4 1 reading 17 understanding business cycles pdf

LOS Economics • Topics in Demand and Supply Analysis • The Firm and Market Structures • Aggregate Output, Prices, And Economic Growth • Understanding Business Cycles • Monetary and

LOS

Economics

• Topics in Demand and Supply Analysis

• The Firm and Market Structures

• Aggregate Output, Prices, And Economic Growth

• Understanding Business Cycles

• Monetary and Fiscal Policy

• International Trade and Capital Flows

• Currency Exchange Rates

LOS LOS Describe the business cycle and its phases

Business cycle is fluctuation of GDP over time

• Alternating periods of expansion and recession

Expansions: Increases in economic output

Recessions: Decrease in industrial production, personal income, employment, and sales

• Cycles generally last from 1 to 12 years

Varies greatly over time

LOS LOS Describe the business cycle and its phases

Business Cycle Phases

1 Expansion

a) Growth of econ activity

b) Rising wages, prices, and

employment levels

2 Peak

a) Growth rate peaks

b) Economy reaches productive

capacity

3 Contraction

a) Economic activity slows

b) Employment drops, overall

production declines

4 Trough

a) Negative trend levels off

LOS LOS Describe how resource use, housing sector activity, and

external trade sector activity vary as an economy moves through the business cycle

1 Expansion

• Low rates encourage business investment and allow financing for large purchases like housing

• Employment picks up as production increases

• Wage and employment growth increase consumer spending

2 Peak

• Economic growth rate flattens out

• The economy is at maximum employment

• Inflation concerns cause the consumption rate to slow

LOS LOS Describe how resource use, housing sector activity, and

external trade sector activity vary as an economy moves through the business cycle

3 Contraction

• Purchasing starts to slow

• Inventories build quickly as demand falls, so companies cut back

on hours and lay off workers

• Increasing unemployment further decreases consumer demand

4 Trough

• Lowest level of economic growth/contraction

• High unemployment and low levels of business spending

• Expansionary monetary policy encourages new investment

LOS LOS Describe theories of the business cycle

Several conflicting theories of how business cycles work and how government intervention affects them:

1 Models with Money

• Believe inflation is the result of the business cycle

• Monetary policy necessary to counteract the impacts of inflation on spending

2 New Classical School

• Economic growth is based on the rational expectations of economic agents

• Government interventions are not effective

LOS LOS Describe theories of the business cycle

3 Neoclassical and Austrian Schools

• Free markets will reach equilibrium without the need for government interference

• Forces of supply and demand will moderate large swings in the

business cycle

4 Keynesian and Monetarist School

• Market forces are not enough to combat large economic swings

• Spending is necessary to keep economy growing, so government spending during recession is needed to offset loss of private sector spending

LOS LOS Describe types of unemployment and compare measures of

unemployment

Unemployment is when willing and capable workers are unable to find

jobs

Three Primary types of unemployment:

1 Structural

• No longer demand for a specific type of worker (Telegram Operator)

2 Frictional

• Workers changing jobs or transitioning from one to another

• Mismatches based on location or skills

3 Cyclical

• Based on business cycles

LOS LOS Describe types of unemployment and compare measures of

unemployment

How can we measure unemployment?

• Unemployment rate:

Percentage of people in labor force that want a job but can’t find one

• Payroll Employment:

Monitors changes in total payroll growth/shrinking over time

LOS LOS Explain inflation, hyperinflation, disinflation, and deflation

1 Inflation

• Persistent increase in price level of goods and services over time

• Caused by:

i Increasing money supply during slow economic growth

ii Injecting large amounts of money in the economy

• Advantages of inflation:

i Reduction in amount of debt

ii Increasing unemployment (due to nominal wage “stickiness“)

• Disadvantages of inflation

i Increases opportunity cost of holding money

ii Discourages savings and investments

LOS LOS Explain inflation, hyperinflation, disinflation, and deflation

2 Hyperinflation

• Extreme case of inflation (above 100%)

• Causes:

i Imbalance between supply and demand of money

ii Excess printing of currency

iii.Lost confidence in country’s currency

• Effects:

i The public transfers wealth to the government

LOS LOS Explain inflation, hyperinflation, disinflation, and deflation

3 Deflation

• Decrease in price level when money supply is reduced

• Causes:

i Reduced money supply

ii Increased econ productivity grows supply of goods

• Effects:

i Discourages expenditures and investing

ii Decreases aggregate demand

4 Disinflation

• Reduction in the inflation rate

 Deflation would be an inflation rate of -2%, while disinflation would

be a change in the inflation rate from 9% one year to 8% in the next

LOS LOS Explain the construction of indices used to measure

inflation

A price index is used to track price level changes over time

• Most indexes use the Laspeyres method

Three steps to creating a price index:

1 Identify kind of index: yearly, monthly, or weekly

2 Identify basket of goods and services to include

3 Calculate general price level of the previous and current periods

4 The price index for the base year is set to be 100 Calculate the price index for the current year

5 The inflation rate is the price index for the current year divided by the price index for the base year minus 1

Example >>

LOS LOS Explain the construction of indices used to measure

inflation

Here is part of a price index for American households What is the inflation rate for 2018?

LOS LOS Explain the construction of indices used to measure

inflation

Here is part of a price index for American households What is the

inflation rate for 2018?

3 To get the general price level, multiply all terms of each year

together

4 The price index for the base year is set at 100 To get the price level

for 2018, divide the price level of 2017 by the price level of 2018

5 The inflation rate is then simply the price index of 2018 divided by

the price index of 2017 minus one

LOS LOS Compare inflation measures, including their uses and

limitations

1 Consumer Price Index

• Looks at basket of goods and tracks their purchase prices over time

• Uses a fixed basket of goods and services, such as the Laspeyres index

• Several limitations:

i Bias against new products

ii Bias against increasing quality of goods over time

iii Bias against substitution effect for goods not in basket

 The Fisher Index was created to correct substitution bias of

Laspeyres

2 Producer Price Index

• Includes products at all stages of production process

LOS LOS Distinguish between cost-push and demand-pull inflation

1 Cost-Push Inflation

• Caused when price increases increase costs of production and

reduce aggregate supply

• Increases production costs flow through to higher costs of goods

and services

• Increased prices could be from increasing wages or higher prices for inputs like raw materials

2 Demand-Pull Inflation

• Increase in aggregate demand outpaces ability to increase supply

• “Too much money chasing too few goods.”

• Supply shortfall leads to price increases

LOS LOS Interpret a set of economic indicators and describe their

uses and limitations

Economic indicators give information about the condition of the

economy and are used for determining the current state and trends of the economic cycle

1 Leading Indicators

• Intended to predict future movements of the economy

• Include share prices, consumer durables, and net business

formations

2 Lagging Indicators

• Only change when the economy has started following a certain pattern

• Includes unemployment, interest rates, GNP, and CPI

3 Coincident Indicators

• Exist during specific economic activities

• Includes GDP, retail sales, and employment levels

LOS LOS Interpret a set of economic indicators and describe their

uses and limitations

What are the uses of Economic Indicators?

• They have unique schedule for release so investors can prepare for them

• They indicate the direction of the economy

• Analysts use them to predict possible future investments

Limitations of Economic Indicators

• The interpretation can be tricky

• Data are usually inaccurate/estimated

• Measuring GDP is practically impossible

LOS

Economics

• Topics in Demand and Supply Analysis

• The Firm and Market Structures

• Aggregate Output, Prices, And Economic Growth

• Understanding Business Cycles

 Monetary and Fiscal Policy

• International Trade and Capital Flows

• Currency Exchange Rates