4.

Question

• Units 13 and 14.

• The business cycle and the role of investment (firms’ decisions).

• The relationship between aggregate demand and unemployment.

 Definition of business cycle – diagram of fluctuation overtime and 4 bullets, investment

info
 Aggregate demand = should mention GDP components and equation
 Okun’s Law (link between unemployment and GDP)
 (Maria’s diagrams), insert meaning of inflation and why price levels are lower at recessions

The Business Cycle

Unemployment, inflation and economic growth tend to change cyclically over time.

The four phases of the business cycle:

1. A peak is when business activity reaches a temporary maximum, unemployment is low, inflation
high.
2. A recession is a decline in total output, unemployment rises and inflation falls.

3. The trough is the bottom of the recession period, unemployment is at its highest, inflation is low.

4. expansion (recovery) is when output is increasing, unemployment begins to fall and later inflation
begins to rise.

Unemployment increases during business cycle recessions and decreases during business cycle
expansions (recoveries). Inflation decreases during recessions and increases during expansions
(recoveries).

Investment: as a coordination game in which:

 actors will be 2 firms

 Actions: invest or do not invest
 Information: they decide simultaneously
 Payoff: profits from investment

The benefits of coordinating investment make cycles self – reinforcing. Firms respond positively to
the growth of demand in the economy. This is why investment is more volatile than GDP.