List and define the phases of a typical business cycle
- An expansionary phase characterized by rising growth in economic activity (real GDP)
- A peak, or high point of economic activity
- Contractionary phase characterized by declining growth in economic activity
- Trough, or low point of economic activity
Recovery phase, during which economic activity starts to increase and return to its long-term growth trend
How is a recession defined?
As a period during which real GDP (national output) is falling for at least two consecutive quarters.
Recessions are characterized by falling real output (negative real GDP growth) and rising unemployment.
What is the definition of a business cycle?
The rise and fall of economic activity relative to its long-term growth trend.
Business cycles vary in duration and severity.
Some cycles are quite mild; others are chracterized by large increases in unemployment and/or inflation.
Business cycles are also called economic fluctuations
What are the characteristics of a depression?
Very severe recession.
- Characterized by a sustained period of falling real GDP and high rates of unemployment.
For ex: during the height of the Great Depression, real GDP fell by approximately 33% and one of every 4 workers was unemployed
Economists generally agree that business cycles result from what?
Shifts in aggregate demand and aggregate supply
List the factors that shift aggregate demand.
- Changes in wealth
- Changes in real interest rates
- Changes in expectations about the future economic outlook
- Changes in exchange rates
- Changes in government spending
- Changes in consumer taxes
List the factors that shift short-run aggregate supply
- Changes in input (resource) prices
- Supply shocks
How is GDP calculated under the expenditure approach?
(GICE)
Summing total expenditures in the domestic economcy.
Calculated as:
(G)ovrnment purchases of goods and services
+ Gross private domestic (i)nvestments
+ Personal (c)onsumption expenditures
+ Net (e)xports (exports minus imports)
How is GDP calculated under the income approach?
(I PIRATED)
Summing the value of resource costs and incomes generated during the measurement period
Calculated as:
(I)ncome of proprietors
+(P)rofits of corporations
+(I)nterest (net)
+(R)ental income
+(A)djustments for net foreign income
+(T)axes (indirect business taxes)
+(E)mployee compensation (wages)
+(D)epreciation (capital consumption allowance)
What are the causes of demand-pull inflation and cost-push inflation?
Demand-pull inflation: caused by increases in aggregate demand.
Thus, demand-pull inflation could be caused by factors such as increases in government spending, decreases in taxes, increases in wealth, increases in consumer confidence, and increases in money supply.
Cost-push inflation is caused by reduction in short-run aggregate supply.
Thus, cost-push inflation could be caused by factors such as increase in oil prices and an increase in nominal wages
What is the difference between nominal GDP and real GDP?
Nominal GDP - measures value of all final goods and services produced within borders of a nation in terms of current dollars (i.e., prices prevailing at the time of production)
Real GDP - measures value of all final goods and services produced within the borders of a nation in terms of constance prices (i.e., the value of goods and services adjusted for changes in the price level)
Real GDP = (Nominal GDP/GDP Deflator) x 100
where GDP deflator is the price index used to adjust nominal GDP for changes in the overall prices of goods and services
Define gross domestic product (GDP)
Total market value of all final goods and services produced within the borders of a nation in a particular period.
GDP includes the output of foreign-owned factories in the U.S., but excludes the output of U.S. - owned factories operating abroad
Explain the relationship between interest rates and the money supply
Changes in the money supply directly affect interest rates through the money market.
Increase in money supply shifts money supply curve to the right and causes interest rates to fall.
Decrease in money supply shifts the money supply curve to the left and causes interest rates to rise.
Thus, an increase in the money supply leads to a decline in interest rates and a decline in the money supply leads to an increase in interest rates
List the 3 ways the Federal Reserve could increase the money supply
- Open market operations: Purchase government securities on the open market
- Changes in the discount rate: Lower the discount rate
- Changes in the required reserve ratio: Lower the required reserve ratio
What is the likely impact of a decrease in the money supply on the interest rates, real GDP, and the overall price level?
Decrease in money supply leads to an increase in interest rates.
As interest rates rise, cost of capital increases, leading to a decline in investment spending and a shift left in the aggregate demand curve.
As aggregate demand curve shifts left, real GDP and the overall price level fall.
Thus, a decrease in the money supply leads to:
1. Increase in interest rates
2. Decrease in real GDP
3. Decrease in overall price level
What is the fundamental law of demand, and what factors shift demand curves?
Fundamental law of demand: Price of a product/service and the quantity demanded of that product/service have an inverse relationship
Factors that shift demand curves include the mneumonic “WRITEN”:
- (W)ealth
- Prices of (r)elated goods
- Consumer (i)ncome
- Consumer (t)astes/preferences
- Consumer (e)xpectations
- (N)umber of buyers in a market
What is the fundamental law of supply, and what factors shift supply curves?
Fundatmental law of supply: price and quantity supplies are positively related. The higher the price received for a good, the more quantity sellers are willing to produce
Factors that shift supply curves include the mneumonic “ECOST”:
- Changes in price (e)xpectations of the supplying firm
- Production (c)osts
- Demand for (o)ther goods
- (S)ubsidies or taxes
- (T)echnology
Changes in equilibrium cause demand & supply curves to shift, and new equilibrium price and quantity result. In general, what effects do the following shifts in demand supply curves have?
- Shift right in the demand curve
- Shift left in the demand curve
- Shift right in the supply curve
- Shift left in the supply curve
- Shift RIGHT in the DEMAND curve: increase in demand, causing increase in price and market clearing quantity
- Shift LEFT in the DEMAND curve: decrease in demand, causing decrease in price and market clearing quantity
- Shift RIGHT in the SUPPLY curve: increase in supply, causing decrease in price and increase in market clearing quantity
- Shift LEFT in SUPPLY curve: decrease in supply, causing increase in price and decrease in market clearing quantity
Market clearing quantity = equilibrium quantity
Define cross elasticity of demand (supply) and demonstrate how it is calculated
Cross elasticity of demand (or supply) represent ths % change in quantity demandED (or suppliED) of a good due to the price change of another good
Cross elasticity = %change in # of units in X demanded (supplied) / % change in price of Y
What are the attributes and basic competitive strategies of pure (perfect) competition?
- Zero economic profit in the long run
- Large number of suppliers and customers acting independently
- Very little product differentiation
- No barriers to entry
- Firms are price-takers
- Strategies include maintaining market share and responsiveness to sales price
What are the attributes and basic competitive strategies of monopoly?
- Positive economic profit in the long run
- Single firm with a unique product
- Significant barriers to entry
- Ability of the firm to set output and prices (e.g., patents and restrictions against competition - firms are price setters)
- No substitute products
- Strategies include ignoring market share and focusing on profitability from production levels that maximize profits
What are the attributes and basic competitive strategies of monopolistic competition?
- Numerous firms with differentiated products
- Few barriers to entry
- Ability of firms to exert some influence over price but have more control over quantity produced
- Significant non-price competition in the market (to promote brand awareness and loyalty)
- Zero economic profits in the long run
- Strategic plans include maintaining the market share but also including a plan for enhanced product differentiation
What are the attributes and basic competitive strategies of oligopoly?
- Positive economic profit in the long run
- Relatively few firms with differentiated products
- Fairly significant barriers to entry (high capital costs, etc.)
- Strongly interdependent firms (prices tend to be fixed)
- Kinked demand curve (firms match price cuts but ignore price increases)
- Strategic plans focus on enhancing market share and call for the proper amount of advertising and ways to adapt to price and volume changes
Elasticity is the measure of how sensitive the demand for or the supply of a dproduct is to a change in its price.
Define price elasticity of demand and price elasticity of supply.
Price elasticity of demand: Percentage change in the quantity demanded divided by percentage change in price
Price elasticity of supply: Percentage change in the quantity supplied divided by percentage change in price
