1. The Business Cycle
Sec. 2
(Read all of Sec. 2)

2. A modern industrial economy repeatedly goes thru good times, then bad, then good…. it goes thru cycles

3. Why is it important to understand the nature of business cycles?
The business cycle directly impacts our daily lives
We are continually faced with decisions that can enable us to take advantage of “good” times… and lessen the hurt of the “bad” times

4. 4 Phases Phase 1: Expansion MANY NEW BUSINESSES OPEN STRONG EMPLOYMENT
period of prosperity
Typical characteristics:
MANY NEW BUSINESSES OPEN
STRONG EMPLOYMENT
FACTORIES WORKING AT OR NEAR FULL CAPACITY
CONSUMER SPENDING IS STRONG

5. Expansion has ceased… Next phase: “Peak”
businesses may have begun to cut back or postpone new spending
Job creation slows

6. Phase 3
From a peak ( where GDP levels off) GDP begins to decline… contraction occurs:
BUSINESS ACTIVITY SLOWS noticeably
UNEMPLOYMENT RISES
FACTORIES WORK AT LESS THAN FULL CAPACITY
CONSUMER SPENDING WEAKENS

7. Important point !
If a contraction lasts at least 2 quarters (6 months), we are said to be in a “recession”
A prolonged recession or one that is particularly severe is called a “depression”

8. Typical symptoms of a recession:
factories cut back production and lay off workers in large #s
Consumers cut back on purchases
More consumers & biz are late on loan payments…increasing loan defaults occur
Fewer new businesses open, many established ones fail
Home foreclosures may rise

9. At some point, the downward trend of the cycle levels off…
The lowest point is called the trough (“troff”)

10. From the trough…
biz cycle enters the recovery and expansion phase (GDP grows)…
Employment rises…new businesses open…spending increases
eventually growth slows…then stalls…contraction begins
And the cycle continues…

11. The Typical Course of Business Cycles
Peak
AND THE CYCLE CONTINUES…
Recovery & Expansion
Level of National Business Activity
Peak
Contraction
Trough
Time
Figure 7-8

12. 4 Main Variables Impact the business cycle

13. 1. Business investment (a.k.a “capital spending”)
When the economy is expanding, firms expect sales & profits to keep rising. Therefore, they are more willing and likely to invest in new equipment , expansion, etc. investment tends to create jobs and increase output, helping to perpetuate the economic expansion

14. 2. Interest Rates & Credit
low interest rates = encourages borrowing & buying on credit (individuals & firms)
Demand for goods/svcs. grows
Important: Stronger demand for goods/services motivates firms to hire more people to increase output
Int. rates today: high or low?

15. 3. Consumer psychology/expectations
Optimism/confidence = strong consumer spending (opposite is true, too… weakening confidence means weakening spending by consumers)

16. 4. External Shocks
Repercussions from an outside event (a war, natural disaster, etc.)
EG: 9/11/2001
Of all the factors that affect the biz cycle, this is most difficult to predict
Could be a positive shock (eg, discovery of huge oil deposit)

17. Forecasting Biz Cycles
Economists collect data on a regular basis to
measure current conditions as well as to forecast
future trends.
Economic Indicators: 3 Categories
A. “Leading indicators” Changes to these data change suggests what will happen to the cycle in the near future (yellow traffic light)
Some Examples:
1. # of building permits issued
2. # of new claims for unemployment insurance
3. survey of inventory levels

18. B. Coincident Indicators
Changes to these data occur at approx. the same time as the conditions they signify. In our traffic light example, the pedestrian walk signal would coincide (happen) at about the same time as a green.
Example:
1. Personal Income

19. C. Lagging Indicators change after the economy as a whole does
Examples:
Avg. length of unemployment

20. Some Notable Cycles in U.S. History
Great Depression ( )
1946 Recession (returning GIs)
1973 Recession (external shock)
1990s Expansion (dot.com bubble)
2007 Recession (housing collapse)

21. U.S. Business Cycles 9/11 2007 Gr. Recession Begins 1990s Boom begins
2000
Peak
9/11
2007 Gr. Recession Begins
1990s Boom begins
Post WWII Recession
Gr. Dep. begins