Chapter 14: Business Cycles and Fluctuations

14.1I. Business Cycles =systematic ups and downs of real GDP Business Fluctuations = rise and fall of real GDP over time in a nonsystematic manner A. Business Cycles in the United States: two phases

1. Recession = real GDP decline for two quarters in a row, or six consecutive months •Begins with a peak--the point where real GDP stops going up •Ends when the economy reaches a trough—the turnaround point where real GDP stops going down

2. Second phase: expansion = a period of recovery from a recession •Continues until the economy reaches a new peak

Contraction/downturn

B. If a recession becomes very severe, it can turn into a depression. 1. Worst US Depression began in

October 1929 2. Caused by various factors

3. During a depression production slows, output declines, unemployment becomes high, acute shortages become common, and the standard of living falls

II. Causes of the Business Cycle A. Capital Expenditures – Businesses reduce capital expenditures once they decide they have expanded enough B. Inventory adjustments – at first sign of economic downturn,

businesses cut back on inventories C. Innovation and imitation – once an innovation takes hold, businesses cut back on investment

D. Monetary factors – “easy $$” can stimulate the economy for a short time, eventually increased demands for loans causes interest rates to , which discourages new borrowers. Conversely, tight $$ policies of the Fed slow the economy

E. External shocks – in oil prices and international conflicts can cause changes in business cycles

III. Predicting Business Cycles A. Econometric models are macroeconomic models that use algebraic equations to describe how the economy behaves

GDP = C + I + G + F (X-M)

B. The index of leading indicators (LEI) helps economists predict the direction of future economic activity Average workweek (manufacturing) Initial unemployment claims New orders for consumer goods     Vendor performance Plant and equipment orders Building permits Change in unfilled durable ordersSensitive material prices Stock prices (S&P 500) Real M2Index of consumer expectations

14.2

* labor force = # employed + # unemployed

* UR = #unemployed

X 100 = % # in civilian

labor force

I. Measuring Unemployment A. The unemployment rate = the

percentage of unemployed people divided by

the total number of people in the civilian labor force

B. Unemployment rate understates unemployment because it does not include “discouraged” workers or people who are working part-time because they cannot find full-time work

II. Types of Unemployment: 1.Cyclical— rises during recessions and depressions; falls during recoveries and booms *2.Structural— cheaper resources found elsewhere… often effects less skilled workers; fundamental change in economy reduces demand for workers and their skills

3.Seasonal— caused by changes in season or weather

4.Frictional— temporary unemployment due to firings, layoffs, retraining, searching for better job… ALWAYS exists to some degree *5.Technological– results when technological advances replace workers or makes some jobs obsolete

III. The Concept of Full Employment A. Full employment is the lowest possible employment rate when the economy is growing and all factors of production are being used as efficiently as possible (95.5% of labor force is employed)

B. Full employment is achieved when the unemployment rate falls below 4.5 percent C. High unemployment wastes human resources, reduces living standards, disrupts families, and lowers self-esteem among the unemployed.

14.3

I. Inflation: A rise in the general level of prices.

* Lowers living standards because consumers lose purchasing

power. Those with fixed incomes are hit hardest.

* Inflation usually happens only when there is full employment.

A. Creeping inflation = 1 to 3 % annually

Formula for calculating inflation: Inflation rate = change in price level X 100

Beginning price level

B. Deflation can occur when there is a decrease in the general price level

C. Galloping inflation = inflation as high as 100% to 300 % annually

D. Hyperinflation = more than 500% a year

In Germany after WWI, it was possible to pay 50 million dollars for a nickel cup of coffee, and $35 million for a $35 suit of clothes. This Berlin woman, realizing that fuel costs money, is starting the morning fire with marks"not worth the paper they are printed on".

Children play with blocks of money!

E. Stagflation = high unemployment, slow economic growth, rise in prices (inflation)

II. Causes of Inflation A. Demand-Pull Theory of Inflation --Prices as a result of excessive business and consumer demand. ·Sometimes caused by the federal government’s deficit spending ·If demand increases faster than total supply, the resulting shortage will lead to a in prices.

2. Increases in government spending and in business investments for expansion = demand.

B. Occurs for several reasons: 1. If the Fed causes the money supply to grow too rapidly then demand = in prices

3. Increases if taxes are reduced … more $$ income being spent

4. Consumers begin saving less … more $$ income being spent

C. Cost-Push Theory of Inflation 1.Wage demands of labor unions and excessive profit motive of large corporations push up prices. 2. During periods of cost-push inflation, unemployment can remain high…prices are being adjusted for higher wages NOT because of increased aggregate demand

D. Occurs because: 1. Large unions have the power to demand and receive wage increases that are not justified by the productivity of workers. 2. When businesses have to pay higher wages, their costs increase. To maintain profit level, businesses raise prices, which causes cost of living to increase. 3.Workers then demand higher wages 4. May result from increasing costs of natural resources

III. Consequences of inflation: Unpredictable inflation has a destabilizing effect on the nation’s economy. A. During high inflation, consumers borrow and spend more, so creditors raise interest rates to maintain profit. This SLOWS the economy.

B. The dollar buys less

C. Inflation can cause people to change their spending habits, which disrupts the economy D. Inflation alters the distribution of income

E. During a period of LONG inflation…consumers and businesses will borrow less because of higher interest rates.

IV. Two theories on how to stabilize the economy:

A. Fiscal Policy:

the federal governments

use of taxation and spending

policies to affect

business activity. (John Maynard

Keynes)

John Maynard Keynes

B. Monetarism: there is a direct relationship between the amounts of money the Fed places in circulation and the level of activity in the economy. (Milton Friedman)

Milton Friedman

14.4

I. The Distribution of Income

Lorenz Curve

http://content.answers.com/main/content/img/oxford/Oxford_Geography/0198606737.

B. Since 1980 the distribution of income in the US has become more unequal

A. The Lorenz curve shows how the actual distribution of income differs from an equal distribution

II. Reasons for Income Inequality A. Level of education B. Differences in wealth lead to differences in income C. Discrimination reduces incomes of women and minorities D. Differences in abilities allow some people to earn more than others E. Monopoly power allows some groups, such as doctors, to maintain high incomes

The 2010 Poverty Guidelines for the 48 Contiguous States and the District of Columbia Persons in family Poverty guideline 1 $10,830 2 14,570 3 18,310 4 22,050 5 25,790 6 29,530 7 33,270 8 37,010

For families with more than 8 persons, add $3,740 for each additional person. SOURCE: Federal Register, Vol. 74, No. 14, January 23, 2009, pp. 4199–4201

III. Poverty A. Poverty is defined as having an income below a certain level – the poverty level B. Poverty in America is extensive: approximately 15% of population lives in poverty in 2012 (U.S. Census Bureau)