1. Chapter 13 Business Cycles & Fluctuations

2. Section I Business Cycles & Fluctuations
Business cycles are largely systematic ups and downs of real GDP
Business fluctuations is the rise and fall of real GDP over time in a nonsystematic manner.

3. Phases of the Business Cycle
Expansion – a productive and increasing period in business activity.
Recession – a period where business activity declines and GDP actually decreases for two consecutive quarters (6 months)
Depression – acute shortages, high unemployment, excess capacity, GDP decreases four or more quarters.
W - marks the spot where the expansion stops increasing. Also known as a peak.
Y – marks the spot where the contraction stops decreasing. Also known as a trough.

4. What causes cycles? Changes in Investment Spending
Capital Expenditures – business invest in capital goods (machinery & buildings) when the economy is expanding. When they pull back business activity declines.
Inventory Adjustments – business either expands or contracts their inventory in anticipation of increasing or decreasing sales.

5. Innovation & Imitation
Another possible cause of business cycles is an innovation that may be a new product or a way of performing a task. Look at how tablets are beginning to replace laptops.
To remain competitive, businesses in the same industry must copy the innovator. The must invest heavily to copy or do something better. This imitation of products or methods will cause swings in investments.

6. What causes cycles? (continued)
Governmental Influences
Monetary Policy
Interest rates – policies initiated by the Federal Reserve, increase or decrease the demand for money (borrowing) by increasing or decreasing the discount rate.
Easy monetary policy helps increase economic activity and tight monetary policy tends to slow the economy down.

7. Outside and Unexpected Factors
External Shocks – wars, natural disasters, and disruptions in energy sources can cause cycles.
Economic Shocks – from outside the U.S. like the Japanese tsunami, collapse of Greece’s economy, and the possible demise of the European economy will affect the U.S. economy.

8. Timing a Recession

9. How long is a Recession?

10. Forecasting Business Cycles
A change in a single statistic often indicates a change in future GDP. (examples)
Changes in the length of the workweek
Inventory changes (increases or decreases)
Composite index of leading indicators – a monthly statically series that uses a combination of ten individual indicators to forecast changes in real GDP.

11. Composite index of leading indicators
Average weekly hours (manufacturing) — Adjustments to the working hours of existing employees are usually made in advance of new hires or layoffs.
Average weekly jobless claims for—The initial jobless-claims data is more sensitive to business conditions than other measures of unemployment.
Manufacturers' new orders (or lack of) for consumer goods/materials — This component is considered a leading indicator because increases in new orders is a positive economic predictor.
Vendor performance (slower deliveries diffusion index) — This component measures the time it takes to deliver orders to industrial companies.
Manufacturers' new orders for non-defense (capital goods)— As stated above, new orders lead the business cycle because increases in orders usually mean positive changes in actual production and perhaps rising demand.

12. Composite index of leading indicators
Building permits for new private housing units.
The Standard & Poor's 500 stock index — The S&P 500 is considered a leading indicator because changes in stock prices reflect investor's expectations for the future of the economy and interest rates.
Money Supply (M2) — Demand deposits, traveler's checks, savings deposits, currency, money market accounts. An increase in demand deposits will indicate expectations that inflation will rise, resulting in a decrease in bank lending and an increase in savings.
Interest rate spread (10-year Treasury vs. Federal Funds target) —Changes in the yield curve have been the most accurate predictors of downturns in the economic cycle. This is particularly true when the curve becomes inverted, that is, when the longer-term returns are expected to be less than the short rates.
Index of consumer expectations — This is the only component of the leading indicators that is based solely on expectations.

13. Section II Changes in the Price Level
Inflation - A sustained rise in the general level of prices.
This the most destructive of all economic events is inflation. If prices rise without a corresponding rise in wages, the consumers disposable income shrinks.
A decline in the general level of prices is called deflation. Deflation is also destructive because it destroys wealth.

14. How do we measure Inflation?
The Consumer Price Index (CPI) is a number used to calculate changes in the average level of prices for a number of market basket items consumed by a typical urban family.
80,000 items in 364 categories, sampled from 85 geographical areas
A price index is a number that compares prices in one year with some earlier base year.

15. Degrees of Inflation - Severity
Creeping Inflation – Inflation in the range of 1% to 3%
Hyperinflation – Inflation in the range of 500% or more.
Stagflation – a period of stagnant economic growth coupled with inflation

16. How do we measure Inflation? continued
Producer Price Index – measures price changes paid by domestic producers for their inputs.
It is based on 100,000 commodities
Can be used to predict future inflation in final goods. Usually predicts about six to nine months in advance.

17. Real GDP
Is GDP with inflation removed.
The term Real GDP is also
known as Constant Dollar GDP.
This is the only way to compute GDP and compare it to previous years and other countries.
Real GDP = GDP in current dollars x implicit GDP price deflator

18. Causes of Inflation
Demand-pull inflation – is a rise in the general level of prices caused by too high a level of aggregate demand in relation to aggregate supply.
Cost-Push Inflation – is a rise in the general level of prices that is caused by increasing (input) costs of making and selling goods.
Wage Price Spiral – a general spiral of wage and price inflation which is difficult to stop.
Excessive monetary growth – the most popular and occurs when the money supply grows faster than GDP
Government Deficit – is caused by the government spending beyond tax revenues.

19. Consequences? Decreasing Purchase Power Distorting Spending Patterns
Encouraging Speculation
Paying Back with Cheaper Dollars (distortion of Income)

20. Unemployment Section III Who is considered unemployed?
Unemployment is the condition of those who are willing and able to work and are actively seeking work but who do not currently work.

21. How do we measure unemployment?
Unemployment is calculated by dividing the number of unemployed by the number the civilian labor force.
Number of unemployed persons = unemployment rate
Civilian Labor Force

22. Who is counted?
Civilian Labor Force is the total number of people in the working age group (16 years or older) who are either employed or actively seeking work.
Note! Slightly less than half of the total labor force belong in this class, or about 150 million people.

23. Unemployed vs. Underemployed
We count only those who are looking for work. Once a person ceases to look (dropping out) we do not count them. However, many people are working in low paying jobs waiting for the job they want. We do not count these either.

24. Sources of Unemployment
Frictional
Structural (serious unemployment)
Technological
Cyclical
Seasonal

25. Frictional Unemployment
People who are temporarily between jobs, they suffer little economic hardship from their lack of employment.

26. Structural Unemployment A serious type of unemployment!
A reduction in demand for workers due to a fundamental change in the operations of the economy.
Skills that do not match the employer’s needs.
Geographical separation from employment.
Note! Many times the jobs are lost forever and many will not come back.

27. Technological Unemployment
Technological unemployment is caused through automation, when mechanical or other processes cause workers with less skills, talent, or education to be replaced by technology.

28. Cyclical Unemployment
Unemployment from a low level of aggregate demand caused by swings in the business cycle.

29. Seasonable Unemployment
This type of unemployment is associated with time of year or seasons. This occurs every year regardless to the health of the economy.

30. Where are the Jobs?

31. What is considered full employment?
When approximately 95% of the civilian workforce is employed, or 5% is unemployed, is considered full employment.
Note! Some unemployment is needed to maintain balance in the labor force. Excess employment will lead to wage price inflation.