Economic Activity and Business Cycle Review

A comprehensive set of 86 question-and-answer flashcards covering key concepts from the lecture on economic activity, circular flow, aggregate demand and supply, the business cycle, indicators, GDP measurement, and the benefits and costs of growth.

What is meant by “economic activity” within an economy?

The producing and purchasing of goods and services by businesses and consumers.

What main purpose does economic activity serve for society?

To use available resources efficiently to produce and sell goods and services that maximise overall satisfaction and living standards.

In the circular flow, how do businesses contribute to economic activity?

They use resources to produce goods and services for sale.

How do consumers participate in economic activity?

They provide resources (mainly labour), earn income, and use that income to purchase goods and services.

What are material living standards?

The ability of people to access goods and services, often measured through income per person, consumption levels, and purchasing power.

What are non-material living standards?

Aspects of well-being unrelated to material goods, such as happiness, life expectancy, literacy, health, and crime rates.

Give two common indicators of material living standards.

Average income per person and the purchasing power of that income.

Give two typical indicators of non-material living standards.

Life expectancy and reported happiness levels.

Define “living standards” in an economic context.

The aggregate well-being of people in a country, combining both material and non-material factors.

How can higher economic activity positively affect material living standards?

It can raise wages and salaries, enabling people to purchase more goods and services.

How might higher economic activity negatively affect material living standards?

If it drives up inflation, purchasing power may fall despite higher incomes.

How can a slowdown in economic activity improve purchasing power?

Lower or slower rates of inflation increase the real value of money, boosting purchasing power.

How can a slowdown in economic activity hurt household purchasing power?

Lower wages or job losses reduce the ability to buy goods and services.

Give one positive non-material effect of higher economic activity.

Higher incomes can allow more leisure and recreational opportunities.

Give one negative non-material effect of higher economic activity.

It can raise pollution levels and lower air quality.

Give one positive non-material effect of reduced economic activity.

People may enjoy more family time if work hours fall.

Give one negative non-material effect of reduced economic activity.

Greater uncertainty can worsen mental health.

In the five-sector model, what is a “leakage”?

Money leaving the circular flow of income (e.g., saving, taxation, imports).

What is an “injection” in the circular flow model?

Money entering the circular flow of income (e.g., investment, government spending, exports).

Why do economists compare total leakages with total injections?

To judge whether the level of economic activity is expanding (injections > leakages) or contracting (leakages > injections).

How are consumers and businesses described in terms of dependence?

They are interdependent: businesses need consumer spending, and consumers need business output and wages.

In the two-sector model, how do households obtain income?

By supplying labour and other resources to firms.

In the two-sector model, on what do households spend their income?

Goods and services produced by firms.

Within the two-sector model, how do firms spend money?

Mainly by paying wages and other resource costs to households.

What is the core function of the financial sector in the circular flow?

Acting as an intermediary that channels savings to borrowers for investment.

Why is saving considered a leakage?

Because it diverts income away from immediate spending on goods and services.

Why is investment viewed as an injection?

Borrowed funds are spent on expanding business production, adding new expenditure to the economy.

Name the two key roles of the government sector in the circular flow.

Collecting taxation (leakage) and undertaking government expenditure (injection).

How does taxation act as a leakage?

It removes income from households and firms before it can be spent privately.

How does government expenditure operate as an injection?

The government spends tax revenue on goods, services, and transfers, adding to total demand.

Why are exports classified as an injection?

They represent spending by foreigners on domestic goods and services, adding income to the economy.

Why are imports treated as a leakage?

They divert domestic spending to overseas producers, removing income from the local economy.

What is Flow 1 in the circular model?

The flow of resources (labour, land, capital, enterprise) from households to businesses.

What is Flow 2 in the circular model?

The income flow (wages, rent, interest, profit) from businesses to households.

What is Flow 3 in the circular model?

The spending flow—household expenditure on goods and services (aggregate demand).

What is Flow 4 in the circular model?

The production flow—goods and services supplied by businesses.

Write the basic algebraic formula for Aggregate Demand (AD).

AD = C + I + G + X – M

In the AD equation, what does “C” represent?

Private consumption expenditure by households.

In the AD equation, what does “I” signify?

Investment spending by businesses on capital goods.

In the AD formula, what does “G” denote?

Government expenditure on goods, services, and transfers.

In the AD formula, what does “X” stand for?

Exports of goods and services.

In the AD formula, what does “M” stand for?

Imports of goods and services.

Why are high levels of AD generally desirable?

They lift economic activity, raising employment and economic growth, though inflation risks can rise.

What may low levels of AD signal for an economy?

Weak economic activity, leading to lower employment, lower inflation, and sluggish growth.

Name one key factor that can increase or decrease AD by altering household purchasing power.

Disposable income.

How can population growth affect AD?

A larger population raises total demand for goods and services, lifting AD.

How do interest rates influence AD?

Lower rates encourage borrowing and spending, raising AD; higher rates do the opposite.

How does consumer confidence affect AD?

Optimistic consumers spend more, boosting AD; pessimistic consumers cut spending, reducing AD.

How can business confidence shift AD?

High confidence raises investment spending (I), while low confidence curtails it.

What effect can an appreciating Australian dollar have on AD?

It makes exports dearer and imports cheaper, reducing net exports (X – M) and lowering AD.

Give one example of a government budgetary policy that can increase AD.

Cuts to personal income tax, which boost disposable income and spending.

Define Aggregate Supply (AS).

The total volume of goods and services producers are willing and able to supply at a given time.

Why are higher levels of AS important?

They allow the economy to meet AD without shortages or excessive inflation.

What risk can arise if productive capacity grows faster than demand?

Under-utilised resources can lift unemployment.

Name one factor that increases AS by raising the quantity of productive resources.

Population growth that expands the labour force.

Name one factor that raises AS by improving resource quality.

Better education and training increasing labour skills.

How do rising production costs affect AS?

They reduce producers’ willingness to supply, shifting AS leftward.

Give an example of a supply shock that can cut AS.

A severe drought, war, or pandemic that interrupts production.

How can a depreciating exchange rate raise AS?

It may increase import costs of inputs, reducing AS (a negative effect).

Give one way technological change can boost AS.

Automation that increases output per worker lowers unit costs and expands supply.

Explain how productivity growth influences AS.

Higher productivity means more output from the same inputs, shifting AS to the right.

What kind of government policies can shift AS rightward over time?

Supply-side measures such as tax incentives for innovation or infrastructure spending.

What is the business cycle?

Regular fluctuations in economic growth around the economy’s long-term potential output.

Define “potential output.”

The level of real GDP achievable when all resources are sustainably employed without excessive inflation.

What is a “boom” in the business cycle?

The peak phase where economic activity, spending, and inflation are at their highest.

What is meant by a “contraction” phase?

A period in which economic growth slows and activity declines from the peak.

How is a “recession” commonly defined?

At least two consecutive quarters (six months) of falling real GDP.

What characterises the “expansion” or “recovery” phase?

Rising economic activity, increasing output, and falling unemployment after a trough.

List two typical features of an expansion phase.

GDP grows faster and unemployment falls as businesses hire more workers.

State two key features of a peak (boom) phase.

Very high spending/low unemployment and rapid inflation due to resource shortages.

Give two indicators of a contraction phase.

Slowing GDP growth and rising unemployment as spending declines.

Provide two characteristics of a trough.

Weak spending and high unemployment; firms cut production and discount prices.

What time criterion distinguishes a recession from a short downturn?

A fall in real GDP lasting at least two consecutive quarters.

What GDP growth, unemployment, and inflation rates signal steady growth for Australia?

GDP growth 3–3.5% per year, unemployment 4–4.5%, inflation 2–3%.

What is a lagging economic indicator?

A statistic that shows how the economy performed in the past, after changes have occurred.

Give one example of a lagging indicator.

The unemployment rate (or GDP, inflation, average weekly earnings).

What is a coincident indicator?

A measure that moves at the same time as overall economic activity, showing current conditions.

Name one coincident indicator.

Monthly retail sales (or share prices, new car registrations).

What is a leading indicator?

A statistic that tends to change before the broader economy, giving an early signal of future trends.

Give one leading indicator.

Consumer confidence (or business confidence, new housing approvals).

How is economic growth measured in Australia?

By the percentage change in real GDP, which adjusts for inflation.

What is the Chain Volume Measure of GDP?

A method that values current-year production using the previous year’s prices to remove inflation effects.

What is Australia’s target range for sustainable GDP growth?

About 3% to 3.5% real GDP growth per year.

State one benefit of strong economic growth.

It creates employment opportunities and reduces unemployment.

Identify one economic cost of excessively strong growth.

It can accelerate inflation, eroding purchasing power.

Explain the “tragedy of the commons” in relation to growth.

Over-exploitation of common resources (e.g., fish stocks) as individuals seek profit, harming overall welfare.

Give one limitation of using real GDP per capita to judge living standards.

It ignores environmental degradation, income distribution, and many non-material aspects of welfare.