Business Cycles 10

Why were Central Banks made independent in the 90s

This is because during election times, politicians would aim to achieve short-run stimulus within the economy to achieve higher employment, but this would increase inflation.

Central Banks Over Government Control to

• Control long-run inflation

• Reduce electorally manipulate cycles in demand and output

Business Cycle

Short Term Fluctuation of Total output around its trend path.

Takes around 5 years to move from one point to an equivalent point.

Trend Path of Output

Straight line averaging out short-term fluctuations.

Output Gap

Differene Between Actual and Potential Output

Political Business Cycles

When politicians manipulate the economy for electoral advantage.

The Real Wage Puzzle

Refers to the idea that real wages are not keeping up with productivity growth and might even be stagnant.

e.g. During a recession firms employ less workers, so this should increase the marginal product of labour, thus increasing real wages. However, real wages decreases.

Causes of the Real Wage Puzzle

• Competition from Globalisation

• Technological advancements reducing labor demand.

• Weakened trade unions leading to lower bargaining power.

Perfect Competition

Perfect:

A market structure where many buyers and sellers trade the same products, so nobody can influence the market price e.g. Agriculture markets (wheat or rice)

Imperfect Competition and Types of Imperfect Competition

Imperfect:

A market structure where some firms have control over prices in the market due to

• Differences in products

• Fewer Competitors

Types of Imperfect Competition

• Monopoly: One Seller Dominates (e.g. Local Utility)

• Oligopoly: A few large firms dominate (e.g. Car industry)

• Monopolistic Competition: Where many firms compete, but sell slightly different products, giving them some control over prices (e.g. Clothings Brands)

The Multiplier Accelerator Model of the Business Cycle

Explains how changes in demand are amplified through a combination of Consumption Spending (Multiplier) and Investment (Accelerator).

How does Investment contribute to the Multiplier effect?

It increases output which increases equilibrium unemployment and increases workers income, thus increasing their consumption.

Consumption Spending is what influences the multiplier.

Practical Limits of Economic Cycles

These are the ceilings and floors of Business cycles causes by the limits in Aggregate Supply and Demand

Business Cycle Ceilings

A boom occurs when there is high growth of supply and demand. Although demand can unlimitedly increase, supply has physical limitations preventing it from growing endlessly.

A supply ceiling thus slows growth during a boom as the growth of supply cannot continue forver.

Business Cycle Floor

A floor is the level that aggregate demand cannot fall below as there will always be a innate demand for goods and services even during a recession when aggregate demand falls.

Market Clearing Def and Classical and Keynesian Assumption

It is the equilibrium of markets

Classical economists believe that markets are always clear due to flexible prices and wages, leading to full employment in the long run.

Keynesian economists argue that markets can be sticky, leading to unemployment and underutilization of resources in the short run.

Different Types of Expectations

• Exogenous Expectations

  • Fixed expectations that come from outside the model and are not influenced by the model itself.

• Extrapolative Expectations

  • Assumes that future trends rely on the recent past, thus extrapolating past information.

• Rational Expectations

  • Logical expectations e.g. Increase of money supply for Central Bank Increases Inflation

  • Predictions made based on facts with reasoning

Marginal Benefit

The additional benefit or utility a person receives from consuming or producing one more unit of a good or service.

The accelerator

Explains how growth/decline in the economy induces more/less investment amplifying booms/busts.

Makes the economy more volatile

At optimal level of capital Marginal … = Marginal …

Marginal Benefit = Marginal Cost