1. An Overview of Business Cycle Theories & The Circular Flow Model
peak
trough
recovery
contraction
Dr. Dennis Foster

2. Characteristics & Features
Rise and fall in Gross Domestic Product (GDP) around some long term trend.
Unemployment generally lags ∆GDP
Inflation generally inversely related and lags during the expansion.
Four phases: peak, contraction, trough , recovery
Contraction aka “recession” or “downturn” or “depression” [old days – “panic ”]

3. National Bureau of Economic Research
Identifies dates of business cycles (here).
Dec peak called in Dec. of 2008 (here).
A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators. A recession begins when the economy reaches a peak of activity and ends when the economy reaches its trough.
June 2009 trough called in Sept (here).
The recession lasted 18 months, which makes it the longest of any recession since World War II.

4. The Data on U.S. Business Cycles

5. Problematic Recovery
Ave. = 2.8%
Ave. = 2.25%
2001
2008

6. Thomas Malthus Joseph Schumpeter
Workers paid < the value of their production.
Excess supply develops across the economy.
Depression.
FYI – long run wages at subsistence.
Joseph Schumpeter
Business cycles form patterns:
Inventory adjustments – 3 to 5 yrs. Fixed investment – 7 to 11 yrs. Infrastructure building – 15 to 25 yrs. Major innovations – 45 to 60 yrs.

7. Lord John Maynard Keynes
Karl Marx
Capitalism produces surplus value.
Production goes unsold.
Crisis ensues; depression.
Worsens over time!!
Lord John Maynard Keynes
Lack of confidence reduces spending.
Wages (and prices) don’t fall  depression.
Solution – replace private spending with public spending.

8. Milton Friedman Ludwig von Mises Emphasizes the role of money.
Depressions preceded by fall in MS.
In a depression, raise MS to counter.
Ludwig von Mises
Depressions due to “credit bubbles.”
Bubbles perpetuated by the Fed.
Depression allows reallocation.
Say’s Law

9. Circular Flow Model I: 2 sectors & no saving
Consumption Expenditures
Goods and Services
Households (HH)
Businesses (Bus)
Factor “rental” – land, labor, capital
Income to factors
Real flows.
Money flows.

10. Financial Intermediaries Factor “rental” – land, labor, capital
Circular Flow Model II: 2 sectors with saving
Consumption Expenditures
Goods and Services
Investment
Saving
Financial Intermediaries
Households (HH)
Businesses (Bus)
Factor “rental” – land, labor, capital
Income to factors
Real flows.
Money flows.

11. Financial Intermediaries Factor “rental” – land, labor, capital
Circular Flow Model II*: 2 sectors with saving
Consumption Expenditures
Goods and Services
Investment
Saving
Financial Intermediaries
Households (HH)
Businesses (Bus) I
Investment Goods
Factor “rental” – land, labor, capital
Income to factors
Real flows.
Money flows.

12. Circular Flow Model III: 3 sectors with saving
Gov’t.
Taxes
Government Expenditures
Gov’t. G & S C
Goods and Services
Investment
Saving
Financial Intermediaries
Businesses (Bus)
Households (HH) I
Investment Goods
Factor “rental” – land, labor, capital
Income to factors
Real flows.
Money flows.

13. Government Expenditures Financial Intermediaries
Circular Flow Model III: 3 sectors – money flows
Gov’t.
Taxes
Government Expenditures C
Investment
Saving
Financial Intermediaries
Households (HH)
Businesses (Bus) I
Income to factors
Money flows.

14. Government Expenditures Financial Intermediaries
Circular Flow Model IV: 4 sectors – money flows
Gov’t.
Taxes
Government Expenditures C
Imports
Foreign Sector
Households (HH)
Exports
Businesses (Bus) I
Saving
Investment
Financial Intermediaries
Income to factors
Imports spending
Exports spending
Money flows.

15. Why the Circular Flow Model?
1. To show how the different sectors of the economy interact with one another.
2. To measure the level of economic activity.
--Can’t measure physical flows.
--Can measure money flows.
--Can measure expenditures or income.

16. An Overview of Business Cycle Theories & The Circular Flow Model
peak
trough
recovery
contraction
Dr. Dennis Foster