Econ 104 Professor Adrienne Kearney Review Questions Second Exam Spring 2013 Chapter 10 beginning with page 320 Packet pages 1 39 Lectures 2 7 2 19 1 What is a business cycle What are the four phases of a business cycle business cycle alternating periods of economic growth and contraction alternating periods of economic expansion and recession 4 Phases recession aggregate economic activity is falling production income employment rate declining real GDP growth 0 trough end of recession and expansion begins expansion aggregate economic activity is rising production income employment are rising real GDP growth 0 peak end of expansion and beginning of recession 2 What are the characteristics of a recession An expansion recovery When was the last recession in the U S characteristics of recession real GDP decreases consumption C decreases NI decreases investments I decreases profits decreases unemployment U increases retail sales decreases production decreases characteristics of an expansion recovery real GDP rises consumption C increases NI increases investments I increases profits increases unemployment U decreases retail sales increases production increases Last recession in the U S December 2007 June 2009 10 unemployment length 18 months change real GDP 8 9 3 What are the challenges confronting forecasters businesses and policymakers with respect to the business cycle What do we mean by economic indicators Why do we look at the other economic indicators besides real GDP Challenges Confronting Policymakers Businesses Forecasters 1 Length of recession expansion varies 2 Recession severity of decrease real GDP and increase U also varies 3 GDP release comes out quarterly after the end of the quarter end of the 1st month after quarter e g 4th quarter real GDP was released end of January policymakers need to anticipate recession before it occurs so they can jump in and decrease interest rates etc Business Cycle Economic Indicators used to forecast real GDP leading coincident lagging 4 What do we mean by leading coincident lagging indicators What are some examples of each leading peaks and troughs before real GDP peaks and troughs examples average labor productivity monthly average weekly hours monthly new orders monthly new building permits monthly stock prices reflect the long term profitability of firms daily indicator index of consumer confidence lagging monthly economic variables unemployment inventories and inflation that peak and trough after real GDP peaks and troughs examples unemployment rate monthly counter cyclical inventories to sales ratio inventories increase during recession because sales decrease and vice versa inflation growth in price level builds up during expansion indicator inflation and unemployment coincident economic variables that peak and trough at the same time as real GDP examples employment employment situations report indicates the number of new jobs created last month and unemployment for last month index of industrial production how many durable goods were produced last month refrigerators cars computers factories airplanes etc indicator employment 5 What causes business cycles changes in total expenditures result in changes in the business cycle GDP C I G NX when in recession aggregate total expenditures GDP if C decreases aggregate expenditures decreases pessimism e g uncertainty about the future in the part of HH s and firms C decreases I decreases firms cut back on production U increases profits decrease NI decreases vice versa Chapter 12 Packet pages 59 60 Lectures 2 19 3 12 1 In your own words what do we mean by Stabilization policy How is fiscal stabilization policy different from monetary stabilization policy in the case of recession Inflationary boom John Maynard Reynes argued that the economy 1 Was not self correcting and could remain below full employment indefinitely because aggregate spending was inadequate 2 Prescription government should play a role in restoring output at full employment stabilization policy 3 Modern macro was developed as a separate subject focus business cycles The General Theory of Employment Interest and Money 1936 2 How did the Great Depression revolutionize economic thought When did the Great Depression begin The 1920s in the US was a time of prosperity and an output growth of 4 6 per year a From 1920 1929 there was a 42 cumulative growth in GDP b stock prices soared c companies expanded adding new jobs and investing with additional funds d a decade of many new inventions ex refrigerators washing machines toasters consumer credit etc Great Depression began on October 29th 1929 Stock market crashed the misery of the Great Depression revolutionized economic thought 3 What are the major differences between the Keynesian and Classical theories Which theory is older How did Keynesian theory come about What is the Keynesian prescription for recession The Classical prescription Who is Adam Smith John M Keynes Classical theories founded by Adam Smith writer of The Wealth of Nations 1776 downturns in the business cycle were temporary forces of supply s and demand d at the price system would automatically restore full employment without government intervention because prices wages and interest rates would adjust John M Keynes wrote The General Theory of Employment Interest and Money in 1936 according to his theory and findings the economy was not correcting itself and it could remain below full employment indefinitely government should step in with a stabilization policy macroeconomics was born aggregate expenditures were inadequate therefore aggregate demand was weak and the US was out of equilibrium developed as a separate subject the focus Business Cycles 4 Define Consumption C What is the C function or equation What does the equation for consumption tell us How do we calculate disposable income DI or Yd Consumption C depends on disposable income as DI increases C increases DI National Income Taxes Transfers DI C S S saving as DI increases C increases S DI C wealth expectations of future The C function or equation MPC and MPS dissaving saving 5 What is breakeven income Yd C 6 Real disposable income not consumed is national income taxes transfers 7 What is the MPS The MPC MPS MPC 1 MPS marginal propensity to save MPC marginal propensity to consumers MPS MPC 1 8 Define what we mean by wealth wealth assets liabilities assets gold land car home financial assets shares of stock bonds savings etc liabilities credit card debt