GDP The Business Cycle 3 — Questions and Answers
Question 1: How does the business cycle typically affect federal government budget deficits in the US without any deliberate policy changes?
- Deficits shrink during recessions due to lower spending
- Deficits grow during recessions as tax revenues fall and automatic stabilizers increase spending (Correct answer)
- Deficits are unaffected because Congress must approve all changes
- Deficits shrink during expansions due to reduced tax rates
Correct answer: Deficits grow during recessions as tax revenues fall and automatic stabilizers increase spending
Automatic stabilizers like unemployment insurance and progressive taxes cause deficits to expand during recessions and shrink during expansions without new legislation.
Question 2: Which of the following best describes the concept of 'output gap' in relation to the business cycle?
- The difference between exports and imports of goods
- The gap between the highest and lowest GDP in a cycle
- The difference between actual GDP and potential GDP (Correct answer)
- The lag between monetary policy action and its effect on GDP
Correct answer: The difference between actual GDP and potential GDP
The output gap measures how far actual GDP is from potential (full-capacity) GDP; a negative gap indicates slack during contractions, a positive gap during overheating expansions.
Question 3: What typically happens to business inventories at the beginning of an unexpected economic contraction?
- Inventories fall as consumers buy more
- Inventories rise as sales fall short of production plans (Correct answer)
- Inventories are unaffected because firms adjust instantly
- Inventories fall because firms immediately cut production
Correct answer: Inventories rise as sales fall short of production plans
When demand unexpectedly drops, goods accumulate unsold, causing inventory levels to rise before firms can reduce production.
Question 4: The 'multiplier effect' in the business cycle refers to which phenomenon?
- Each dollar of investment generates more than one dollar of total income in the economy (Correct answer)
- Interest rates multiply the effect of monetary policy
- GDP grows faster than investment during expansions
- Tax cuts have larger effects than spending increases
Correct answer: Each dollar of investment generates more than one dollar of total income in the economy
The multiplier effect occurs because an initial injection of spending circulates through the economy, generating additional rounds of income and spending greater than the original amount.
Question 5: Which of the following is a lagging economic indicator that confirms business cycle turning points after they occur?
- Building permits
- Stock prices
- Average prime rate charged by banks (Correct answer)
- Consumer confidence index
Correct answer: Average prime rate charged by banks
The average prime rate is a lagging indicator because banks adjust lending rates only after economic conditions have already changed, confirming rather than predicting cycle turns.
Question 6: During which phase of the business cycle would inflationary pressure most likely peak?
- Trough
- Early expansion
- Late expansion near the peak (Correct answer)
- Mid-contraction
Correct answer: Late expansion near the peak
Inflation tends to peak near the business cycle peak when resource utilization is highest, labor markets are tightest, and demand-pull pressures are strongest.
Question 7: What is the average duration of a US economic expansion since World War II?
- About 18 months
- About 3 years
- About 5 years (Correct answer)
- About 10 years
Correct answer: About 5 years
Post-WWII US expansions have averaged roughly 58–65 months (approximately 5 years), though duration has varied widely across cycles.
GDP The Business Cycle 3
How does the business cycle typically affect federal government budget deficits in the US without any deliberate policy changes?