Transcript File - VaNDERNOMICS

Chapter 8- The Business Cycle
Objective – Students will be able to
answer questions regarding the business
cycle.
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© 2001 by Prentice Hall, Inc.
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The Business Cycle
 The United States’ GDP is not constant from
year to year.
 Instead, the GDP grows most years and then
shrinks in some years.
 The ups and downs in GDP over time is
referred to as the business cycle.
The Business Cycle Illustrated:
The Business Cycle Illustrated:
 Peak
 temporary maximum in Real GDP. At this point
the unemployment rate (u%) is probably below
the natural rate of unemployment, and the
inflation rate (π%) is probably increasing.
 Recession
 The contractionary phase of the business cycle.
A period of decline in Real GDP accompanied
by an increase in u%. To be classified as a
recession, the economic decline must be at least
6 months long.
The Business Cycle Illustrated:
 Trough
 The bottom of the business cycle. The u% is
probably high and π% is probably low.
 Recovery
 The phase of the business cycle where the
economy is returning to full employment.
The Business Cycle Illustrated:
 Important note
 The various phases of the business cycle last for
different amounts of time.
 In recent history, expansions have lasted years
longer than have recessions.
 The Great Depression is the most notable
example of a long recession/trough
The Business Cycle Illustrated:
 Causes
 Irregularity of Investment
 Changes in productivity
 Changes in total spending (aggregate demand)
 Durable goods manufacturing is most susceptible
to the effects of the business cycle
The Business Cycle Illustrated:
 Business cycle has become less severe because of
technological advancements in supply-chain
management and structural changes in U.S.
economy.
Section 1 Assessment
1. Describe the four phases of the business cycle.
2. Describe the causes of the business cycle.
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 Summary: In a paragraph, describe what you
have learned today.
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Key to Macroeconomic Symbols
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GDPR – Real GDP (Output)
C – Consumption
IG – Gross Private Investment
G – Government Spending
XN – Net Exports (Exports – Imports)
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w- wages (primary cost of production)
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T – taxes
DI – disposable income
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X – Exports
M – Imports
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AD – aggregate demand
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SRAS – short-run aggregate supply
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LRAS – long-run aggregate supply
PL – Price Level
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SRPC – short-run Phillips curve
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LRPC – long-run Phillips curve
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u% - unemployment rate
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π% - inflation rate
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SLF – Supply of loanable funds
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DLF – Demand for loanable funds
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r% - real interest rate
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MS – Money Supply
MD – Money Demand
ER – Excess Reserves
i% - nominal interest rate
DR – discount rate
RR – reserve ratio
OMO – open market operations (buying
and selling gov’t bonds)
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FOREX – foreign exchange market
D$ - demand for dollars in FOREX
S$ - supply of dollars in FOREX
$ - value of dollar in FOREX
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↑ - increase
↓ - decrease
→ - shift right (increase)
← - shift left (decrease)
.: - therefore
Δ - change
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Self-correcting economy: below full-employment (recession)
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Assume recessionary gap with flexible wages (w)
u% ↑.: w↓ .: SRAS→.: GDPR↑ & PL↓.: u%↓ & π%↓ = SRPC←
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Self-correcting economy: above full-employment (inflation)
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Assume inflationary gap with flexible wages (w)
u%↓ .: w↑ .: SRAS←.: GDPR↓ & PL ↑.: u%↑ & π%↑ = SRPC→
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Expansionary fiscal policy on economy below full-employment (recession)
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Assume recessionary gap with sticky wages (note: DI = disposable income)
T↓.: DI↑.: C↑.: AD→.: GDPR↑ & PL↑.: u%↓ & π%↑ = move up/left along SRPC
OR
G↑.: AD→.: GDPR↑ & PL↑.: u%↓ & π%↑ = move up/left along SRPC
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Contractionary fiscal policy on economy above full-employment (inflation)
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Assume inflationary gap
T↑ .: DI↓.: C↓ .: AD← .: GDPR↓ & PL↓ .: u%↑ & π%↓ = move down\right along SRPC
OR
G↓ .: AD← .: GDPR↓ & PL↓ .: u%↑ & π%↓ = move down\right along SRPC
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Expansionary monetary policy on economy below full-employment (recession)
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Assume recessionary gap with sticky wages
Fed buys bonds, DR↓, and/or RR↓ .: ER↑ .: MS→ .: i%↓ .: IG↑ .: AD→.: GDPR↑ & PL↑.: u%↓ & π%↑ = move up/left along SRPC
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Contractionary monetary policy on economy above full-employment (inflation)
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Assume inflationary gap
Fed sells bonds, DR↑, and/or RR↑ .: ER↓ .: MS ← .: i%↑ .: IG ↓ .: AD← .: GDPR↓ & PL↓ .: u%↑ & π%↓ = move down\right along SRPC
‘Crowding Out’ of Gross Private Investment (effect of deficit spending)
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Assume Expansionary Fiscal Policy (G↑ and/or T↓ .: government budget moves toward deficit)
deficit spending .: DLF → or SLF ← .: r%↑ .: IG ↓ (partially or completely offsets intended increase in AD)
‘Crowding In’ of Gross Private Investment (effect of budget surplus)
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Assume Contractionary Fiscal Policy (G↓ and/or T ↑ .: government budget moves toward surplus)
budget surplus .: DLF ← or SLF→ .: r% ↓ .: IG↑ (partially or completely offsets intended decrease in AD)
Expansionary Fiscal Policy Net Export Effect (counters policy)
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Assume Expansionary Fiscal Policy (G↑ and/or T↓ .: government budget moves toward deficit)
deficit spending .: DLF → or SLF ← .: r%↑ .: D$ → .: $↑ .: U.S. goods/services relatively expensive and foreign goods/services are relatively cheap .: X↓
and/or M↑ .: XN ↓
Contractionary Fiscal Policy Net Export Effect (counters policy)
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Assume Contractionary Fiscal Policy (G↓ and/or T ↑ .: government budget moves toward surplus)
budget surplus .: DLF ← or SLF→ .: r% ↓ .: S$ → .: $↓ .: U.S. goods/services relatively cheap and foreign goods/services are relatively expensive .: X↑
and/or M↓ .: XN↑
Expansionary Monetary Policy Net Export Effect (reinforces policy)
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Fed buys bonds, DR↓, and/or RR↓ .: ER↑ .: MS → .: i%↓ .: S$ → .: $↓ .: U.S. goods/services relatively cheap and foreign goods/services are relatively
expensive .: X↑ and/or M↓ .: XN↑
Contractionary Monetary Policy Net Export Effect (reinforces policy)
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Fed sells bonds, DR↑, and/or RR↑ .: ER↓ .: MS↓ .: i%↑ .: D$ → .: $↑ .: U.S. goods/services relatively expensive and foreign goods/services are
relatively cheap .: X↓ and/or M↑ .: XN ↓