Evaluate fluctuations of Australia’s GDP in light of business cycle theories.
Throughout the history of the Australian economy there has been constant fluctuations of the Gross Domestic Product (GDP), these fluctuations strongly affect the strength of the Australian economy at certain points in time. Fluctuations are a common part of every economy throughout the world; they occur inturn with positive or negative times of economic growth. Many economists have tried to relate these fluctuations in GDP with several business cycle theories. The most recent results from Australia’s GDP is from February 2012 where the Australian public was told that GDP anticipated steady acceleration and “predicted to be at 2.9% in 2012” (Economic Forecast 2012). There are many theories that relate to the fluctuations of Australia’s GDP, such as the Real Business Cycle Theory (RBC), the Political Business Cycle Theory, and many more. It is through the evaluation of these theories that we are able to understand why there are these fluctuations in the business cycle, and it is through our understanding that we are able to help our economy grow.
When we look at trying to initially understand these fluctuations in GDP we will often look at the basic equilibrium Business Cycle Model. When looking at this model it is clear to see that we use equilibrium conditions, the main condition of this model is that “markets have to clear” (Barro pg 133). This means that the total amount of labour and capital that is supplied equal to the total amount of labour and capital demanded. The equilibrium business cycle model also features “intertemporal decision making by households as the primary means of generating empirically plausible output dynamics” (Branch 2010). It is well known throughout the economic world however that when this equilibrium model is undertaken there are a few negatives which are impossible to dismiss. For example this basic equilibrium model is known to have unrealistic responses to technology shocks. “In response to transitory technology shocks, the time series data for output exhibit a humped shape response, with output continuing to increase following the shock” (Cogley & Nason). When we compare this reaction to one that occurs when we apply the RBC model we see different results. We can look at the equilibrium business cycle model in terms of the 2007 Global Financial Crisis and see that the shocks that occurred within the economy and their consequences we can see that the reactions of households is different than what would be expected of the equilibrium business cycle model.
A theory which is widely talked about and accepted in the economics world is the Real Business Cycle Theory. The RBC theory is actually a form of the equilibrium model which we have just discussed. The RBC theory is technically a class of models in which the fluctuations of the business cycle can be accounted for by shocks. “The empirical success of RBC models is often judged by their ability to explain the behaviour of a multitude of real macroeconomic variables using a single exogenous shock process (Nakamura). It is through the study of the RBC that economists have evaluated past shocks in the economic world and given reasons as to why they have occurred. The main conceptual issue that we again look at here is how fluctuations we see in our GDP reflect the shocks experienced.
Y = A . F(K,L)
In the production function above it is clear to see that an increase or decrease in A (technology) will bring about a change in Y. An increase in A essentially results in a increase in production, and the change in Y is what we consider as the result of a shock. We should note that in an economy technology is not the only shock that can be received, a key one which should also be noted is climate shocks (cyclones, tornados, tsunami’s). Climate shocks can have a huge impact on several different aspects of an economy at one time.
