Question

1. Define economic recession. Discuss the variables that are likely to change as a result of economic recession? Do the variables have similar pattern of change? Explain your answer.

2. Discuss variables that can change the aggregate demand curve and their direction of change.

3. Discuss business cycles? Why the business cycle curve is upward trending?

4. What is sticky wage theory? How sticky wage theory is related to supply curve?

Answer 1

1) Economic recession occurs when there is decline in overall economic activity. It will reduce aggregate demand in an economy by reducing investment and consumption thereby reducing real GDP which reduce employment rate. Inflation rate also falls. Thus, we can say that all variables have similar pattern.

2) Recession cause willingness to pay by consumers to fall and investment by producers to fall. As consumption holds a major chunk of aggregate demand, decrease in consumption and investment reduce aggregate demand. We can see from the above graph that aggregate demand curve shift backward.

3) Business cycle is the movement of GDP along in long run. It shows upward and downward trend of business cycle.

Peaks UNP Expansion contraction Expansion I contraction trough Trough trough Time

4) Sticky wage theory is based on theory of labor market. Wages are set by contracts set by labor unions in short run in which wages cannot be changed as per economic activity. If price level in the economy rise, nominal wage reamins same while real wage of labor falls as they can buy less units of goods from the same nominal wage as before due to rise in price. Fall in real wage reduces cost of production of producers which induce them to produce more and shift aggregate supply curve to its right which raise output level in the economy.