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2. slide 1 Business Cycles  Business Cycles – Business cycles are 2-year to 5-year fluctuations around trends in real GDP and other related variables – A recession is a large fall in the growth of real GDP and related variables A depression is an especially large recession

3. slide 2 Business Cycles

4. slide 3 Real GDP Growth in the United States Average growth rate = 3.5%

5. slide 4 Recessions in the U.S. since World War II Year and quarter of peak in RGDP Number of quarters until trough in RGDP Change in RGDP, peak to trough (%) 1948:4 1953:2 1957:3 1960:1 1970:3 1973:4 1980:1 1981:3 1990:2 232315243232315243 -1.7 -2.7 -3.7 -1.6 -1.1 -3.4 -2.2 -2.9 -1.5 No simple regular or cyclical pattern: output changes very considerably in size and spacing

6. slide 5 Behavior of the Components of Output in Recessions Component of GDP Average Share in GDP (%) Average Share in fall in GDP in recessions relative to normal growth (%) Consumption Durables Nondurables Services Investment Residential Business Fixed Inventories Net Export Gov’t Purchases 8.4 25.8 29.5 4.7 10.7 0.7 -0.4 20.6 15.6 11.2 9.1 20.9 11.7 40.6 -12.3 3.3 Fluctuations are distributed very unevenly over the components of output

7. slide 6 Cyclical Behavior of Key Macroeconomic Variables  Procyclical variable – An economic variable that moves in the “same” direction as aggregate economic activity industrial production, consumption, investment, employment, real wage, inflation, stock prices  Countercyclical variable – An economic variable that moves in the “opposite” direction as aggregate economic activity unemployment

8. slide 7 Cyclical behavior of the index of industrial production

9. slide 8 Cyclical behavior of consumption and investment

10. slide 9 Cyclical behavior of civilian employment

11. slide 10 Cyclical behavior of the unemployment rate

12. slide 11 Cyclical behavior of average labor productivity and the real wage

13. slide 12 Supply shocks A supply shock alters production costs, affects the prices that firms charge. (also called price shocks) Examples of adverse supply shocks:  Bad weather reduces crop yields, pushing up food prices.  Workers unionize, negotiate wage increases.  New environmental regulations require firms to reduce emissions. Firms charge higher prices to help cover the costs of compliance. (Favorable supply shocks lower costs and prices.)

14. slide 13 CASE STUDY: The 1970s oil shocks  Early 1970s: OPEC coordinates a reduction in the supply of oil.  Oil prices rose 11% in 1973 68% in 1974 16% in 1975  Such sharp oil price increases are supply shocks because they significantly impact production costs and prices.

15. slide 14 SRAS 1 Y P AD LRAS Y2Y2 The oil price shock shifts SRAS up, causing output and employment to fall. A B In absence of further price shocks, prices will fall over time and economy moves back toward full employment. SRAS 2 CASE STUDY: The 1970s oil shocks A

16. slide 15 CASE STUDY: The 1970s oil shocks Predicted effects of the oil price shock: inflation  output  unemployment  …and then a gradual recovery.

17. slide 16 CASE STUDY: The 1970s oil shocks Late 1970s: As economy was recovering, oil prices shot up again, causing another huge supply shock!!!

18. slide 17 CASE STUDY: The 1980s oil shocks 1980s: A favorable supply shock-- a significant fall in oil prices. As the model would predict, inflation and unemployment fell: