0 Business Cycles Business Cycles Business cycles are
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Business Cycles §Business Cycles – Business cycles are 2 -year to 5 -year fluctuations around trends in real GDP and other related variables – A recession is a large fall in the growth of real GDP and related variables • A depression is an especially large recession 1
Business Cycles 2
Real GDP Growth in the United States Average growth rate = 3. 5% 3
Recessions in the U. S. since World War II Year and quarter Number of quarters of peak in RGDP until trough in RGDP Change in RGDP, peak to trough (%) 1948: 4 2 -1. 7 1953: 2 3 -2. 7 1957: 3 2 -3. 7 1960: 1 3 -1. 6 1970: 3 1 -1. 1 1973: 4 5 -3. 4 1980: 1 2 -2. 2 1981: 3 4 -2. 9 1990: 2 3 -1. 5 No simple regular or cyclical pattern: output changes very considerably in size and spacing 4
Behavior of the Components of Output in Recessions Component of GDP Consumption Durables Nondurables Services Average Share in fall in GDP in Share in GDP recessions relative to normal (%) growth (%) 8. 4 25. 8 29. 5 15. 6 11. 2 9. 1 4. 7 10. 7 20. 9 11. 7 40. 6 Net Export -0. 4 -12. 3 Gov’t Purchases 20. 6 3. 3 Investment Residential Business Fixed Inventories Fluctuations are distributed very unevenly over the components of output 5
Cyclical Behavior of Key Macroeconomic Variables §Procyclical variable – An economic variable that moves in the “same” direction as aggregate economic activity industrial production, consumption, investment, employment, real wage, inflation, stock prices §Countercyclical variable – An economic variable that moves in the “opposite” direction as aggregate economic activity unemployment 6
Cyclical behavior of the index of industrial production 7
Cyclical behavior of consumption and investment 8
Cyclical behavior of civilian employment 9
Cyclical behavior of the unemployment rate 10
Cyclical behavior of average labor productivity and the real wage 11
Supply shocks A supply shock alters production costs, affects the prices that firms charge. (also called price shocks) Examples of adverse supply shocks: § Bad weather reduces crop yields, pushing up food prices. § Workers unionize, negotiate wage increases. § New environmental regulations require firms to reduce emissions. Firms charge higher prices to help cover the costs of compliance. (Favorable supply shocks lower costs and prices. ) 12
CASE STUDY: The 1970 s oil shocks § Early 1970 s: OPEC coordinates a reduction in the supply of oil. § Oil prices rose 11% in 1973 68% in 1974 16% in 1975 § Such sharp oil price increases are supply shocks because they significantly impact production costs and prices. 13
CASE STUDY: The 1970 s oil shocks The oil price shock shifts SRAS up, causing output and employment to fall. In absence of further price shocks, prices will fall over time and economy moves back toward full employment. P LRAS B SRAS 2 SRAS 1 A AD Y 2 Y 14
CASE STUDY: The 1970 s oil shocks Predicted effects of the oil price shock: • inflation • output • unemployment …and then a gradual recovery. 15
CASE STUDY: The 1970 s oil shocks Late 1970 s: As economy was recovering, oil prices shot up again, causing another huge supply shock!!! 16
CASE STUDY: The 1980 s oil shocks 1980 s: A favorable supply shock-a significant fall in oil prices. As the model would predict, inflation and unemployment fell: 17
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