Download The Business Cycle

Principles of Economics:
Macroeconomics - Econ101
The Business Cycle
Chapter 8
McGraw-Hill/Irwin
Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.
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?
8-2
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
8-3
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.
8-4
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
8-5
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
8-6
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
8-7
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
8-8
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
8-9
Government Intervention
• In Keynes’ view, the inherent instability of the
marketplace required government intervention
– We can’t afford to wait for some assumed selfadjustment mechanism
– Must intervene to protect jobs and income
8-10
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
8-11
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
8-12
The Business Cycle
Peak
Growth trend
REAL GDP
Peak
Peak
Trough
Trough
TIME
8-13
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
8-14
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
8-15
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
8-16
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
8-17
The Macro Economy
DETERMINANTS
OUTCOMES
Internal
market
forces
Output
Jobs
External
shocks
MACRO
ECONOMY
Prices
Growth
Policy
levers
International
balances
8-18