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Becker – 2008 Edition Chapter 2 Page 1 of 13
Chapter 2
Business Cycles and Reasons for Business FluctuationsBusiness cycle: rise and fall of economic activity relative to its long-term growth trend.Macroeconomics: study of economy as a whole – National income, unemployment, inflation.Microeconomics: studies consumers, producers, and suppliers operating in a narrowly defined market.Gross Domestic Product (GDP): most common measure of economic activity or output of an economy-
Total market value of all final goods and services produced within the borders of a nationNominal GDP: measures the value of all final goods and services in current prices. No inflationadjustment.Real GDP: measures the value of all final goods and services in current prices. Adjusted for inflation byusing a price index.Price index (GDP Deflator): used to calculate real GDP.Real GDP = Nominal GDP x 100GDP DeflatorBusiness cyclesExpansionary phase: rising economic activity (Real GDP) and growth.Peak: high point of economic activity.Contractionary phase: falling economic activity and growth and follows a peak.Trough: low point of economic activity.Recovery phase (expansionary phase): follows a trough and economic activity begins to increaseRecession: economy experiences negative real economic growth.-
Two consecutive quarters of falling national output.-
Resources are underutilized and unemployment is highDepression: a very severe recession.Leading indicators (Before)-
New unemployment claims-
Building permits for residences-
Average length of the workweek-
Money supply-
Prices of selected stocks-
Orders for goods-
Price changes of materials-
Index of consumer expectations
Becker – 2008 Edition Chapter 2 Page 2 of 13Lagging indicators (After)-
Prime rate charged by banks-
Duration of unemployment-
Bank loans outstandingCoincident indicators (During/Contemporaneously)-
Industrial production-
Manufacturing and trade salesAggregate Demand (AD) Curve: the maximum quantity of all goods and services the households, firms,and the government are willing and able to purchase at any given price level.Aggregate Supply (AS) Curve:-
The maximum quantity of all goods and services producers are willing and able to produce atany given price level-
Short run aggregate supply (SRAS)
o
Curve is upward sloping. As the price rises, firms are willing to produce more goods-
Long run aggregate supply (LRAS)
o
Curve is vertical corresponding to the potential level of output in the economyAD, AS, and Economic Fluctuations:1.
Reduction in Demand: Shift left AD
GDP
P
2.
Increase in Demand: Shift right AD
GDP
P
3.
Reduction of Supply: Shift left SRAS
GDP
P
4.
Increase in Supply: Shift right SRAS
GDP
P
Factors that shift AD1.
Increase in wealth: W
spend
AD
GDP
P
2.
Decrease in wealth: W
spend
AD
GDP
P
3.
Increase in real interest rates: I
borrow
spend
AD
GDP
P
4.
Decrease in real interest rates: I
borrow
spend
AD
GDP
P
5.
Confident economic outlook:
spend
AD
GDP
P
6.
Uncertain economic outlook:
spend
AD
GDP
P
7.
Appreciated domestic currency:
exports
imports
AD
GDP
P
o
Goods will become expensive for foreigners, foreign goods become cheap for US.8.
Depreciated domestic currency:
exports
imports
AD
GDP
P
9.
Increase in government spending:
AD
GDP
P
10.
Decrease in government spending:
AD
GDP
P
Becker – 2008 Edition Chapter 2 Page 3 of 1311.
Increase in taxes:
spend
AD
GDP
P
12.
Decrease in taxes:
spend
AD
GDP
P
*Federal government controls the economy:1. Increase or decrease in government spending2. Increase or decrease in consumer taxesMultiplier effect: $1 increase in government spending results in greater than $1 increase in real GDP.-
Results from the marginal propensity to consumeMultiplier = 1 x Change in spending(1-MPC)
(1-MPC) = MPS
Factors that shift SRAS1.
Increase in input price:
SRAS
GDP
P
2.
Decrease in input price:
SRAS
GDP
P
3.
Supplies are plentiful:
SRAS
GDP
P
4.
Supplies are curtailed:
SRAS
GDP
P
Economic Measures and Reasons for Changes in the Economy
Real GDP
Unemployment rate
Inflation rate
Interest rateGDP includes the economic output of these four sectors:-
Household (consumers)-
Businesses-
Federal, state, and local governments-
The foreign sectorHow to calculate the GDP?Expenditure Approach (G + I + C + E = GDP)
G – G
overnment purchases of goods and services
I –
Gross private domestic
I
nvestment
C –
Personal
C
onsumption expenditures
E –
Net
E
xports (exports – imports)= GDP
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