CFA Level I- Economics- Reading 11: Overview of the Business Cycle

A diffusion index: A. measures growth. B. reflects the consensus change in economic indicators. C. is roughly analogous to the indexes used to measure industrial production.

B. The diffusion indexes are constructed to reflect the common trends embedded in the movements of all the indicators included in such an index.

3 biases that affect Laspeyres index: [...] bias - Rather than consuming the same basket of goods and services, people will choose other goods and services that have a lower price. [...] bias - A constant consumption basket will not include new products unless it is regularly updated. [...] bias - Prices may rise to reflect the improved quality; this can be accounted for through hedonic pricing.

3 biases that affect Laspeyres index: Substitution bias - Rather than consuming the same basket of goods and services, people will choose other goods and services that have a lower price. New product bias - A constant consumption basket will not include new products unless it is regularly updated. Quality bias - Prices may rise to reflect the improved quality; this can be accounted for through hedonic pricing.

A common rule of thumb is to consider [...] as the beginning of an expansion and [...] as indicating the beginning of a contraction.

A common rule of thumb is to consider two consecutive quarters of growth in real GDP as the beginning of an expansion and two consecutive quarters of declining real GDP as indicating the beginning of a contraction.

A contraction or recession is associated with [...] in most sectors, with [...] typically decreasing.

A contraction or recession is associated with declines in most sectors, with inflation typically decreasing.

The most commonly used method of calculating price index is: A. Laspeyres index B. Fisher index C. Paasche index

A.

The unemployment rate is defined as the number of unemployed as a percentage of: A. the labor force. B. the number of employed. C. the working-age population.

A.

Which of the following statements is most accurate? Once the economy moves into the contraction phase of a typical business cycle, inflation: A. eventually decelerates, but with a lag. B. remains moderate and may continue to fall. C. continues its deceleration, which began during the slowdown phase.

A. A weakening economy and activity measures that are below potential signal the beginning of the contraction phase of the business cycle. After achieving its fastest rate of growth during the slowdown phase, inflation eventually begins to decelerate during the contraction phase, but with a lag.

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. 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.

As an economy starts to recover from a trough in the business cycle, the unemployment rate is most likely to: A. continue to rise with a decline in the number of discouraged workers. B. start to decline with an increase in the number of discouraged workers. C. continue to rise with an increase in the number of discouraged workers.

A. As the economy starts to recover, discouraged workers return to the labor force and start looking for jobs, which increases both the number of unemployed and the size of the labor force. The unemployment rate rises because the rise in the unemployed population is proportionately larger than the increase in the size of the labor force. B and C are incorrect because an increase in the number of discouraged workers typically occurs when the economy is contracting.

Durable goods have the most pronounced cyclical behavior because: A. they have a longer useful life. B. their purchase cannot be delayed. C. they are needed more than non-durable goods or services.

A. Because durable goods purchases usually replace items with longer useful lives, households usually postpone such purchases during economic downturns. Therefore, a weakness in durables spending may be an early indication of general economic weakness, and an increase in such spending may signal a more general cyclical recovery.

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 in the future.

A. Both inventory-sales and unit labor costs are lagging indicators that decline somewhat after a peak. Real personal income is a coincident indicator that by its decline shows a slowdown in business activity. The inventory-sales ratio tends to rise when sales initially decline. Companies don't slow down production until after they realize demand is less. So because this ratio is high, it indicates we're just past the peak. The unit labor costs tend to rise into the early stages of a recession, because the labor force is not being fully used. They can also rise late in a recovery when the labor market is tight. But right after the peak, the unit labor cost should be stable. The production levels will be steady. So this ratio also indicates we're just past the peak. The last indicator, real personal income, is a coincident indicator. That means it will help identify where we are in the economic cycle. If the real personal income has decreased, you must be past the peak. Before the peak the real personal income would be rising. The correct answer is "A". It is most likely that a peak in the business cycle has occurred.

Which of the following categories will most likely have a higher weight in the consumer price index of a developing economy relative to its weight in a developed economy's consumer price index? A. Food B. Apparel C. Transportation

A. Consumer price indexes use weights that are meant to reflect prices of items in a representative basket of goods and services. Consumers in developing economies typically spend a significantly higher share of their income on food compared to consumers in developed economies. On the other hand, developed economies are most likely to be driven by a larger apparel industry and a more advanced transportation system.

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. Discouraged workers have given up seeking employment and are statistically outside the labor force. Therefore, an increase in discouraged workers will decrease the labor force and thus the labor participation ratio, which is the ratio of labor force to total working age population. Additionally, an increase in discouraged workers will decrease the unemployment rate because discouraged workers are not counted in the official unemployment rate.

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

A. During a peak, there is a decelerating rate of growth. Hiring slows, and the unemployment rate continues to fall, but at a decreasing rate. Capital spending expands, but growth rate slows. And inflation continues to accelerate. Compare this list to the three answer choices. Inflation is accelerating during an economic peak, so answer choice "A" is correct. The unemployment rate is falling, not stable. So answer choice "B" is incorrect. And the capital spending is still expanding, but just growing at a slower rate. So answer choice "C" is also incorrect.

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. During the peak, inflation accelerates. The economy is going full throttle. But during the contraction phase, inflation decelerates. And during the early expansion phase, inflation will stay the same or continue to fall. So from the perspective of accelerating inflation, the correct answer is "A". Let's consider what happens with borrowing at the peak. During the peak, capital spending expands rapidly. Companies must finance this spending with either equity of debt. So borrowing will typically accelerate at the peak. The correct answer is "A".

Which of the following statements about employment levels over the course of a typical business cycle is most accurate? A. The unemployment rate remains high during the recovery phase B. Businesses slow their rate of hiring, causing the unemployment rate to begin to rise during the slowdown phase C. Adding employees on a part-time basis in order to meet rising demand is most common in the expansion phase

A. During the recovery phase of the business cycle, layoffs slow but unemployment remains higher than average. Businesses meet rising demand by relying on temporary, part-time employees and overtime rather than taking on more full-time employees. As the economy moves into the expansion phase, businesses become sufficiently confident to resume adding full-time employees in earnest. Although hiring slows during the slowdown phase of the business cycle, the unemployment rate continues to fall (albeit at a decreasing rate) until the economy begins to contract.

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. Hyperinflation is an extremely fast increase in the aggregate price level. This corresponds to a very high inflation rate, like 1000 percent per year. Hyperinflation usually occurs when large government spending is not backed by real tax revenue. So the government has to increase the money supply to keep spending. Hyperinflation can also be triggered by the shortage of supply after a war, or a prolonged period of economic distress. Let's consider the answer choices. A reduced velocity of money means consumers slow down their spending. Just the opposite occurs during hyperinflation. Consumers speed up their spending and try and beat the rising prices. So this is the correct answer. Reduced velocity of money is a least likely consequence of hyperinflation. Let's go ahead and look at the other two answer choices. An increased supply of money often occurs with hyperinflation. The government is intentionally increasing the money supply to keep up with its spending. The possibility of social unrest is very real with hyperinflation. Consumers panic because the money they hold becomes less valuable each day. The wages are not sufficient to buy basic necessities. The correct answer is "A".

An increase in spending on durable goods indicates [...] [...] income and economic [...]. A rise in the savings rate may signal economic [...].

An increase in spending on durable goods indicates higher disposable income and economic expansion. A rise in the savings rate may signal economic weakening.

An inflation index's failure to capture the impact of greater processing power in each new version of a particular computer included in the underlying basket of goods is most accurately described as: A. quality bias. B. substitution bias. C. new product bias.

A. Quality bias occurs when an inflation index fails to adequately reflect improvements in the quality of goods and services. For example, a new version of a computer may be 5% more expensive than the previous version while offering 20% more processing power. The price of the new computer is higher, but the cost per unit of processing power has decreased. New product bias is the failure of an inflation index to reflect consumers purchases of products that have yet to be included in the underlying basket of goods. Substitution bias impacts inflation indexes to the extent that they are unable to capture the impact of foregoing purchases of more expensive items in the basket in order to purchase less expensive items as substitutes.

The reason analysts follow developments in the availability of credit is that: A. loose private sector credit may contribute to the extent of asset price and real estate bubbles and subsequent crises. B. loose credit helps reduce the extent of asset price and real estate bubbles. C. credit cycles are of same length and depth as business cycles.

A. Studies have shown that loose credit conditions contribute to the extent of asset price and real estate bubbles that tend to be followed by crises.

The Laspeyres index uses: A. the base period consumption weights, prices from the current period, and prices in the current period. B. the current consumption weights, prices from the base period, and prices in the current period.

A. The Paasche index uses the current consumption weights, prices from the base period, and prices in the current period.

If a strengthening economy leads discouraged workers to return to an active employment search, the number of unemployed people would, at least initially, most likely: A. increase. B. decrease. C. remain unchanged.

A. The unemployed are defined as those who are actively seeking employment but are currently without a job. Discouraged workers are without a job but have given up searching for work and so are not classified as being unemployed. A strengthening economy will lead discouraged workers to once again actively search for work; they will be reclassified as unemployed, and at least initially, the number of unemployed people will increase and the unemployment rate will rise.

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

All else equal, imports rise with the pace of [...] GDP growth because rising [...] demand increases purchases of goods and services from [...]. Imports respond to the [...] cycle. Exports are dependent on cycles in [...]. A strong [...] GDP growth can increase exports even when [...] growth is weak. Currency appreciation leads to an increase in [...] and a decrease in [...] as [...] goods seem cheaper than [...] goods to the domestic population.

All else equal, imports rise with the pace of domestic GDP growth because rising domestic demand increases purchases of goods and services from abroad. Imports respond to the domestic cycle. Exports are dependent on cycles in the rest of the world. A strong global GDP growth can increase exports even when domestic growth is weak. Currency appreciation leads to an increase in imports and a decrease in exports as foreign goods seem cheaper than domestic goods to the domestic population

An expansion features [...] in most sectors of the economy, with increasing [...], [...], and [...].

An expansion features growth in most sectors of the economy, with increasing consumer spending, business investment and employment.

With which sector of the economy would analysts most commonly associate credit cycles? A. Exports B. Construction and purchases of property C. Food retail

B. Credit cycles are associated with availability of credit, which is important in the financing of construction and the purchase of property.

An individual has taken out a fixed-rate mortgage from a bank in order to finance the purchase of a home. A subsequent period of deflation would most likely have a negative impact on: A. the lender only. B. the borrower only. C. both the lender and the borrower.

B. During periods of deflation, the value of a fixed-rate liability increases in real terms. This is a negative development for the borrower, but a positive development for the lender.

Austrian economists stress the importance of [...] and argue that a recession is caused by [...] [...] and [...] [...] that leads to [...] in projects that will likely [...]. They say governments should [...] in the economy because business cycles arise from [...] that creates artificially[...] [...].

Austrian economists stress the importance of money and argue that a recession is caused by low interest rates and excessive credit that leads to over-investment in projects that will likely fail. They say governments should rarely intervene in the economy because business cycles arise from government intervention that creates artificially low interest rates.

An increase in new capital goods orders and a decrease in the weekly unemployment insurance claims are most accurately characterized as: A. providing contradictory indications. B. leading indicators of an economic expansion. C. coincident indicators of an economic expansion.

B.

The participation ratio is the percentage of the: A. labor force who are currently employed B. working-age population who are either employed or actively seeking employment. C. Working age population who are not employed but actively seeking employment

B.

The relative strength of an economic trend, as measured by the proportion of economic indicators moving in the same direction, is most likely provided by a: A. Paasche index. B. diffusion index. C. Laspeyres index.

B. A diffusion index reflects the proportion of indicators that are moving in a pattern that is consistent with the overall index. It serves to summarize the common elements of a group of data points. Paasche and Laspeyres indexes are used to assess price inflation.

An increase in the inventory-to-sales ratio most likely indicates that the business cycle: A. is in the expansion phase. B. has entered the slowdown phase. C. has transitioned from the contraction phase into the recovery phase.

B. After the business cycle has bottomed out, businesses begin to build up their inventories in order to meet rising demand. As the economy moves through the recovery and expansion stages, inventory levels continue to grow, but either at the same pace as sales growth or more slowly. The ratio of inventory-to-sales begins to increase as businesses continue to stockpile inventory while sales growth slows. This indicates that the economy is has entered the slowdown phase.

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. 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.

Orders for technology and light equipment decline before construction orders in a contraction because: A. businesses are uncertain about cyclical directions. B. they are easier to cancel than large construction contracts. C. businesses value light equipment less than structures and heavy machinery.

B. Because it usually takes much longer time to plan and complete large construction projects than for equipment orders, construction projects may be less influenced by business cycles.

Evidence that a country is experiencing cost-push inflation is most likely to be found by analyzing: A. commodity prices. B. the unemployment rate. C. the capacity utilization rate.

B. Cost-push inflation is characterized by rising prices of inputs causing companies to increase their prices. Because labor represents that highest proportion of costs incurred by businesses, the unemployment rate will likely provide the best information about whether an economy may be experiencing cost-push inflation. In the absence of information about the labor market, commodity prices are of limited use for this purpose. The capacity utilization rate is more likely to be used to indicate the presence of demand-pull inflation.

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. Homeowners with fixed 30-year mortgages means their mortgage payments would stay constant regardless of the general price increases in the economy due to inflation. That's good for homeowners, because the real cost of the mortgage payment will decline if inflation is high. So "A" is not the correct answer. Answer choice "B" is retirees relying on a fixed annuity payment. The income for these retirees is fixed. It will not rise with inflation. Ultimately, that will make the real value of these annuity payments go down, which is bad for the retirees. They will be able to buy less goods with their annuity payments. So we've found the correct answer. But let's go ahead and talk about answer choice "C". Workers under contracts with escalator clauses will have their pay increase with inflation. So they are protected against a rise in prices. That means they will not likely be harmed by an increase in the rate of inflation. The correct answer is "B".

Permanent income provides a better guide to: A. saving rates. B. spending on services. C. spending on durable goods.

B. Households adjust consumption of discretionary goods and services based on the perceived permanent income level rather than temporary earning fluctuations. Saving rates and durable goods consumption are more related to the short-term uncertainties caused by recessions.

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. In an economic recovery, new job seekers return to the labor force, and because they seldom find work immediately, their return may initially raise the unemployment rate.

Which of the following statements gives the best description of nowcasting? A. It is a method used to forecast future trends in economic variables based on their past and current values. B. It is a method used for real-time monitoring of economic and financial variables to continuously assess current conditions and provide an estimate of the current state. C. It is a technique used to study past relationships between variables to explain which ones have explained the path of a particular variable of interest.

B. Nowcasting involves the use of techniques to estimate the present state. A is incorrect because nowcasting aims to estimate the present, not forecast the future. C is incorrect because the focus of nowcasting is to estimate the current, present value of a variable, such as GDP.

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. Physical capital adjustments to downturns come through aging of equipment plus lack of maintenance. During a recession, companies try to reduce expenditures. They are often just trying to survive. Physical capital includes items like machinery, buildings, vehicles, and computers. They are all used in the production process, either directly or indirectly. Companies aren't likely to try and sell the physical capital at fire sale prices. That would mean they would not be able to produce more goods. Companies would only do this if they planned to permanently shut down production. It's more common to sell inventory at fire sale prices when desperate for cash. But inventory is not a part of physical capital. So answer choice "A" is incorrect. Companies are likely to cut back on equipment maintenance. This may not be a good long-term decision, but it does reduce expenses in the short-term. The lack of maintenance will reduce the value of the physical capital. Answer "B" is correct. It's not easy to cancel orders for new construction equipment. Those projects are planned far into the future, so it's difficult to make short-term adjustments. That's why answer choice "C" is incorrect.

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 the 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. Rising building permits—a leading indicator—indicate that an upturn is expected to occur or continue. Increasing average duration of unemployment—a lagging indicator—indicates that a downturn has occurred, whereas the lack of any change in services inflation—also a lagging indicator—is neither negative nor positive for the direction of the economy. Taken together, these statistics indicate that a cyclical upturn may be expected to occur.

All else equal, if 1 percent of discouraged workers in an economy are reclassified as voluntarily unemployed, the activity ratio will most likely: A. decrease. B. be unaffected. C. increase.

B. The activity ratio is calculated as the number of people in the labor force divided by the working age population. Note that the labor force only includes people with a job or actively looking for a job. Neither discouraged workers nor the voluntarily unemployed are considered to be actively seeking work, so both groups are excluded from the labor force. Reclassifying discouraged workers as voluntarily unemployed will have no impact on the activity ratio.

All else remaining equal, a decline in the average duration of unemployment most likely indicates that an economic: A. upturn is beginning. B. upturn has already occurred. C. downturn is forthcoming.

B. The average duration of unemployment is a lagging economic indicator because businesses wait until a downturn looks genuine before laying off employees and until recoveries look secure before rehiring. If there is a decline in the average duration of unemployment, then it means that companies have been hiring, which indicates that an economic upturn has already occurred. A is incorrect. Average duration of unemployment is a lagging indicator, not a coincident indicator. C is incorrect. Although the average duration of unemployment is a lagging indicator, it is more directly indicating that an upturn has been underway, not that a downturn is forthcoming.

Levels of capacity utilization are one of the factors that determine companies' aggregate need for additional capital expenditure. Which of the following is another factor that impacts the capital expenditure decision? A. The rate of unemployment. B. The composition of the economy's capacity in relation to how it can satisfy demand. C. The ability to re-instate orders canceled during the contraction stage.

B. The composition of the current productive capacity may not be optimal of the current structure of demand. C is incorrect because the ability to re-instate canceled orders is a matter that is relevant once the decision to increase capital expenditure is made.

The following table shows the trends in various economic indicators in the two most recent quarters: Economic Indicator Trend Interest rate spread between long-term government bonds and overnight borrowing rate: Narrowing New orders for capital goods: Declining Residential building permits: Declining Employees on non-agricultural payrolls: Turned from rising to falling Manufacturing and trade sales: Stable Average duration of unemployment: Small decline Change in unit labor costs: Rising Given the information, this economy is most likely experiencing a: A. continuing recession. B. peak in the business cycle. C. strong recovery out of a trough.

B. The first three indicators are leading indicators, and all of them are indicating an impending recession, which means the economy has reached the peak in this cycle. - Narrowing of interest rate spread meaning short-term interest rate exceeds long term rates, meaning ST rates are expected to fall and economic activities to be weakened. - Declining new orders and building permits signal decreased business expectations and construction activities. Non-agricultural payrolls and manufacturing and trade sales are coincident indicators. The trends in these two variables further indicate that the economy may begin to decline. The trends in the last two indicators—both lagging indicators—indicate that the economy may either continue to grow or it may be close to a peak. Aggregating the signals given by all three groups of economic indicators, it appears the economy may be near the peak of a business cycle.

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. 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 relative to potential output is decreasing. C. investor preference for government securities declines.

B. The net trend during contraction is negative. What happens during the contraction phase of a business cycle? Economic activity shows outright declines. Businesses first cut hours and freeze hiring. Then layoffs begin, which increases the unemployment rate. Spending is decreased for industrial production, housing, and consumer durable items. And inflation slows down, but with a lag. Take a look at the answer choices. During a contraction, the inflation rate goes down. It's not stable. So answer choice "A" is incorrect. Economic activity does decrease during a contraction. That means answer choice "B" is correct. And investors will prefer government securities during a contraction. Those are safe investments when the economy is going down. So answer choice "C" is incorrect.

After noting positive changes in the aggregate index of coincident economic indicators, an increase in the ratio of consumer installment debt to income would most likely help confirm that an expansion is: A. forthcoming. B. underway. C. ending.

B. The ratio of consumer installment debt to income is a lagging indicator. An increase in it, by itself, would be evidence that an upturn is already underway. This would confirm the implication of positive changes in coincident indicators that an expansion is in place. A is incorrect. Leading indicators indicate what is coming, but the ratio of consumer installment debt to income is a lagging indicator. The reason it is a lagging indicator is because consumers only borrow heavily when they are confident in the economy. C is incorrect. Although the ratio of consumer installment debt to income is a lagging indicator, it is more directly indicating that an upturn has been underway, not that the expansion is over because consumers only borrow heavily when they are confident in the economy.

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

B. The stages of the business cycle occur repeatedly over time but not at regular intervals (not periodic).

Business conditions and expectations: [...] conditions Utilization of capacity [...] and may begin to [...] the ability to respond to demand Increased [...] supported by growth in [...] and [...] Capital spending: Focused on capacity [...] New types of [...] needed to meet demand Purchase of [...] and [...] equipment Companies expand [...] space to new locations

Business conditions and expectations: Favorable conditions Utilization of capacity increases and may begin to limit the ability to respond to demand Increased investment spending supported by growth in earnings and cash flow Capital spending: Focused on capacity expansion New types of equipment needed to meet demand Purchase of heavy and complex equipment Companies expand warehouse space to new locations

Business cycles can be [...] by changes in credit. If a recession is accompanied by house and equity price busts, it will be [...] and last [...]. When recoveries are combined with rapid growth in credit and house prices, they tend to be [...]. Credit cycles are usually [...], [...], and [...]than business cycles. They tend to [...] before [...].

Business cycles can be amplified by changes in credit. If a recession is accompanied by house and equity price busts, it will be deeper and last longer. When recoveries are combined with rapid growth in credit and house prices, they tend to be stronger. Credit cycles are usually longer, deeper, and sharper than business cycles. They tend to boom before recessions.

Business cycles: a cycle consists of [...] occurring at about [...] in many economic activities, followed by similarly general [...], [...], and [...] which merge into the [...] phase of the next cycle; this sequence of events is [...] but not [...]; in duration, business cycles vary from more than [...] year to [...] or [...] years.

Business cycles: a cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general recessions, contractions, and revivals which merge into the expansion phase of the next cycle; this sequence of events is recurrent but not periodic; in duration, business cycles vary from more than 1 year to 10 or 12 years.

What are included in leading indicators? A. Employees on nonfarm payrolls; real personal income; index of industrial production; manufacturing and trade sales. B. Average duration of unemployment; inventory-sales ratio; change in unit labor costs; average prime lending rate; commercial and industrial loans; ratio of consumer installment debt to income; change in consumer price index. C. Average weekly hours in manufacturing; initial claims for unemployment insurance; manufacturers' new orders for consumer goods; manufacturers' new orders for non-defense capital goods ex-aircraft; Institute for Supply Management new orders index; building permits for new houses; S&P 500 equity price index; Leading Credit Index; 10-year Treasury to Fed funds interest rate spread; and consumer expectations.

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. 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 follow increases in average aggregate income during the typical business cycle. If the aggregate real personal income is rising, then the economy is also likely rising. An indicator that will likely rise after this is a lagging indicator. They have turning points that take place later than the overall economy. So lagging indicators tend to rise after the overall economy rises. Equity prices and building permits for new private housing units are both leading indicators. They tend to turn before the overall economy. So answer choices "A" and "B" are both incorrect. The ratio of consumer installment debt to income is a lagging indicator. It tends to go up after a cyclical upturn. Consumers borrow more when they are confident. So the correct answer is "C".

The impact of substitution bias will most likely be greatest if inflation is calculated using a: A. Fisher index. B. Paasche index. C. Laspeyres index.

C. An inflation rate determined by a Laspeyres index assumes that consumers purchase the same basket of goods as the previous period. If consumers substitute a more expensive good in the basket for a less expensive one, this shift is more likely to be captured by a Paasche index or a Fisher index (which is the geometric mean of the Paasche index and the Laspeyres index). Failure to capture such a shift is referred to as substitution bias.

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. At the end of a recession, firms will run "lean production" to generate maximum output with the fewest number of workers. At the peak of a boom, employers have a lot of employees. They've been responding to the increasing demand. But this leads to some inefficiencies, so the productivity per worker will go down. Answer choice "A" is incorrect. In the maturing expansion stage, business begin rehiring and overtime hours rise. This will reduce the productivity, as more worker-hours are brought into the process. So answer choice "B" is also incorrect. At the bottom of a recession, businesses are very lean. Workers have been cut, and hours have been reduced. The employers are trying to get the maximum output from a limited number of workers. They are just trying to survive the downturn. This will increase the productivity. The correct answer is "C". Productivity is most likely highest at the bottom of a recession.

The consumer price index (CPI) this year is 252. The CPI last year was 246. The inflation rate this year is closest to: A. 6.00%. B. 2.38%. C. 2.44%.

C. The inflation rate is measured as [(CPI this year - CPI last year)/CPI last year] × 100. In this case, [(252 - 246)/246] × 100 = 2.439%. A is incorrect. It is the difference between the two CPI numbers. B is incorrect. It uses 252 in the denominator instead of 246.

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. This effect makes unemployment rise more slowly as recessions start and fall more slowly as recoveries begin.

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. Central banks are the monetary authority in most economies. They closely monitor the domestic inflation rates to determine the appropriate monetary policy. A high inflation rate combined with fast economic growth and low unemployment could be a sign the economy is overheating. This could lead the central bank to try and cool down the economy, perhaps by raising short-term interest rates. This will slow down the economic growth. A low inflation rate combined with slow economic growth and high unemployment generally means the economy needs a jump start. The central bank can do this by lowering short-term interest rates, making it cheaper for individuals and businesses to borrow money. But if the inflation rate is high, unemployment is high, and the economy is slow, there's not much the central bank can do. This is called stagflation. Short-term economic policies aren't effective. So in this situation, the central bank lets the economy correct itself. The correct answer is "C". The central bank can't do much about stagflation.

The growth rate of economic activity most likely reaches its highest level during which phase of a typical business cycle? A. Recovery B. Slowdown C. Expansion

C. Economic activity declines during an economic contraction before stabilizing and resuming positive growth in the recovery stage of the business cycle and growing at an accelerated rate during the expansion stage. As the business cycle moves into its slowdown phase, the growth rate of economic activity is still positive but has begun to decelerate.

Holding the working-age population constant, if the labor force participation ratio declines while the number of people employed remains unchanged, the unemployment rate will most likely: A. increase. B. remain unchanged. C. decrease.

C. For a given working-age population, a decline in the labor force participation rate, often because of an increase in discouraged workers, reduces the labor force. If the number of people employed remains the same while the labor force is smaller, the number of workers defined to be unemployed must be smaller and the unemployment rate lower.

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. Leading economic indicators have turning points that usually precede those of the overall economy. Average weekly hours, manufacturing is a leading economic indicator. The Industrial Production Index is a coincident economic indicator, and the average bank prime lending rate is a lagging economic indicator.

The characteristic of national consumer price indexes that is most likely 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. Most countries use a consumer price index to track inflation in their domestic economy. The categories of goods and services, or the consumption basket, varies by country. For example, food weights are less in developed countries. That knocks out answer choice "B". Some countries collect data for both urban and rural areas. Others only focus on urban areas, like the CPI-U in the United States. That eliminates answer choice "A". Central banks typically use a consumer price index to monitor inflation. This helps determine monetary policy. That's consistent with answer choice "C". The correct answer is "C".

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. Near the top of a cycle, sales begin to slow before production is cut, leading to an increase in inventories relative to sales. As a contraction unfolds, companies will have already reduced production levels, effectively reducing the inventory to account for the lower sales during this phase of the economic cycle. This will keep the inventory to sales ratio at normal levels. The ratio will not be rising. So answer choice "A" is incorrect. Partially into a recovery, the sales will trend up. But it will take companies a while to ramp up production. So the inventory will be going down, while the sales are going up. This will cause the inventory to sales ratio to fall. So answer choice "B" is also incorrect. Near the peak of the economic cycle, sales begin to slow, but production cuts will lag. This will drive up the inventory. So the inventory is going up, and the sales are going down. That will clearly cause a rise in the inventory to sales ratio. The correct answer is "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 PPI reflects the price changes experienced by domestic producers in a country. These price increases may eventually be passed on to consumers, so the PPI can influence the future CPI. That means answer choice "A" is incorrect. This is not a least likely choice, because it's likely the PPI will influence the future CPI. The weights for the goods used by domestic producers varies by country. The weights also vary for the CPI basket of goods. But with the PPI, the weight differences by country can be more dramatic, because countries can specialize in different industries. That knocks out answer choice "B". It's also not least likely correct. The terms of labor contracts and commercial real estate leases may adjust periodically according to the CPI. Recurring payments in business contracts are commonly linked to the PPI. That means answer choice "C" is correct. The PPI is not used more frequently than the CPI as a benchmark for adjusting labor contract payments.

Which one of the following trends in various economic indicators is most consistent with a recovery from a recession? A. A declining inventory-sales ratio and stable industrial production index B. A rising broad stock market index and unit labor costs turning from increasing to decreasing C. A decrease in average weekly initial claims for unemployment insurance and an increase in aggregate real personal income

C. The improving leading indicator, average weekly initial claims for unemployment insurance, and the improving coincident indicator, aggregate real personal income, are most consistent with an economic recovery. Even though a declining inventory-to-sales ratio, a lagging indicator, is consistent with an early recovery, the coincident indicator, the stable industrial production index, does not support that conclusion. Although a rising stock market index can signal economic expansion, the lagging indicator, the unit labor costs, has peaked, which is more consistent with a recession.

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. When a nation's currency depreciates, domestic goods seem cheaper than foreign goods, placing downward pressure on demand for imports. When the depreciation persists for some time, the country's total imports are likely to decrease.

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. When an economy's expansion is well established, businesses often have difficulty finding qualified workers. In the late expansion stage, businesses begin rehiring, and overtime hours rise. This will increase the labor costs. So answer choice "A" is incorrect. During the early expansion, spending increases in areas like housing and durable consumer items. But during the late expansion, the upturn in spending becomes more broad-based. So capital investments will increase as you move from the early stage to the late stage. Answer choice "B" is also incorrect. The unemployment rate remains high during the early expansion, but falls during the late expansion. That means the availability of qualified workers will decrease as you move from the early stage to the late stage. The correct answer is "C".

Imports most clearly respond to: A. the level of exports. B. domestic industrial policy. C. domestic GDP growth rate.

C. As a part of aggregate demand, imports reflect the domestic needs for foreign goods, which vary together with domestic economic growth.

Contraction Business conditions and expectations: [...] in demand, profits, and cash flows Capital spending: Existing orders are [...] and companies [...] placing new orders [...] and [...] equipment with [...] lead times get cut first, then cutbacks in [...] equipment and [...] follow Scale back on [...]

Contraction Business conditions and expectations: Fall in demand, profits, and cash flows Capital spending: Existing orders are canceled and companies stop placing new orders Technology and light equipment with short lead times get cut first, then cutbacks in heavy equipment and construction follow Scale back on maintenance

Contraction: Investors turn to [...] assets and shares of companies with [...] and [...] cash flows. The [....] of a [...] income stream increases when [...] is falling.

Contraction: Investors turn to safer assets and shares of companies with steady and positive cash flows. The marginal utility of a safe income stream increases when employment is falling.

Credit cycles refer to cyclical [...] in [...] and the availability of [...]([...]). Typically, lenders are [...] willing to lend and tend to offer [...] interest rates during economic expansions and are [...] willing to lend and require [...] interest rates when the economy is slowing (contracting).

Credit cycles refer to cyclical fluctuations in interest rates and the availability of loans (credit). Typically, lenders are more willing to lend and tend to offer lower interest rates during economic expansions and are less willing to lend and require higher interest rates when the economy is slowing (contracting).

Cyclical unemployment is positive when the economy is operating at [..........] and can be negative when an [...] leads to employment temporarily over the [...] [...] level.

Cyclical unemployment is positive when the economy is operating at less than full capacity and can be negative when an expansion leads to employment temporarily over the full employment level.

Demographic factors: The proportion of the population in the 25- to 40-year-old segment is [...] related to activity in the housing sector because these are the ages of [...] household formation.

Demographic factors: The proportion of the population in the 25- to 40-year-oldsegment is positively related to activity in the housing sector because these are the ages of greatest household formation.

During a peak, the rates of increase in [...], [...], and [...] slow but remains positive, while [...] accelerates.

During a peak, the rates of increase in consumer spending, business investment, and employment slow but remains positive, while inflation accelerates.

During a trough, the economy begins a new [...] or [...], [...] becomes positive again and [...] is typically moderate, but [...] growth may not start to increase until the [...] has taken hold convincingly.

During a trough, the economy begins a new expansion or recovery, economic growth becomes positive again and inflation is typically moderate, but employment growth may not start to increase until the expansion has taken hold convincingly.

Slowdown: During the boom, prices for risky assets [...] while prices for safe assets, such as government bonds, [...]. Concern over higher [...] drives higher [...].

During the boom, prices for risky assets increase while prices for safe assets, such as government bonds, decrease. Concern over higher inflation drives higher nominal yields.

Housing costs relative to income: When incomes are cyclically [...] relative to [...] costs, including [...] costs, home buying and construction tend to [...]. Housing activity can [...] even when incomes are [...] late in a cycle if [...] prices are [...] faster than [...], leading to [...] in purchase and construction activity in the housing sector.

Housing costs relative to income: When incomes are cyclically high relative to housing costs, including mortgage costs, home buying and construction tend to increase. Housing activity can decrease even when incomes are rising late in a cycle if housing prices are rising faster than incomes, leading to decreases in purchase and construction activity in the housing sector.

[...] are an important business cycle indicator for firms

Inventory - sales ratio are an important business cycle indicator for firms

Core inflation can sometimes be a more useful measure of the underlying trend in prices because...

It excludes price increase of food and energy, which are more volatile than prices of other goods.

Keynesian economists believe shifts in [...] due to excessive [...] or [...] cause business cycles and that contractions can persist because of [...] [...]. Government should [...] during an economic recession by increasing its [...] [...]. New Keynesians believe input prices other than wages are also slow to move downward.

Keynesian economists believe shifts in aggregate demand due to excessive optimism or pessimism cause business cycles and that contractions can persist because of sticky wages. Government should intervene during an economic recession by increasing its fiscal deficit. New Keynesians believe input prices other than wages are also slow to move downward.

Monetarists believe inappropriate changes in the [...] cause business cycles, and that [...] growth should be maintained at a moderate and predictable rate to support the growth of real GDP. Monetarists suggest minimal government intervention because [............].

Monetarists believe inappropriate changes money supply growth cause business cycles, and that money supply growth should be maintained at a moderate and predictable rate to support the growth of real GDP. Monetarists suggest minimal government intervention because the timing of the impact from government policies is uncertain.

Important determinants of the level of economic activity in the housing sector are (4)

Mortgage rates Housing costs relative to income Speculative activities Demographic factors

Mortgage rates: [...] interest rates tend to [...] home buying and construction while [...] interest rates tend to [...] home buying and construction.

Mortgage rates: Low interest rates tend to increase home buying and construction while high interest rates tend to reduce home buying and construction.

Neoclassical economists and the Real Business Cycle (RBC) advocates believe that the expansion and contraction in the business cycle represent [...] responses to [...] shocks. The level of economic activity at any time [...] [...] and fluctuations in the cycle are [...]. Policy recommendation is for governments to [...] as it will [...] in the economy. The theory advocates removing [...] [...]. If all market participants are [...] [...], then the prices should adjust quickly. Policies should not prevent Schumpeterian "[...] [....]". This refers to [...] from innovations that can cause shifts in the [...] which should [...] by [...].

Neoclassical economists and the Real Business Cycle (RBC) advocates believe that the expansion and contraction in the business cycle represent efficient economic responses to external shocks. The level of economic activity at any time maximizes expected utility and fluctuations in the cycle are temporary. Policy recommendation is for governments not to intervene as it will cause lags in the economy. The theory advocates removing information asymmetries. If all market participants are well informed, then the prices should adjust quickly. Policies should not prevent Schumpeterian "creative destruction". This refers to disruptions from innovations that can cause shifts in the supply curve which should not be intervened by government.

Spending on durable goods throughout the business cycle: Recovery: Expansion: Slowdown: Contraction:

Spending on durable goods throughout the business cycle: Recovery: Spending limited as households postpone spending. Expansion: Spending increases. Slowdown: Spending above average. Contraction: Purchases postponed; spending decreasing.

Spending on non- durable goods throughout the business cycle:

Spending shows little change through the cycle.

Summary of business cycle characteristics (GDP growth, employment, consumer spending, investment, imports/exports and inflation in each phase of the cycle)

Recovery: - GDP growth rate stops decreasing and starts increasing - Higher than average unemployment rate, increasing use of overtime and temporary workers. - Spending on consumer durable goods and housing may increase. - Moderate or decreasing inflation rate. Expansion: - GDP growth rate increases - Unemployment rate decreases as hiring increases. - Investment increases in producers' equipment and home construction. - Inflation rate may increase. - Imports increase as domestic income growth accelerates. Slowdown: - GDP growth rate decreases. - Unemployment rate decreases but at slower rate as hiring slows. - Consumer spending and business investment grow at slower rates. - Inflation rate increases. Contraction/recession: - GDP growth rate is negative. - Hours worked decrease, unemployment rate increases. - Consumer spending, home construction, and business investment decrease. - Inflation rate decreases with a lag. - Imports decrease as domestic income growth slows.

Recovery: Business conditions and expectations: [...] [...] of capacity results in [...] capacity and [...] need for capacity expansion [...] interest rates support investment Capital spending: [...] but [...], with a focus on [...] rather than [...] [...] producer equipment and equipment with a [...] rate of obsolescence are reinstated first

Recovery: Business conditions and expectations: Low utilization of capacity results in excess capacity and little need for capacity expansion Low interest rates support investment Capital spending: Low but increasing, with a focus on efficiency rather than capacity Light producer equipment and equipment with a high rate of obsolescence are reinstated first

Employment during business cycle: Recovery: Layoffs are [...]. Businesses rely on [...] before [...]. Unemployment is [...] than average. Exapnsion: Businesses move from [...] and [..] to [...]. Unemployment rate [...] and starts [...]. Slowdown: Businesses continue [...] at a [...] pace. Unemployment rate continues to [...] at [...] rates. Contraction: Businesses [...] hours, [...] overtime, and [...] hiring, followed by [...]. Unemployment rate starts to [...].

Recovery: Layoffs are slow. Businesses rely on overtime before hiring. Unemployment is higher than average. Exapnsion: Businesses move from overtime and temporary employees to hiring. Unemployment rate stabilizes and starts falling. Slowdown: Businesses continue hiring at a slower pace. Unemployment rate continues to fall at decreasing rates. Contraction: Businesses cut hours, eliminate overtime, and freeze hiring, followed by layoffs. Unemployment rate starts to rise.

Spending on services: throughout the business cycle:

Recovery: Spending below average Expansion: Spending increases Slowdown: Spending above average Contraction: Spending declines

[...] slow faster than [...] when the economy is in the slowdown phase, causing a [...] in inventory-sales ratio. When the economy is in contraction, companies often [...] prices to unload [...] inventories. The inventory-sales ratio begins to [...] back to normal. When demand bounces back, [...] will often drop because [...] cannot keep pace with [...]. The [...] in the inventory-to-sales ratios will encourage companies to increase production. The expansion phase is the stage of [...].

Sales slow faster than production when the economy is in the slowdown phase, causing a spike in inventory-sales ratio. When the economy is in contraction, companies often reduce prices to unload surplus inventories. The inventory-sales ratio begins to fall back to normal. When demand bounces back, inventories will often drop because production cannot keep pace with sales. The drop in the inventory-to-sales ratios will encourage companies to increase production. The expansion phase is the stage of inventory restocking.

Slowdown Business conditions and expectations: [...] business conditions with [...] cash flows [...] interest rates avoid [...] of the economy Capital spending: [...] orders as companies operate [...] capacity

Slowdown Business conditions and expectations: Peak business conditions with healthy cash flows Higher interest rates avoid overheating of the economy Capital spending: New orders as companies operate at or near capacity

Speculative activity: [...] home prices can lead to purchases based on [...] of further [...]. [...] prices led to [...] construction and eventually [...] building. This resulted in [...] prices that [...] or [...] speculative demand and led to dramatic [...] in housing activity overall

Speculative activity: rising home prices can lead to purchases based on expectations of further gains. Higher prices led to more construction and eventually excess building. This resulted in falling prices that decreased or eliminated speculative demand and led to dramatic decreases in housing activity overall

The business cycles has 4 phases: [...] or going through a [...] (real GDP stops [...] and begins [...]), [...] (real GDP is [...]), [...] or going through a [...] (real GDP stops [...] and begins [...]) and [...] or [...] (real GDP is [...]).

The business cycles has 4 phases: recovery or trough (real GDP stops decreasing and begins increasing), expansion (real GDP is increasing), slowdown or going through a peak (real GDP stops increasing and begins decreasing) and contraction or recession (real GDP is decreasing).

Expansion: The later part of an economic expansion is called the [...] phase, during which the economy is operating at [...] full capacity and is at risk of [...]. Companies compete for [...] by raising [...] and continue to [...] capacity through strong [...] and [...].

The later part of an economic expansion is called the boom phase, during which the economy is operating at above full capacity and is at risk of overheating. Companies compete for qualified workers by raising wages and continue to expand capacity through strong cash flows and borrowing.

The stage of a credit cycle helps investors: Understand developments in the [...] and [...] markets Assess the extent of business cycle [...] and [...], particularly the severity of a [...] if it coincides with the [...] phase of the credit cycle Anticipate [...] actions

The stage of a credit cycle helps investors: Understand developments in the housing and construction markets Assess the extent of business cycle expansions and contractions, particularly the severity of a recession if it coincides with the contraction phase of the credit cycle Anticipate policymakers' actions

Recovery: When an expansion is expected, risky assets will be repriced [...] as the markets start incorporating [...] profit expectations into the prices of corporate bonds and stocks. Equity values typically [...] [...] to [...] months before the overall economy reaches its trough.

When an expansion is expected, risky assets will be repriced upward as the markets start incorporating higher profit expectations into the prices of corporate bonds and stocks. Equity values typically bottom out three to six months before the overall economy reaches its trough.

3 categories of unemployment

frictional, structural, cyclical