The Economic Cycle

Question 1

What happens in the economic cycle?

Answer 1

GDP fluctuates around its underlying trend, following a regular pattern.
Rises and falls may over time follow a regular pattern.
4 stages in the economic cycle:
Recession
Recovery
Boom
Slowdown

Question 2

What causes variations in short run economic growth?

Answer 2

If SRAS shifts to the right, then a greater quantity of real GDP is produced at every price level. If the SRAS curve shifts to the left, then a lower quantity of real GDP is produced at every price level

Question 3

What factors may cause SRAS to shift?

Answer 3

Employment costs e.g. wages, employment taxes.
Unit labour costs are also affected by the level of labour productivity
Costs of other inputs e.g. commodity prices, raw materials.
The exchange rate can affect the prices of key imported products
Impact of government e.g. environmental taxes such as carbon duties & business regulations which affect the costs of production

ALL CAUSE SUPPLY TO EITHER INCREASE OR DECREASE WHETHER IT BE DOMESTIC OR FOREIGN

Question 4

What is a recovery?

Answer 4

When economic growth becomes positive after recession.

Question 5

What is a boom?

Answer 5

When the rate of economic growth exceeds the potential growth of GDP (output gap is narrowed).

Question 6

What is a slowdown?

Answer 6

When economic growth begins to fall and nears 0.

Question 7

What is a recession?

Answer 7

When the rate of economic growth becomes negative and real GDP actually falls (GDP falls in 2 consecutive quarters).

Question 8

What is the output gap?

Answer 8

The difference between actual and potential (trend) GDP growth.

Question 9

When does the output gap become positive?

Answer 9

When actual growth exceeds potential growth.

Indicates little or no spare capacity. As it is closer to full capacity it is likely to generate inflationary pressure.

Question 10

What is a negative output gap?

Answer 10

Where actual output is below potential output. Indicates that the economy has spare capacity.

Question 11

What is a problem with the output gap?

Answer 11

It is very difficult to measure the ‘potential’ output of a country, therefore the output gap can therefore only be an estimate.

Question 12

What is the multiplier?

Answer 12

It is the process by which any change in a component of AD results in a greater final change in real GDP. ‘One person’s spending becomes another’s income’.

Question 13

How do you work out the size of the multiplier?

Answer 13

1-MPC

Question 14

How does an initial injection into the circular flow experience the multiplier effect?

Answer 14

One person’s spending becomes another’s income.

Question 15

How do you work out how much GDP will have increased by as a result of the multiplier?

Answer 15

Multiplier x initial injection into the circular flow

Question 16

What is the accelerator?

Answer 16

The concept which explains how changes in investment can be directly linked to changes in the rate of GDP growth, not its level.

Question 17

What is investment needed for?

Answer 17

1. To replace capital stock

2. To provide new capital stock

Question 18

What are some limitations of the multiplier and accelerator theory?

Answer 18

1. The accelerator theory ignores the role of confidence and expectations, a firm may be confident to invest regardless of the rate of GDP growth,
2. Some investment decisions are planned well in advance of changes in economic activity.
3. Multiplier effects on investment may be small so may not have a significant impact on AD.
4. Firms may have spare capacity and you can never know the effect if they don’t know spare capacity.