GDP and Economic Challenges Unit 6 Macroeconomics: GDP and Economic Challenges Chapters 12.2 Economics Mr. Biggs

Business Cycles A modern industrial economy repeatedly experiences cycles of good times, then bad times, and then good times again.

Phases of Business Cycles Business cycle - A period of macroeconomic expansion, followed by a period of contraction. Expansion - A period of economic growth as measured by a rise in real GDP. Economic growth - A steady, long-term increase in GDP. Peak - The height of an economic expansion, when real GDP stops rising. Contraction - A period of economic decline marked by falling real GDP. Trough - The lowest point in an economic contraction when real GDP stops falling.

During the contraction phase, GDP is always falling. Economists created terms to describe contractions with different characteristics and levels of severity. Recession - A prolonged economic contraction. Depression - A recession that is especially long and severe. Stagflation - A decline in real GDP combined with a rise in price levels. A business cycle’s behavior and duration are unpredictable. The only certainty is that a growing economy will eventually experience a downturn and will later bounce back.

What Keeps a Business Cycle Going? Business cycles are affected by four main economic variables. Business Investments In the expansion part of a cycle, businesses continue to expand. The expansion continues until businesses feel that they have expanded enough or demand falls. A snowball effect is created and other industries may follow. Interest Rates and Credit As interest rates rise, consumers buy less on credit and business do not borrow as much for expanding. The opposite is true when interest rates fall.

Consumer Expectations If consumers perceive that the economy is weakening, they may start “saving for a rainy day” which makes the economic decline more severe. External Shocks Negative external shocks, like disruption in the oil supply or a war, decrease aggregate supply. It shifts the AS to the left and increases prices. Positive external shocks, like the discovery of large oil reserves, increase aggregate supply. It shifts the AS to the right and decreases prices.

Business Cycle Forecasting Business cycle forecasting is very difficult because economists have to predict movements in GDP before they occur. Economists use leading indicators to help make these predictions. Leading indicators - Key economic variables that economists use to predict a new phase of a business cycle. For example, stock prices, interest rates, and manufacturers’ new orders of capital goods. Business Cycles in American History Economic activity in the United States has followed a cyclical pattern.

The Great Depression The Great Depression of the 1930s was the worst economic decline of industrial capitalism in America. Between 1929 and 1933, GDP fell by almost 1/3. Unemployment rose to about 25%. Many economists accepted John Maynard Keynes idea that government intervention might be needed to pull an economy out of a depression. FDR began a series of government programs to get people back to work. For example, Civilian Conservation Corps (CCC) and the Works Progress Administration (WPA). Not until the US entered into WWII did we completely recover from the Great Depression.

The Future of U.S. Business Cycles Some Later Recessions In the 1970s, the Organization of Petroleum Exporting Countries (OPEC) began an oil embargo that plunged the United States into a recession. In the early 1980s, high interest rates and other factors caused real GDP to fall and the unemployment rate to rise to over 9%. The Future of  U.S. Business Cycles Economists predict that the US will continue to experience the normal patterns of peaks and troughs during the 21st century.

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