Business Cycles: Conceptual Questions and Solutions

Problem 26. What is the output gap?

(a) The difference between output at the peak of an expansionary boom and output at the bottom of a recession's trough.
(b) The difference between output produced and output consumed.
(c) The difference between output consumed at the upper 50% of income levels
and the output consumed at the lower 50% of income levels.
(d) The difference between the trend or potential output and actual output.
(e) The difference between the current year's output and output in the past year.
(f) A fashionable clothing retail store that has added "output" to its name and began to write its name using all lowercase letters.

Solution 26. The correct answer is (d): The difference between the trend or potential output and actual output.

Problem 27. Which of these variables tend to have large fluctuations during business cycles? More than one answer is possible.

(a) Interest rates
(b) Employment
(c) Wages
(d) Inflation
(e) Output
(f) Consumption
(g) Investment

Solution 27. Output, employment, and investment tend to have large fluctuations during business cycles. The other variables listed tend to have small fluctuations. So (b), (e), and (g) are correct answers.

Problem 28. In the Frisch-Slutsky Paradigm, what are the three components of any business cycle?

(a) Impulse, Propagation, Business Cycle
(b) Expansion, Contraction, Recovery
(c) Boom, Bust, Bailout
(d) Peak, Trough, Peak
(e) Consumption, Investment, Government Spending

Solution 28. The correct answer is (a): Impulse, Propagation, Business Cycle

Problem 29. According to the Keynesian view, what initially causes business cycles? More than one answer is possible.

(a) A drop in aggregate demand or a lack of consumer demand for goods in existence.
(b) Price and wage stickiness.
(c) Artificially lowered interest rates by the Federal Reserve, leading to an unsustainable credit expansion.
(d) An over-tightening of monetary policy at a time when easier credit is needed.
(e) Coordination failures among firms on the free market.
(f) Business cycles do not exist. At each point in time, individuals act optimally and try to maximize economic value.

Solution 29. The correct answers are
(a): A drop in aggregate demand or a lack of consumer demand for goods in existence.
(b): Price and wage stickiness
(e): Coordination failures among firms on the free market.
Keynesians think that any of these phenomena may cause a business cycle.

Problem 30. According to the Real Business Cycle Theory, what is the source of changes in output in the economy?

(a) Increases in the money supply
(b) Overproduction and underconsumption
(c) Technology shocks
(d) Fluctuations in economic actors' preferences
(e) Government investment in infrastructure and economic development
(f) Changes in consumer spending

Solution 30. The correct answer is (c): technology shocks. According to the Real Business Cycle Theory, some kind of positive or negative technology shock is virtually always the cause of output changes.

See Mr. Stolyarov's complete index of Intermediate Macroeconomics Problems and Solutions here.