Today’s Schedule – 10/28 Business Cycle PPT Business Cycle Diagrams Homework – Read Ch. 12, Section 2

Definition of a Business Cycle A period of expansion followed by a period of contraction Involve major changes in real GDP

Phases of a Business Cycle 1.Expansion- Period of economic growth; rise in real GDP -High employment; low unemployment 2.Peak- When real GDP stops increasing 3.Contraction- Fall in real GDP; rise in unemployment 4.Trough- The lowest point in an economy; when real GDP stops falling

Types of Contractions Recession- When real GDP fall for 6 straight months – Lasts for 6-18 months – Rising unemployment (6-10%) Depression- Deep recession – High unemployment – Decreased production of goods Stagflation- Decrease in real GDP with an increase in price of goods/services

Four Factors of a Business Cycle 1.Business Investment -When in expansion, businesses invest in their firms by opening more jobs and increasing output (increases real GDP) -Once demand falls, they cut back on investments -Decrease in production = job layoffs

Four Factors of a Business Cycle 2.Interest Rates/Credit -When interest rates rise, consumers purchase less and business buy less new equipment -When interest rates fall, consumers purchase more big ticket items

Four Factors of a Business Cycle 3. Consumer Expectations -When consumers expect the economy to start falling, they spend less and save more  businesses respond to reduced demand by producing less – Fear/expectation becomes reality

Four Factors of a Business Cycle 4.External Shocks -War, natural disasters, droughts -Decrease in supply of oil = increase in price of oil -GDP declines and price increases -Increases cost to transport goods = increase in cost of goods to consumers

Predicting the Business Cycle Economists use leading indicators/Conference Board Index to predict the next phase of the business cycle – Stock market performance often mirrors business cycle – Short term interest rates reflect current events – Long term interest rates (i.e. on bonds) predict future health of the economy

Historical Events of the Business Cycle 1.Great Depression -real GDP fell by 1/3; unemployment = 25% -Changed opinions as to how long a contraction could last -First realization that government intervention may sometimes be necessary

Historical Events of the Business Cycle 2.OPEC -1970s embargo on oil to the U.S. = increase in price of oil = increase cost in goods -U.S. developed new ways to conserve energy -Required less oil -OPEC lowered oil prices