Understanding Business Cycles
How do you calculated CPI?
(Cost of basket at current prices/cost of basket at base prices) x 100
What are characteristics of a trough?
1. GDP growth changes from negative to positive 2. High unemployment rate 3. Spending on consumer durable goods and housing may increase 4. Moderate or decreasing inflation rate
What are characteristics of a peak?
1. GDP growth rate decreases 2. Unemployment rate decreases but hiring slows 3. Consumer spending a business investment grow at slower rates 4. Inflation rate increases
What are characteristics of expansion?
1. GDP growth rate increases 2. Unemployment rate decreases 3. Inflation rate may increase 4.Imports increase as domestic income growth accelerates
What are characteristics of a contraction/recession?
1. GDP growth rate is negative 2. Unemployment rate increases 3. Consumer spending, home construction, and business investment decrease 4. Inflation rate decreases with a lag 5. Imports decrease as domestic income growth slows
What are determinants of the level of economic activity in the housing sector?
1. Mortgage rates 2. Housing costs relative to income 3. Speculative activity (buying houses thinking prices will increase and then selling them) 4. Demographic factors
What is inflation?
A persistent increase in price level over time
What is deflation?
A persistently decreasing price level commonly associated with deep recessions
What causes cost-push inflation?
An increase in the real price of an important factor of production such as wages or energy
What is disinflation?
An inflation rate that is decreasing over time but remains greater than zero
What is a producer price index (PPI) or wholesale price index (WPI)>
Average prices for a defined basket of producer goods
What did neoclassical school economists believe was the reason that AD and AS shifted?
Because of changes in technology over time
What do economists of the Austrian school think are the reason why business cycles occur?
Business cycles are caused by government intervention in the economy. Examples is when policymakers force interest rates down to artificially low levels
What causes demand pull inflation?
Can result from an increase in the money supply, increased government spending, or any change that increases AD
What is cyclical unemployment?
Caused by changes in the general level of economic activity. Cyclical unemployment is positive when the economy is operating at less than full capacity and can be negative when expansion leads to employment over full employment level
What is structural unemployment?
Caused by long run changes in the economy that eliminate some jobs while generating others for which unemployed workers are not qualified
What is a coincident indicator?
Change direction at roughly the same time as peaks are troughs
What are the 2 types of inflation?
Cost-push and demand pull
What are important factors that determine the level of a country's imports and exports?
Domestic GDP growth, GDP growth of trading partners, and currency exchange rates
What is a lagging indicator?
Don't tend to change direction until after expansions or contractions are already underway
What do Monetarists (views of Monetarist School) believe variations in AD that cause business cycles are caused by?
Due to variations in the rate of growth of the money supply, likely from inappropriate decisions by monetary authorities.
What is the real business cycle theory (RBC) by new classical school economists?
Emphasizes the effect of real economic variables such as changes in technology and external shocks. These economists argue that expansions and contractions are efficient market responses to real external shocks.
What are the 4 phases of the business cycle?
Expansion, peak, contraction or recession, trough
What are the 3 categories of unemployment
Frictional, structural, and cyclical
What happens once AD increases?
GDP is above full employment level, unemployment falls below its natural rate, there is upward pressure on real wages and a decrease in AS
What is a leading indicator?
Have been known to change direction before peaks or troughs in the business cycle
What is the difference between headline inflation and core inflation?
Headline inflation refers to price indexes for all goods Core inflation excludes food and energy since their prices are more volatile
How is expected inflation a source of wage pressure?
If workers expect inflation to increase, they will increase their wage demands accordingly
What is the labor force defined as?
Includes all people who are either employed or unemployed.
What is hyper inflation?
Inflation that accelerates out of control
What are Keynesians' views on the movement of AS curve?
It is hard to reduce AS and move the economy from recession back to full employment because wages are downward sticky and is hard to reduce.
What are the 3 categories of economic indicators?
Leading indicator, coincident indicators, lagging indicators
What is a price index?
Measures the average price for a defined basket of goods and services
Do business cycles occur in regular intervals
No
What is productivity (in the context of unemployment)?
Output per hour worked
What does the New Keynesian school believe about moving the economy from recession to full employment?
Prices of productive inputs other than labor are also downward sticky, presenting additional barriers to the restoration of full-employment.
What is cost-push inflation?
Results from a decrease in aggregate supply
What is demand pull inflation?
Results from an increase in aggregate demand
What is frictional unemployment?
Results from the time lag necessary to match employees who seek work with employers needing their skills. This type of unemployment is always with us.
What did Keynes believe were the primary cause of business cycles?
Shifts in the AD curve due to changes in expectations. Keynesian school economists believe fluctuations are primarily due to swings in the level of optimism of those who run businesses
What is the criteria to be considered unemployed?
Someone who is actively searching for work. Someone who has been seeking work unsuccessfully for several months is long-term unemployed.
What does it mean to be underemployed?
Someone who is is employed part time but wants to work full time, or someone who is employed at a low paying job despite being qualified for a higher paying job.
What is the consumer price index?
The best known indicator of U.S. inflation. Represents the purchasing patterns of a typical urban household
What did neoclassical school economists believe were the cause of business cycles?
The economy has a strong tendency toward full employment equilibrium, and that business cycles result from temporary deviations from long-run equilibrium
What is the Fisher index?
The geometric mean of the Laspeyres and Paasche
What is inflation rate?
The percentage increase in price level, typically compared to the prior year
What is unemployment rate defined as?
The percentage of people in the labor force who are unemployed.
What is participation ratio?
The percentage of working age population who are either employed or actively seeking employment
What is the natural rate of unemployment?
The rate associated with the absence of cyclical unemployment. But can be higher than this rate because every individual provides different quality of labor and some segments in the economy may have trouble finding enough qualified workers even during a contraction
What are Keynesians' views on the movement of AD curve?
They believe in increasing AD directly through monetary policy (increasing money supply) or fiscal policy (increasing gov spending or decreasing taxes)
What are discouraged workers?
Those who are available for work but are neither employed nor actively seeking employment.
What is the general rule of thumb for determining when an expansion or contraction is happening?
Two quarters of real GDP growth = expansion Two quarters of real GDP decline = contraction
What is the Laspeyres index?
Uses a constant basket of goods and services to calculate CPI (between two periods)
What is the Paasche index?
Uses the current consumption weights and prices for the base and current period to calculate CPI
What kind of people are excluded when calculating labor force?
Voluntarily unemployed people who choose not to be in the labor force.
What is the most important cost of production?
Wages
At what point during the business cycle does a firm see its inventory-sales ratio decrease below its normal level?
When contraction reaches its trough. Having reduced their production levels to adjust for lower sales demand, firms find their inventories becoming depleted more quickly once sales growth begins to accelerate
At what point during the business cycle does a firm see its inventory-sales ratio increase above its normal level?
When expansion is approaching its peak, sales growth begins to stop, and unsold inventories accumulate