Topic 1- The Business Cycle

Economics

The “social science” of unlimited wants with limited resources and how that shapes society’s decisions

*AKA the study of trade-offs

Factors of Production

inputs used to produce goods and resources (these are SCARCE!)

• Land (natural resources)

• Labor (people’s effort/skills)

• Capital (machines, factories, technology)

• Entrepreneurship (new ventures)

Microeconomics

the small picture/individual decisions of specific firms, markets, and households

• Focus = individual economic units

• Main Goal = understand price determination and resource allocation in single markets

• Key Variables = individual prices, firm output, market demand, consumer choices

Macroeconomics

the big picture/economy-wide performance

• Focus = the economy as a whole

• Main Goal = understand national economic health, stability, and growth over time

• Key Variables = GDP, inflation, national unemployment, interest rates, monetary and fiscal policy

3 Goals in Macroeconomics

1. Economic Growth- increase in total output (ideally 2-3%)

2. Low Unemployment- results in higher quantity of goods/services and less waste (ideally 4-6%)

3. Low and Stable Prices- minimizing price changes (inflation is 1-2% ideally)

*it is NOT possible to have all 3 at once for a long period of time- the economy has trade-offs

Inflation

the percentage increase in the average level of prices from one year to the next

Real GDP

the value of goods and services evaluated at base year prices (GDP adjusted for inflation)

The Business Cycle

the recurring pattern of growth (expansion) and decline (contraction) in the economy

*on a graph, time is the x-axis and real GDP is the y-axis

*peak → peak = 1 full cycle

Potential GDP

what the economy produces if ALL resources are used (it’s possible for us to be above OR below this line)

Peak

highest point where economy reaches maximum output

Trough

lowest point in the business cycle

Expansion

when production, employment, and income are all increasing

• recovery- expansion immediately after a trough (below potential GDP)

• boom- expansion above potential GDP (or a rapid increase in GDP)

Contraction

when production, employment, and income are decreasing

• recession- contraction for 2 straight quarters (6 months)

• depression- contraction for an extended period of time (3+ years or a decline of 10% or more each year)

Things that Influence the Business Cycle

• changes in aggregate demand

• external shocks (ex: COVID-19)

• fiscal and monetary policy (governement intervention)

• technological advancements

• changes in population

The Business Cycle in Recent History

• small expansion before the 2007-2008 recession

• mid-2009 economy reached a trough but then starts recovering

• large expansion from 2009-2020

• very small recession in 2020 (COVID)

• back to expanding by 2021

Events at the End of Expansion

• interest rates are increasing, wages are increasing FASTER THAN PRICES

• as a result, firm’s profits start decreasing (employees are getting too expensive)

• households/firms start to decrease spending

• the peak is when prices are the highest

Events at the Beginning of Recession

• decrease in spending by firms on investments

• decrease in spending by households on consumption (specifically durable goods like cars, houses, fridges)

Events at the Start of Expansion

• prices and interest rates are decreasing (because people started spending less)

• so households and firms start spending again

Recessions

• triggered by adverse (negative) shocks

• the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) indicates when the economy is in a recession (usually delayed)

• determined by looking at data such as real GDP, employment, income, production, and sales

• Ex: Dec 2007 - June 2009, and Feb 2020 - April 2020

Unemployment Rate

• countercyclical with the Business Cycle (unemployment decreases during expansion and increases during recession)

• unemployment continues to to increase even after a recession ends

  • employment increases slower than growth in the labor force

  • it takes a minute to get unemployed people back to work

  • employment LAGS economic expansion

Inflation Rate

• inflation is pro cyclical with the Business Cycle (inflation increases during expansion and decreases during contraction)

• rate is lower in the months following a recession → prices are affordable

• end of expansion → inflation increases (prices are expensive)

• during contraction → inflation decreases (less spending = low prices)