Understanding Business Cycles

Question 1

Real GDP and Unemployment are key variables used to determine the current phase of the business cycle

Answer 1

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Question 2

Four Stages of a Business Cycle

Answer 2

1. Expansion
2. Peak
3. Contraction/Recession
4. Trough

Question 3

Inventories are used as an important business cycle indicator.

Answer 3

• In Inventories accumulate when expansion is reaching peak

* Inventories deplete when contraction is reaching the trough

Question 4

As Expansion is approaching its peak

Answer 4

• Sales growth slows

* * Inventories accumulate

Question 5

As Contraction is reaching the trough

Answer 5

• Sales growth begins to increase

* * Inventories deplete

Question 6

Housing Sector Influence on Business Cycle

Answer 6

• Mortgage Rates – when interest rates are low, they tend to increase home buying and construction
• Housing costs relative to income – when incomes are cyclically high relative to home costs, home buying and construction tend to increase.
• Speculative Activity – rising home prices can be bought on expectation of further gains.
• Demographic Factors – proportion of population in the 25 to 40 year old demographic is positively related to activity in the housing sector.

Question 7

External Trade Sector Activity

Answer 7

• domestic GDP growth
• GDP growth in trading partners
• currency exchange rates

Question 8

Characteristics of a Trough

Answer 8

• GDP growth rate goes from - to +
• High unemployment, overtime increases
• Spending on durables and housing increase
• Moderate or decreasing inflation

Question 9

Characteristics of Expansion

Answer 9

• GDP ^, Unemployment decreases
• Investment ^ (by firms and consumers)
• Inflation ^
• Imports ^, (more $$ for demand to ^)

Question 10

Characteristics of a Peak

Answer 10

• GDP decreases, Unemployment decreases, but slows
• Spending and business investment slows
• Inflation ^

Question 11

Characteristics of a Contraction/Recession

Answer 11

• GDP decreases, Unemployment ^
• Spending and Investment decrease
• Inflation decrease, with a lag
• Imports decrease as income growth slows

Question 12

Neoclassical Theory

Answer 12

• Shifts in Aggregate Demand and Aggregate Supply are driven by changes in technology
• Business Cycles are temporary deviations from LR equilibrium

Question 13

Keynesian Theory

Answer 13

• Fluctuations are primarily due to swings in levels of optimism of those who run businesses
• Increase in Aggregate Demand directly through monetary or fiscal policy

Question 14

New Keynesian Theory

Answer 14

• Keynesian School, plus prices of production inputs other than labor are “downward sticky” presenting additional barriers to reaching full employment.

Question 15

Monetarist Theory

Answer 15

Aggregate Demand that causes business cycles are caused by rate of growth of Money Supply likely from inappropriate decisions by monetary authorities.

Question 16

Austrian School Theory

Answer 16

Business cycles are caused by government intervention in the economy

Question 17

New Classical Theory (Real Business Cycle Theory)

Answer 17

RBC theory emphasizes economic changes likely technological adaptation and external shocks. Not monetary variables.

Question 18

3 categories of Unemployment

* Unemployed means they are proactively looking for a job

Answer 18

1. Frictional
2. Structural
3. Cyclical

Question 19

Frictional Unemployment

Answer 19

results from time lag necessary to match employees who seek work with employers need their skills

Question 20

Structural Unemployment

Answer 20

LR changes in the economy that eliminate jobs and/or add jobs unemployed do not have the skills for.

Question 21

Cyclical Unemployment

Answer 21

Caused by changes in the general level of economic activity

Question 22

Unemployment Rate

Answer 22

The percentage of people in the labor force who are unemployed

Question 23

Labor Force

Answer 23

All people who are either employed or unemployed

Question 24

Discouraged Workers

Answer 24

Those who are available for work but chose not to get employed and are not seeking a job

Question 25

Inflation

Answer 25

Persistent increase in price level over time.

Question 26

Deflation

Answer 26

Associated with deep recessions

Question 27

Consumer Price Index

Answer 27

CPI represents the purchasing patterns of an urban household.

CPI = [(cost of basket @ current prices) / (cost of basket @ base prices)] * 100

Question 28

GDP deflator

Answer 28

Also used as an inflation estimator

Question 29

Producer Price Index (PPI)

Answer 29

Watches for different stages of processing to identify emerging price pressures

Question 30

Headline Inflation

Answer 30

Refers to price indexes for all goods

Question 31

Core Inflation

Answer 31

Price indexes that exclude food and energy, because they are more volatile

Question 32

Laspeyres Index

Answer 32

Uses a constant basket of goods and services to measure inflation

Question 33

3 factors that cause Laspeyres Index to be biased upwards

Answer 33

1. New goods – Old goods replaced by newer, more expensive goods trending the index ^
2. Quality Index – If quality of index ^, the price of the index ^. Biasing the index up, when the prices didn’t inflate.
3. Substitution – cheaper products that will replace more expensive goods changes.

Question 34

Hedonic Pricing

Answer 34

Adjusts a price index for product quality

Question 35

For substitution, Fischer Index is used as a chain-weighted price index.

Answer 35

Fisher Index is a geometric mean of Laspeyres Index and Paasche Index.

Question 36

Paasche Index uses the current consumption weights, prices from the base period and prices in the current period

Answer 36

PI = current price / (base period)

Question 37

Cost-push inflation

Answer 37

Results from a decrease in Aggregate Supply, caused by an increase in the real price of an important factor of production, such as wages or energy.

Question 38

Demand-Pull Inflation

Answer 38

Results from an increase in money supply, increased gov’t spending or any change in Aggregate Demand

Question 39

Leading Indicators

Answer 39

Change direction before peaks and troughs in business cycles

ex. Average weekly hours,
Stock Prices,
Leading Credit Index
Index of Consumer Expectations

Question 40

Coincident Indicators

Answer 40

Change direction at roughly the same time as peaks or troughs

ex. Employees on nonagricultural payrolls
Personal Income less transfer payments
Industrial Production

Question 41

Lagging Indicators

Answer 41

Don’t change directions until after peaks and troughs

ex. Average rate of unemployment
Commerical and Industrial Loans
CPI for services
Labor cost per unti