Business Cycle Theory Changes in Business Activity ©2012, TESCCC Economics, Unit: 06 Lesson: 01.

Business Cycle TheoryChanges in Business Activity

©2012, TESCCC Economics, Unit: 06 Lesson: 01

Answer in ISN:

• How do physicians measure people’s health?

Measuring the Economy

• Every economy wants 3 things:

1. Growth

2. Stabilized Prices

3. Limited Unemployment

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Objectives

1. Describe phases of business cycle2. Identify and explain the factors that

cause business cycles3. 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

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HOW DO WE MEASURE?

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1. GROWTH Business Cycle and GDP

2. STABILIZED PRICES CPI (Consumer Price Index)

3. UNEMPLOYMENT Natural Rate of Unemployment

Business Cycle TheoryA 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.

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Geneva

Add a comma after the word pattern.

Geneva

Add a space between itself and You.

Business Cycle Theory

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Business Cycle Theory Four Phases of business

cycle are:

–Expansion–Peak

–Contraction–recession–Trough

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Business Cycle Theory

Trough

Peak

Expansion

Stages

Recession

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“CONTRACTION”“Economy speeding up”

“Full Employment”

Trough

“Unemployment” “RE

CO

VE

RY

”

“Inflation”

Contraction or Recession

For a contraction to be a true recession, you must see 2 consecutive quarters or six months of declining real GDP.

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Expansion Phase

1. GDP2. Durable goods3. Factory orders4. Raw materials orders5. Unemployment6. Consumer confidence 7. problem: inflation

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Contraction or Recession

1. Demand2. GDP3. Durable goods4. Factory orders5. Unemployment6.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.

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Internal factors (within the economic system)

1. Business InvestmentIn 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.

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Geneva

add a comma after the word economy

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.

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Geneva

Add a comma after the word down

3. Consumer Expectations

Fears of the economy slowing down can 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.

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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

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Must anticipate changes in real GDP Economic Indicators-

Business Cycle Forecasting

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Leading Indicators• Stock prices• Manufacturing

orders• Housing starts• Consumer

confidence

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Lagging Indicators

• Interest rates

• Unemployment

• Credit/Income ratio

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Inflation

Prices Prices©2012, TESCCC

Price Instability

2 types of Price Instability

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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”

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Major Types of Inflation

and Their Causes

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1.Demand-pull inflation: “too many dollars chasing too few goods”

demand > supply

AD1

AS1

PL1

Q1GDP©2012, TESCCC

1.Demand-pull inflation: “too many dollars chasing too few goods”

aggregate demand > aggregate supply

AD2

AD1

AS1

PL1

Q1 Q2

PL2

GDP©2012, TESCCC

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.

AD2

AD1

AS1

PL1

Q1 Q2

PL2

GDP©2012, TESCCC

2. Cost-push inflation: cost of producing goods rises

(ex. cost of inputs increases)

AD1

AS1

Q1

PL1

GDP©2012, TESCCC

2. Cost-push inflation: cost of producing goods rises

(ex. cost of inputs increases). This is more harmful because not only does the PL go up, output or GDP declines.

AD1

AS1

PL2

Q1

AS2

PL1

Q2GDP©2012, TESCCC

Causes of Inflation

There are several factors that can cause or lead to one of the major types of inflation.

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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. . .

©2012, TESCCCRelated to cost-push inflation

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.

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3. Distribution of income is altered

•lenders hurt (money paid back worth less)

•borrowers helped (used $ when worth more)

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Cost Of Living Adjustments

COLA’s

automatic adjustments to

wages each year that takes into

account the rate of inflation

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Stagflation

• This refers to a time of high unemployment (stagnant growth)

plus

high rates of inflation

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Business Cycle Theory Changes in Business Activity ©2012, TESCCC Economics, Unit: 06 Lesson: 01.

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