Business Cycles
Economic Performance
Business Cycles
• Fluctuations or changes in a market
system’s economic activity
• Changes are measured by increases or
decreases in real GDP
• Duration of upturns or downturns can last
from a few months to several years
Phases of the Business Cycle
•
•
•
•
Expansion-recovery
Peak-prosperity
Contraction-recession
Trough-depression
Expansion – Recovery
• People, optimistic about the
future, begin to buy again,
even “big ticket” items
• Housing starts go up;
productivity increases in the
manufacturing sector.
• Stores order more inventory;
factories gear up and hire
more people.
• More money gets into
circulation.
• Borrowing increases, both in
the buyer and producer
sectors.
Peak - Prosperity
• Economy begins to reach the
limits of its resources.
• Demand begins to exceed supply,
resulting in rising wages, prices,
and interest rates
• When all this happens, people
think twice about “big ticket” credit
items
• Consumers gradually cut back on
spending.
• Producers think twice about
opening new plants and hiring
new workers with wages so high.
Contraction - Recession
•
•
•
•
People stop spending;
Inventories build up in stores;
Stores order fewer goods;
Factories cut back on
production, hire workers at
lower wages.
• People begin to lose optimism
and buy even less.
• GDP declines.
• When it has declined for two
quarters (half a year), we
classify that we are in a
recession.
Trough - Depression
• If the recession hangs on,
producers lay off workers.
• Both producers and sellers find
themselves stuck with
inventories.
• People hold off borrowing, so
demand for loans is down and
loan rates decline.
• There sits everyone at the
bottom of the trough until some
kick in the pants causes
people to get optimistic again
and start buying more goods
and services.
External Causes affecting the
Business Cycle
• These are causes not
part of the economic
system itself. Examples
are:
– Instability in other parts of
the world can affect the
economy (such as war,
OPEC embargo)
– Technological
breakthroughs that allow us
to produce more with the
same resources can
stimulate the cycle’s
expansion phase and put
off contraction.
– Social and political
changes can affect the
economy. The election
of FDR in 1932 had a
short expansive effect
on the economy.
Watergate’s aftermath
had the opposite effect
in 1973-1975
Internal Causes Affecting the
Business Cycle
•
These are causes which are part
of the economic system itself.
Examples are:
– Capital. If equipment all wears out
at about the same time, or if it
goes out of date, it has to be
replaced. All those new orders
spur the economy into an
expansion phase.
– Inventories. It’s holiday time, so
stores are ordering large
inventories. Factories are
humming. If the holiday season
doesn’t go well, stores will hold off
ordering, production will go down,
layoffs will occur, etc..
– Aggregate Demand. If
everyone decides to hide his
money in his mattress,
spending goes down and the
economy contracts. If people
decide to save less,
production goes up.
– Government activity. If the
government increases the
money supply, it can
encourage expansion. If it
increase the supply too
rapidly, there may be “too
many $$ chasing after too few
goods” and inflation can
occur. If the government
scraps the NASA space
program, all sorts of producers
could be left “home alone”.
Business Cycle
For each of the following
headlines, which phase of the
business cycle is the U.S. in?
• Durable goods orders slip 8%; factory
orders are piling up.
• Recession - contraction
• Housing industry booms as new housing
starts are up 15%.
• Recovery - expansion
• Ford Motor Company announces 15-week
delay in delivery of new models to
dealership due to successful selling
season.
• Prosperity - peak
• Unemployment drops 1% for the fourth
straight month.
• Recession - contraction
• Bureau of Statistics reports new business
failures are at an all time high.
• Depression - trough
• Installment debt rises as consumers go on
spending spree.
• Recovery - expansion
• Obama Administration fears tight credit
policy of FED will slow economic
expansion.
• Recession - contraction