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Gross Domestic Product Chapter 12 Section 2 Business Cycles
Gross Domestic Product n n n William Stanley Jevons was one of the first economists to see a pattern in the economy. His theory was called “Sunspots” – he said that sunspot activity affect crop harvests – this is back when agriculture was the major occupation. This theory was rejected by many economists.
Gross Domestic Product Economists did embrace the notion that the economy undergoes periodic changes. n A modern industrial economy repeatedly experiences cycles of good times, then bad times, and then good times again. n
Gross Domestic Product n Phases of Business Cycles – It is a period of macro-economic expansion followed by a period of macroeconomic contraction. – They are major changes in Real GDP above or below the normal levels. – The typical business cycle consists of four phases.
Gross Domestic Product n Phases: 1. Expansion – a period of economic growth as measured by a rise in Real GDP. * Economy experiences plentiful jobs, a falling unemployment rate, and business prosperity. 2. Peak – When Real GDP stops rising, the economy has reached its peak. Height of an economic expansion
Gross Domestic Product n Phases: 3. Contraction – An economic decline marked by falling Real GDP. n This usually causes unemployment to rise. 4. Trough – When the economy has “bottomed out”, it has reached the lowest point in an economic contraction, Real GDP stops falling.
Gross Domestic Product n Types of Contraction: 1. Recession – If Real GDP falls for two consecutive quarters (6 months). This is a prolonged economic contraction. Generally, it will last from 6 to 18 months. Unemployment is rising into the range of 6 to 10%.
Gross Domestic Product n Types of Contraction: 2. Depression - If a recession is especially long and severe, it called a depression. Refers to a deep recession with features such as high unemployment and low factory output.
Gross Domestic Product n Types of Contraction: 3. Stagflation – The term combines Stagnant – a word meaning unmoving or decayed and Inflation. Stagflation – is a decline in Real GDP (output) combined with a rise in the price level (inflation).
Gross Domestic Product Economists know much about business cycles, they cannot predict any one cycle’s behavior, nor can they tell exactly how long its phases will last. n They are only certain that a growing economy will eventually experience a downturn and will later bounce back. n
Gross Domestic Product n Business Cycles are affected by four main economic variables 1. 2. 3. 4. Business Investment Interest Rates and Credit Consumer Expectations External Shocks
Gross Domestic Product n 1. Business Investments – When the economy is expanding a firm expects sales and profits to keep rising. They have to invest in new plants and equipment. Some times they invest in expanding old factories.
Gross Domestic Product n 2. Interest Rates and Credit – Corporations use credit to buy big ticket items – cars, houses, etc. – If interest rates rise, business will not purchase as much. – If interest rates are low, business will purchase more. – As consumers reduce their spending, the economy enters a recession.
Gross Domestic Product The recession drives up unemployment rates. n Economists watch interest rates very closely. n
Gross Domestic Product n 3. Consumer Expectations – Consumer spending is determined partly by consumer expectations. – Fears of a weakening economy can cause consumer confidence to fall, meaning that a majority of the people expect the economy to begin contracting. People will start to save for a rainy day and not spend as much
Gross Domestic Product Reduced spending can cause a contraction to occur. n Firms then respond to reduced demand by the consumers. n
Gross Domestic Product n 4. External Shocks – This is the most difficult to predict. – i. e. disruption in oil supply, wars that interrupt normal trade relations, and droughts that severely reduce crop harvests. – This can have a powerful effect on the economy. – This will cause the production costs to rise.
Gross Domestic Product Positive internal shocks will benefit the economy. n i. e. discovery of a large deposit of oil or minerals will contribute to the nation’s wealth. n
Gross Domestic Product n Business Cycle Forecasting – Predicting changes in a business cycle is difficult for many reasons. – Economists have to anticipate movements in Real GDP before they occur. – Government and business decision makers need accurate economic predictions to respond to change in a business cycle.
Gross Domestic Product If business expects a contraction, they may reduce inventories and postpone building new factories. n If government policymakers expect a contraction, they may launch spending and taxation measures to try to prevent a recession. n
Gross Domestic Product n One tool is called Leading Indicators – a set of economic variables that economists use to predict a new phase of a business cycle. a. Stock Market b. Conference Board – private business research organization maintains an index of ten leading indicators including stock prices , interest rates, manufacturers’ new orders of capital goods.
Gross Domestic Product n Business Cycles in American History: – Great Depression n Started in 1929 with the crash of the stock market. Hurt Am. Economy for a long time. n There have been no economic downturns since the 1930 s as severe as the G. D. n 1970 – OPEC launched an oil embargo on oil to the US – caused prices to quadruple – lead to smaller cars being produced. n 1980 s – high interest rates & high unemployment (9%)