AP Macro AP Macro Business Cycles and Output Gaps 2 — Questions and Answers
Question 1: Which of the following is a leading economic indicator used to predict future business cycle turning points?
- Average duration of unemployment
- Change in manufacturing and trade inventories
- New orders for consumer goods and materials (Correct answer)
- Outstanding commercial and industrial loans
Correct answer: New orders for consumer goods and materials
New orders for consumer goods and materials signal future production activity and are classified as a leading indicator.
Question 2: The output gap is calculated as:
- Actual GDP minus nominal GDP
- Actual GDP minus potential GDP (Correct answer)
- Potential GDP divided by actual GDP
- Nominal GDP minus the GDP deflator
Correct answer: Actual GDP minus potential GDP
The output gap = Actual GDP − Potential GDP; a negative value indicates a recessionary gap and a positive value an inflationary gap.
Question 3: Automatic stabilizers help dampen business cycle fluctuations because they:
- Require Congressional approval before taking effect
- Automatically increase government spending or reduce taxes during a recession without legislative action (Correct answer)
- Raise interest rates when GDP exceeds potential
- Reduce the money supply when inflation rises
Correct answer: Automatically increase government spending or reduce taxes during a recession without legislative action
Automatic stabilizers like unemployment benefits and progressive taxes kick in automatically, supporting aggregate demand in downturns without requiring new legislation.
Question 4: During a contraction phase of the business cycle, which of the following would you most likely observe?
- Rising investment spending and falling unemployment
- Increasing consumer spending and rising stock prices
- Declining output, rising unemployment, and falling business profits (Correct answer)
- Surging exports and rising wage growth
Correct answer: Declining output, rising unemployment, and falling business profits
Contractions are characterized by falling real GDP, rising unemployment, and shrinking corporate profits as demand weakens.
Question 5: Which type of unemployment tends to rise the MOST during a recession?
- Frictional unemployment
- Structural unemployment
- Seasonal unemployment
- Cyclical unemployment (Correct answer)
Correct answer: Cyclical unemployment
Cyclical unemployment is directly caused by insufficient aggregate demand during recessions and is the primary form that increases in downturns.
Question 6: The 'paradox of thrift' suggests that during a recession, if all households simultaneously increase saving:
- National income rises because investment funds increase
- Aggregate demand falls, potentially deepening the recession (Correct answer)
- The money supply expands as banks gain deposits
- Interest rates rise, attracting foreign investment
Correct answer: Aggregate demand falls, potentially deepening the recession
While saving is rational for individuals, collective increases in saving reduce consumption spending, lowering aggregate demand and worsening the recession.
AP Macro AP Macro Business Cycles and Output Gaps 2
Which of the following is a leading economic indicator used to predict future business cycle turning points?