Podcast
Questions and Answers
Which component of GDP is typically the most volatile?
Which component of GDP is typically the most volatile?
- Government Spending
- Net Exports
- Consumption
- Investment (correct)
Potential output refers to the theoretical limit that an economy cannot surpass under any circumstances.
Potential output refers to the theoretical limit that an economy cannot surpass under any circumstances.
False (B)
List the four stages of the business cycle.
List the four stages of the business cycle.
Expansion, peak, recession, and trough
During economic ________, an economy's output (GDP) declines.
During economic ________, an economy's output (GDP) declines.
Match the following terms with their descriptions:
Match the following terms with their descriptions:
When an economy is operating at its potential output, what is the state of unemployment?
When an economy is operating at its potential output, what is the state of unemployment?
If GDP = $C + I + G + X - M$, what does each component represent?
If GDP = $C + I + G + X - M$, what does each component represent?
Potential output is directly observable in economic data.
Potential output is directly observable in economic data.
What is the term used to describe the difference between real GDP and potential output?
What is the term used to describe the difference between real GDP and potential output?
What distinguishes a period of 'expansion' in the business cycle?
What distinguishes a period of 'expansion' in the business cycle?
A positive output gap is generally considered beneficial for an economy as it indicates production is below its potential level.
A positive output gap is generally considered beneficial for an economy as it indicates production is below its potential level.
Explain how an economy can produce beyond its potential output.
Explain how an economy can produce beyond its potential output.
What type of function can be used to determine the relationship between output and inputs used in production, thereby helping to understand the contributions of factors like labor, capital, and technology to economic growth?
What type of function can be used to determine the relationship between output and inputs used in production, thereby helping to understand the contributions of factors like labor, capital, and technology to economic growth?
Central banks aim to control inflation using _______ policy, where the output gap serves as a key indicator of inflationary pressure.
Central banks aim to control inflation using _______ policy, where the output gap serves as a key indicator of inflationary pressure.
Match the following concepts with their descriptions:
Match the following concepts with their descriptions:
According to the content, what is a potential consequence of firms and workers operating above their efficient capacity during a positive output gap?
According to the content, what is a potential consequence of firms and workers operating above their efficient capacity during a positive output gap?
Potential output and the equilibrium rate of unemployment are determined by short-term policies.
Potential output and the equilibrium rate of unemployment are determined by short-term policies.
Policies employed to manage short-term economic fluctuations are collectively known as what?
Policies employed to manage short-term economic fluctuations are collectively known as what?
Which of the following best describes the role of the Institute for Fiscal Studies in the context of potential output estimation?
Which of the following best describes the role of the Institute for Fiscal Studies in the context of potential output estimation?
If real GDP is growing significantly faster than potential output, this typically indicates a ______ output gap, which may prompt concerns about rising inflation.
If real GDP is growing significantly faster than potential output, this typically indicates a ______ output gap, which may prompt concerns about rising inflation.
Flashcards
Potential Output
Potential Output
The level of output an economy can produce when using its resources efficiently.
Production Function
Production Function
A mathematical equation showing how inputs create outputs.
Output Gap
Output Gap
The difference between actual GDP and potential GDP.
Okun's Law
Okun's Law
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Positive Output Gap
Positive Output Gap
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Firms operate above their capacity
Firms operate above their capacity
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Monetary Policy
Monetary Policy
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Fiscal Policy
Fiscal Policy
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Stabilisation Policy
Stabilisation Policy
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Demand-side policies
Demand-side policies
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Business cycles
Business cycles
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Stages of a business cycle
Stages of a business cycle
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GDP (as Aggregate Demand)
GDP (as Aggregate Demand)
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Components of GDP
Components of GDP
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Investment Volatility
Investment Volatility
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Economic Downturn
Economic Downturn
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Economic Boom
Economic Boom
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Maximum Sustainable Employment
Maximum Sustainable Employment
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Study Notes
- During this term, the focus will be on the short-run relationship between output (real GDP), unemployment, and inflation.
- They will analyze the fluctuations of these variables year by year and what causes these fluctuations.
GDP and Aggregate Demand
- GDP can be estimated as the total aggregate demand in an economy.
- GDP = AD = C + I + G + X - M
- Consumption is the main component of GDP for most countries, but Investment is the most volatile.
Business Cycles
- Investment volatility is one of the main drivers of business cycles, which are the 'ups and downs of the economy'.
- They are alternating periods of faster and slower growth rates.
- The four stages of the business cycle are expansion, peak, recession, & trough.
- During economic downturns, an economy's output (GDP) declines; during booms, it increases.
Potential Output
- Potential output is the maximum amount of goods and services that the economy can produce operating at the maximum sustainable employment.
- This refers to when unemployment is equal to its equilibrium level.
- The economy can produce more than potential output by utilizing more resources, especially if unemployment is below equilibrium.
Estimating Potential Output
- Potential output is not directly observable and has to be estimated.
- Some may use an estimate of real GDP trend as a good proxy for potential output.
- The Institute for Fiscal Studies uses a production function to estimate potential output for the UK.
- A production function gives the technical relationship between output and inputs used in production.
- It attributes how much factors of production (labor, capital, technology) contribute to economic growth.
Output Gap
- The difference between real GDP and potential output is the output gap, expressed in percentage terms.
- Read Jahan & Sahmed Mahmud (2013) for an explanation of positive and negative output gaps.
Business Cycles, Unemployment and Inflation
- Unemployment levels fluctuate with the business cycle around its long-run equilibrium level.
- These fluctuations are related to output fluctuations.
- The relationship between output and unemployment fluctuations is known as Okun's Law.
Positive Output Gap
- A positive output gap means production is above its potential level, and unemployment is lower.
- Firms and workers operate above their efficient capacity which increases costs for firms and will translate into an increase in prices i.e. higher inflation.
- Workers demand higher salaries which increases costs for firms and will translate into an increase in prices i.e. higher inflation.
- A positive output gap is related to high inflation (above its target).
Output Gap and Policy-Making
- The output gap plays a key role in policy-making.
- Central banks use monetary policy to control inflation, and the output gap is key in determining inflation pressure.
- Governments use fiscal policy to close the output gap.
- Monetary and fiscal policy are known as stabilization policy or demand-side policies.
Short-Term vs. Long-Run
- The focus is on short-term fluctuations.
- Potential output and the equilibrium rate of unemployment are set in the long-run and are not affected by short-term policies.
- The long-run will be covered in Year 2.
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