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101 Concepts for the Level I Exam

Concept 25: Theories of The Business Cycle


Theory Causes of Business Cycles Recommended Policy
Neoclassical Changes in technology. No action is necessary; wages and prices adjust through demand-supply characteristics pulling or pushing the economy form expansion or recession level to its full-employment level.
Keynesian Shifts in AD due to changes in business expectations can lead to over or under investments.

Downward sticky wages prevent a self-recovery from contraction (SRAS curve is slow to move down).

Authorities should use fiscal and/or monetary policy to shift the AD curve directly to get the GDP to its full employment level.
New Keynesian In addition to Keynesian beliefs, this theory believes other factors of production are also downward sticky, presenting additional barriers to self-recovery. Same as Keynesian (use fiscal and/or monetary policy to shift the AD curve directly to get the GDP to its full employment level).
Monetarist Inappropriate changes in money supply growth rate. Monetary authorities should follow policies of steady, predictable growth rate of money supply.
Austrian Government intervention in economy. Policymakers shouldn’t keep interest rates at artificially low levels. Markets should be allowed to self-correct.
New Classical (RBC Theory) Changes in technology and external shocks. Policymakers shouldn’t try to counteract business cycles, as expansions and contractions are rational market reactions to external shocks. Theory assumes that individuals and firms try to maximize their utility functions.