Reading 15. Understanding Business Cycles

A decrease in both the labor force participation ratio and the unemployment rate is most likely caused by: A an increase in discouraged workers. B an increase in underemployed workers. C a decrease in voluntarily unemployed persons.

A

A national government responds to a severe recession by funding numerous infrastructure projects using deficit spending. Which school of economic thought is most consistent with such action. A Keynesian B Monetarist C Neoclassical

A

A price index of goods and services that excludes food and energy is most likely used to calculate: A core inflation. B the GDP deflator. C headline inflation.

A

According to the Austrian school, the most appropriate government response to an economic recession is to: A allow the market to adjust naturally. B maintain steady growth in the money supply. C decrease the market rate of interest below its natural value.

A

An analyst writes in an economic report that the current phase of the business cycle is characterized by accelerating inflationary pressures and borrowing by companies. The analyst is most likely referring to the: A peak of the business cycle. B contraction phase of the business cycle. C early expansion phase of the business cycle.

A

An economic peak is most closely associated with: A accelerating inflation. B stable unemployment. C declining capital spending

A

If relative to prior values of their respective indicators, the inventory-sales ratio has risen, unit labor cost is stable, and real personal income has decreased, it is most likely that a peak in the business cycle: A has occurred. B is just about to occur. C will occur sometime into the future

A

The Austrian economic school attributes the primary cause of the business cycle to: A misguided government intervention. B the creative destruction of technological progress. C sticky price and wage expectations that exaggerate trends

A

The inflation rate most likely relied on to determine public economic policy is: A core inflation. B headline inflation. C index of food and energy prices

A

When aggregate real personal income, industrial output, and the S&P 500 Index all increase in a given period, it is most accurate to conclude that a cyclical upturn is: A occurring. B about to end. C about to begin

A is correct. Aggregate real personal income and industrial output are coincident indicators, whereas the S&P 500 is a leading indicator. An increase in aggregate personal income and industrial output signals that an expansion is occurring, whereas an increase in the S&P 500 signals that an expansion will occur or is expected to continue. Taken together, these statistics indicate that a cyclical upturn is occurring.

The least likely consequence of a period of hyperinflation is the: A reduced velocity of money. B increased supply of money. C possibility of social unrest.

A is correct. In hyperinflation, consumers accelerate their spending to beat prices increases and money circulates more rapidly.

Monetarists favor a limited role for the government because they argue: A government policy responses may lag. B firms take time to adjust to systemic shocks to the economy. C resource use is efficient with marginal revenue and cost equal.

A is correct. Monetarists caution policy effects can occur long after the need for which they were implemented is no longer an issue.

Date November 2010 December 2010 Goods Quantity Price Quantity Price Sugar 70 kg € 0.90 / kg 120 kg € 1.00 / kg Cotton 60 kg € 0.60 / kg 50 kg € 0.80 / kg Assuming the base period for 2010 consumption is November and the initial price index is set at 100, then the inflation rate after calculating the December price index as a Laspeyres index is closest to: A 19.2%. B 36.4%. C 61.6%.

A is correct. The Laspeyres index is calculated with these inputs: ● November consumption bundle: 70 × 0.9 + 60 × 0.6 = 99 ● December consumption bundle: 70 × 1 + 60 × 0.8 = 118 ● December price index: (118/99) × 100 = 119.19 ● Inflation rate: (119.19/100) - 1 = 0.1919 = 19.19%

Date November 2010 December 2010 Goods Quantity Price Quantity Price Sugar 70 kg € 0.90 / kg 120 kg € 1.00 / kg Cotton 60 kg € 0.60 / kg 50 kg € 0.80 / kg For the December consumption basket in Exhibit 1, the value of the Paasche index is closest to: A 116. B 148. C 160.

A is correct. The Paasche index uses the current product mix of consumption combined with the variation of prices. So for December, its value is (120 × 1 + 50 × 0.8)/(120 × 0.9 + 50 × 0.6) = (160/138) × 100 = 115.9

Current economic statistics indicating little change in services inflation, rising residential building permits, and increasing average duration of unemployment are best interpreted as: A conflicting evidence about the direction of economy. B evidence that a cyclical upturn is expected to occur in the future. C evidence that a cyclical downturn is expected to occur in the future.

B

Deflation is most likely to be associated with: A a shortage of government revenue. B substantial macroeconomic contraction. C explicit monetary policy to combat inflation.

B

During an economic recovery, a lagging unemployment rate is most likely attributable to: A businesses quickly rehiring workers. B new job seekers entering the labor force. C underemployed workers transitioning to higher- paying jobs.

B

The characteristic business cycle patterns of trough, expansion, peak, and contraction are: A periodic. B recurrent. C of similar duration

B

The discouraged worker category is defined to include people who: A are overqualified for their job. B could look for a job but choose not to. C currently look for work without finding it

B

A product is part of a price index based on a fixed consumption basket. If, over time, the product's quality improves while its price stays constant, the measured inflation rate is most likely: A unaffected. B biased upward. C biased downward.

B is correct. As the quality of a product improves, it satisfies people's needs and wants better. The measured inflation rate is skewed higher than otherwise unless an adjustment is made for the increase in the quality of the good. Even if the good's price had increased over time, the improvements in quality would still bias the measured inflation rate upward.

An economist expects the following: ● The decline in the unemployment rate will result in higher revenues for home retailers. ● A tighter labor market will put upward pressure on wages, compelling home retailers to raise prices. Which type of inflation best corresponds to the economist's expectations? A Stagflation B Cost- push inflation C Demand- pull inflation

B is correct. Cost- push inflation refers to the situation in which rising costs, usually wages, compel businesses to raise prices.

In a recession, companies are most likely to adjust their stock of physical capital by: A selling it at fire sale prices. B not maintaining equipment. C quickly canceling orders for new construction equipment

B is correct. Physical capital adjustments to downturns come through aging of equipment plus lack of maintenance.

According to Real Business Cycle models, an economic contraction is most likely caused by: A sticky wages. B rising energy prices. C a contraction in the money supply

B is correct. Real Business Cycle models conclude that expansions and contractions of the economy are responses to external shocks, such as supply shocks arising from advances in technology or changes in the relative prices of inputs (e.g., energy prices). An increase in energy prices shifts short- run aggregate supply to the left, resulting in higher prices and lower GDP.

The following presents selected commodity price data for July-August 2015: July 2015 August 2015 Goods Quantity Price Quantity Price Milk 18 €1.00/L 17 €1.00/L Orange juice 6 €2.00/L 4 €2.50/L Given the consumption basket and prices presented, which type of price index will result in the highest calculated inflation rate over a two- month time period? A One that uses a current consumption basket B One that uses a constant consumption basket C One reflecting substitutions made by consumers over time

B is correct. The inflation rate calculated by using a constant consumption basket (the Laspeyres index) is 10%, derived as follows: July 2015 consumption basket = (18 × €1) + (6 × €2) = €30 August 2015 consumption basket = (18 × €1) + (6 × €2.5) = €33 Value of the Laspeyres index (IL) = (€33/€30) × 100 = €110 Inflation rate = (110/100) - 1 = 0.10 = 10% The inflation rate calculated using a current consumption basket (the Paasche index) is 8%, derived as follows: July 2015 consumption basket = (17 × €1) + (4 × €2) = €25 August 2015 consumption basket = (17 × €1) + (4 × €2.5) = €27 Value of the Paasche index (IP) = (€27/€25) × 100 = €108 Inflation rate = (108/100) - 1 = 0.08 = 8% The inflation rate calculated by "chaining" the monthly prices of consumption baskets as they change over time (the Fisher index) is derived as follows: Value of the Fisher index = (Ip*Il)^1/2 Value of the Fisher Index = (110*108)^1/2 = €108.99 Inflation rate = (108.99/100) - 1 = 0.0899 = 8.99%

When the spread between 10- year US Treasury yields and the federal funds rate narrows and at the same time the prime rate stays unchanged, this mix of indicators most likely forecasts future economic: A growth. B decline. C stability

B is correct. The narrowing spread of this leading indicator foretells a drop in short- term rates and a fall in economic activity. The prime rate is a lagging indicator and typically moves after the economy turns.

During the contraction phase of a business cycle, it is most likely that: A inflation indicators are stable. B aggregate economic activity is decreasing. C investor preference for government securities declines

B is correct. The net trend during contraction is negative.

The category of persons who would be most likely to be harmed by an increase in the rate of inflation is: A homeowners with fixed 30- year mortgages. B retirees relying on a fixed annuity payment. C workers employed under contracts with escalator clauses

B is correct. With inflation, a fixed amount of money buys fewer goods and services, thus reducing purchasing power.

A central bank will most likely allow the economy to self- correct in periods of: A high inflation, fast economic growth, and low unemployment. B low inflation, slow economic growth, and high unemployment. C high inflation, slow economic growth, and high unemployment.

C

A decrease in a country's total imports is most likely caused by: A an increase in the pace of domestic GDP growth. B a cyclical downturn in the economies of primary trading partners. C persistent currency depreciation relative to primary trading partners.

C

Disinflation is best described as a: A decline in price levels. B negative inflation rate. C decline in the inflation rate.

C

Of the following statements regarding the Producer Price Index (PPI), which is the least likely? The PPI: A can influence the future CPI. B category weights can vary more widely than analogous CPI terms. C is used more frequently than CPI as a benchmark for adjusting labor contract payments.

C

The term that describes when inflation declines but nonetheless remains at a positive level is: A deflation. B stagflation. C disinflation

C

The treasury manager of a large company has recently left his position to accept a promotion with a competitor six months from now. A statistical employment survey conducted now should categorize the status of the former treasury manager as: A underemployed. B voluntarily unemployed. C frictionally unemployed.

C

The unemployment rate is considered a lagging indicator because: A new job types must be defined to count their workers. B multi- worker households change jobs at a slower pace. C businesses are slow to hire and fire due to related costs.

C

Which of the following indicators is most appropriate in predicting a turning point in the economy? A The Industrial Production Index B The average bank prime lending rate C Average weekly hours, manufacturing

C

Which of the following statements is the best description of the characteristics of economic indicators? A Leading indicators are important because they track the entire economy. B Lagging indicators in measuring past conditions do not require revisions. C A combination of leading and coincident indicators can offer effective

C

Which of the following is most likely to increase after an increase in aggregate real personal income? A Equity prices B Building permits for new private housing units C The ratio of consumer installment debt to income

C is correct. Aggregate real personal income is a coincident indicator of the business cycle and the ratio of consumer installment debt to income is a lagging indicator. Increases in the ratio of consumer installment debt follows increases in average aggregate income during the typical business cycle

Based on typical labor utilization patterns across the business cycle, productivity (output per hours worked) is most likely to be highest: A at the peak of a boom. B into a maturing expansion C at the bottom of a recession

C is correct. At the end of a recession, firms will run "lean production" to generate maximum output with the fewest number of workers.

The characteristic of national consumer price indexes which is most typically shared across major economies worldwide is: A the geographic areas covered in their surveys. B the weights they place on covered goods and services. C their use in the determination of macroeconomic policy.

C is correct. Central banks typically use consumer price indexes to monitor inflation and evaluate their monetary policies

Which of the following economic developments is most likely to cause costpush inflation? A Industrial capacity utilization rises to a very high level. B Labor productivity increases faster than hourly labor costs. C A shortage of trained workers emerges throughout the economy

C is correct. Cost- push inflation occurs when rising costs compel businesses to raise prices generally. A shortage of trained workers leads to wage pressures, and even if such shortages impact only certain sectors of the economy, the economy overall may experience inflationary pressure.

What is the most important effect of labor productivity in a cost- push inflation scenario? A Rising productivity indicates a strong economy and a bias towards inflation. B The productivity level determines the economy's status relative to its "natural rate of unemployment." C As productivity growth proportionately exceeds wage increases, product price increases are less likely.

C is correct. For productivity, or output per hour, the faster that it can grow, the further that wages can rise without putting pressure on business costs per unit of output.

The inventory/sales ratio is most likely to be rising: A as a contraction unfolds. B partially into a recovery. C near the top of an economic cycle

C is correct. Near the top of a cycle, sales begin to slow before production is cut, leading to an increase in inventories relative to sales.

As the expansion phase of the business cycle advances from early stage to late stage, businesses most likely experience a decrease in: A labor costs. B capital investment. C availability of qualified workers.

C is correct. When an economy's expansion is well established, businesses often have difficulty finding qualified workers.