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Why should we know about business cycles? History of business cycles provides us with data which contain clues about the causes of business cycles. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Why should we know about business cycles? History of business cycles provides us with data which contain clues about the causes of business cycles. These clues (causes) enable us to predict the future. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Why should we know about business cycles? History of business cycles provides us with data which contain clues about the causes of business cycles. These clues (causes) enable us to predict the future. Government might want to learn from the past to develop a correct mix of policies for the future. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Why should we know about business cycles? History of business cycles provides us with data which contain clues about the causes of business cycles. These clues (causes) enable us to predict the future. Government might want to learn from the past to develop a correct mix of policies for the future. Businesses might want to study business cycles to prepare for their impacts when it materializes. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Why should we know about business cycles? • History of business cycles provides us with data which contain clues about the causes of business cycles. These clues (causes) enable us to predict the future. Government might want to learn from the past to develop a correct mix of policies for the future. Businesses might want to study business cycles to prepare for their impacts when it materializes. Or, they might want to lobby the Government to undertake a policy according to their benefits. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Why should we know about business cycles? • History of business cycles provides us with data which contain clues about the causes of business cycles. These clues (causes) enable us to predict the future. Government might want to learn from the past to develop a correct mix of policies for the future. Businesses might want to study business cycles to prepare for their impacts when it materializes. Or, they might want to lobby the Government to undertake a policy according to their benefits. Managers by studying the behavior of business cycles could anticipate the Government policy in the future. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Business Cycles Business cycles refer to ups and downs in the level of economic activity extending over several years. They are due to changes in output and employment of the factors of production. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Phases of Business Cycles: Peak: a temporary Maximum. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Phases of Business Cycles: Peak: a temporary Maximum. Recession: A period of decline in output, employment and income lasting 6 months or more. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Phases of Business Cycles: Peak: a temporary Maximum. Recession: A period of decline in output, employment and income lasting 6 months or more. Trough: Where the economy is bottomed out at its most recent lowest level. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Phases of Business Cycles: Peak: a temporary Maximum. Recession: A period of decline in output, employment and income lasting 6 months or more. Trough: Where the economy is bottomed out at its most recent lowest level. Recovery (boom) when output and output expands toward full employment. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Business Cycles and Inflation, Historical Facts Phases of Business Cycles: Peak: a temporary Maximum. Recession: A period of decline in output, employment and income lasting 6 months or more. Trough: Where the economy is bottomed out at its most recent lowest level. Recovery (boom) when output and output expands toward full employment. • The great challenge for a manager is to find a way of surviving a recession because it is much easier to ride to expansion tide. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Cycle Patterns, Impulses, and Mechanisms • The business cycle is an irregular and nonrepeating up-and-down movement of business activity that takes place around a generally rising trend and that shows great diversity. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Percentage change in real GDP Some Business Cycle Patterns 150 World War II 100 Booming 1960s 50 Booming 1980s 0 Great Depression 1937 recession Postwar recession OPEC recession 1982 recession 1990-1991 recession –50 1920 1930 1940 1950 1960 1970 1980 1990 2000 Year Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Cycle Patterns, Impulses, and Mechanisms • Business Cycle Patterns • There is no simple explanation for the causes of the business cycle. • There is no way of forecasting when the turning points will come. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Business Cycles Recovery(boom) recession trough peak Long term trend line Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Aggregate Demand Theories of the Business Cycle • Keynesian Impulse • The impulse of the business cycle is a change in expected future sales and profits. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Aggregate Demand Theories of the Business Cycle • Keynesian Impulse • The impulse of the business cycle is a change in expected future sales and profits. • This changes the level of investment in new capital. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Aggregate Demand Theories of the Business Cycle • Keynesian Impulse • Keynes reasoned that news or rumors of future tax changes, interest rate changes, advances in technology, global economic and political events (for example) affect expectations and investment. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Aggregate Demand Theories of the Business Cycle • Keynesian Impulse • Keynes reasoned that news or rumors of future tax changes, interest rate changes, advances in technology, global economic and political events (for example) affect expectations and investment. • Referred to as “animal spirits” Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Aggregate Demand Theories of the Business Cycle • Keynesian Cycle Mechanism • A change in animal spirits which causes a change in investment leads to a cycle mechanism. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Aggregate Demand Theories of the Business Cycle • Keynesian Cycle Mechanism • The cycle mechanism has two key elements: 1) The initial change in investment has a multiplier effect. • It changes aggregate expenditure, real GDP, and disposable income Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#› Aggregate Demand Theories of the Business Cycle • Keynesian Cycle Mechanism • The cycle mechanism has two key elements: 2) The response of real GDP to a change in aggregate demand. • If money wages are sticky, a decline in and investment would reduce aggregate demand which brings recession. Copyright © 1998 Addison Wesley Longman, Inc. TM 16-‹#›