David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

Review questions
• Some swings in potential output do occur, but many short-run fluctuations probably reflect Keynesian
departures from potential output. Aggregate demand and aggregate supply both contribute to the
business cycle.
• Increasing integration of world financial and product markets has made most countries heavily
dependent on the wider world. Business cycles in the rich countries are closely correlated.
• In 2001 central banks cut interest rates to prevent recession from spiralling. Japan's difficulty escaping
from the deflation trap suggests that dampening business cycles remains an important aim for other
countries.
Review questions
'If firms could forecast future output and profits accurately, there could not be a business cycle: Is
this true?
2 Heavily dependent on output of oil and fishing, Norway's business cycle goes in the opposite
direction from those in other European countries. Why?
3 Why might voters care more about the direction in which the economy is heading than about the
absolute level of its position at election time?
4 Would it help the world economy if all the largest countries elected governments on the same day?
Why, or why not?
5 What is real about a business cycle?
6 Common fallacies Why are these statements wrong? (a) Closer integration of national economies
will abolish business cycles. (b) The more we expect cycles, the more we get them. (c) Because
output and labour productivity are closely correlated, fluctuations in productivity are the main
cause of business cycles.
7 Which is correct? (a) Business cycles imply that people are stupid: if they could see a cycle coming
they would already be taking action to abolish it. (b) It is easy to explain why it takes a while to
return to long-run equilibrium but hard to explain why this return then overshoots and has to
come back again. (c) Economic dynamics are slow and complicated. There are many models in
which cycles result.
8 Greece, Spain, Portugal, Ireland and Italy have emerged as weak members of the eurozone. Do you
think this is because their business cycles are less correlated with France and Germany or because
their political institutions are weak?
9 Consider an economy with a fixed exchange rate. Beginning from internal and external balance,
the economy experiences an adverse domestic demand shock that is not fully offset by a policy
response. Draw a diagram to illustrate subsequent adjustment. Why does the requirement to get
back to both internal and external balance generate a cyclical response?
10 Plot the data of Table 27.l and confirm that both output and investment exhibit cyclical behaviour.
Which is causing which?
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