Macroeconomics Principles - Short Run Fluctuations

Quiz 4/14 TuTh; FINAL 4/30!

Q: What is a recession?

A: A recession is a period of at least two quarters in which real GDP falls. (“Recessions are periods… in which real GDP falls.”)

Q: What is an economic boom?

A: A boom is a period of GDP expansion with rising employment and falling unemployment. (“Economic booms… associated with increasing employment and declining unemployment.”)

Q: What are the three key features of economic fluctuations?

A: Co‑movement, limited predictability, and persistence. (“Economic fluctuations have three key features: co‑movement, limited predictability, and persistence.”)

Q: What is co‑movement?

A: Many macro variables move together: consumption, investment, and employment move with GDP; unemployment moves opposite GDP. (“Variables… move positively… unemployment moves negatively.”)

Q: What does Okun’s Law describe?

A: For every 2% GDP falls below trend, unemployment rises about 1%. (“A useful rule of thumb… GDP falls… unemployment rises by about 1 percentage point.”)

Q: What is limited predictability?

A: Recessions and expansions cannot be forecast precisely; their turning points are unpredictable. (“Impossible to forecast… when the expansion will end.”)

Q: What are leading indicators?

A: Variables that move before the economy changes direction, such as the yield curve, consumer confidence, and stock market trends. (“Economists use leading indicators… yield curve… consumer confidence… stock market.”)

Q: What is persistence in economic growth?

A: Growth tends to continue next quarter; contraction tends to continue next quarter. (“When the economy is growing, it will probably keep growing… contracting… keep contracting.”)

Q: What causes recessions according to Real Business Cycle theory?

A: Productivity and technology shocks; increases in input prices like oil. (“Emphasizes changes in productivity and technology… increase in input prices… causes recessions.”)

Q: What causes recessions according to Keynesian theory?

A: Changes in expectations (“animal spirits”) that reduce spending, amplified by multipliers. (“Animal spirits… lead to decreases in spending… shock is amplified by multipliers.”)

Q: What causes recessions according to financial/monetary theory?

A: Changes in prices and interest rates; falling money supply lowers price level and raises real interest rates. (“A decrease in the money supply… price level to fall… increase in the real interest rate.”)

Q: What is downward wage rigidity?

A: Wages do not fall even when labor demand weakens. (“Wages tend not to fall even when labor demand weakens.”)

Q: Why are wages sticky downward?

A: Morale/effort, long‑term contracts, minimum wage laws, efficiency wages. (“Morale… long‑term contracts… minimum wage laws… efficiency wages.”)

Q: How does downward wage rigidity cause unemployment?

A: If wages can’t fall, firms cut employment instead, creating a gap between labor supplied and labor demanded. (“Unemployment: gap between quantity of labor supplied and quantity… demanded.”)

Q: What is a multiplier?

A: A process where an initial shock causes further income and spending changes, amplifying the effect. (“Multipliers can amplify the effects of any economic shock.”)

Q: What is the spending multiplier formula?

A: 1 / (1 – MPC). (“Multiplier = 1 / (1 – MPC).”)

Q: If MPC = 0.8, what is the multiplier?

A: 5. (“If MPC = 0.80… multiplier = 5.”)

Q: How do multipliers worsen recessions?

A: A fall in spending reduces income, which reduces spending again, shifting labor demand further left. (“Multipliers… shift the labor demand curve further to the left.”)

Q: What forces drive economic recovery?

A: Market forces and government policies. (“Many forces… reverse the effects… market forces… government policies.”)

Q: What market forces help recovery?

A: Inventory rebuilding, return of household spending, firm restructuring, technological advances, financial intermediation. (“Inventory rebuilding… households return… healthier firms… technological advances… financial intermediation.”)

Q: What government policies help recovery?

A: Expansionary monetary policy (lower interest rates) and fiscal policy (higher government spending or lower taxes). (“Monetary policy… lower interest rates… Fiscal policy: increase government spending and/or lower taxes.”)

Q: What triggered the Great Recession (2007–2009)?

A: A collapsing housing bubble, fall in household wealth, and a financial crisis. (“Three key factors… collapsing housing bubble… fall in household wealth… financial crisis.”)

Q: What triggered the 2020 COVID recession?

A: A pandemic causing both a demand shock and a supply/technology shock. (“Pandemic… demand shock… firms found it costly… technology shock.”)

Q: How severe was the COVID recession?

A: GDP fell nearly 10% in one quarter; unemployment peaked at 14.7%. (“Real GDP fell nearly 10%… unemployment… 14.7%.”)

Q: Why was the COVID recession short?

A: Massive and rapid government intervention. (“Recovery… aided by massive and rapid government intervention.”)

Q: How did the Great Recession and COVID recession differ?

A: Great Recession: financial crisis, slow recovery. COVID: pandemic, fast recovery, double shock. (Based on the comparison table.)

What is the yield curve?

When short-term interest rates exceed long-term rates (inverted yield curve), a recession often follows within 12–18 months.

What is consumer confidence?

Sharp drops in confidence often precede spending slowdowns.

What is the stock market?

Large, sustained declines can signal investor pessimism about future earnings.

What causes the labor demand curve to shift left at the beginning of a recession?

1. fall in output prices

2. A decrease in labor productivity

3. A rise in input prices

With flexible wages, what happens ?

a leftward shift in labor demand lowers wages but keeps more workers employed.

With rigid wages, what happens?

the wage stays fixed at 𝑊 ∗, and the firm responds by cutting employment to 𝐿2.

What does MPC stand for?

Marginal Propensity to Consume

How is the MPC defined?

the fraction of each additional dollar of income that households spend.

What was the double shock during COVID?

Demand Shock and a Supply Shock

What was the demand shock during COVID?

Consumers sharply cut spending due to fear of infection and job loss. Spending on travel, restaurants, and entertainment collapsed almost overnight.

What was the supply shock during COVID?

Firms could not operate safely or at all. Global supply chains broke down. Workers stayed home. This raised production costs (a technology shock).

How did the government respond to the double shock during COVID?

$2+ trillion in fiscal stimulus (CARES Act) and near-zero interest rates.