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 7-8 Time Level of National Business Activity Peak Recovery & Expansion 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 Income 2. # of employees on non-farm payrolls 2. Coincident Indicators

 3. Lagging Indicators change after the economy as a whole does  Examples:  Avg. length of unemployment  Ratio of consumer debt to income

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

2000 Peak 1990s Boom begins Gr. Dep. begins Post WWII Recession 9/ Gr. Recession Begins