The Business Cycle

What are the key elements that the supply side describes?

(1) long run trend output (2) ∆ in potential output (capacity) (3) labor force growth + gains in worker productivity (4) independent of policies and exogenous to business cycle

What are the key elements that the demand side describes?

(1) measures actual output of the economy (2) real GDP (3) represents ∆'s in business cycle (4) influenced by monetary and fiscal policy

What factors causes the annual aggregate supply to grow?

(1) net growth in labor force (~1%/yr in US); diff btw ppl entering work force (e.g. high school and college grads) minus those leaving work force (e.g. retirees, deceased) (2) gains in worker productivity (~2%/yr in US); output per worker or number of workers to produce given level of output, improves w/ educ., experience, & advances in capital used by workers

How did the Great Recession affect supply-side growth?

1. decline of capital accumulation ∴ decr productivity 2. structural damage to labor market ∴ incr natural unemployment rate

During what period(s) of the business cycle is there an output gap? What is it? And why does it occur?

An output gap is the gap between actual output and full employment output and it appears during a downturn, recession, or recovery period.

What are inflationary pressures?

Demand-pull inflation: incr in quantity of money (∴incr agg demand) w/o corresponding incr in output (∆demand+no∆supply=inflation) Cost-pull inflation: cause by shock to supply side, e.g. ∆ in cost of oil, intermediate goods, labor, etc

What is the difference between an economic downturn and a recession.

During an economic downturn, the aggregate demand (AD) is growing at a slower rate than aggregate supply (AS) and there is a slowing rate of GDP growth. Once the real GDP growth turns negative, the economy enters into a recession.

Explain the typical actions under a monetary expansionary policy. When? Why? How?

Economic policy enact expansionary policies to stoke the economy out of a recession by increasing the amount of money in circulation. Typically, the Fed lowers interest rates which allows consumers more spendable income.

What is full employment and what is the full employment rate in the US?

Full unemployment is the rate of unemployment when just about anyone looking for a job is able to find one. This usually occurs during the peak of the business cycle. The full employment rate in the US is about 5% unemployment.

What factors cause the rise in prices during the peak of the business cycle?

Increase in input prices (i.e. intermediary goods) due to bottleneck of raw materials. Increase in labor costs (i.e. wages and benefits) to entice new employees. B/c demand is high during this period the ∆'s in production cost are passed along to consumers rather than absorbed by suppliers (max π).

Describe relationship between interest rates and inflation.

Interest rates and inflation are inversely related. As interest rates rise, consumers have less money to spend, therefore driving down consumption which slows the economic growth and inflation decreases. Oppositely, a fall in interest rates causes consumers to have more money which spurs the economy and raises prices. Interest rates are controlled by the Fed.

What events cause a shift in demand?

P.Y.N.T.E 1. Price of related goods: complementary or substitute goods 2. Income: normal or inferior goods 3. Number of buyers 4. Tastes: fashions, fads, seasonal 5. Expectations of buyers: what consumer expects to happen to good in recent future

Describe how aggregate demand changes throughout the business cycle.

Recession: negative rGDP, below potential output, large output gap, constant inflation Recovery: rGDP growing faster than AS growth, below potential output, shrinking output gap, constant inflation Peak: growing rGDP, above potential output, increase inflation Downturn: positive rGDP growth rate, growing slower than AS, high interest rate due to Fed policy

What are the 3 types of unemployment?

Structural: mismatch of jobs and workers due to lack of skills or change in technology Frictional: temp. transition btw jobs Cyclical: influenced by business cycle

What is the business cycle? How is it measured?

The business cycle is the fluctuation that an economy experiences over time due to economic growth measured by real GDP.

What does the supply side of a country's economy represent?

The supply side represents (long run) potential economic growth rather than (short run) actual growth (which is show by the demand side).

What is excess capacity? Describe its relevance to each part of the business cycle.

When actual output is less than potential output an economy exhibits an excess capacity; meaning there are underutilized resources or capital which, if employed/utilized, could allow for a higher level of production.

Draw the aggregate supply curve (AS). Label and describe features: Y{f}, excess capacity, output growth, inflation rate. Show growth in AS.

Y = actual output Y{f} = output at full employment