The term “business cycle” refers to the pattern of alternation between expansions (upturns) and recessions (downturns). The term ‘cycle’ implies a regular pattern; the term ‘business cycle’ therefore connotes a regular pattern of expansions and recessions.
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5. Explain intuitively why the unemployment rate is countercyclical. A countercyclical economic quantity is one which is inversely correlated with the general economic condition. The unemployment rate is countercyclical for it tends to increase during economic slowdowns and decrease during economic expansions. The increase in demand which characterizes economic expansions drives firms to increase employment; on the contrary, the fall in demand characteristic of slowdowns urges firms to lay off workers.
6. Explain why the aggregate demand curve is downward sloping. An aggregate demand curve illustrates the negative relationship between the quantity demanded of aggregate output and the aggregate price level. The curve slopes downward due to two factors, both brought about by a change in the aggregate price level: (1) the wealth effect and (2) the interest rate effect. The wealth effect is due to the change in the purchasing power of assets brought about by a change in the aggregate price level.
On a collective note, an increase/decrease in the aggregate price level leads to a loss/gain in consumers’ purchasing power and therefore, a reduction/increase in consumption as a natural reaction. The interest rate effect, however, pertains to the effect in investment (I) and consumer spending (C) from the interest rate increase/decrease brought about by the reduction/growth in the supply of loanable funds. An aggregate price level increase/decrease prompts people to increase/decrease their cash holdings (by borrowing or selling financial assets), thereby reducing/augmenting the available funds for lending.
This reduction/augmentation in the supply of loanable funds drives interest rates up/down, leading to a decrease/increase in investment spending. The upward/downward interest rates movement likewise dampens/stimulates consumer spending as consumers would want to save/dispose more of their income. 7. Give another example of a good or service whose prices are sticky. What factors tend to make its price sticky? Luxury watches are a price-sticky good; their prices are sticky downward.
Luxury watch companies are reluctant to cut prices in the face of a dampened demand from an economic slowdown- preferring cutting output instead. Fairness concerns are a possible factor for their price-stickiness. Possibly out of fairness for former buyers, luxury watchmakers decide not to slash their prices. Second, it is also an effort at protecting the brand image
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