Question

5. Business cycles

Complete the following statement.

As the economy contracts, employment _______________( decreases / increases ) and households’ disposable income _______________( decreases / increases ) , which leads to a ______________ ( higher / lower ) level of consumption. To meet the new consumer demand, firms _______________( decreases / increases ) output, which _______________( decreases / increases )   sales, so that corporate earnings  _______________( decreases / increases ) and stock prices ___________ ( rise / fall ).

The previous statement implies that the stock market is _______________ ( procyclical / counteryclical )

Answer 1

As the economy contracts, employment decreases and households’ disposable income decreases , which leads to a lower level of consumption. To meet the new consumer demand, firms decreases output, which decreases sales, so that corporate earnings decreases and stock prices fall.

The previous statement implies that the stock market is procyclical i.e. as the business cycle contracts the stock market will contract and as the business cycle expands it will also expand.