1. Business Cycles and Fluctuations

2. Business Cycles in the United States
The business cycle consists of two phases: expansion and recession.
Recession begins with a peak and ends with a trough.
Expansion is the recovery from a recession.
If a recession becomes very severe, it can turn into a depression.

3. Business Cycles in the United States
The worst depression in U.S. history was the Great Depression, which began in 1929.
The Great Depression was caused by various factors, including excessive borrowing in the 1920s and global economic conditions.
Since the Great Depression, the United States has experienced several recessions, but each was short compared with the recovery that followed.

4. Business Cycles in the United States

5. Causes of the Business Cycle
Businesses reduce their capital expenditures once they decide they have expanded enough.
Businesses cut back their inventories at the first sign of an economic slowdown.
Businesses cut back on investment after an innovation takes hold
Tight money policies of the Federal Reserve System slow the economy.
External shocks, such as increases in oil prices and international conflicts, can cause business cycles.

6. Predicting Business Cycles
Econometric models are macroeconomic model that use algebraic equations to describe how the economy behaves.
The index of leading indicators is a monthly statistical series that helps economists predict the direction of future economic activity.

8. UNEMPLOYMENT

9. Measuring Unemployment
The Census Bureau surveys 50,000 homes each month.
Each household must answer a series of questions.
Broken down into:
Non-institutional Population
Not in Labor Force
Labor Force
Employed
Unemployed

10. What is an Unemployed Person?
People available for work who:
Made a specific effort to find a job during the past month
Worked less than 1 hour for pay or profit
Worked in a family business without pay for less than 15 hours a week

11. Unemployment Rate
The number of unemployed individuals divided by the total number of persons in the civilian labor force
Unemployment rate rises during recessions and comes down slowly afterwards
Affected by downturns in real GDP – cost of a recession.

12. People NOT Counted
People who have stopped looking for work. “Dropouts”
People who have no interest in finding a job.
Retired persons
Housewives
Students
Disabled persons

13. Who Can Skew? People who hold part-time jobs
Person who has lost his high-paying job, but is working part-time at a minimum wage job.

14. American Labor Force 136.5 million people in the labor force
0.1 % rise in the unemployment rate means that 136,500 people have lost their jobs.

15. Kinds of Unemployment Frictional Structural Cyclical Seasonal
Technological

16. Frictional
Workers who are between jobs
Will always be present. WHY?

17. Structural
Occurs when a fundamental change in the operations of the economy reduces a demand for workers & their skills
Consumer tastes change and therefore causes certain goods to no longer be demanded.

18. Cyclical Related to swings in the business cycle
Recession: people don’t buy as many durable goods (cars, homes)
May result in lay-offs
People usually get their jobs back when the economy improves

19. Seasonal
Results from changes in seasons and demand for certain products
Ex: construction
Difference between seasonal and cyclical:
Cyclical follows the business cycle. Can last 3-5 years.
Seasonal can take place every year despite the health of the economy

20. Technological
Workers are replaced because machines can do the work more efficiently

21. Full Employment
Lowest possible unemployment rate with the economy growing and all factors of production being used as efficiently as possible
Acceptable unemployment rate = below 5%
(full employment is reached)

23. INFLATION

24. INFLATION
A rise in the general price level of goods/services - reported in terms of annual rates of change
Decrease in the value of money

25. INFLATION RATE 1st year price level Example: (115-111) X 100 = 3.6%
2nd year price level minus 1st yr price level X 100
1st year price level
Example: ( ) X 100 = 3.6%
111

27. CAUSES OF INFLATION Demand-pull:
All sectors of the economy try to buy more than the economy can produce
Causes shortages
Excess demand for goods and services causes businesses to raise prices; this can result when there is an increase in the money supply also

28. CAUSES OF INFLATION Cost-push:
labor negotiations as well as an increase in the cost of inputs causes businesses to raise prices

29. CAUSES OF INFLATION
Wage-price spiral: higher prices force workers to ask for higher wages; forces producers to recover with higher prices; workers have more money to spend and create higher demand; self-perpetuating

30. Effects of Inflation: Effect #1
The purchasing power of the dollar falls - after inflation, a dollar buys less than it did before
Real vs. Nominal Income: real income is expressed in terms of purchasing power;
Nominal income is expressed as an actual dollar amount (ex: $50,000)

31. Question: Can someone's nominal income increase but their purchasing power decrease?
YES!!! If there is inflation, an increase in nominal income may not make a difference since the dollar is worth less.

32. Who is hurt the most by inflation?
People on fixed incomes are especially hurt because their money buys less each month, unless they receive a cost of living adjustment (COLA) to keep up with inflation

33. Effects of Inflation: Effect #2
Spending habits change
Interest rates go up in times of inflation
This causes people to borrow less, spend less, and some businesses may have to lay off workers

34. Effects of Inflation: Effect #3
Speculative investing increases to take advantage of higher price level & diverts spending from "normal" purchases, which could lead to some structural unemployment

36. How is Inflation Tracked?
By comparing prices from one year to the next
These numbers are then reported through the CPI
CPI = Consumer Price Index

37. Consumer Price Index (CPI)
The Labor Department surveyed the purchasing patterns of consumers to determine a group of about 400 items that buyers typically use.
These 400 items makes up a “Market Basket”
Each month surveyors check on the prices of these items in cities across America.
Results are used to compute what the market basket costs compared to what it cost in a base period.

38. Poverty and Distribution of Income

39. The Distribution of Income
The Lorenz curve shows how the actual distribution of income differs from an equal distribution.
Since 1980 the distribution of income in the United States has become more unequal.

40. Reasons of Income Inequality
Level of education affects people’s ability to get high-paying jobs.
Differences in wealth lead to difference in income.
Discrimination reduces the incomes of women and minorities.
Differences in abilities allow some people to earn more than others.
Monopoly power allows some groups, such as doctors, to maintain high incomes.

41. Poverty
Poverty is defined as having an income below a certain level (poverty guidelines).
Poverty in America is extensive: more than 13 percent of the population lives in poverty.

42. Poverty has increased growing gap in the distribution of income
structural changes from a goods production to a service production economy,
the widening gap between well-educated and poorly educated workers,
declining unionism
the changing structure of the American family.

44. Antipoverty Programs
Income assistance provides cash to people in need.
General assistance provides noncash assistance, such as food stamps, to people in need.
Social service programs provide assistance with family planning, job training, child abuse prevention, and other problems affecting lower-income people.
The earned income tax credit provides federal tax credits and/or cash to low-income workers.

45. Antipoverty Programs
Enterprise zones provide jobs in poor neighborhoods.
Workfare programs require welfare recipients to work in order to receive benefits.
A negative income tax would replace welfare programs by providing cash to people living below the poverty line.

47. Federal Reserve System

48. Organization of the FED
Board of Governors
7 governors- appointed by the Pres. and approved by the Senate
14 year terms/4 year term for the chairman
Chairman – Ben Bernanke
Open Market Committee
7 governors and 5 presidents of district banks

49. Organization of the FED
Federal Advisory Council – offers advice
12 Commercial bankers – 1 from each district
District Banks
1 regional bank in each of 12 geographic districts

50. What are the FED’s responsibilities?
Provide banking services for financial institutions
Hold deposit accounts for member banks
Control and supply currency
Process checks
Make loans to member banks
Transfer funds
Approve bank mergers
Set margin requirements

51. Responsibilities Cont.
Serve as the federal government’s bank
Supervise and regulate the nation’s banking system
Control monetary policy

52. Monetary Policy
Actions by the FED to regulate the money supply and to stabilize the economy.

53. Fractional Reserve System
System requiring financial institutions to set aside a fraction of their deposits in the form of reserves

54. Excess Reserves
Financial institution’s cash, currency, and reserves not needed to back existing loans
Potential source of new loans

55. Easy Money/Expansionary Policy
The FED expands the money supply when spending is too low (recession)

56. Tight Money/Contractionary Policy
The FED decreases the money supply when spending is too high and prices are rising (inflation)

57. Tools of Monetary Policy
Reserve Requirement
Open Market Operations
Discount Rate
Moral Suasion

58. Reserve Requirement
The % of deposits banks must keep on reserve and not loan out.
This creates required reserves and excess reserves.
Only excess reserves can be loaned out
Every time a deposit, and then a loan, is made, the money supply is increased.

59. Open Market Operations
The FED buys and sells govt. securities from member banks.
By buying securities (writing a check to a bank) the money supply is increased.
By selling securities (a bank writes a check to the Fed) the money supply is decreased.

60. Discount Rate Interest rate the Fed charges banks for loans.
This affects the prime rate.
Prime rate – interest rate banks charge customers

61. Moral Suasion
The Fed tries to direct the economy by making announcements, speeches, testifying before Congress, etc.
Unofficial tool

62. Tool (used by the FED unofficial)
Stimulate Economy (Recession)
Cool Off Economy
(Inflation)
Reserve Requirement
decrease
increase
Open Market
Operations
Buy
Sell
Discount Rate
Lower
Raise

63. How is money defined?
M1 – transactional components of the money supply, or the components of the money supply that most closely match money’s role as a medium of exchange. Ex: coins, currency, traveler’s checks

64. How is money defined?
M2 – a measure of money that includes those components most closely conforming to money’s role as a store of value. Ex: time deposits, savings deposits, money market funds, includes M1

65. Weaknesses of Monetary Policy
Tight money policy works better than a loose money policy
By enacting a loose money policy, the Fed encourages spending, but can’t guarantee it
Businesses don’t always depend on credit

66. Strengths of Monetary Policy
Changes take effect quickly
Members of the Fed are not elected, so they feel freer to make changes, even though they may be unpopular