Business Cycle Theory Changes in Business Activity 2012
Business Cycle Theory Changes in Business Activity © 2012, TESCCC Economics, Unit: 06 Lesson: 01
Answer in ISN: • How do physicians measure people’s health?
Measuring the Economy • 1. 2. 3. Every economy wants 3 things: Growth Stabilized Prices Limited Unemployment © 2012, TESCCC
Objectives 1. Describe phases of business cycle 2. Identify and explain the factors that cause business cycles 3. Analyze how economists use business cycle theory to predict what is going to happen 4. Analyze how the government uses predictions to make public policy © 2012, TESCCC
HOW DO WE MEASURE? 1. GROWTH Business Cycle and GDP 2. STABILIZED PRICES CPI (Consumer Price Index) 3. UNEMPLOYMENT Natural Rate of Unemployment © 2012, TESCCC
Business Cycle Theory A free market economy does not grow at a constant rate. It goes through a series of expansions and contractions. These fluctuations are called business cycles. Business cycles reflect patterns to the general level of economic activity or the level of production of goods and services (GDP). Since this is a pattern it keeps repeating itself. You can see the business cycle activity from 1914 to 1992 below in the graph. © 2012, TESCCC
Business Cycle Theory © 2012, TESCCC
Business Cycle Theory Four Phases of business cycle are: –Expansion –Peak –Contraction–recession –Trough © 2012, TESCCC
Business Cycle Theory Recession “CONTRACTION” “Full Employment” “REC “Economy speeding up” “Unemployment” Trough © 2012, TESCCC RY” Expansion “Inflation” OVE Stages Peak Trough
Contraction or Recession For a contraction to be a true recession, you must see 2 consecutive quarters or six months of declining real GDP. © 2012, TESCCC
Expansion Phase 1. 2. 3. 4. 5. 6. 7. © 2012, TESCCC GDP Durable goods Factory orders Raw materials orders Unemployment Consumer confidence problem: inflation
Contraction or Recession 1. Demand 2. GDP 3. Durable goods 4. Factory orders 5. Unemployment 6. Consumer confidence 7. problem: unemployment. © 2012, TESCCC
Causes • There are several things that may lead to fluctuations in the economy. Some are within the economy and we call them internal factors. Some are outside the economy and we call them external factors. © 2012, TESCCC
Internal factors (within the economic system) 1. Business Investment In an expanding economy firms invest in new capital goods. This investment spending creates new jobs and growth. If firms decide to halt investment, this slows the economy down and can cause unemployment. © 2012, TESCCC
2. Interest Rates and Credit When interest rates go up, consumers will not make big ticket purchases. Lower demand slows down economy. When interest rates go down we see more purchases being made – causing growth. © 2012, TESCCC
3. Consumer Expectations Fears of the economy slowing down cause consumers to stop spending. This will then actually slow down the economy. If consumers feel confident about the economy, they spend more. Spending more can cause growth. © 2012, TESCCC
External factors (outside the economic system) External Shocks These are factors outside the economic system, but they can cause fluctuations in business activities. Examples include: wars natural disasters foreign economies 9/11 © 2012, TESCCC
Business Cycle Forecasting Must anticipate changes in real GDP Economic Indicators- © 2012, TESCCC
Leading Indicators • Stock prices • Manufacturing orders • Housing starts • Consumer confidence © 2012, TESCCC
Lagging Indicators • Interest rates • Unemployment • Credit/Income ratio © 2012, TESCCC
Inflation Prices © 2012, TESCCC Prices
Price Instability 2 types of Price Instability © 2012, TESCCC
1. Inflation - a rise in the general level of prices -value of the dollar decreases. 2. Deflation - a decline in the general level of prices” © 2012, TESCCC
Major Types of Inflation and Their Causes © 2012, TESCCC
1. Demand-pull inflation: “too many dollars chasing too few goods” demand > supply AS 1 PL 1 AD 1 GDP © 2012, TESCCC Q 1
1. Demand-pull inflation: “too many dollars chasing too few goods” aggregate demand > aggregate supply AS 1 PL 2 PL 1 AD 2 AD 1 GDP © 2012, TESCCC Q 1 Q 2
1. Demand-pull inflation: all sectors of the economy contribute to demand-pull inflation. Aggregate demand is C+I+G so the household sector, the business sector and the government sector contribute to too much aggregate demand. AS 1 PL 2 PL 1 AD 2 AD 1 GDP © 2012, TESCCC Q 1 Q 2
2. Cost-push inflation: cost of producing goods rises (ex. cost of inputs increases) AS 1 PL 1 AD 1 GDP © 2012, TESCCC Q 1
2. Cost-push inflation: cost of producing goods rises AS 2 AS 1 PL 2 PL 1 AD 1 GDP Q 2 © 2012, TESCCC Q 1 (ex. cost of inputs increases). This is more harmful because not only does the PL go up, output or GDP declines.
Causes of Inflation There are several factors that can cause or lead to one of the major types of inflation. © 2012, TESCCC
1. Wage-price spiral. . . – prices rise – workers want raises to pay higher prices – prices go up b/c workers paid more money – workers want raises to pay higher prices – prices rise – higher wages – ETC. . . Related to cost-push inflation © 2012, TESCCC
2. Government deficit or deficit spending “crowding-out effect” – related to demand-pull inflation © 2012, TESCCC
3. Quantity Theory • Quantity theory of inflation- Milton Friedman and University of Chicago economists (Monetarists) stated that too much money in the economy causes inflation. The money supply is growing; leave it alone -Fed should not increase or decrease. © 2012, TESCCC
Effects of Inflation © 2012, TESCCC
1. The dollar buys less purchasing power decreases © 2012, TESCCC
3. Distribution of income is altered • lenders hurt (money paid back worth less) • borrowers helped (used $ when worth more) © 2012, TESCCC
2. Spending habits change, interest rates rise (won’t get loans for big ticket purchases) © 2012, TESCCC
4. Reduces real wages of workers. © 2012, TESCCC
5. Decreases value of savings dollar is worth less © 2012, TESCCC
Ways to Measure Inflation 1. CPI 2. PPI © 2012, TESCCC
Cost Of Living Adjustments COLA’s automatic adjustments to wages each year that takes into account the rate of inflation © 2012, TESCCC
Stagflation • This refers to a time of high unemployment (stagnant growth) plus high rates of inflation © 2012, TESCCC
- Slides: 42