CA Foundation P4 · Chapter 6
Business Cycles MCQs with Answers
15 multiple-choice questions on Business Cycles for CA Foundation P4 Business Economics. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
The correct sequence of the phases of a business cycle is:
- A) Peak, expansion, trough, contraction
- B) Trough, peak, expansion, contraction
- C) Contraction, peak, expansion, trough
- D) Expansion, peak, contraction, trough
Show answer & explanation
Answer: D) Expansion, peak, contraction, trough
Economic activity rises during expansion, reaches its highest point at the peak, declines during contraction (recession, possibly deepening into depression), and touches its lowest point at the trough, after which recovery begins.
Question 2
Which statement about business cycles is correct?
- A) They occur at fixed, regular intervals
- B) They affect only the agricultural sector
- C) Every cycle has identical duration of expansion and contraction
- D) They are recurrent but not periodic, varying in length and intensity
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Answer: D) They are recurrent but not periodic, varying in length and intensity
Business cycles recur, but their duration and amplitude differ from one cycle to another, so they cannot be predicted precisely. They are economy-wide, affecting output, employment, prices and incomes across many sectors.
Question 3
Which of the following is generally regarded as a leading indicator of economic activity?
- A) Unemployment rate
- B) Gross domestic product
- C) Personal income
- D) Stock market prices
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Answer: D) Stock market prices
Leading indicators change before the economy as a whole changes; examples include stock prices, new orders for capital goods and building permits. GDP and personal income are coincident indicators, while the unemployment rate is typically a lagging indicator.
Question 4
Industrial production, which moves at the same time as the overall economy, is an example of a:
- A) Coincident indicator
- B) Leading indicator
- C) Lagging indicator
- D) Structural indicator
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Answer: A) Coincident indicator
Coincident indicators move simultaneously with the business cycle, giving information about the current state of the economy. Industrial production, GDP and retail sales are commonly cited examples.
Question 5
Which of the following is a characteristic of the depression phase?
- A) Full utilisation of productive capacity
- B) Rapidly rising wages and prices
- C) Large-scale unemployment and a sharp fall in output and prices
- D) High optimism among investors
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Answer: C) Large-scale unemployment and a sharp fall in output and prices
During depression aggregate demand is very low, firms cut production, unemployment is widespread, prices and profits fall and business confidence is weak. Full capacity, rising wages and optimism characterise the boom phase.
Question 6
According to Keynes, business cycles are caused mainly by:
- A) Changes in sunspot activity
- B) Expansion and contraction of bank credit alone
- C) Fluctuations in aggregate effective demand
- D) Innovations introduced by entrepreneurs
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Answer: C) Fluctuations in aggregate effective demand
Keynes attributed economic fluctuations to changes in aggregate effective demand, particularly volatile investment driven by changes in the marginal efficiency of capital. Credit expansion is Hawtrey's explanation, innovations are Schumpeter's and sunspots are Jevons'.
Question 7
The view that the trade cycle is 'a purely monetary phenomenon' caused by expansion and contraction of bank credit is associated with:
- A) Hawtrey
- B) Schumpeter
- C) Pigou
- D) Keynes
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Answer: A) Hawtrey
R. G. Hawtrey argued that changes in the flow of money, especially bank credit, cause booms and depressions. When banks expand credit, demand and prices rise; when they contract it, a downturn follows.
Question 8
According to Schumpeter, business cycles are caused by:
- A) Innovations introduced by entrepreneurs
- B) Changes in psychological moods of businessmen
- C) Changes in weather affecting agriculture
- D) Over-saving by households
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Answer: A) Innovations introduced by entrepreneurs
Schumpeter's innovation theory holds that the introduction of new products, methods or markets triggers bursts of investment, leading to expansion. As innovations are absorbed and imitators enter, the boom gives way to contraction.
Question 9
The theory that business cycles result from waves of optimism and pessimism among businessmen is associated with:
- A) Pigou
- B) Hawtrey
- C) Jevons
- D) Hicks
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Answer: A) Pigou
A. C. Pigou emphasised psychological factors: optimism leads to over-investment and a boom; when errors of optimism are discovered, pessimism sets in and leads to a downturn. Jevons linked cycles to sunspots and Hicks to the multiplier-accelerator interaction.
Question 10
The 'sunspot theory' of business cycles, which linked fluctuations in agricultural output to changes in sunspot activity, was put forward by:
- A) J. A. Schumpeter
- B) A. C. Pigou
- C) R. G. Hawtrey
- D) W. S. Jevons
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Answer: D) W. S. Jevons
Jevons suggested that sunspots affect weather, which affects agricultural yields; since agriculture was a large share of economic activity, this would affect trade and industry. It is an example of an external (exogenous) explanation of cycles.
Question 11
The worldwide economic downturn that began with the stock market crash of 1929 is known as:
- A) The Great Moderation
- B) The Industrial Revolution
- C) Stagflation
- D) The Great Depression
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Answer: D) The Great Depression
The Great Depression of the 1930s followed the 1929 Wall Street crash and saw massive unemployment and falling output in many countries. It was a major influence on Keynes' General Theory of 1936.
Question 12
A commonly used rule of thumb defines a recession as:
- A) Any single month in which industrial output falls
- B) Two consecutive quarters of decline in real GDP
- C) A rise in the inflation rate for two consecutive quarters
- D) A fall in the stock market index by 5% in a year
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Answer: B) Two consecutive quarters of decline in real GDP
A widely used practical definition of a recession is a fall in real GDP for two successive quarters. Inflation or stock market movements alone do not define a recession.
Question 13
To counter a recession, the government is most likely to:
- A) Increase taxes and cut public expenditure
- B) Increase public expenditure and/or reduce taxes
- C) Raise interest rates sharply
- D) Reduce money supply
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Answer: B) Increase public expenditure and/or reduce taxes
During a recession aggregate demand is deficient, so expansionary (counter-cyclical) fiscal policy - more spending and lower taxes - is used to boost demand. Raising taxes, raising interest rates and cutting money supply are contractionary measures suited to an inflationary boom.
Question 14
Samuelson and Hicks explained business cycles through the interaction of:
- A) The multiplier and the accelerator
- B) Money supply and velocity of circulation
- C) Sunspots and agricultural output
- D) Innovation and imitation
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Answer: A) The multiplier and the accelerator
In the multiplier-accelerator model, a rise in investment raises income via the multiplier; the rise in income induces further investment via the accelerator (investment depends on the change in output). This interaction can generate cumulative upswings and downswings.
Question 15
Which of the following statements about the impact of business cycles is INCORRECT?
- A) Durable and capital goods industries tend to fluctuate more than non-durable consumer goods industries
- B) All sectors of the economy are affected equally during a downturn
- C) Business cycles affect firms' decisions on investment, inventory and hiring
- D) Downturns tend to lower business profits and employment
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Answer: B) All sectors of the economy are affected equally during a downturn
Purchases of durable and capital goods can be postponed, so these industries usually show sharper fluctuations than necessities. Hence sectors are not affected equally. Business cycles do influence investment, inventory and hiring decisions, and downturns typically reduce profits and employment.