Download BM 2.04 Notes - ycampbell

2.04 Understand economic
indicators to recognize
economic trends and
conditions.
Describe the economic impact of inflation on business
Define the following terms: inflation, inflation rate, deflation, Consumer Price Index,
standard of living, targeted inflation rate, and price stability.
• INFLATION: A persistent increase in the average price level in the economy.
Inflation occurs when the AVERAGE price level (that is, prices IN GENERAL)
increases over time.
• INFLATION RATE: The percentage change in the price level from one period
to the next. The two most common price indices used to measure the
inflation are the Consumer Price Index (CPI) and the GDP price deflator.
• DEFLATION: An extended decline in the average level of prices. This is the
exact opposite of inflation
• CONSUMER PRICE INDEX: An index of prices of goods and services typically
purchased by urban consumers.
• STANDARD OF LIVING: In principle, an economy's ability to produce the
goods and services that consumers use to satisfy their wants and needs. In
practice, it is the average real gross domestic product per person--usually
given the name per capita real GDP.
• PRICE STABILITY: The condition in which the average price level in the
economy does not change or changes very slowly.
Describe causes of inflation.
• The two basic types (or causes) of inflation: demand-pull inflation and
cost-push inflation.
• Demand-pull inflation, as the name clearly indicates, results when
economy-wide shortages are created by increases in aggregate
demand.
• Cost-push inflation results when an economy-wide shortages are
created by decreases in aggregate supply, which are so named
because they are more often than not triggered by increases in
production cost.
Explain how inflation impacts the
economy.
• INFLATION PROBLEMS: Two notable problems are
associated with inflation: uncertainty and haphazard
redistribution.
• Inflation, especially inflation that varies from month to
month and year to year, makes long-term planning quite
difficult.
• Prices, wages, taxes, interest rates, and other nominal values
that enter into consumer, business, and government planning
decisions can be significantly affected by inflation.
• Moreover, inflation tends to redistribute income and
wealth in a haphazard manner; some people win and
some people lose. But this redistribution might not that
desired by society, failing to promote any of the basic
economic goals of efficiency, equity, stability, growth, or
full-employment.
Describe the relationship between price
stability and inflation.
• Price stability is commonly indicated by the inflation rate, calculated
as percentage changes in either the Consumer Price Index (CPI) or the
GDP price deflator. However, price stability is more generally the
ABSENCE of large or rapid increases or decreases in the price level.
• Inflation results when the AVERAGE of these assorted prices follows
an upward trend. Inflation is the most common phenomenon
associated with the price level.
Explain problems associated with deflation.
• Like inflation, deflation occurs when the AVERAGE price level
decreases over time. While some prices might decrease, other prices
could increase or remain unchanged, so long as the AVERAGE follows
a downward trend.
• Deflation is a rare bird indeed in our economy and typically happens
only when we're in a prolonged period of stagnation. We might see
some deflation during a fairly lengthy recession, but more than likely
deflation saves itself for the occasional depression that dots our
economic landscape.
Discuss reasons why the inflation rate should
be above zero.
• When the rate falls below zero, as it did briefly in 1954, average prices
actually are falling (deflation). While lower prices may seem ideal at
first from a consumer's point of view, deflation leads to rising
unemployment and falling production, a situation from which it is
extremely difficult to recover. An inflation rate of 1 - 2.5% currently
seems to be acceptable by many economists.
Explain how businesses can use the Consumer Price Index & Discuss the
purpose of the Consumer Price Index (CPI).
• The CPI is compiled and published monthly by the Bureau
of Labor Statistics (BLS), using price data obtained from an
elaborate survey of 25,000 retail outlets and quantity data
generated by the Consumer Expenditures Survey.
• The CPI is unquestionably one of the most widely
recognized macroeconomic price indexes, running second
only to the Dow Jones Industrial Average in the price
index popularity contest.
• It is used not only as an indicator of the price level and
inflation, but also to convert nominal economic indicators
to real terms and to adjust wage and income payments
(such as Social Security) for inflation.
Describe how the Consumer Price Index is
determined
• The CPI is calculated by taking price changes for each item in the
predetermined basket of goods and averaging them; the goods are
weighted according to their importance. Changes in CPI are used to
assess price changes associated with the cost of living.
http://www.investopedia.com/video/play/what-is-the-consumerprice-index-CPI#axzz1YauKv934
Identify the major kinds of consumer spending
that make up the Consumer Price Index.
• The CPI represents all goods and services purchased for consumption by
the reference population (U or W) BLS has classified all expenditure items
into more than 200 categories, arranged into eight major groups. Major
groups and examples of categories in each are as follows:
• FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, full
service meals, snacks)
• HOUSING (rent of primary residence, owners' equivalent rent, fuel oil,
bedroom furniture)
• APPAREL (men's shirts and sweaters, women's dresses, jewelry)
• TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle
insurance)
• MEDICAL CARE (prescription drugs and medical supplies, physicians'
services, eyeglasses and eye care, hospital services)
• RECREATION (televisions, toys, pets and pet products, sports equipment,
admissions);
• EDUCATION AND COMMUNICATION (college tuition, postage, telephone
services, computer software and accessories);
• OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and
other personal services, funeral expenses).
Explain how the Consumer Price Index is used
to find the rate of inflation
• The CPI measures the average change over time in the prices paid by
urban consumers for a representative selection of consumer goods
and services.
• The rate of inflation is a measure of how fast prices are rising. It is
computed as the percentage increase in the level of prices between
two time periods.
Describe limitations on the use of the
Consumer Price Index
• The CPI is subject to both limitations in application and limitations in
measurement.
• Limitations of application
• The CPI may not be applicable to all population groups. For example, the CPI-U is
designed to measure inflation for the U.S. urban population and thus may not
accurately reflect the experience of people living in rural areas. Also, the CPI does
not produce official estimates for the rate of inflation experienced by subgroups of
the population, such as the elderly or the poor.
• The CPI cannot be used to measure differences in price levels or living costs
between one place and another; it measures only time-to-time changes in each
place.
• Limitations in measurement
• Limitations in measurement can be grouped into two basic types, sampling errors
and non-sampling errors.
• Sampling errors. Because the CPI measures price changes based on a sample of
items, the published indexes differ somewhat from what the results would be if
actual records of all retail purchases by everyone in the index population could be
used to compile the index.
• Non sampling errors. Nonsampling errors are caused by problems of price data
collection.
2.04 Understand economic
indicators to recognize
economic trends and
conditions.
Discuss the measure of consumer spending as an economic indicator
Define the term Consumer Confidence Index
(CCI)
• The Conference Board defines the Consumer Confidence Survey as “a
monthly report detailing consumer attitudes and buying intentions,
with data available by age, income and region.”
Describe how consumer spending reacts to
shifts in the well-being of the economy
• Since consumer spending is so important to the nation's financial
health, the Consumer Confidence Index is one of the most accurate
and closely watched economic indicators. The index is based on a
survey of five questions posed to 5,000 households, measuring their
optimism on the health of the economy. The CCI, however, is a lagging
indicator, so, whatever the survey says, remember that it doesn't tell
us what is going to happen, but what has happened and if it can be
expected to continue.
Explain how the Consumer Confidence Index
functions
• Each month the Conference Board surveys 5,000 U.S. households. The
survey consists of five questions that ask the respondents' opinions about
the following:
Current business conditions.
•
•
•
•
•
Business conditions for the next six months.
Current employment conditions.
Employment conditions for the next six months.
Total family income for the next six months. Survey participants are asked to answer
each question as "positive", "negative" or "neutral".
The results from the Consumer Confidence Survey are released on the last
Tuesday of each month at 10am EST.
Describe how businesses use and react to
changes in the Consumer Confidence Index
• Manufacturers, retailers, banks and the government
monitor changes in the CCI in order to factor in the data in
their decision-making processes. While index changes of
less than 5% are often dismissed as inconsequential,
moves of 5% or more often indicate a change in the
direction of the economy.
• A month-on-month decreasing trend suggests consumers
have a negative outlook on their ability to secure and
retain good jobs. Thus, manufacturers may expect
consumers to avoid retail purchases, particularly largeticket items that require financing. Manufacturers may
pare down inventories to reduce overhead and/or delay
investing in new projects and facilities. Likewise, banks
can anticipate a decrease in lending activity, mortgage
applications and credit card use.
Discuss government’s options when the Consumer
Confidence Index indicates a decreasing trend
• When faced with a down-trending index, the government has a
variety of options, such as issuing a tax rebate or taking other fiscal or
monetary action to stimulate the economy.
• Conversely, a rising trend in consumer confidence indicates
improvements in consumer buying patterns.
• Manufacturers can increase production and hiring. Banks
can expect increased demand for credit. Builders can prepare for a
rise in home construction and government can anticipate improved
tax revenues based on the increase in consumer spending.
2.04 Student Activity
• Ask students to interpret the Consumer Price Index over a 10-year
period and draw conclusions about the prices of food, clothing, and
medical care. Each student should collaborate with a classmate to
discuss the pair’s findings and conclusions
• CPI Calculator: Online Consumer Price Index Calculator
www.cpi.memphiscapital.com/
• http://inflationdata.com/Inflation/Inflation_Calculators/Inflation_Calc
ulator.asp#calcresults
2.04 Understand economic
indicators to recognize
economic trends and
conditions.
Explain the concept of Gross Domestic Product (GDP)
Define the following terms:
• Gross Domestic Product (GDP) : The total market value of all final goods
and services produced within the political boundaries of an economy
during a given period of time, usually one year. This is the official measure
of the aggregate output produced by the economy.
• Personal consumption expenditures: the official government measure of
consumption expenditures undertaken by the household sector. It seeks to
quantify that portion of gross domestic product that is purchased by the
household sector and which is used, in theory at least, to satisfy wants and
needs.
• Gross Private Domestic Investment: The official measure of investment
expenditures on gross domestic product by the business sector. Gross
private domestic investment averages about 15 percent of gross domestic
product. These expenditures come in two broad categories: (1) fixed
investment and (2) changes in private inventories.
• GOVERNMENT PURCHASES OF GOODS AND SERVICES: Expenditures on
final goods and services (that is, gross domestic product) undertaken by the
government sector. Government purchases are used to operate the
government (administrative salaries, etc.) and to provide public goods
(national defense, highways, etc.). These are expenditures on final goods by
all three levels of government: federal, state, and local governments.
Define the following terms:
• Net Exports of Goods and Services: The official measure of net exports of gross
domestic product by the foreign sector, which is the difference between
exports and imports. Net exports of goods and services average about 2
percent of gross domestic product, with exports and imports individually in the
range of about 10 percent.
• TRADE DEFICIT: Formally termed a balance of trade deficit, a condition in which
a nation's imports are greater than exports. In other words, a country is buying
more stuff for foreigners than foreigners are buying from domestic producers.
• TRADE SURPLUS: Formally termed a balance of trade surplus, a condition in
which a nation's exports are greater than imports. In other words, a country is
buying less stuff from foreigners than foreigners are buying from domestic
producers.
• Uncounted production: Items that do not go through the standard markets and
are not counted.
• Underground economy: the exchange of goods and services which are hidden
from official view. Examples of such activities range from babysitting “off the
books” to selling narcotics.
• Double counting results if the value of an intermediate good is included in the
gross domestic product more than once. Such double counting would seriously
overstate gross domestic product.
Identify the categories of goods and services
that make up GDP
• The monetary value of all the finished goods and services produced within a
country's borders in a specific time period, though GDP is usually calculated on an
annual basis. It includes all of private and public consumption, government
outlays, investments and exports less imports that occur within a defined
territory.
GDP = C + G + I + NX
where:
"C" is equal to all private consumption, or consumer spending, in a nation's
economy
"G" is the sum of government spending
"I" is the sum of all the country's businesses spending on capital
"NX" is the nation's total net exports, calculated as total exports minus total
imports. (NX = Exports - Imports)
Describe problems encountered in calculating
GDP
• Critics of using GDP as an economic measure say the statistic does not
take into account the underground economy - transactions that, for
whatever reason, are not reported to the government. Others say
that GDP is not intended to gauge material well-being, but serves as a
measure of a nation's productivity, which is unrelated.
Explain the importance of a country's GDP
Describe ways to increase GDP
• There are really only 2 ways you can increase GDP.
• First, have more people working.
• Second, have people work more efficiently
Describe how the government responds to
changes in GDP
• A significant change in GDP, whether up or down, usually has a
significant effect on the stock market. It's not hard to understand
why: a bad economy usually means lower profits for companies,
which in turn means lower stock prices. Investors really worry about
negative GDP growth, which is one of the factors economists use to
determine whether an economy is in a recession.
• As a result of such a wide-spread global recession, the economies of
virtually all the world's developed and developing nations suffered
extreme set-backs and numerous government policies were
implemented to help prevent a similar future financial crisis.
Describe ways that businesses respond to
changes in GDP
• When GDP and other economic indicators are on the rise, producers
become hopeful about the future, and they buy new equipment,
build new facilities, or expand their current operations.
• This increase in capital-goods investment encourages the expansion
of other economic activities. Producers continue to encourage this
expansion by increasing their inventory levels to be prepared for the
increase in demand that they anticipate.
2.04 Understand economic
indicators to recognize
economic trends and
conditions.
Discuss the impact of a nation’s unemployment rates
Define the following terms:
• UNEMPLOYMENT RATE: The proportion of the civilian labor force 16 years or older that is actively seeking
employment, but is unemployed and not engaged in the production of goods and services.
• FRICTIONAL UNEMPLOYMENT: Unemployment attributable to the time required to match production
activities with qualified resources. Frictional unemployment essentially occurs because resources, especially
labor, are in the process of moving from one production activity to another. Employers are seeking workers
and workers are seeking employment, the two sides just have not matched up.
• STRUCTURAL UNEMPLOYMENT: Unemployment caused by a mismatch between workers' skills and the skills
needed for available jobs. Structural unemployment essentially occurs because resources, especially labor,
are configured (trained) for a given technology but the economy demands goods and services using another
technology.
• CYCLICAL UNEMPLOYMENT: Unemployment attributable to a general decline in macroeconomic activity,
especially expenditures on gross domestic product, that occurs during a business-cycle contraction. When
the economy dips into a contraction, or recession, aggregate demand declines, so less output is produced
and fewer workers and other resources are employed.
• SEASONAL UNEMPLOYMENT: Unemployment attributable to relatively regular and predictable declines in
particular industries or occupations over the course of a year, often corresponding with the climatic
seasons.
• TECHNOLOGICAL UNEMPLOYMENT (e.g. due to the replacement of workers by robots) might be counted as
structural unemployment. Alternatively, technological unemployment might refer to the way in which
steady increases in labor productivity mean that fewer workers are needed to produce the same level of
output every year.
• FULL EMPLOYMENT: The state that occurs when all of the economy's resources are engaged in the
production of output. In practice, an economy is considered to be at full employment when the
unemployment rate is around 5 to 5 1/2 percent and the capacity utilization rate of capital is about 85
percent.
Discuss individual costs of unemployment.
• Unemployment creates personal hardships for the owners of the
unemployed resources. When resources do not produce goods, their
owners do not earn income. The loss of income results in less
consumption and a lower living standard.
• The personal hardships suffered by the unemployed are of concern
to government leaders for reasons that are both in the common
good and somewhat more selfish.
• In terms of the common good, the unemployed are members of society
just like everyone else and deserve the opportunities to enjoy the fruits of
a productive economy. An affluent society "should" be able to provide for
everyone. In addition, social problems that cause personal hardships to
other members of society tend to increase with the personal hardships of
the unemployed, including crime, divorce, suicides, etc.
• Government leaders are also concerned with the personal hardships of the
unemployed for more selfish reasons. When the voting public is unhappy,
they tend to elect new leaders and toss the old ones out of office. There
are few things that voters like less than suffering the personal hardships
that come with unemployment. Presidential elections have been decided
on a few million votes. A typical business-cycle contraction can add four to
five million workers to the ranks of the unemployed, enough votes to
change the "employment" status of any incumbent President seeking reelection.
Describe economic benefits of unemployment.
• The general purpose of the unemployment compensation system is the provide
financial assistance to unemployed workers. The modern system, however, has two
interrelated functions.
• Financial Assistance: First, it does provide needed financial assistance to workers
who are involuntarily unemployed. This need tends to be most acute during
business-cycle contractions, but it is valuable during all periods. Without such
assistance, workers who are unemployed only temporarily are likely encounter
serious financial and personal hardships (bankruptcy, home foreclosure, etc.) from
which they might never recover.
• Economic Stability: Second, it helps stabilize the macroeconomy during businesscycle contractions. Because unemployed workers continue to receive income, they
are able to continue consumption expenditures, which prevents aggregate
production from dropping as much as it might have otherwise. This, as such,
prevents the economy from slipping deeper into a business-cycle contraction.
• Unemployment may have advantages as well as disadvantages for the overall
economy. Notably, it may help avert runaway inflation, which negatively affects
almost everyone in the affected economy and has serious long term economic
costs. As in the Marxian theory of unemployment, special interests may also
benefit: some employers may expect that employees with no fear of losing their
jobs will not work as hard, or will demand increased wages and benefit. According
to this theory, unemployment may promote general labour productivity and
profitability by increasing employers monopsony like power (and profits).
Explain theories of the causes of unemployment
• The five key reasons for unemployment are: (1) job losers, (2) job leavers, (3) those of have
completed temporary jobs, (4) re-entrants, and (5) new entrants.
• Job Losers: A job loser is an unemployed person who has been involuntarily terminated or laid
off from a job. More specifically, a job loser is:
• A person who has been permanently terminated from a job and is actively seeking
employment.
• A person who has been temporarily laid off from a job and is not actively seeking
employment due to expectations being called back to work within six months.
• Job Leavers: A job leaver is a person who has voluntarily quit one job and is actively seeking
employment elsewhere.
• Completed Temporary Job: An unemployed person can also be one who has recently
completed a temporary job and is actively seeking employment elsewhere.
• Re-entrants: A re-entrant is a person who had previously been classified as an employed
person, but has been out of the labor force for a period of time before actively seeking
employment once again.
• New Entrants: A new entrant is a person who has never before been employed and is actively
seeking employment for the first time.
• The causes of unemployment are complex. Some kinds are long term: technical
unemployment happens when people's skills are made redundant. Some are medium term:
cyclical unemployment happens because there is inadequate demand to keep production
going. Some are short term: frictional unemployment happens because people change jobs or
locations. Seasonal work, casual employment and subemployment are patterns of work which
lead to people being employed only for short periods at a time.
• Exclusion from the labour market takes many forms: some people can opt for early retirement,
further education or domestic responsibility, and others cannot. If poor people are
unemployed more, it is not just because they are more marginal in the labour market; it is also
because they have fewer choices, and because people who become classified as 'unemployed'
are more likely to be poor.
Explain why the unemployment rate
understates employment conditions
• A couple of measurement problems exist that could cause the official
unemployment rate to be understated or overstated.
• Understated: Anyone with a paying job is officially counted as being employed.
Unfortunately, this includes those working part-time, who want to work full-time.
• In theory, a person working 20 hours a week, who is willing and able to work 40 hours a week
should be considered as "half employed." The official unemployment rate calculation only
considers such workers as employed.
• Moreover, to be officially counted as unemployed a person must be actively seeking a job.
Unfortunately, this excludes discouraged workers who have stopped looking for employment.
They are willing and able to work, and in principle should be considered as unemployed, but
they have simply stopped looking.
• The official unemployment rate calculation does not consider these workers as unemployed
nor part of the labor force.
• Including both part-time workers and discouraged workers would tend to
increase the unemployment rate.
Describe the costs of unemployment for a
nation
• We know that high unemployment is not a good thing, but you may not be aware of all
of the reasons. Unemployment clearly has costs for the person who is jobless, but the
true costs extend beyond the individual or the family affected.
• Unemployment costs the economy as a whole. If we are experiencing unemployment,
then we are not using all of our labor resources.
• Unemployment has a domino effect as well: As people lose their jobs, they cut back on
spending, which causes other workers to lose their jobs. Unemployed people will likely
postpone the purchase of a new car, and not go out to eat. This may cause auto workers
and waiters to lose their jobs as well.
• Unemployment increases government expenditures on unemployment benefits, food
stamps, etc., while decreasing income tax revenue, potentially creating a budget deficit.
• Probably the most serious and most difficult to quantify are the personal costs. Higher
unemployment is associated with increasing rates of suicide, domestic violence, drug
abuse, and health problems.
Student Activity
• Ask students to assume that the United States is in a recessionary period
and that consumers are worried about losing their jobs and experiencing a
reduction in wages. Each student should explain in a brief paragraph how
this fear among consumers will be reflected in GDP.
Or
• Instruct students to determine the current unemployment rate in their
state, and compare this with the national unemployment rate. Students
should then identify ways that the state’s fiscal policy might account for the
differences identified. Engage the students in a class discussion about their
findings.
• http://www.investopedia.com/ask/answers/199.asp
• http://www.search.com/reference/unemployment
2.04 Understand economic
indicators to recognize
economic trends and
conditions.
Explain the economic impact of interest-rate fluctuations
Define the following terms:
• The interest rate is the yearly price charged by a lender to a borrower in order for the borrower to
obtain a loan. This is usually expressed as a percentage of the total amount loaned.
• The nominal interest rate, is one where the effects of inflation have not been accounted for.
Changes in the nominal interest rate often move with changes in the inflation rate, as lenders not
only have to be compensated for delaying their consumption, they also must be compensated for
the fact that a dollar will not buy as much a year from now as it does today.
• Real interest rates are interest rates where inflation has been accounted for.
• The interest-rate fluctuation are interest rate changes due to changes in supply and demand for
bonds.
• DEFAULT RISK: The probability that a borrowing agent will not pay in full the agreed interest
and/or principal.
• liquidity risk is the risk that a given security or asset cannot be traded quickly enough in the
market to prevent a loss (or make the required profit).
• Maturity risk refers to the risk that is associated with uncertainty of interest rate.
Discuss causes of interest-rate fluctuations.
• The Federal Reserve directs interest rates as a means of controlling economic growth in the U.S. If
the economy grows too fast, it will experience inflation. That's when prices rise so high that no
one can afford anything.
• The following are some of the factors that affect a country's economic growth:
• The financial stability of major companies
• The financial stability of consumers and whether or not they feel comfortable spending money
• The amount of national debt
• Stock and bond market valuations
• The amount of money pouring into investments
• Consumer confidence in the current presidential administration
• When the Federal Reserve instructs the central banks to raise the Treasury bill or prime rate,
banks make money on the increased margin. However, since consumers cut back on their
spending, banks extend fewer loans and credit lines, so their profits may experience a decline.
Explain the impact of interest rate fluctuations on
an economy.
• Interest rates are determined by the Federal Reserve Board, which
meets on a regular basis throughout the year to review how the
economy is performing.
• During slowing economies, or recessions, the Federal Reserve will
lower interest rates to encourage consumer spending.
• When the economy is booming, the board may raise rates to
capitalize on your spending and keep inflation in check.
Describe the relationship between interest
rates and the demand for money
• Money generally pays very little interest (and in the case
of paper currency, none at all) but it can be used to
purchase goods and services.
• Bonds do pay interest, but cannot be used to make
purchases, as the bonds must first be converted into
money. If bonds paid the same interest rate as money,
nobody would purchase bonds as they are less convenient
than money.
• Since bonds pay interest, people will use some of their
money to purchase bonds. The higher the interest rate,
the more attractive bonds become. So a rise in the
interest rate causes the demand for bonds to rise and the
demand for money to fall since money is being exchanged
for bonds.
• So a fall in interest rates cause the demand for money to
rise.
Describe the relationship between inflation
and interest rates
• There is a strong correlation between interest rates and inflation.
• Interest rates reflect the cost of money, such as the rate you pay
when you borrow money to buy a house or spend on your credit card.
• Inflation is the cost of things.
• Most of the time, when inflation increases, so do interest rates.
Discuss factors that create differences in the amount of interest charged
on credit transactions
• Typical credit cards have interest rates between 7 and 36% in the U.S.,
depending largely upon the bank's risk evaluation methods and the
borrower's credit history, levels and kinds of risk, borrowers’ and
lenders’ rights, and tax considerations).
Describe kinds of risk associated with
variances in interest rates (i.e., default,
liquidity, and maturity).
• Interest rate risk is the risk (variability in value) borne
by an interest-bearing asset, such as a loan or a bond,
due to variability of interest rates. In general, as rates
rise, the price of a fixed rate bond will fall, and vice
versa. Interest rate risk is commonly measured by the
bond's duration.
Explain how fiscal policies can affect interest
rates.
• Expansionary fiscal policy pushes interest rates up, while
contractionary fiscal policy pulls interest rates down.
• Expansionary: When output increases, the price level tends to
increase as well.
• Contractionary: When output decreases, the price level tends to fall
as well.
Student Activity
• Direct students to read articles about trends in interest rates.
Students should summarize the articles, identifying the nature of the
trends and reasons that they are occurring. Students should also
determine the impact that these trends are having on local
businesses and discuss their findings with the class.
• Websites: CNN Money, Wall Street Journal, MSN Money
2.04 Understand economic
indicators to recognize
economic trends and
conditions.
Determine the impact of business cycles on business activities
Define the following terms:
• Define business cycles.
• The ups and downs in economic activity
• Business fluctuations
• Periods of expansion and contraction in economic activities (i.e., production,
consumption, exchange, and distribution)
• They affect all aspects of our economy, including employment, prices,
incomes, and production.
Explain the phases of business cycles.
• Expansion: The growth part of the cycle; a time of economic prosperity; everyone has a hopeful economic
outlook and spends more money (i.e., consumers buy more durable goods; producers invest in new
equipment that enables them to produce more goods and services); demand, therefore, is increasing which
requires more workers to be hired and more factories and businesses to be built; more money is put into the
circulation and interest rates are decreased by the Federal Reserve System.
• Peak: The high point of the economic prosperity that has existed; demand begins to exceed production
capacities, and producers raise prices to offset the high demand; interest rates begin to rise; demand for all
resources exceeds their availability; everyone has a less hopeful economic outlook, and consumers begin to
save more so that their spending decreases; economic activities level off.
• Contraction: The demand for goods/services begins to fall and unemployment rises; a bad time for
businesses since consumers are spending less and saving more; businesses’ bottom lines suffer, and some
are experiencing losses to the point that they are forced to close; demand continues to fall, and production
is decreased; inventories build up causing workers to lose their jobs, thereby further decreasing the demand
for goods and services; prices decrease to attract customers; interest rates decrease. When a contraction
lasts for six months, it’s considered a recession. If a recession continues and is severe, it’s a depression; many
people lose their jobs, and businesses fail.
• Trough: The final phase of a business cycle; reached when economic activities stop their decline. This is the
low point of economic activity when unemployment is very high, and even more businesses fail. This phase
stays in effect until consumers and producers become more hopeful about the economy and start to buy
more goods and services.
Explain that when studying
business cycles, economists
examine fluctuations in the
level of an economy’s total
output.
• Total output is based on real gross
domestic product (GDP).
• Real GDP is GDP that has been
adjusted for inflation.
• As a country’s real GDP increases,
economic activities increase; the
• economy grows.
• As a country’s real GDP decreases,
so do its economic activities; the
economy declines.
Explain the benefits of a growing
economy.
• Provides a higher standard of
living
• Creates new and additional jobs
• Enables the government to fulfill
its duties more thoroughly
• Resolves domestic problems
Describe the unpredictability of
business cycles.
Discuss the importance of
understanding business cycles.
• There’s no exact way to predict
the length or severity of a
business cycle.
• Some have lasted two years,
others 10 years.
• It’s difficult to predict the
beginning and end of cycles.
• This heightens the uncertainty
of producers and consumers.
• Businesspeople can take steps to
avoid the extreme ups and
downs of the cycle by
anticipating changes needed in
employment, production,
pricing, and purchasing.
Discuss internal causes of business cycles that take place within
the economic system itself.
• Aggregate demand: This is the total demand for an economy’s goods
and services and can pull GDP up or down to cause business cycles.
When it’s rising, businesses increase production, more workers are
hired, and employees earn more to spend on goods and services. If
aggregate demand continues to grow to the point that production
can’t meet demand, prices will rise rapidly—known as inflation, and
consumers have to pay more to buy the same goods and services. If
aggregate demand decreases, production and employment will
decrease, and production will slow. Recessions or depressions result
when aggregate demand stays too low for a long time. Once it starts
rising again, expansion and prosperity return.
Discuss internal causes of business cycles that
take place within the economic system itself.
• Money supply: This is the total quantity of money that
exists at one time in a nation, and as it goes up or down,
so does the economy. The federal government restricts
the flow of money by raising taxes, raising the interest
rates to borrow money, and purchasing fewer goods and
services to run the government. The amount of money in
circulation can be increased when the federal government
spends more, lowers interest rates, and lowers taxes.
When interest rates are low, more money can be
borrowed to build houses, office buildings, and industrial
plans. Greater production results in more available work
and lowered unemployment rates. This is a period of
expansion. When money is in short supply,
unemployment will be high, business activities slow
down, and a period of contraction begins.
Discuss internal causes of business cycles that take place within
the economic system itself.
• Investment in capital goods: When producers are hopeful about the
future of business, they buy new equipment and build or expand
their business facilities. This investment encourages the expansion of
economic activities. When producers decrease their investment in
capital goods, economic activities contract.
Discuss internal causes of business cycles that take place within
the economic system itself.
• Inventory levels: When producers are optimistic about business
activity, they increase their inventory levels to be prepared for the
increase in demand, thereby expanding economic activities. When
they feel less hopeful, they decrease their buying of new goods and
try to sell the ones on hand, thereby causing the economy to
contract.
Explain external causes of business cycles that take place
outside the economic system.
• Political changes: A change in the political party in power can cause
changes in economic activities. For example, if the elected officials
support business interests, economic activities are likely to expand.
• Climatic changes: Many jobs are affected by climatic conditions.
Extreme weather conditions, such as droughts, floods, and blizzards,
can negatively affect many economic activities.
• International relations: The interaction of our country with other
countries can expand or contract economic activities. For example, a
war or conflict may increase the production of defense materials,
thereby expanding our economic activities. When the conflict ends,
the same quantity of defense materials will no longer be needed,
thereby contracting economic activities.
• Discoveries and innovations: The discovery of new products,
techniques, and resources can stimulate economic activities. Large
sums of money must be invested to develop and improve the
products, and a variety of new jobs is created. Since these occur
irregularly, they contribute to changes in economic activities.