Download Why Business Cycles?

Economics 2/14/11
http://mrmilewski.com
• OBJECTIVE: Demonstration of Chapter#12 and begin
examination of the business cycle.
• I. Administrative Stuff
-attendance & distribution of test
• II. Chapter#12 Test
• III. Journal #31 pt.A
-Examine the cartoon p.343
-Answer the caption question p.343
-Examine Figure 13.2
-Answer the caption question p.345
• IV. Journal #31 pt.B
-notes on the business cycle
This week
• Chapter#13 section#1
• Chapter#14 section#1
• Chapter#14 section#3
• Chapter#13&14 Test is Friday!
• Progress Report Distributed Tomorrow!
ACT Testing Schedule
• Testing will run from 7:41-10:45 (1st hour through 1st lunch)
 February 17, Mr. Milewski’s 2, 3, 4 hours will test in the library all
together from 7:40-10:40
 February 18, Ms. Pampu’s 2, 3, 4 hours will test in the library all
together from 7:40-10:40
 February 23, Ms. Miah’s 2, 3, 4 hours will test in the library all
together from 7:40-10:40
 February 24, Ms. Woodruff’s 2, 3, 4 hours will test in the library all
together from 7:40-10:40
• On their testing day, the ACT students will follow the lunch
schedule as follows:
• 1. If they normally have 1st lunch: go to 3rd hour then 3rd lunch
(missing the second part of 3rd hour.
• 2. If they normally have 2nd lunch: go to 2nd lunch, then report to
the second part of 3rd hour at 11:20.
• 3. If they normally have 3rd lunch: go to 3rd hour then 3rd lunch.
The Business Cycle
• Business cycle - the rise and fall of GDP over
time.
• GDP – Gross Domestic Product
• GDP= C+I+G+(X-M)
• C – consumer
• I – business
• G – government
• X – exports
• M - imports
Phases of the Business Cycle
• Ch#14 sec#1 p.376
The Recession Phase of the Business Cycle
• There are two phases of the business cycle
• Recession – when real GDP declines for two
quarters in a row (6 months)
• A recession begins following a peak
• Peak – the point where GDP stops going up
• A recession ends at a trough
• Trough – the turnaround point where GDP stops
going down.
The Expansion Phase of the Business Cycle
• Expansion – period of recovery from a
recession.
• Expansion begins at the trough of the business
cycle.
• Expansion ends when the business cycle reaches
a new peak.
• Since WWII, the average recession lasted 11
months. The average expansion lasted 43
months.
• The expansion that began in March 1991 &
almost ended in March 2001 is the longest in
history. (1st and 3rd quarters of 2001 GDP
dropped)
CPI 2002-2011
US Real GDP 2006-2010
http://www.finfacts.com/artman/uploads/3/US-gdp-Q3-2009_oct292009.jpg
US Real GDP 1999-2009
http://www.econedlink.org/lessons/images_lessons/904_em904_figure11.jpg
US Real GDP 1990-2006
http://www.econedlink.org/lessons/images_lessons/756_756_figure1311.jpg
Real GDP v. Unemployment
http://jmuservice.com/img/news/US_Real_GDP_&_Unemployment_Rate.jpg
GNP v. GDP
• GDP- the dollar value of all final goods
and services produced within a country’s
national borders in a year.
• GNP- the dollar value of all final goods,
services, and structures produced with
labor and property supplied by a countries
residents.
Depression
• If a recession becomes very severe, it may turn
into a depression
• A depression is a state of the economy with large
numbers of people out of work, acute shortages,
and excess capacity in manufacturing plants
• Between 1929 and 1933, GDP declined nearly
50% and unemployment rose 8 times!
Depression
• Currency was in such short supply that towns, counties,
chambers of commerce, and other civic bodies resorted to
printing their own money, known as depression scrip
• Several factors contributed to the Great Depression
• One was the disparity in the distribution of income
• Easy and plentiful credit also appears to have played a
role
• Global economic conditions also played a part as
American tariffs on imports kept many countries from
selling goods to the United States
Economics 2/15/11
http://mrmilewski.com
• OBJECTIVE: Examine of the business cycle.
• I. Journal #32 pt.A
-Questions on Econ U.S.A. episode#3
• II. Quiz#19
• III. Return of Chapter#12 Test
• IV. Journal #32 pt.B
-notes on the business cycle
Econ U.S.A. episode #3
• 1.) Why was Congress unable to determine the true
severity of the Great Depression?
• 2.) What was the result of this problem?
• 3.) How did the U.S. Government prepare economically
for WWII?
• 4.) How does government spending affect the circular
flow?
• 5.) How did the environmental concerns of the 1970’s
effect the economy?
• 6.) How does the government know if the policies they
enact have helped the economy?
This week
• Chapter#13 section#1
• Chapter#14 section#1
• Chapter#14 section#3
• Chapter#13&14 Test is this Friday!
Figure 13.3
Circular Flow of Economic Activity
The End of the Depression
• Massive government spending during World War II added
a huge stimulant to the economy for most of the early
1940s
• Recession returned in 1945, but it did not last
• As soon as the war was over, consumers went on a
buying binge that stimulated expansion again
• Since 1965, there has been a recurring pattern of
recessions and expansions
• After 1980, however, recessions occurred less frequently
• The expansion that began in 1991 is the longest
expansion in United States history
Why Business Cycles?
• No one theory seems to explain past business cycles, or
serves as a way to predict future ones
• Changes in capital expenditures are one cause of business
cycles
• When the economy is expanding, businesses expect
future sales to be high, so they invest heavily in capital
goods
• After a while, businesses may decide they have expanded
enough and they begin to pull back on their capital
investments
Inventory Adjustments & Innovation
• Inventory adjustments, or changes in the level of business
inventories, are a second possible cause of business
cycles
• Some businesses cut back on inventories at the first sign
of an economic slowdown and then build them back up
again at the first sign of an upturn
• When a business innovates, it often gains an edge on its
competitors because its costs go down or its sales go up
• The imitating companies must invest heavily to do this,
and an investment boom follows
Monetary Policy
• A fourth possible cause of business cycles is the credit
and loan policies of the Federal Reserve System
• When “easy money” policies are in effect, interest rates
are low and loans are easy to get
• Eventually the increased demand for loans causes interest
rates to rise, which in turn discourages new borrowers
• As borrowing and spending slow down, the level of
economic activity declines
Shocks
• A final potential cause of business cycles is
external shocks, such as increases in oil prices,
wars, and international conflict
• Some shocks drive the economy up, as when
Great Britain discovered North Sea oil in the
1970s
• Other shocks can be negative, as when high oil
prices hit the United States in the early 1970s
Economics 2/16/11
http://mrmilewski.com
• OBJECTIVE: Examine of the effects of
monetary policy on the business cycle & types of
inflation.
• I. Journal #33 pt.A
-Read “Business Week Newsclip” p.362
-Answer questions (1-2) p.362
• II. Journal #33 pt.B
-notes on the business cycle
• III. Journal #33 pt.C
-notes on the Commanding Heights
(episode#2 day#2)
ACT Testing Schedule
• Testing will run from 7:41-10:45 (1st hour through 1st lunch)
 February 17, Mr. Milewski’s 2, 3, 4 hours will test in the library all
together from 7:40-10:40
 February 18, Ms. Pampu’s 2, 3, 4 hours will test in the library all
together from 7:40-10:40
 February 23, Ms. Miah’s 2, 3, 4 hours will test in the library all
together from 7:40-10:40
 February 24, Ms. Woodruff’s 2, 3, 4 hours will test in the library all
together from 7:40-10:40
• On their testing day, the ACT students will follow the lunch
schedule as follows:
• 1. If they normally have 1st lunch: go to 3rd hour then 3rd lunch
(missing the second part of 3rd hour.
• 2. If they normally have 2nd lunch: go to 2nd lunch, then report to
the second part of 3rd hour at 11:20.
• 3. If they normally have 3rd lunch: go to 3rd hour then 3rd lunch.
Shocks
• A final potential cause of business cycles is
external shocks, such as increases in oil prices,
wars, and international conflict
• Some shocks drive the economy up, as when
Great Britain discovered North Sea oil in the
1970s
• Other shocks can be negative, as when high oil
prices hit the United States in the early 1970s
Inflation
• Inflation is a special kind of economic instability, one that
deals with changes in the level of prices rather than the
level of employment and output
• To better understand inflation, we must first examine how
it is measured
• Then we can examine the causes of inflation and its
consequences
• In order to find inflation, we start with the price level, the
relative magnitude of prices at one point in time
• To measure the price level, economists select a market
basket of goods
CPI
• They then construct a price index such as the
consumer price index (CPI), the producer price
index, or the implicit GDP price deflator
• Prices tend to rise faster during expansions and
then slow down during recessions
• On rare occasions, unusual circumstances may
cause deflation, or a decrease in the general price
level
14.5
The Rate of Inflation
Types of Inflation
• Creeping inflation - inflation in the range of 1 to
3 percent per year
• Galloping inflation - a more intense form of
inflation that can go as high as 100 to 300 percent
• When inflation gets totally out of control,
hyperinflation - inflation in the range of 500
percent a year and above–occurs
Causes of Inflation
• Nearly every period of inflation is due to
one of the following causes
• First explanation demand-pull theory all sectors in the economy try to buy more
goods and services than the economy can
produce
• As C + I + G converge on stores, shortages
occur and prices go up
Causes of Inflation
• Second explanation - federal
government’s deficit - blames inflation
only on the federal government’s deficit
spending
• Third explanation claims that rising input
costs (cost push)–especially labor–drive
up the cost of products for manufacturers
and cause inflation
Causes of Inflation
• Still another explanation says that no single group is to
blame for inflation
• According to this view, a self-perpetuating wage/price
spiral of wages and prices begins that is difficult to stop
• The final and most popular explanation for inflation is
excessive monetary growth
• This occurs when the money supply grows faster than
real GDP
• Inflation cannot be maintained without a growing money
supply to fuel it
Consequences of Inflation
• When inflation is
present, it can have a
disruptive effect on an
economy for several
reasons
• The most
obvious effect of
inflation is that the
dollar buys less
Consequence of Inflation
• Decreased purchasing power is especially hard on retired
people with fixed incomes because their money buys a
little less each month
• A second destabilizing effect is that inflation can cause
people to change their spending habits, which disrupts the
economy
• A third destabilizing effect of inflation is that it tempts
some people to speculate heavily in an attempt to take
advantage of a higher price level
• Finally, inflation alters the distribution of income
• During long inflationary periods, lenders
are generally hurt more than borrowers
• Loans made earlier are repaid later in inflated dollars
Economics 2/17/11
http://mrmilewski.com
• OBJECTIVE: Examine the Role of the Federal
Reserve.
• I. Journal #34 pt.A
-Read “The Global Economy” p.420
-Answer questions (1-3) p.420
• II. Quiz#20
• III. Journal #34 pt.B
-questions on Fed Film: What should the Fed do?
• NOTICE: Chapter#13&14 Test Tomorrow!
The Role of the Fed
• Main goal of the Fed Open Market
Committee…control inflation
• How can the Fed control inflation?
1.) Change the interest rate
2.) Change the reserve requirement
3.) Open Market Operations - Buy or Sell
securities (bonds)
*buy – increases the money supply
*sell – decreases the money supply
Fed Video
• 1.) What is the role of the Fed?
• 2.) What causes inflation?
• 3.) What happened to the cost of a bagel when
the money supply was increased?
• 4.) How does the Fed determine the money
supply?
• 5.) Why do people spend money when inflation
hits?
• 6.) What were fears of the Fed if inflation
continued to rise?
• 7.) What portion of the money supply is in the
form of cash and coins?
• 8.) What was the prime rate in 1980?
• 9.) What did this rate do to the housing and auto
industry?
• 10.) What happened to the unemployment rate
when the money supply shrank?
• 11.) What happened to the inflation rate?
• 12.) What happened to the unemployment rate in
1984?
• 13.) What role does the Federal Reserve District
President play?
• 14.) How has the Globalization of the economy
effected the role of the Fed?
Economics 2/18/11
http://mrmilewski.com
• OBJECTIVE: Demonstration of Chapters#13&14 and
begin examination of Monetary Policy.
• I. Administrative Stuff
-attendance & distribution of test
• II. Chapter#13&14 Test
• III. Journal #35 pt.A
-Read “Profiles in Economics” p.414
-Answer questions (1-2) p.414
• IV. Journal #35 pt.B
-notes on monetary policy
Monetary Policy
• Monetary policy – the expansion or contraction
of the money supply in order to influence the cost
and the availability of credit.
• In English, when the Fed raises interest rates the
amount of money in the economy gets smaller.
• When the Fed lowers interest rates, the amount of
money in the economy gets bigger.
• Higher interest rates encourage people to save
money.
• Lower interest rates encourage people to spend
and borrow money.
Structure of the Fed
How does the Fed influence interest rates?
• Fractional reserve system – requires banks and
other depository institutions to keep a certain
percentage of their deposits on hand as legal
reserves.
• Legal reserves – consists of coins and currency
held in the bank’s vault and the currency it has on
deposit with the Federal Reserve.
• The Fed requires that banks keep a reserve of
12% against demand deposit accounts.
How Banks Operate
• You deposit $100 in your savings account.
• The bank MUST keep 12% of that $100 on
reserve. (They must keep $12)
• The bank loans out the other $88.
• If the person who borrows the money puts it in a
checking account, the $88 is treated as a new
deposit and 12% or $10.56 of it must be set aside
as a reserve. The other $77.44 can now be
loaned out.
• This is the multiplication of the money supply.
Example of Fractional Reserve at 20%
• Ch#15 sec#2 p.419
Tools of Monetary Policy
• If the Fed wants the money supply to grow
they can do the following:
• 1.) Lower the interest rate
• 2.) Lower the reserve requirement
• 3.) Buy securities (buy bonds)
• This is known as easy money policy.
Tight money policy
• If the Fed wants the money supply to
contract, or slow they can do the following:
• 1.) Increase the interest rate
• 2.) Increase the reserve requirement
• 3.) Sell securities (sell bonds)
• This is known as tight money policy.
Tight money policy
The Role of the Fed
• Main goal of the Fed Open Market
Committee…control inflation
• How can the Fed control inflation?
1.) Change the interest rate
2.) Change the reserve requirement
3.) Open Market Operations - Buy or Sell
securities (bonds)
*buy – increases the money supply
*sell – decreases the money supply
M1 v. M2
• The main difference is function!
• M1, represents the transactional components of
the money supply, or the components of the
money supply that most closely match money’s
role as a medium of exchange
• M2 is a measure of money that includes those
components most closely conforming to money’s
role as a store of value
• M2 includes M1, small denomination time
deposits, savings deposits, and money market
funds
M1 & M2
Figure 15.9