
-The coefficient β is often negative, and the slope of a line with GDP growth on the x axis and unemployment on the y axis
-A change in output tends to be associated with a lesser change in the unemployment rate (β < 1), because:
:labour hording
:tighter regulations on hiring and firing
:the economically inactive
