ECO101 Worksheet 9: Analyzing Business Cycles and GDP Trends

This economics assignment delves into the analysis of business cycles, GDP fluctuations, and their relationship with unemployment, economic welfare, and consumption patterns. The assignment explores the inverse relationship between GDP growth and the unemployment rate, examines the impact of WWII on GDP, and analyzes Okun's coefficient across different countries. It also addresses the challenges in measuring the contribution of the government to GDP, the impact of product quality changes on GDP, and the limitations of GDP as a measure of well-being, particularly during wartime. Furthermore, it investigates the effects of shifts in household and social functions on GDP and explores methods of consumption smoothing, including self-insurance and co-insurance, within the context of economic fluctuations.

Worksheet 9
A. Introduction
- NO Questions
B. Business Cycle (4 MARKS)
1. The following chart shows fluctuations in GDP and unemployment
for the United Kingdom.
a) What is the general relationship between the growth rate in GDP
and the unemployment rate? (1 mark)
b) Look at the size of the fluctuations in GDP before and after WW2.
What do you notice? (1 mark)
In general, an inverse relation exists between growth in real GDP and unemployment rate. A growth in
real GDP implies increase in production capacity which in turn comes with the added benefit of
employment creation.
Before WWII, GDP though initially increases from 1920 to 1925, then falls slightly, then again rises to
reach at the peak level in 1935. However, from 1935 onwards GDP falls sharply till 1945. After WWII,
growth in GDP remain relatively stable implying stable GDP. The GDP growth is negative in 1975, 1980
and 2005. This implies that GDP in these years was lower as compared to preceding year.

2. The following charts show estimates of the relationship between
GDP growth and the rate of unemployment (Okun’s coefficient).
Okun’s coefficient is an estimate of the impact on the
unemployment rate from a 1% change in the growth rate of GDP.
For example, Okun’s coefficient for the United States = -0.3768,
which means a 1% decrease in GDP is associated with a 0.3768%
increase in the unemployment rate.
What is the percentage change in the rate of unemployment for a
decrease in GDP of 1% for the other countries? (2 marks)
Impact on the Unemployment Rate from a 1% ↓ in GDP (Okun’s
Coefficient)
Germany Japan Brazil Spain US Malaysia
0.2048% 0.0291% 0.1183% 0.3597% 0.3768% 0.0511%

C. Measuring the Aggregate Economy (8 Marks)
1. The following questions address a couple of issues regarding the
problems associated with measuring the value of the contribution of
government to GDP.
a) When statisticians calculate GDP, they have traditionally used
different methods for valuing goods and services provided by the
private and government sectors. Explain the reason for the
difference. (1 mark)
b) “Fairly recently statisticians have started to measure some bits of
public-sector output directly by, for instance, counting the number
of operations performed by health services or the number of
students taught in schools”.1 This represents a change in the way
economists have measured the contribution of government to GDP.
Why is this an improvement over the traditional method of
measuring the contribution of government to GDP? (2 marks)
1 https://www.economist.com/news/briefing/21697845-gross-domestic-product-gdp-increasingly-poor-
measure-prosperity-it-not-even
The goods provided by private sectors are exchanged in the market place and hence, has a certain
market value. It is easy to value these items. On the other hands goods and services provided by
government sector are not marketed. Therefore, it become difficult to value these items. The
public goods and non-excludable and non-rival. Because of a different characteristics of private
and public goods different measures are employed by statisticians to compute GDP.
This is an important improvement as prior to this, it was difficult to measure actual values of
goods and services provided by government. Under traditional approach the aggregate
government expenditure is included in GDP. It was not possible to measure sector wise
contribution of government like those for private sectors. This will provide a detail and more
accurate understanding of government expenditure and will help to understand role of
government as an economic agent.

2. “There are now many products whose quality is complex, multi-
dimensional and subject to rapid change”. Many of these goods and
services have decreased in price. Name one type of good or services
where there have been substantial increases in its quality. Have
increases in quality been accompanied by commensurate increases in
their prices? Discuss the implication for GDP as a measure of
economic welfare, especially in those countries that specialise in
producing these services?2 (2 marks)
3. Many economists have called for an end to GDP fetishism because
GDP is a limited measure of welfare. In fact, people can become
worse off even when GDP increases.
a) Have a look at the first chart in the worksheet that shows
fluctuations in GDP growth rates for the United Kingdom. It shows
that GDP growth rates during WW2 are historically high. What
does this suggest about GDP growth rates being used as a measure
of well-being? Comment with reference to the types of goods and
services produced. (1 mark)
2 Statisticians do try to adjust for improvements in quality when they are not matched by price increases but
this is not easy.
GDP does not consider changes in quality of the product. There are many goods such as cars and
medical services have accounted a significant improvement in product and service quality. They are
now available with additional features as compared to that obtained previously. The exclusion of
products quality raises questions on GDP as a measure of well-being. Price does not fully signal
quality. If it does, then the quality aspect of good or services can be captured by GDP.
The growth rate of GDP during WW2 is found to be very high. GDP being a measure of overall
output in the nation, high real GDP growth implies a higher output. The quality of life severely
disturbed during wars. The increased output makes people no better off during this time. GDP
though measures output but it cannot differentiate the different impact on economic well-being
arises from different production sources. For example, output might be increased due to increase in
government spending in military and other necessary spending to support the war. This does not
add to social or economic welfare hence reflecting another shortcoming of GDP. The types of
goods produced this time mostly include arms, ammunitions and other military production.

b) “There have been major changes in how households and society
function”. For example, in Australia, there has been a shift in the
care of the elderly by the family to nursery home. What is the
impact on GDP from this shift? Has welfare been improved? (2
marks)
The shifts in household and social function has an obvious impact on GDP. When the functions
are done within the family, then such services are not marketed and hence, cannot be included
in GDP. However, after the shift of these functions from family to nursing home, this has become
part of the marketed activity and hence, likely to be included in GDP.

D. Economic Fluctuations and Consumption (7 Marks)
1. Let’s assume households are completely able to smooth their
consumption. Let’s assume that someone in these households loses their
job (or becomes seriously ill or say dies)?
a) What must households have done or been able to do to maintain their
consumption? Explain. (Refer to methods of self-insurance) (1 mark)
b) The idea that households can smooth their consumption over a
lifetime is a great idea. Discuss with reference to the methods
households use to engage in self-insurance in your home country. (2
marks)
Insurance is a method that can be used to smooth consumption. In a perfect world, the
household would have been saved some amount of money to compensate lack of income after
injury or death. Rather than spending the entire money in present consumption household can
purchase insurance that provides a certain amount of coverage during illness or after death
The most common method of smoothing consumption is insurance. People purchase insurance in
fear that unexpected event might occur in future and affect their consumption. They purchase
Insurance to smooth consumption over different period. In Australia, people are engaged in
different type of insurance to smooth their consumption over one period to another. Most
commonly used self-insurance in Australia is life insurance. People often get insure against total
and permanent disability insurance. Other form of self-insurance method in Australia include
income protection insurance, insurance against critical illness and such others

2. Societies have different forms of co-insurance. In your home
country what are the most common methods of co-insurance? Is
co-insurance extensive? (2 marks)
3. Use your analysis of the extent of self-insurance and coinsurance in
your home country.
a) Will consumption expenditure fluctuate when there is an
economy-wide shock to households? (1 mark)
b) What is the implication for fluctuations in GDP? (1 mark)
Co-insurance or under insurance is the situation where the insured value of the property is not
sufficient to cover full value of the property. In Australia, most commercial property insurance is
in form of co-insurance.
Consumption expenditure fluctuates in response to economy wide fluctuation. In times of
economic shocks, household use strategies of saving, borrowing and sharing in order to smooth
consumption of goods and services. However, credit constraints limit the ability to borrow. As a
result, the common strategies of consumption smoothing cannot resist shocks to consumption.
Household consumption is an important part of GDP. Fluctuation in consumption implies a
fluctuation in the level of output and GDP.

E. Economic Fluctuations and Investment (6 Marks)
1. The following chart is for the US economy showing fluctuations in
investment in new technologies, particularly in information and
communications technology. The Nasdaq Index includes the shares of
companies from industries such as computer hardware and software,
telecommunications and biotechnology.
a) Investment in new technology by one firm pushes other firms to invest
as happened with the rapid uptake in new information and
communication technologies that occurred in the United States during
the 1990s. What was likely to happen if firms in the United States did
not invest in this new technology? (2 marks)
b) Investor confidence (which here is captured by the Nasdaq Index) can
also induce firms to invest. How is this illustrated in the above chart?
(2 marks)
Technology is a weapon that helps firms to compete with each other and on international
platforms. In a globalized world, quick dissemination of information and fast communication
has become utmost important. If firms did not invest in new technology, then firms lagged
behind other nations and could have not been enjoyed the important position as like today.
Technology pushes the nation forward.
As shown from the above chart the growth of firms’ investment in technology follows the same
pattern as that of Nasdaq index. The upswing in the index is associated with an increase in
growth in investment technology while a downturn in the index is associated with a decline in
firms’ investment in new technology. The index reaches peak 2009. The growth in investment
also increases in that year. In 2010, the Nasdaq index accounted a sharp fall. Investment also
declines in this year.

c) Consumption is more volatile than investment. Discuss. (2
marks)
The statement is false. Investment is much more volatile than consumption. This is not due to
the fact that investment represents a larger share of output. The share of investment in output is
in fact much smaller than consumption. Individual or household tries to smooth their
consumption over time. Investment on the other hand is much more sensitive to changes in
economic condition as compared to current consumption.