2.2 Economic conditions change The business cycle Inflation and deflation Interest rates

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THE BUSINESS CYCLE Prosperity Recession Depression Recovery All economies have good times and bad. This movement of the economy from good to bad to good is called a business cycle. Recurring ups and downs of GDP Business cycle has four phases: Prosperity Recession Depression Recovery

PROSPERITY Peak of the business cycle Unemployment is low Businesses produce G&S in record numbers Wages are good GDP is increasing Demand for G&S is high Does not go on forever, eventually activity slows down

RECESSION The economy slows down Demand decreases Businesses lower production Unemployment rises GDP slows for two or more quarters May not be serious but often signals trouble Can cause the ripple effect

Depression When a recession deepens and spreads throughout the entire economy Long period of high unemployment Weak consumer sales Business failures GDP falls rapidly USA has not had a depression in 70 years During the Great Depression between 1930-1940, unemployment was 25%

recovery Economic downturns do not last forever, Unemployment begins to decrease Demand for G&S increases GDP begins to rise Because people gain employment, they regain confidence about their future and begin buying again As it continues, the nation moves to prosperity

INFLATION AND DEFLATION Inflation is the increase in the general level of prices Buying power decreases It takes more $ to buy the same things Most harmful to people on fixed incomes Causes of Inflation When demand for G&S is higher than supply When $ is spent for goods that are in short supply

DEFLATION Opposite of inflation Decrease in the general level of prices Usually occurs during recessions and depressions Prices are lower, but people have less money During the Great Depression prices lowered 25%

Measuring inflation Mild inflation can stimulate the economy (2-3%) Wages rise more slowly than the prices of products Producers make higher profits, expand production and hire more workers New workers increase spending and the total demand increases The Consumer Price Index (CPI) compares prices in one year with prices in some earlier base year

Interest rates Cost of money Higher interest rates mean higher business costs People with poor credit ratings pay a higher interest rate

Types of interest rates PRIME RATE – Rate banks make available to their best business customers (large corporations) DISCOUNT RATE – Rate banks are charged to borrow money from the Federal Reserve banks T-BILL RATE – Yield on short-term (13wk)U.S. government debt obligations TREASURY BOND RATE – Yield on long-term (up to 30 years) U.S. government debt obligations

CORPORATE BOND RATE – The cost of borrowing for U.S. corporations MORTGAGE RATE – Rate individuals pay to borrow for a purchase of a new home CORPORATE BOND RATE – The cost of borrowing for U.S. corporations CERTIFICATE OF DEPOSIT RATE – Rate for time deposits at savings institutions In conclusion: The supply and demand for money is the major influence on the level of interest rates As amounts saved increase, interest rate decline When amounts borrowed increase, interest rates increase