Aggregate Supply and Demand The Business Cycle Aggregate Supply and Demand

Business Cycle Covers periods of economic growth and recession and is measured by real change in GDP. Business cycles have ups and downs!

BUSINESS CYCLE Real GDP TIME PEAK TROUGH RECOVERY / EXPANSION RECESSION / CONTRACTION Decreasing Prices Higher Unemployment Decreasing Prod’n Decreasing Incomes Real GDP RECOVERY / EXPANSION Rising Prices Lower Unemployment Rising Prod’n Rising Incomes TROUGH TIME

Prosperity Cycle Increase in aggregate demand, leads to higher levels of output, and employment as well as higher prices. This higher demand leads to increased production, more workers being hired, and so on.

Increased Consumption PROSPERITY CYCLE Increased Production Higher AD Higher Employment Demonstrates economic business cycle. Increased Consumption Increased Income

Peak! The economy will peak. Usually after consumers have exhausted purchasing patterns. Demand then begins to exceed the economy’s ability to produce, inflation begins to occur, and prices rise, which makes consumer’s buying power less. The AD then moves to the left. Why does inflation occur?

Recession Period Firms, at this point, are overstocked, cut production, layoff workers, or even shut down. Recessions: increasing levels of unemployment, low levels or negative GDP growth, inflation or even deflation (falling of prices)

Depression If the recessionary period becomes prolonged with very high unemployment and low output levels, it becomes a depression.

But How does the Economy Work? Businesses hire individuals from households to work for them and pay them a wage in exchange. Individuals then spend that money on goods and services the businesses produce. But what happens to that money?

CIRCULAR FLOW OF INCOME Imports (M) Exports (X) Foreign Trade Payments for goods & services Product Markets (Goods & Services) Wages & Transfers (G) Purchases & Transfers (G) Households Government Businesses Taxes (T) Taxes (T) Resource Markets (Land, Labour Capital) Payments for Productive Resources Financial Institutions Savings (S) Investments (I) LEAKAGE (Money out of system) INJECTION (Money into system)

Leakages Any uses of income that cause money to be taken out of the income - expenditure stream of the economy. There are 3 types of leakages: Taxes (T) Savings (S) Imports (M) Note: The amount of these leakages will depend on the level of production

Where does the money go? Often back into the economy! But how depends on the situation: Can you think of ways it could re-enter the economy?

Injections Any expenditure that causes money to be put into the income - expenditure stream. There are 3 types of injections: Government Spending (G) Investment Spending (I) Exports (X) Note: Consumption doesn’t count. If leakages go up, they reduce consumption spending, if they go down they increase spending.

The Relationship If the sum of the leakages is greater than the sum of the injections, aggregate demand will shrink. If the total of the injections is larger than the total of the leakages, the economy will grow as aggregate demand increases.

Think of Tub! A Really Nice Tub! If the amount of water coming in (the injection) is greater that he amount going down the drain (the leakage), the bathtub fills up (GDP Gets Bigger!). If the amount of water coming in is less than the amount that is leaking out, the bathtub empties (GDP Shrinks!). If the water coming in and water going out are equal, the amount of water in the tub remains the same (equilibrium).