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Lesson 5-1
Growth of Real GDP
and
the Business Cycle
GDP is a measure of total national output
Real Gross Domestic Product (real GDP)
is the total value of all final goods and services
produced in a year,adjusted to eliminate the effects
of changes in prices.
Nominal GDP is the total value of final goods and
services produced in a year not adjusted for price
changes.
The business cycle is the economy’s pattern of
expansion and contraction. For a number of years the
economy grows, then it stops growing, or even shrinks
for a period of time.
Why does the Business Cycle occur. The cycles have
many causes. In some ways each business cycle is unique.
Much of modern economics is devoted to trying to figure
out the business cycle and to ameliorate the swings.
Why is this important. Last spring, nobody was talking
about layoff. Now many companies have announced
layoffs of thousands of workers. Why are people losing
their jobs.
This downturn started because of a bit to much optimism on
the part of some high tech firms. Previously these companies
had lost business because they did not have the inventory and
production capacity to meet demand. Determined not to make
the same mistake, they bulked up on capacity and inventory
but this time overestimated the demand. When sales fell short
of projections, these companies had to much inventory. They
cut production in order to reduce inventory to the desired
level. Those sales figures that did not meet estimates and the
cuts in production started the snowball rolling.
As you know, this started a stampede out of tech stocks. Panic
selling caused the value of many companies to fall 50% to 80%.
For example Corning, which in September was selling for over
$100 a share, is now selling for $25. Lower valuation means
higher borrowing costs. Higher borrowing costs mean
cancelled investment projects. Cancelled projects mean less
demand for the high tech products that started the decline. Less
demand for high tech products starts the downward cycle over
again.
As you can see, downward momentum grows as one thing feeds
upon another. Fortunately, the remainder of the economy
appears strong so this downturn should be mild and short, but
that may be small consolation to those who are losing their job.
Before we leave this topic, it is important to note the role of the
federal government and the Federal Reserve in containing this
business downturn. Both entities have been working hard to
stop the downturn from snowballing into a major recession.
Will they be successful, we don’t know yet. The specific
actions taken will be the subject of much of this course.
Business Cycles and the Growth of Real GDP in the
United States
Exhibit 5-2 shows movements in real GDP in the United
States from 1960 to 1998 graphically
Real GDP grew at an average annual rate of 3 percent
From 1960 to 1998, the U.S. economy experienced six
recessions
The average expansion has lasted 61 months and the
average recession has lasted 11 months
The longest expansion was from February 1961 to
December 1969 until being surpassed by the expansion
that began in March 1991 and has continued since.