Week 5 - Business Cycle Facts & RBC model

Question 1

What is the business cycle?

Answer 1

• Short-run fluctuations between economic downturns.

Question 2

What is a recession and what happens during a recession?

Answer 2

• A recession is a period of economic downturn when output and employment fall

Question 3

What are depressions?

Answer 3

• Extended periods of a recession

Question 4

How has the frequency of recession changed over time?

Answer 4

• Recessions were much more common before the 1980’s and recently have become much less common

Question 5

How are business cycle fluctuations measured?

Answer 5

• Yt Cyclical = Yt - Yt trend ( the difference between actual output and the trend output

Question 6

What is procyclical, countercyclical and acyclical

Answer 6

• ProCyclical - Positively correlated with GDP
• CounterCyclical - Negativley correlated with GDP
• ACyclical - Not correlated with GDP

Question 7

Is; Consumption, Investment, Capital, Hours worked, Productivity and wages ProCyclical, CounterCyclical OR Acyclical?

Answer 7

• Consumption - Procyclical and less volatile than GDP
• Investment - Procyclical, more volatile than output
• Capital - Acrylic, less volatile than output
• Total hours worked - Procyclical and as volatile as output
• Productivity - Pro Cyclical and less volatile than output

Question 8

Describe the Real Business Cycle model

Answer 8

• No friction
• All markets are competitive
• Shocks to supply side
• Exogenous business shocks to technology
• No role for stabilisation policies

Question 9

Describe the Keynsian/ New Keynsian model

Friction exists

Non completive markets

Demand shock are the ones which drive the business cycle

A role for policies especially monetary policy

Answer 9

• Friction exists
• Noncompetitive markets
• Demand shock are the ones that drive the business cycle
• A role for policies especially monetary policy

Question 10

What does the RBC model assume for households?

Answer 10

• They live infinitely
• They decide how much to consume, work and save in order to maximize utility
• Dynamic Model

Question 11

What does the RBC model assume for firms?

Answer 11

• Produce and sell one good only
• Demands K and L to maximise profit
• Production Technology, with TFP fluctuating over time
• Stochastic Model

Question 12

What does the RBC model assume for markets?

Answer 12

• Perfectly competitive for final goods, capital and labor
• Supply = Demand, Simultaneously in all markets
• General Equilibrium Model

Question 13

What is the production technology function equal to?

Answer 13

• Production function has constant returns to scale

Question 14

State and Explain the Dynamic Budget Constraint

Answer 14

• Income - Consumption = Investment
• rtkt + wtht (Income as its the given amount of resources in each period) - Ct = Kt+1 -(1-depreciation rate)Kt ( This is the difference between capital available at t+1 and the undepreciated portion of Kt, essentially the new capital stock)

Question 15

What is the household maximization problem?

Answer 15

Question 16

What 2 assumptions do we make about household expectations?

Households know exactly what’s going on and how the economy works, allowing them to make the best possible forecast

Households know what will happen in the future

Answer 16

• Households knows exactly what’s going on and how the economy works, allowing them to make the best possible forecast
• Households know what will happen in the future