1. Chapter 8- The Business Cycle
2/25/2019
Chapter 8- The Business Cycle
Objective – Students will be able to answer questions regarding the business cycle.
SECTION 1
© 2001 by Prentice Hall, Inc.

2. The Business Cycle
The United States’ GDP is not constant from year to year.
Instead, the GDP grows most years and then shrinks in some years.
The ups and downs in GDP over time is referred to as the business cycle.

3. The Business Cycle Illustrated:

4. The Business Cycle Illustrated:
Peak
temporary maximum in Real GDP. At this point the unemployment rate (u%) is probably below the natural rate of unemployment, and the inflation rate (π%) is probably increasing.
Recession
The contractionary phase of the business cycle. A period of decline in Real GDP accompanied by an increase in u%. To be classified as a recession, the economic decline must be at least 6 months long.

5. The Business Cycle Illustrated:
Trough
The bottom of the business cycle. The u% is probably high and π% is probably low.
Recovery
The phase of the business cycle where the economy is returning to full employment.

6. The Business Cycle Illustrated:
Important note
The various phases of the business cycle last for different amounts of time.
In recent history, expansions have lasted years longer than have recessions.
The Great Depression is the most notable example of a long recession/trough

7. The Business Cycle Illustrated:
Causes
Irregularity of Investment
Changes in productivity
Changes in total spending (aggregate demand)
Durable goods manufacturing is most susceptible to the effects of the business cycle

8. The Business Cycle Illustrated:
Business cycle has become less severe because of technological advancements in supply-chain management and structural changes in U.S. economy.

9. Section 1 Assessment Describe the four phases of the business cycle.
2. Describe the causes of the business cycle.

10. Summary: In a paragraph, describe what you have learned today.

11. Key to Macroeconomic Symbols
GDPR – Real GDP (Output)
C – Consumption
IG – Gross Private Investment
G – Government Spending
XN – Net Exports (Exports – Imports)
w- wages (primary cost of production)
T – taxes
DI – disposable income
X – Exports
M – Imports
AD – aggregate demand
SRAS – short-run aggregate supply
LRAS – long-run aggregate supply
PL – Price Level
SRPC – short-run Phillips curve
LRPC – long-run Phillips curve
u% - unemployment rate
π% - inflation rate
SLF – Supply of loanable funds
DLF – Demand for loanable funds
r% - real interest rate
MS – Money Supply
MD – Money Demand
ER – Excess Reserves
i% - nominal interest rate
DR – discount rate
RR – reserve ratio
OMO – open market operations (buying and selling gov’t bonds)
FOREX – foreign exchange market
D$ - demand for dollars in FOREX
S$ - supply of dollars in FOREX
$ - value of dollar in FOREX
↑ - increase
↓ - decrease
→ - shift right (increase)
← - shift left (decrease)
.: - therefore
Δ - change

12. Self-correcting economy: below full-employment (recession)
Assume recessionary gap with flexible wages (w)
u% ↑.: w↓ .: SRAS→.: GDPR↑ & PL↓.: u%↓ & π%↓ = SRPC←
Self-correcting economy: above full-employment (inflation)
Assume inflationary gap with flexible wages (w)
u%↓ .: w↑ .: SRAS←.: GDPR↓ & PL ↑.: u%↑ & π%↑ = SRPC→
Expansionary fiscal policy on economy below full-employment (recession)
Assume recessionary gap with sticky wages (note: DI = disposable income)
T↓.: DI↑.: C↑.: AD→.: GDPR↑ & PL↑.: u%↓ & π%↑ = move up/left along SRPC OR
G↑.: AD→.: GDPR↑ & PL↑.: u%↓ & π%↑ = move up/left along SRPC
Contractionary fiscal policy on economy above full-employment (inflation)
Assume inflationary gap
T↑ .: DI↓.: C↓ .: AD← .: GDPR↓ & PL↓ .: u%↑ & π%↓ = move down\right along SRPC
G↓ .: AD← .: GDPR↓ & PL↓ .: u%↑ & π%↓ = move down\right along SRPC
Expansionary monetary policy on economy below full-employment (recession)
Assume recessionary gap with sticky wages
Fed buys bonds, DR↓, and/or RR↓ .: ER↑ .: MS→ .: i%↓ .: IG↑ .: AD→.: GDPR↑ & PL↑.: u%↓ & π%↑ = move up/left along SRPC
Contractionary monetary policy on economy above full-employment (inflation)
Fed sells bonds, DR↑, and/or RR↑ .: ER↓ .: MS ← .: i%↑ .: IG ↓ .: AD← .: GDPR↓ & PL↓ .: u%↑ & π%↓ = move down\right along SRPC

13. ‘Crowding In’ of Gross Private Investment (effect of budget surplus)
‘Crowding Out’ of Gross Private Investment (effect of deficit spending)
Assume Expansionary Fiscal Policy (G↑ and/or T↓ .: government budget moves toward deficit)
deficit spending .: DLF → or SLF ← .: r%↑ .: IG ↓ (partially or completely offsets intended increase in AD)
‘Crowding In’ of Gross Private Investment (effect of budget surplus)
Assume Contractionary Fiscal Policy (G↓ and/or T ↑ .: government budget moves toward surplus)
budget surplus .: DLF ← or SLF→ .: r% ↓ .: IG↑ (partially or completely offsets intended decrease in AD)
Expansionary Fiscal Policy Net Export Effect (counters policy)
deficit spending .: DLF → or SLF ← .: r%↑ .: D$ → .: $↑ .: U.S. goods/services relatively expensive and foreign goods/services are relatively cheap .: X↓ and/or M↑ .: XN ↓
Contractionary Fiscal Policy Net Export Effect (counters policy)
budget surplus .: DLF ← or SLF→ .: r% ↓ .: S$ → .: $↓ .: U.S. goods/services relatively cheap and foreign goods/services are relatively expensive .: X↑ and/or M↓ .: XN↑
Expansionary Monetary Policy Net Export Effect (reinforces policy)
Fed buys bonds, DR↓, and/or RR↓ .: ER↑ .: MS → .: i%↓ .: S$ → .: $↓ .: U.S. goods/services relatively cheap and foreign goods/services are relatively expensive .: X↑ and/or M↓ .: XN↑
Contractionary Monetary Policy Net Export Effect (reinforces policy)
Fed sells bonds, DR↑, and/or RR↑ .: ER↓ .: MS↓ .: i%↑ .: D$ → .: $↑ .: U.S. goods/services relatively expensive and foreign goods/services are relatively cheap .: X↓ and/or M↑ .: XN ↓