Changes in Business Activity Business Cycle Theory Changes in Business Activity ©2012, TESCCC Economics, Unit: 06 Lesson: 01

Objectives Describe phases of business cycle Identify and explain the factors that cause business cycles Analyze how economists use business cycle theory to predict what is going to happen Analyze how the government uses predictions to make public policy ©2012, TESCCC

Business Cycle Theory A free market economy does not grow at a constant rate. It goes through a series of expansions and contractions. These fluctuations are called business cycles. Business cycles are a pattern to the general level of economic activity or the level of production of goods and services (GDP). Since this is a pattern it keeps repeating itself.You can see the business cycle activity from 1914 to 1992 below in the graph. ©2012, TESCCC

Contraction–recession Business Cycle Theory Four Phases of business cycle are: Expansion Peak Contraction–recession Trough ©2012, TESCCC

Contraction or Recession For a contraction to be a true recession, you must see 2 consecutive quarters or six months of declining real GDP. ©2012, TESCCC

Business Cycle Theory Stages Recession Peak Expansion Trough ©2012, TESCCC

Expansion Phase 1. GDP 2. Durable goods 3. Factory order 4. Raw materials orders 5. Unemployment Consumer confidence problem: inflation ©2012, TESCCC

Contraction or Recession 1. Demand 2. GDP 3. Durable goods 4. Factory orders 5. Unemployment 6.Consumer confidence 7. problem: unemployment. ©2012, TESCCC

Causes There are several things that may lead to fluctuations in the economy. Some are within the economy and we call them internal factors. Some are outside the economy and we call them external factors. ©2012, TESCCC

Internal factors (within the economic system) 1. Business Investment In an expanding economy firms invest in new capital goods. This investment spending creates new jobs and growth. If firms decide to halt investment, this slows the economy down and can cause unemployment. ©2012, TESCCC

2. Interest Rates and Credit When interest rates go up, consumers will not make big ticket purchases. Lower demand slows down economy. When interest rates go down we see more purchases being made – causing growth. ©2012, TESCCC

3. Consumer Expectations Fears of the economy slowing down can cause consumers to stop spending. This will then actually slow down the economy. If consumers feel confident about the economy, they spend more. Spending more can cause growth. ©2012, TESCCC

External Shocks External factors (outside the economic system) These are factors outside the economic system, but they can cause fluctuations in business activities. Examples include: wars natural disasters foreign economies 9/11 Wars: Increase in defense spending affects many industries, affecting employments, markets for goods, etc.. Shortage of some resources and products leads to higher prices for some goods WWII (shortages, women in workforce, rationing) Kuwait (war in Kuwait threatened oil fields and gas prices went up.) Natural disasters: Monsoons in China: caused paper prices to go up when forests were destroyed by severe monsoons after deforestation food prices went up because farmland was flooded and eroded (rice, grains, vegetables) Tsunamis: ©2012, TESCCC

Business Cycle Forecasting Must anticipate changes in real GDP Economic Indicators- ©2012, TESCCC

Leading Indicators Stock prices Consumer Confidence Interest rates Manufacturing orders GDP CPI Retail Sales Housing Starts Consumer Confidence PPI Unemployment ©2012, TESCCC