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Sec. 2
(Read all of Sec. 2)

A modern industrial economy
repeatedly goes thru good
times, then bad, then good…. it
goes thru cycles
Why is it important to understand the
nature of business cycles?


The business cycle directly impacts our
daily lives
We are continually faced with decisions
that can enable us to take advantage of
“good” times… and lessen the hurt of
the “bad” times

Phase 1: Expansion
period of prosperity
 Typical characteristics:

 MANY NEW BUSINESSES OPEN
 STRONG EMPLOYMENT
 FACTORIES WORKING AT OR NEAR
FULL CAPACITY
 CONSUMER SPENDING IS STRONG
 Expansion
has ceased…
 businesses
may have begun to
cut back or postpone new
spending
 Job creation slows
Phase 3

From a peak ( where GDP levels off) GDP
begins to decline… contraction occurs:
 BUSINESS ACTIVITY SLOWS noticeably
 UNEMPLOYMENT RISES
 FACTORIES WORK AT LESS THAN FULL
CAPACITY
 CONSUMER SPENDING WEAKENS


If a contraction lasts at least 2
quarters (6 months), we are said to
be in a “recession”
A prolonged recession or one that is
particularly severe is called a
“depression”





factories cut back production and lay off
workers in large #s
Consumers cut back on purchases
More consumers & biz are late on loan
payments…increasing loan defaults occur
Fewer new businesses open, many
established ones fail
Home foreclosures may rise
The lowest point is called the
trough
(“troff”)



biz cycle enters the recovery and
expansion phase (GDP grows)…
Employment rises…new businesses
open…spending increases
eventually growth slows…then
stalls…contraction begins
And the cycle continues…
Level of National Business Activity
Figure 7-8
Peak
AND THE
CYCLE
CONTINUES…
Peak
Time
4 Main Variables
Impact the
business cycle
When the economy is expanding, firms expect
sales & profits to keep rising.
Therefore, they are more willing and likely to
invest in new equipment , expansion, etc.
investment tends to create jobs and increase
output, helping to perpetuate the economic
expansion

low interest rates = encourages borrowing
& buying on credit (individuals & firms)
Demand for goods/svcs. grows


Important: Stronger demand for
goods/services motivates firms to hire more
people to increase output
Int. rates today: high or low?

Optimism/confidence = strong
consumer spending (opposite is
true, too… weakening confidence
means weakening spending by
consumers)



Repercussions from an outside event (a
war, natural disaster, etc.)
 EG: 9/11/2001
Of all the factors that affect the biz cycle,
this is most difficult to predict
Could be a positive shock (eg, discovery of
huge oil deposit)
Economists collect data on a regular basis to
measure current conditions as well as to forecast
future trends.
Economic Indicators: 3 Categories
A. “Leading indicators”
Changes to
these data change suggests what will happen to
the cycle in the near future (yellow traffic light)
Some Examples:
1. # of building permits issued
2. # of new claims for unemployment insurance
3. survey of inventory levels
B. Coincident Indicators
Changes to these data occur at approx. the same
time as the conditions they signify. In our
traffic light example, the pedestrian walk signal
would coincide (happen) at about the same time
as a green.
Example:
1. Personal Income

C.
Lagging Indicators change
after the economy as a whole does

Examples:

Avg. length of unemployment


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
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Great Depression (1929-1940)
1946 Recession (returning GIs)
1973 Recession (external shock)
1990s Expansion (dot.com bubble)
2007 Recession (housing collapse)
2000
Peak
9/11
Gr. Dep.
begins
Post WWII
Recession
1990s Boom
begins
2007 Gr.
Recession
Begins