3 Business Cycles vs. Business Fluctuations Business Cycles: regular increases and decreases in real GDPBusiness Fluctuations: irregular increases and decreases in real GDPThey both can interrupt economic growth
4 First phase is recession, a period during which real GDP (GDP measured in constant prices) declines for at least 2 quarters in a row or 6 consecutive months.
5 The recession begins when the economy reaches a peak, the point where real GDP stops going up.
6 The recession ends when the economy reaches a trough, the turnaround point where real GDP stops going down.
7 As soon as the declining real GDP bottoms out, the economy moves into the second phase, expansion – a period of recovery until the economy reaches a new peak.
8 When it does, the current business cycle ends and a new one begins.
9 Trend line: growth path the economy would follow if it were not interrupted by alternating periods of recession and recovery
10 Causes of Changes in the Business Cycle Changes in investment spending: When the economy is expanding, businesses expect future sales to be high, so they invest heavily in capital goods.Innovation and Imitation: Come up with a new product or new way of doing things; copying what other companies may be doingMonetary Policy Decisions: Change of interest rates causing incentives to invest or notExternal Shocks: oil prices, wars, international conflict, natural disasters
11 What Happens if a recession becomes very severe? Depression: a state of the economy with large numbers of people out of work, acute shortages, and excess capacity in manufacturing plants.
12 The Great Depression Causes Effects Unequal distribution of income Easy CreditGlobal economic conditionsGDP fell almost 50 percentUnemployment rose nearly 800 percentAverage manufacturing wage fell from 55 cents an hour to 5 cents an hourBanks failedMoney supply contracted
13 What’s the difference between inflation and deflation? Inflation: increase in the general level of prices of goods and servicesDeflation: decrease in the general level of prices for goods and services
14 Market Basket: commonly purchased goods and services Total of approx. 354 determined items
15 Constructing the Consumer Price Index Consumer Price Index (CPI): series used to measure prices changes for a representative sample of frequently used consumer itemsSelect a Market BasketFind the average price of each item in the market basket. Then add up the total for the basket.Have a base year: a year that serves as a comparison for all other yearsConvert the dollar cost of a market basket to an index value so that it is easier to interpret.
16 (current year CPI – previous year CPI) Previous year CPI Measuring Inflation(current year CPI – previous year CPI) Previous year CPI
17 Types of InflationCreeping Inflation: 1-3% inflation per year; not much of a problemHyperinflation: 500% and above inflation per year; very very rareStagflation: period of slow economic growth coupled with inflation
18 Causes of InflationCauses of inflation include strong demand, rising costs, and wage-price spirals, along with a growing supply of money.Demand-pull inflation: prices rise because all sectors try to buy more goods and services than the economy can produce; cause shortages, which drive up pricesCost-push inflation: rising costs drive up prices of products
19 Consequences of Inflation Inflation can reduce purchasing power, distort spending, and affect the distribution of income.Reduce Purchasing Power: dollar buys less as prices riseDistort Spending Patterns:Encourage Speculation: Spend money on luxury items if the prices are expected to increaseDistorted Distribution of Income:
22 Measuring Unemployment Civilian Labor Force: sum of all people age 16 and above who are either employed or actively seeking employmentWho is classified as unemployed?People available to work who made a specific effort to find a job during the past month AND worked less than 1 hour for pay in a weekWork 15 hours or less in a week in a family business for no pay
23 How to Calculate the Unemployment Rate Number of unemployed persons Civilian Labor Force 7,015,000 = = 4.6% 150,991,000
25 Limitations of the Unemployment Rate Doesn’t measure people too frustrated or discouraged to look for workPeople are considered employed even if they only have part-time jobs
26 Sources of Unemployment Frictional: workers are between jobs; short-term conditionStructural: fundamental change in the economy; more serious type of unemployment, also includes Technological: workers are replaced by machines or automated systemsCyclical: related to changes in the business cycle, also includes Seasonal: annual changes in the weather or other conditions that reduce the demand for jobs