3.1 The Economic Cycle

Question 1

Economic cycle definition

Answer 1

The repeated pattern of fluctuations in the short run economic growth and how it differs from the trend growth of an economy

Question 2

Boom definition

Answer 2

Period of above average short run economic growth

Question 3

Downturn definition

Answer 3

Period where short run economic growth falls from above average to below average

Question 4

Recession definition

Answer 4

Two successive quarters of a year where short run economic growth is negative

Question 5

Recovery definition

Answer 5

When short run economic growth starts to increase after a recession

Question 6

Characteristics of a boom

Answer 6

• high economic growth
• positive output gap
• near full employment
• demand-pull inflation
• high rates of investment, business confidence
• balance budget improves due to higher taxes revenues and less spending on welfare payments

Question 7

Characteristics of a recession

Answer 7

• negative economic growth
• negative output gap
• spare capacity
• demand-deficit unemployment
• low inflation rates
• balance budget worsens, less tax revenue and more spending of welfare payments
• less investment

Question 8

Output gap definition

Answer 8

Difference between actual growth and trend growth

Question 9

Positive output gap definition

Answer 9

Actual growth is higher than trend growth

Question 10

Why might there be a positive output gap?

Answer 10

• labour works overtime

- high productivity

Question 11

Negative output gap definition

Answer 11

Actual growth is below trend growth

Question 12

What does negative output gap’s produce?

Answer 12

Unemployment as there is spare capacity

Question 13

What does positive output gaps produce?

Answer 13

Increases in the price level due to excessive demand for goods and services than the productive capacity of the economy

Question 14

Why does the economic cycle occur, what factors can be linked to it?

Answer 14

• multiplier-accelerator model
• asset price bubbles
• animal spirits
• herding
• economic shocks

Question 15

What is the multiplier-accelerator model?

Answer 15

And explanation of the trade cycle where the multiplier and accelerator combine to magnify cyclical fluctuations in economic growth

Question 16

How does asset price bubbles affect the economic cycle?

Answer 16

Asset price bubbles lead to the wealth effect = more consumption. If these bubbles ‘burst’ falling prices lead to a strong downward wealth effect = further reduction in consumption = magnifying a downturn

Question 17

What are animal spirits?

Answer 17

The collective feeling of consumers and businesses confidence which can affect economic decisions such as those affecting consumption and investment
(Keynes theory)

Question 18

How do animal spirits effect the economic cycle?

Answer 18

If confidence is low within businesses and consumers, then even with e.g low interest rates the economy may remain in recession phase as it is ‘expected’ to be there

Question 19

What is herding?

Answer 19

Consumer and investor behaviour often moves in similar directions at the same time, where people imitate other people’s behaviour

Question 20

How does herding have an effect on the economic cycle?

Answer 20

People copy other people’s behaviour in both consumption and investment e.g. in shares or investing in properties. These have a large influence of the level of spending in an economy as large numbers (herds) of people get involved = influence boom or recovery in an economy