CHAPTER 5: MANAGING THE CHANGING ECONOMIC ENVIRONMENT

Activity 1

Link the following descriptions to the different phases of the business cycle.

Descriptions Phase of business cycle

Monetary sector stabilises and real sector of the economy contracts. Recession
Real sector expansion slows down and the monetary sector stagnates. Slump
Both the real and monetary sectors expand. Boom
Real sector stabilises and the monetary sector improves. Recovery

Activity 2

Assume an economic “boom” phase. Explain what will happen to the following aggregates.

Economic aggregate Explanation

Production capacity of firms. Slow down input purchases
Fixed investment. Re-evaluate new capital expenditure
Employment. Re-evaluate new hiring
Incomes. Rising incomes in line with inflation
Business profits. Rising profits in line with inflation
Monetary sector. Expansion, but slower improvement towards the end

Activity 3

Assume the latter stage of an economic “boom” phase. Explain what will happen to the following
aggregates.

Economic aggregate Explanation

Costs. Increase
Prices. Rise at faster rate
Inflation rate. increases
Imports. Rise faster than exports
Current account of Balance of Payments. Moves towards a deficit (existing deficit widens)
Monetary sector. Financial markets stagnate, speculative
investments fail, unsustainable debt & increased
expectation of contraction

Activity 4

Assume the latter stages of an economic slowdown. Explain what will happen to the following
aggregates.

Economic aggregate Explanation

Incomes. Lower incomes
Consumer spending. Lower spending
Employment. Higher unemployment
Sales. Lower sales
Economic growth. Economic activity declines, may turn negative
Inflation rate. Inflation falls
Current account of Balance of Payments. Moves to a surplus
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 Monetary sector. Slight improvements in monetary sector

Activity 5

Link the following policy responses to the different phases of the business cycle.

Descriptions Phase of business cycle

Government spending continues to rise relative to tax revenue Recovery
Rising tax revenues start to slow down and interest rates high with
Slump
moderate reduction later.
Increased tax revenues and moderate government spending. Boom
Aggressive reduction of interest rates. Recession

Activity 6

The following activity deals with specifically with the recession phase of the business cycle.

Question Answer
What will happen to income levels in the economy? Decrease
What will happen to profit levels in the economy? Decrease
What kind of fiscal policy will the government engage in? Expansionary (decreased
tax/increased government
spending)
What kind of monetary policy will the Reserve Bank engage Expansionary (decreased interest
in? rates)

Activity 7

Link the following macroeconomic indicators to the different business cycle indicators.

Macroeconomic indicator Business cycle indicator

The JSE index is currently at 57500 points. Leading
It was announced by the SARB that the economy grew at an
Coincident
annual rate of 1.8%.
StatsSA announced that our imports grew by 2.6% year-on-
Lagging
year.
NAAMSA announced a 2.2% growth in the sales of new motor
Leading
vehicles.
Retail sales grew by 1.3% year-on-year. Coincident

Activity 8

Link the following descriptions to main schools of thought on why we see business cycles in economic
activity.

Descriptions Main school of thought

Governments are in a position to stabilise the business cycle
Keynesian
through prudent countercyclical policy.
Believe in minimal government intervention and markets are
Austrian/Libertarian
inherently stabile.
Business cycles are inherent to the market economy and will
worsen over time and ultimately cause capitalism to self- Marxist
destruct.
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Activity 9

Assume a functional view of firm strategy on the different phases of the business cycle. Indicate what
firms should do in the following cases when they anticipate movements in the business cycle.

Descriptions Answer
There are signs that a recession is coming. What should firms
Gradually reduce inventory
do in regard to inventory?
There are signs that an expected recovery is coming. What
Timed capacity expansion
should firms do in regards to input purchases?
What should firms do in terms of long-term contracts with Re-negotiate long-term contracts
suppliers towards the end of a recession? with suppliers
What should firms do in terms of capital expenditure projects Significant reductions in capital
during a boom phase? expenditure
During which phase of the business cycle is it the best time to
Recession
upgrade, modernise and upgrade R&D activities?
During which phase of the business cycle is it the best time to
renegotiate soon-to-expire leases or negotiate lower new Recession
leases at significantly lower prices?
At what stage of the business cycle should firms start to
Recession
expand marketing spending?
What should firms do in terms of product offering and Focus on value and areas
marketing message during a recession? neglected by rivals
During which phase of the business cycle will customers
Recession
become more price sensitive?
What is the best time for firms to increase prices? Boom
At which phases of the business cycle are equity prices at their End of recession and beginning of
lowest? recovery
During which phase of the business cycle will successful firms
Recessions
make most of their acquisitions?
At which phases of the business cycle is it the ideal time for
Early to middle parts of boom
firms to sell off non-core business?
At what stage of the business cycle should firms enhance the
Recovery
cross-training of their employees?

Activity 10

Assume the yield curve.

Descriptions Answer
What is the slope of the yield curve when short-rates are
Negative slope
greater than long-rates?
What is the slope of the yield curve when short-rates are less
Positive slope
than long-rates?
What would the slope of the yield curve be in a boom phase? Negative slope
What would the slope of the yield curve be in a recession? Positive slope
At what stages of the business cycle would it be profitable for
Recession and recovery
firms to use short-term debt?
At what stages of the business cycle would it be profitable for
Boom and slump
firms to use long-term debt?