CHAPTER 03: THE

MACROECONOMY AND
BUSINESS FORECASTS
INSTRUCTOR: ZUHAIB KHOKHAR
 Outline

 Introduction  Macroeconomic Models and Forecasting

 Business Cycle  Use of Macroeconomic Models at the Industry
and Firm Level
 Phases of Business Cycle
1. Peak
2. Recession
3. Trough
4. Recovery
 Historical Events and Their Impacts on
Business Cycle
Introduction

 Nations seek economic growth, full employment, and price-level stability as their
major macroeconomic goals.
 Business decisions are made in the context of the macroeconomy of a nation. Firms
take their cues from the economic environment in which they operate.
 When favorable macroeconomic conditions prevail, businesses expand operation and
output.
 Contractions in the economy generally lead to slower growth patterns.
Introduction

 Long-term trends, seasonal variations, cyclical movements, and irregular factors

combine to generate widely divergent paths for businesses in an economy. Given these
conditions, how are businesses to predict future growth and contractions in the
economy?
 In this, we will discuss specifically those cyclical linkages that bind the economy
together during a typical business cycle, and how our knowledge of these linkages
help us in making good forecasts at the industry and firm level.
Business Cycle

 The business cycle is the natural rise and fall of economic growth that occurs over
time. The cycle is a useful tool for analyzing the economy and can help you make
better decisions.
 Business cycle is a cycle of expansion and contraction that economies undergo over
time.
 The business cycle is the pattern of economic booms and busts that is characteristic of
developed economies.
Phases of Business Cycle

4.
Recovery
3. Trough
2.
Recession
1. Peak
Phases of Business Cycle

1. Peak:
 Peak refers to the economic condition at which business activity has reached a
temporary maximum and shows the onset of a recession or upper turning point.
 During this phase the economy is at full employment and the level of real output is at,
or very close to, its capacity.
 It is expected that the price level will rise during this phase of the business cycle.
Phases of Business Cycle

2. Recession:
 Recession follows a peak in the economy. In this phase a decline lasting more than 6
months in total output, income, employment, and trade will be noted.
 This downturn is marked by the widespread contraction of the business in many
sectors of the economy.
 Because of inflexibility of downward price movement, one does not expect prices to
fall unless a severe and prolonged recession or depression occurs.
Phases of Business Cycle

3. Trough:
 Trough refers to that phase of the business cycle where output and employment
“bottom out” at their lowest levels. It is also called the lower turning point. The
duration of the trough may be short-lived or very long.
Phases of Business Cycle

4. Recovery:
 In the recovery phase, output and employment surge toward full employment, and as
recovery intensifies, the price level may begin to rise before full employment is
reached.
Phases of Business Cycle
Historical Events and Their Impacts on
Business Cycles
Growth Rate for the Various Macroeconomic Indicators:
Macroeconomic Models and Forecasting

 Many variables interact with each other in shaping the economy, it would be of value
to forecasters to have the tools necessary to observe the interrelationships in the
overall economy as well as the means to measure the impact of these variables on one
another.
 Macroeconomic models are general equilibrium models.
 In building macroeconomic models, the forecaster depends on economic theory and
statistical techniques.
Use of Macroeconomic Models at the
Industry and Firm Level
 Available computer technologies and information systems (databases) allow today’s
forecasters to develop models that appropriately handle the interrelationships at the
macroeconomy and link the firms to industry, and industry to the overall
macroeconomic model. To see how these units of the economy are linked with one
another, consider this simple diagram of the economy shown in Figure 3.1.
Use of Macroeconomic Models at the
Industry and Firm Level
 Given these interrelationships that exist between the macroeconomy and individual
firms within the economy, forecasts that are generated by the macroeconomic models
are quite useful to firms.
 Because of the changing economic environment, models have to be constantly revised
so that appropriate forecasts are made.