Intermediate Macroeconomic Theory Chapter 8

The three main components of the aggregate demand-aggregate supply model include

AD, SRAS, LRAS.

Christina Romer argued that

measured properly, GNP before 1929 varied substantially less over time than the official statistics showed.

Define the following characteristics of business cycles: recurrence and persistence.

(1) Recurrence means that each complete cycle is followed by another complete cycle. (2) Persistence means that, once begun, each contraction tends to continue. Likewise, once begun, each expansion tends to continue. For example, the 1981-1982 contraction lasted for 16 months, and the 1982-1990 expansion lasted for 93 months. These are persistent events.

Identify the comovement (i.e., direction and timing) of the following variables over a business cycle: (a) industrial production; (b) unemployment; (c) nominal interest rates; (d) nominal money supply growth; and (e) investment.

(a) Industrial production is a procyclical and coincident variable. (b) Unemployment is a countercyclical variable whose timing is unclassified by the Conference Board. (c) Nominal interest rates are procyclical and lagging. (d) Nominal money supply growth is a procyclical and leading variable. (e) Investment includes inventory investment and residential investment, which are procyclical and leading variables; it also includes business fixed investment, which is a procyclical and coincident variable.

Suppose the economy is initially in long-run equilibrium. For each of the shocks listed below, explain the short-run effects on output and the price level. (a) A stock market crash reduces consumers' wealth. (b) Businesses decide to hold larger inventories. (c) The government cuts defense spending. (d) Foreign countries buy more U.S. goods.

(a) Output declines and the price level is unchanged. (b) Output rises and the price level is unchanged. (c) Output declines and the price level is unchanged. (d) Output rises and the price level is unchanged.

Suppose the economy is initially in long-run equilibrium. For each of the shocks listed below, explain the long-run effects on output and the price level. (a) Labor supply decreases. (b) The government shuts down the Bureau of Economic Analysis. (c) Productivity increases.

(a) Output declines and the price level rises. (b) Output is unchanged and the price level falls. (c) Output rises and the price level falls.

For each outcome below, tell what type of shift must have taken place in either the aggregate demand curve or the long-run aggregate supply curve. (a) In the short run, the price level is unchanged and output rises. (b) In the long run, the price level declines and output is unchanged. (c) In the long run, the price level rises and output declines.

(a) The aggregate demand curve shifts to the right. (b) The aggregate demand curve shifts to the left. (c) The long-run aggregate supply curve shifts to the left.

Use the NBER data in Table 8.1 in the textbook on U.S. business cycle turning points to calculate: a) the shortest business cycle from peak to peak; b) the shortest business cycle from trough to trough; c) the longest business cycle from peak to peak; and d) the longest business cycle from trough to trough.

(a) The shortest business cycle from peak to peak is 17 months, which extended from August 1918 to December 1919. This includes 7 months of contraction followed by 10 months of expansion. (b) The shortest business cycle from trough to trough is 28 months, which extended from July 1980 to October 1982. This includes 12 months of expansion followed by 16 months of contraction. (c) The longest business cycle from peak to peak is 128 months, which extended from July 1990 to March 2001. This includes 8 months of contraction followed by 120 months of expansion. (d) The longest business cycle from trough to trough is 128 months, which extended from March 1991 to November 2001. This includes 120 months of expansion followed by 8 months of contraction.

The long boom occurred in the

1980s and 1990s.

The longest economic expansion in the United States occurred during the

1990s

The Great Depression consisted of how many business cycles?

2

The long boom ended in

2001

You want to invest in a firm whose profits show large fluctuations throughout the business cycle. Which of the following would you invest in?

A corporation that depends heavily on business fixed investment

What are the two main components of business cycle theories?

A description of shocks and a model of how the economy responds to them

When plotted with the aggregate price level on the vertical axis and output on the horizontal axis, which of the following curves slopes downward?

AD

The Great Recession began in ________ and ended in ________.

December 2007; June 2009

Which of the following statements is true? A) Both nominal and real interest rates are procyclical and leading. B) Both nominal and real interest rates are procyclical and lagging. C) Nominal interest rates are procyclical and real interest rates are countercyclical. D) Nominal interest rates are procyclical and real interest rates are acyclical.

D) Nominal interest rates are procyclical and real interest rates are acyclical.

The longest contraction in American history occurred

During the 1870s

Which of the following is true?

Employment is procyclical and unemployment is countercyclical.

The widespread decline in the volatility of many macroeconomic variables after 1984 led economists to term this period the

Great Moderation.

When plotted with the aggregate price level on the vertical axis and output on the horizontal axis, which of the following curves is vertical?

LRAS

When a recession occurs, do economists expect it to be a temporary phenomenon? Or is there some degree of permanence? What is the empirical evidence?

Recent research suggests that recessions may contain permanent components. Some economists argue that only the 1973-1975 recession led to a permanent change in the U.S. economy, because it changed the economy's use of oil permanently. Other studies suggest that perhaps 30% of changes in real output are permanent and 70% are temporary for the postwar United States.

Who officially determines whether the economy is in a recession or expansion?

The National Bureau of Economic Research

Describe the major features of the business cycle. Be sure to discuss what variables are affected by the cycle, a description of the key features that are apparent in the data, how variables are related to one another, how regular the cycle is, and how predictable the cycle is.

The business cycle is defined as a fluctuation of aggregate economic activity. There are recurrent but not periodic movements of aggregate activity, with many variables moving in the same direction at the same time (comovement). Increases in aggregate economic activity are expansions, while reductions in aggregate economic activity are contractions, or recessions. Both expansions and contractions exhibit persistence, so once an expansion or contraction begins, it tends to last some time.

Suppose labor supply declined. Would this affect the aggregate demand curve or the aggregate supply curve? What would be the effect on output and the price level?

The decline in the labor supply shifts the long-run aggregate supply curve to the left, causing the price level to increase and output to decline.

A variable that tends to move at the same time as aggregate economic activity is called

a coincident variable

When aggregate economic activity is decreasing, the economy is said to be in

a contraction

A variable that tends to move in advance of aggregate economic activity is called

a leading variable

An economic variable that doesn't move in a consistent pattern with aggregate economic activity is called

acyclical

Real interest rates are

acyclical, while nominal interest rates are procyclical.

The trough of a business cycle occurs when ________ hits its lowest point.

aggregate economic activity

Stock and Watson found that ________ was responsible for about 20-30 % of the reduction in output volatility that occurred in the mid-1980s.

better monetary policy

Industries that are extremely sensitive to the business cycle are the

capital goods and durable goods sectors.

The CFNAI is a

coincident index based on 85 monthly variables.

The ADS Business Conditions Index is a

coincident index based on variables released with different frequencies.

The NBER's Business Cycle Dating Committee picks recession dates by looking at many variables, the four most important of which are industrial production, manufacturing and trade sales, nonfarm employment, and real personal income. These variables are known as

coincident indicators.

An economic variable that moves in the opposite direction as aggregate economic activity (down in expansions, up in contractions) is called

countercyclical

The worst recessions after World War II occurred

during 1973-1975 and 1981-1982.

Christina Romer's criticism of the belief that business cycles had moderated since World War II depended on the fact that

economists had left out important components of GDP, such as wholesale and retail distribution, transportation, and services, in their pre-World War II estimates.

Which of the following macroeconomic variables is the most seasonally procyclical?

expenditure on durable goods

Which of the following macroeconomic variables is procyclical and coincident with the business cycle?

industrial production

Which of the following macroeconomic variables would you exclude from an index of leading economic indicators?

industrial production

An economic variable that moves in the same direction as aggregate economic activity (up in expansions, down in contractions) is called

procyclical

According to classical macroeconomists, prices adjust ________ to shocks, so the government should ________.

rapidly; do little

Research on the effects of recessions on the real level of GDP shows that

recessions cause both temporary and permanent declines in real GDP, but most of the decline is temporary.

Which of the following macroeconomic variables is procyclical and leads the business cycle?

residential investment

In the long run, an increase in productivity would cause output to ________ and the aggregate price level to ________.

rise; fall

In the short run, an increase in export sales would cause output to ________ and the price level to ________.

rise; stay constant

Wars, new inventions, harvest failures, and changes in government policy are examples of

shocks

According to Keynesian macroeconomists, prices adjust ________ to shocks, so the government should ________.

slowly; fight recessions

In the long run, an increase in consumer spending would cause output to ________ and the price level to ________.

stay constant; rise

In the long run, an increase in government purchases of military equipment would cause output to ________ and the aggregate price level to ________.

stay constant; rise

Turning points in business cycles occur when

the economy hits the peak or trough in the business cycle.

The job finding rate is defined as

the probability that someone who is unemployed will find a job in the next month.

The 1973-1975 recession was caused by

the quadrupling of oil prices by OPEC.

The key difference between classical and Keynesian macroeconomists is their differing beliefs about

the speed at which prices adjust.

The idea that the business cycle is recurrent means that

the standard pattern of contraction-trough-expansion-peak occurs again and again in industrial economies.

Persistence is

the tendency for declines in economic activity to be followed by further declines, and for growth in economic activity to be followed by more growth.

Comovement is

the tendency of many economic variables to move together in a predictable way over the business cycle.

Economists use the term shocks to mean

typically unpredictable forces that have major impacts on the economy.