econ chap 9 review

What is the trade/business cycle, and what does it show about an economy over time?

the cycle represents the health of the economy over time. Shows how it grows, declines, its peaks, and recessions. Helps predict regulations and policies

Describe the five typical phases of the trade cycle and what happens to output and employment in each.

• expansion: economic activity increases and causes higher production levels. This makes more output because businesses can produce more goods to meet demand. This also increases more employment because companies more workers to meet demand

• peak: the economy reaches its maximum output and production is at its highest. Employment is at its highest

• contraction (recession): after the peak, economy will start to slow down and output will slowly decline because of decreased demand. Employment will begin to decrease and may cause layoffs

• trough: the lowest point of the cycle. output is at its minimum and economy doesn’t grow. Employment is at its lowest

• recovery: the economy starts to recover and output begins to rise as demand picks up. employment will also begin to rise again

Lines A, B, and C are often shown on a trade cycle diagram. What does each represent, and why are these lines important for understanding economic performance?

• line A: actual output

  • measures real GDP

  • Shows how the economy performs at a specific moment by comparing it to its potential output to see what stage it is at (5 stages)

• Line B: potential/trend output

  • shows the potential output an economy can produce when resources are used to the max

  • shows economic performance (underperforming is when line A is below B). (Overheating is when actual is above potential, causing inflation)

• line C: Long-term trend line

  • shows the long-term growth trajectory of the economy

  • helps show fluctuations to predict the general growth over time

What does the vertical distance between the trend line (A) and the actual output line (C) represent, and what does it tell us about the economy?

• the vertical distance between these lines show the output gap. it shows the difference between the actual output and the potential output

• positive output gap (actual over potential): economy is overheating → inflation, less unemployment

• negative output gap (actual < potential): economy is underperforming → more unemployment

Why is line B (the long-term growth trend) significant when analyzing business cycles?

• the long-term growth trend helps assess economic performance to see short-term fluctuations and long-term trends

• helps see the growth and declines

  • economists can help predict trends about the economy

When the government increases spending, a multiplier effect occurs. Why does a rise in the marginal propensity to save (MPS) weaken this multiplier?

• multiplier effect: an initial change in spending causes an increase in economic activity

  • one person’s spending becomes another’s income

• a rise in MPS weakens this multiplier because individuals save additional income rather than spending it. This reduces overall spending within the economic and creates less economic stimulation

In the circular flow of income, why must injections equal withdrawals for an economy to be in equilibrium? Explain.

• circular flow of income: how money moves through an economy

  • production creates income, income is spent for goods

• injections (government spending, investments of businesses, exports)

• withdrawals (taxes, savings, imports)

  • it creates equilibrium because injections allow money to come into the economy while withdrawals allow money to leave the economy. the balance helps create consistency in the economy

  • more injections: increased demand, inflation

  • more withdrawals: decreased demand and production, more unemployment.

Define aggregate demand (AD) in your own words.

the total amount of goods and services that all consumers, businesses, government individuals and foreign buyers are willing to purchase in a given price and time period. Considers the imports, exports, investments, government spending, and consumption

List and briefly describe the five components of aggregate demand.

• consumption: spending by households on goods and services

• investments: spending by businesses on capital goods

• government spending: spending by government officials for public goods and services

• exports: goods and services being sold to other markets

• imports: goods and services being bought by the country

What are the major determinants of consumption, and how can they influence total spending in the economy?

• Income levels: the amount of money households make

  • with more income, there is more spending and vice versa

• consumer confidence: how optimistic consumers are about the economy and their own financial decisions

  • more confidence leads to more spending due to financial security, and vice versa

• wealth: how changes in household wealth influence consumer spending (stock marketing and real estate)

  • wealthier individuals tend to spend more on goods and vice versa

• interest rates: how consumers are likely to borrow something (homes, cars) and spend

  • low interest rates lead to borrowing cheaper and increased consumption

• demographics: the age, family size, and gender of households

  • varying spending habits

What are the major determinants of investment spending, and why is investment considered volatile?

• interest rates: how consumers are likely to borrow something (homes, cars) and spend

  • low interest rates lead to borrowing cheaper and increased consumption

• business expectations: firms can predict certain economic conditions and respond with how they buy

  • with strong expectations, they are likely to buy better equipment

• economic growth: overall health of economy

  • when businesses grow, businesses invest due to the increasing demand

• technological change: advances in technology can create more opportunities and efficient supply leading to more investments

• availability of funding: with ready availability, firms invest into more projects

• Investments are considered volatile because 

  • they can be highly responsive to changes in economic conditions leading to lots of fluctuations

  • they need a long-term commitment

What factors influence government spending, and how can these decisions affect AD?

• political factors like political parties and beliefs can influence government spending because some politicians may prioritize different areas of spending, leading to fluctuations

• economic conditions: recessions cause government spending to increase while booms can reduce the spending 

• public needs and demand: government spending can be influenced by the spending of healthcare or education because they are necessities and citizens may advocate to increase the demand

• these decisions affect AD because they can create the multiplier effect, where the increase in government spending causes an overall increase in consumption and investment → this leads to more employment and spending on goods

What are the major determinants of export demand and import demand, and how do they contribute to net exports?

• export determinants

  • foreign income levels: how much income foreign consumers have to spend on goods

  • exchange rates: if currency is weaker, then exports are cheaper for foreign buyers, which increases demand

  • competitiveness: if a country’s products are viewed as superior or more affordable, demand for those exports will be higher

• import determinants:

  • higher income within a country can lead to increased demand for goods

  • consumer preferences: shifts in preference can influence import demand

• net exports:

  • the difference between exports and imports

  • positive net export (more exports): causes trade surplus and more economic growth

  • negative net export (more imports): causes trade deficit and reliance on goods

Why does the AD curve slope downward? Provide two clear explanations.

• slope:to show the overall price of the economy in relation to the demand

• the wealth effect: as consumers feel more wealthier, they are likely to spend more money and vice versa. lower prices lead to higher demand

• interest rate effect: lower interest rates make it easier to borrow cheaper because it is affordable; lower prices lead to increased spending and demand

identify five government policies that could shift AD to the right, and explain how one of them increases spending in the economy.

• increased government spending

• subsidies

• public investment

• tax cuts

• decreased rate in interest

• Subsidies increase the spending in the economy because it is government financial aid that supports goods and services that the public needs. With higher support from the subsidies, spending is more likely to increase based on greater opportunities provided by the subsidies

Identify five non-government factors that could shift AD to the left and explain how one of them reduces overall demand.

• high-interest rates

• reduced consumer demand

• more imports

• more taxes

• declining rates of income

• Declining rates of income can reduce the overall demand because with lower income, less money will be spent within the economy. Lower wealth lowers the maximum amount of spending one can afford, leading to less affordability of goods and lower overall economic spending, which decreases the economic activity of the nation.

Explain the three phases of the Keynesian AS curve and what they show about capacity and prices.

• Keynesian phase: showing how capacity stays constant

• the intermediate phase: prices start to rise due to rising demand

• the classical phase: capacity is at its max and is perpendicular to the output activity.

Why do economists draw both SRAS and LRAS in the Neo-Classical model, and what does each curve represent?

• they can see the trends in economic activity to determine if a problem will occur on a long-term or short-term basis.

• The SRAS curve depicts how price and wages are utilized

• the LRAS curve depicts how resources are used to their pull potential when products are made.

List the major factors that can shift SRAS and the major factors that can shift LRAS. Explain why LRAS shifts only with long-term changes.

• SRAS

  • the amount of productivity

  • the rates of supply shocks

  • the amount of money used to support input resources

• LRAS

  • quality of technology

  • amount of labor

  • capital performance

What is a deflationary (recessionary) gap and what is an inflationary gap? Explain why each type of gap is considered harmful to an economy.

• deflationary gap shows that the actual output is lower than the potential output, and it is harmful because it creates higher unemployment rates and resources are not utilized to their full potential.

• The inflationary gap shows that the actual output is higher than the potential output, which can cause inflation and overuse of resources.

• ·Both gaps are harmful because they either exceed or underuse the potential of resources within an economy.