Intro to Business 2-2

The Business Cycle  All economies experience good and bad economic periods  This economic shift between good and bad economic conditions is called the business cycle.  Business cycles have four phases  Prosperity  Recession  Depression  Recovery

Prosperity  Prosperity is a period in which most people who want to work are working, wages are high, and the rate of GDP growth increases.  Demand for goods and services is high.  Prosperity is usually the high point of the business cycle.

Recession  Occurs when the economy slows down from the prosperity phase.  A recession is a period in which demand begins to decrease as production decreases, unemployment begins to rise, and GDP growth slows for two or more quarters,  May not be serious, but often signals trouble for workers in related businesses.  Eventually weakens economy and total output declines in the next quarter.

Depression  Occurs when a recession deepens and spreads throughout the entire economy.  Depression is a phase marked by a prolonged period of high unemployment, weak consumer sales, and business failures.  GDP falls rapidly.  Has not occurred in the US since the 1930’s.

Recovery  Recovery is the phase in which unemployment begins to decrease, demand increases, and GDP begins to rise.  Can occur quickly or slowly  Consumer confidence increases  Returns the country to the prosperity phase.

Consumer Prices  Buying power of money changes over time.  Technology becomes less expensive over time  Amounts of an time may be sold for the same price in smaller quantities.  Changes may occur as either inflation or deflation.

Inflation  An economic issue that all developed nations must deal with.  Inflation is an increase in the general level of prices  Decreases buying power of the nation’s currency.  Most harmful to families living on fixed incomes.  Retirees and others on fixed income cannot afford as many goods or services.

Causes of Inflation  When demand for goods or services in greater than supply.  Wages tend to rise during inflation, but prices usually rise faster.  Typically considered harmful, as consumers must earn more money to maintain the same standard of living.  If wages increase too quickly, business tend to hire fewer workers, raising unemployment.

Measuring Inflation  Inflation rates vary.  Mild inflation (around 2 or 3 percent) can stimulate economic growth as prices increase faster than wages, allowing the producer to hire more workers.  The most watched measure of inflation in the US is the Consumer Price Index (CPI).  A price index is a number that compares prices in one year with prices in some earlier base year.  Cost of living inflation may change differently than the products used to calculate inflation with the CPI.

Deflation  Deflation is the opposite of inflation.  Deflation means a decrease in the general level of prices.  Usually occurs in recession and depression.  Even though prices drop, people tend to have less money to afford them.  Occurred most significantly during the Great Depression  Many technological products are deflating in price as technology advances.

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Interest Rates  Interest rates represent the “cost of money.”  Interest rates have a strong influence on business activities.  Companies and governments that borrow money are affected by interest rates.  Consumers are affected by interest rates.  Interest on loans reflects current interest rates, as to earnings from savings and investments.

Types of Interest Rates  There are many different types of interest rates that represent the cost of money in different settings.  The prime rate is the rate banks make available for their best customers, such as large corporations  The discount rate is the rate financial institutions are charged to borrow funds from Federal Reserve banks.  The T-bill rate is the yield on short-term (13 week) U.S. government debt obligations.

Types of Interest Rates (cont.)  The treasury bond rate is the yield on long-term (20 year) U.S. government debt obligations.  The mortgage rate is the amount individuals pay to borrow for the purchase of a new home.  The corporate bond rate is the cost of borrowing for large U.S. corporations.  The certificate of deposit rate is the rate for time deposits at savings institutions.

Changing Interest Rates  The cost of money changes every day due to various factors.  The supply and demand for money is the major influence on the level of interest rates.  As amounts saved increase, interest rates tend to decline.  When borrowing by consumers, businesses, and government increases, interest rates are likely to rise.  See assignment in G:drive (Banks)