The Business Cycle

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Oct 28, 2013 (4 years and 13 days ago)

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The Business Cycle

Chapter 8

Copyright
© 2010 by the
McGraw
-
Hill Companies, Inc. All rights reserved.

McGraw
-
Hill/Irwin

Principles of Economics:

Macroeconomics
-

Econ101

8
-
2

The Business Cycle


Basic purpose of macroeconomics is to explain
how and why economies grow and what
causes recurrent ups and downs


How stable is a market
-
driven economy?


What forces cause instability?


What, if anything, can the government do to
promote steady economic growth?

8
-
3

Macroeconomics


Macroeconomics:
The study of aggregate
economic behavior, of the economy as a whole


Business cycle:
Alternating periods of
economic growth and contraction


Macro theories try to
explain

the business
cycle, economic policies try to control it

8
-
4

The Business Cycle in U.S. History

Source: U.S. Department of Commerce (2009)

From 1929 to 2009, real GDP increased at an average rate of 3 percent a year.

8
-
5

Stable or Unstable?


Prior to the 1930s, macroeconomists thought
there could never be a Great Depression


They believed a market
-
driven economy was
inherently stable


Laissez faire:
The doctrine of “leave it alone,”
of nonintervention by government in the
market mechanism


8
-
6

Classical Theory


According to the classical view, the economy
“self
-
adjusts” to deviations from its long
-
term
growth trend


a
self
-
regulating
economy


The cornerstones of classical optimism were
flexible prices and flexible wages


8
-
7

Classical Theory


Say’s Law:
Supply creates its own demand


Whatever was produced would be sold


All workers seeking employment would be hired


Unsold goods and unemployed labor could
emerge, but both would disappear once people
had time to adjust prices and wages


8
-
8

Macro Failure


The Great Depression was a stunning blow


Unemployment grew and persisted despite falling
prices and wages


The classical self
-
adjustment mechanism simply
didn’t work

8
-
9

The Keynesian Revolution


John Maynard Keynes developed an alternate
view of the macro economy, asserting that a
market
-
driven economy is
inherently unstable


Small disturbances in output, prices, or
unemployment were likely to be magnified by the
invisible hand of the marketplace


8
-
10

Government Intervention


In Keynes’ view, the inherent instability of the
marketplace required government intervention


We can’t afford to wait for some assumed self
-
adjustment mechanism


Must intervene to protect jobs and income

8
-
11

Historical Cycles


Upswings and downturns of the business cycle
are gauged in terms of changes in total output


Real GDP:
The value of final output produced
in a given period, adjusted for changing prices


Changes in employment typically mirror
changes in production

8
-
12

The Business Cycle


An economic upswing (expansion) is an
increase in the volume of goods and services
produced


An economic downturn (contraction) occurs
when the volume of production declines


Successive short
-
run contractions and
expansions are the essence of business cycles

8
-
13

The Business Cycle

Trough

Peak

REAL GDP

TIME

Growth trend

Peak

Peak

Trough

8
-
14

The Business Cycle


Recession:
A decline in total output (real
GDP) for two or more consecutive quarters


Growth recession:
A period during which real
GDP grows, but at a rate below the long
-
term
trend of 3 percent


8
-
15

A Model of the Macro Economy


Both Keynes and the Classical economists
agreed that business cycles occur, but
disagreed on whether they’re an appropriate
target for government intervention


Need to understand origins of the business
cycle

8
-
16

Macroeconomic Performance


Macro outcomes include:


Output

-

Value of goods and services produced


Jobs

-

Levels of employment and unemployment


Prices

-

Average price of goods and services


Growth

-

Year
-
to
-
year expansion in production


International balances

-

International value of the
dollar; trade and payments balances with other
countries


8
-
17

Macroeconomic Performance


Determinants of macro performance include:


Internal market forces

-

Population growth,
spending behavior, intervention & innovation, etc.


External shocks

-

Wars, natural disasters, terrorist
attacks, trade disruptions, and so on


Policy levers

-

Tax policy, government spending,
changes in the availability of money, and
regulation, for example


8
-
18

The Macro Economy

Internal
market
forces

External

shocks

Policy

levers

DETERMINANTS

Output

Jobs

Prices

Growth

International
balances

OUTCOMES

MACRO

ECONOMY