GDP The Business Cycle 4 — Questions and Answers
Question 1: Which school of economic thought argues that business cycles are primarily caused by shifts in technology and productivity, not demand shocks?
- Keynesian economics
- Real Business Cycle theory (Correct answer)
- Monetarism
- Post-Keynesian economics
Correct answer: Real Business Cycle theory
Real Business Cycle (RBC) theory holds that fluctuations stem from real supply-side shocks like technology changes, not monetary or demand factors.
Question 2: During a business cycle contraction, what typically happens to the yield curve?
- It steepens as long-term rates rise faster than short-term rates
- It inverts as short-term rates exceed long-term rates (Correct answer)
- It flattens as both short and long rates converge near zero
- It is unaffected because the Fed controls all maturities
Correct answer: It inverts as short-term rates exceed long-term rates
Yield curve inversion (short-term rates exceeding long-term rates) is a well-known leading indicator of recession, often appearing before contractions begin.
Question 3: Which concept explains why small fluctuations in consumer demand can cause much larger swings in business investment spending?
- The paradox of thrift
- The accelerator principle (Correct answer)
- Ricardian equivalence
- Say's Law
Correct answer: The accelerator principle
The accelerator principle states that investment depends on the change in output, so even modest demand growth can trigger disproportionately large investment increases.
Question 4: What does it mean when economists say the US economy has entered a 'technical recession'?
- Unemployment has risen above 7% for two quarters
- Real GDP has declined for two consecutive quarters (Correct answer)
- The stock market has fallen more than 20% from its peak
- The Fed has raised interest rates in two consecutive meetings
Correct answer: Real GDP has declined for two consecutive quarters
A technical recession is commonly defined as two consecutive quarters of negative real GDP growth, though the NBER uses a broader set of criteria for official recession dating.
Question 5: How do automatic stabilizers help moderate the business cycle without legislative action?
- They automatically raise taxes during recessions to balance the budget
- They increase government spending and reduce tax burdens during downturns, boosting demand (Correct answer)
- They adjust interest rates counter-cyclically through the Federal Reserve
- They freeze government spending to prevent deficits from growing
Correct answer: They increase government spending and reduce tax burdens during downturns, boosting demand
Automatic stabilizers like unemployment benefits and progressive income taxes inject spending during recessions and withdraw it during booms, dampening cyclical swings.
Question 6: In business cycle terminology, what is meant by the 'amplitude' of a cycle?
- The length of time between two consecutive peaks
- The magnitude of rise and fall in economic activity between peak and trough (Correct answer)
- The speed at which the economy moves through each phase
- The difference between real and nominal GDP growth rates
Correct answer: The magnitude of rise and fall in economic activity between peak and trough
Amplitude measures the severity of the cycle — how far GDP or economic activity rises above trend at the peak and falls below trend at the trough.
Question 7: Which of the following best explains why housing investment is considered one of the most cyclically volatile components of GDP?
- Housing prices are set by the government and change slowly
- Interest rate sensitivity and the long construction lag make housing boom-bust prone (Correct answer)
- Housing demand is perfectly inelastic regardless of the cycle
- Housing is exempt from cyclical forces because it is a basic necessity
Correct answer: Interest rate sensitivity and the long construction lag make housing boom-bust prone
Housing is highly sensitive to interest rates and credit conditions, and the long construction timeline creates lags that amplify boom-bust swings relative to other GDP components.
GDP The Business Cycle 4
Which school of economic thought argues that business cycles are primarily caused by shifts in technology and productivity, not demand shocks?