Sec. 2

(Read all of Sec. 2)

A modern industrial economy repeatedly goes thru good times, then bad, then good…. it goes thru cycles

The business cycle directly impacts our daily lives

We are continually faced with decisions that can enable us to take advantage of “good” times… and lessen the hurt of the “bad” times

Why is it important to understand the nature of business cycles?

Phase 1: Expansion period of prosperity Typical characteristics:

MANY NEW BUSINESSES OPEN STRONG EMPLOYMENT FACTORIES WORKING AT OR NEAR FULL CAPACITY

CONSUMER SPENDING IS STRONG

Expansion has ceased…businesses may cut back or postpone new spending

Job creation slows

From a peak ( where GDP levels off) GDP begins to decline… contraction occurs:

BUSINESS ACTIVITY SLOWS noticeably

UNEMPLOYMENT RISES FACTORIES WORK AT LESS THAN FULL CAPACITY

CONSUMER SPENDING WEAKENS

Phase 3

If a contraction lasts at least 2 quarters (6 months), we are said to be in a “recession”

A prolonged recession or one that is particularly severe is called a “depression”

factories cut back production and lay off workers in large #s

Consumers cut back on purchases

More consumers & biz are late on loan payments…increasing loan defaults occur

Fewer new businesses open, many established ones fail

Home foreclosures may rise

The lowest point is called the

trough (“troff”)

biz cycle enters the recovery and expansion phase (GDP grows)…

Employment rises…new businesses open…spending increases

eventually growth slows…then stalls…contraction begins

And the cycle continues…

Figure 7-8Time

Lev

el o

f N

atio

nal

Bu

sin

ess

Act

ivit

y

Peak

Peak

Rec

over

y &

Exp

ansi

on

Trough

Contraction

AND THE CYCLE

CONTINUES…

4 Main Variables

Impact the business cycle

When the economy is expanding, firms expect sales & profits to keep rising.

Therefore, they are more willing and likely to invest in new equipment , expansion, etc.

investment tends to create jobs and increase output, helping to perpetuate the economic expansion

Currently: Corporations sitting on $2 trillion in CASH…not investing…why???

low interest rates = encourages borrowing & buying on credit (individuals & firms)

Demand for goods/svcs. grows

Stronger demand for goods/services motivates firms to hire more people to increase output

Int. rates today: high or low?

Optimism/confidence = strong consumer spending (opposite is true, too… weakening confidence means weakening spending by consumers)

Repercussions from an outside event (a war, natural disaster, etc.)EG: 9/11/2001

Of all the factors that affect the biz cycle, this is most difficult to predict

Could be a positive shock (eg, discovery of huge oil deposit)

Economic Indicators:Economists collect data on a regular basis to

measure current conditions as well as to forecast

future trends.

1. Leading Indicators signal future events. Think of how the amber traffic light indicates the coming of the red light.

Examples: building permits stock prices retail sales

occur at approx. the same time as the conditions they signify. In our traffic light example, the green light would be a coincidental indicator of the associated pedestrian walk signal.

Examples: 1. Personal Income2. # of employees on non-farm

payrolls

2. Coincident Indicators

3. Lagging Indicators change after the economy as a whole does

Examples:Avg. length of unemploymentRatio of consumer debt to income

Great Depression (1929-1940) 1946 Recession (returning GIs) 1973 Recession (external shock) 1990s Expansion (dot.com bubble) 2007 Recession (housing collapse)

2000

Peak

1990s Boom beginsGr. Dep.

begins

Post WWII Recession

9/11

2007 Gr. Recession

Begins