Business Cycle Chapter 15

Definition and History Def. –A periodic but irregular up and down movement in production and jobs –Two phases (expansion and recession) and two turning points (peak and trough) –Recession: a decrease in real GDP that lasts for at least two quarters Current cycle –Recession from July 1990 to March 1991 –Expansion from March 1991 to the end of (the longest expansion in the US history)

Definition and History Continued US business cycle history –Since 1854, 31 completed cycles with the average length of an expansion of 35 months and the average length of a recession of 18 months. –During the 20 th century, complete cycles have lengthened. –During the 20 th century, expansions have lengthened while recessions have shortened.

Causes of Business Cycle Due to changes in AD and AS AD fluctuations –Profit expectations (optimism) –Changes in government taxes and purchases –Changes in money supply and interest rate –Changes in foreign demand AS fluctuations –Changes in the quantity or price of factors of production (e.g. crude oil price) –Stagflation: a combination of inflation and recession Possible with decline in AS (the and recessions)

Causes of Business Cycle Continued Examples – recession Crude oil price increase  higher cost of production  AS decline  recession (stagflation) –1982 recession Decrease in M  AD decline  recession – expansion Reagan tax cuts and star wars spending  AD increase  expansion – expansion Technology revolution  optimism  AD increase  expansion

Adjustment Toward Full Employment Why repeating the cycle? –Because of forces that move the economy back toward full employment Inflationary gap when real GDP > potential GDP  prices rise  wages rise  higher costs causing a decline in AS  elimination of inflation gap Deflationary gap when real GDP < potential GDP  prices fall  wages fall  lower costs causing an increase in AS  elimination of deflation gap