Understanding Business Cycles Flashcards
Real GDP and Unemployment are key variables used to determine the current phase of the business cycle
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Four Stages of a Business Cycle
- Expansion
- Peak
- Contraction/Recession
- Trough
Inventories are used as an important business cycle indicator.
- In Inventories accumulate when expansion is reaching peak
* Inventories deplete when contraction is reaching the trough
As Expansion is approaching its peak
- Sales growth slows
* * Inventories accumulate
As Contraction is reaching the trough
- Sales growth begins to increase
* * Inventories deplete
Housing Sector Influence on Business Cycle
- Mortgage Rates – when interest rates are low, they tend to increase home buying and construction
- Housing costs relative to income – when incomes are cyclically high relative to home costs, home buying and construction tend to increase.
- Speculative Activity – rising home prices can be bought on expectation of further gains.
- Demographic Factors – proportion of population in the 25 to 40 year old demographic is positively related to activity in the housing sector.
External Trade Sector Activity
- domestic GDP growth
- GDP growth in trading partners
- currency exchange rates
Characteristics of a Trough
- GDP growth rate goes from - to +
- High unemployment, overtime increases
- Spending on durables and housing increase
- Moderate or decreasing inflation
Characteristics of Expansion
- GDP ^, Unemployment decreases
- Investment ^ (by firms and consumers)
- Inflation ^
- Imports ^, (more $$ for demand to ^)
Characteristics of a Peak
- GDP decreases, Unemployment decreases, but slows
- Spending and business investment slows
- Inflation ^
Characteristics of a Contraction/Recession
- GDP decreases, Unemployment ^
- Spending and Investment decrease
- Inflation decrease, with a lag
- Imports decrease as income growth slows
Neoclassical Theory
- Shifts in Aggregate Demand and Aggregate Supply are driven by changes in technology
- Business Cycles are temporary deviations from LR equilibrium
Keynesian Theory
- Fluctuations are primarily due to swings in levels of optimism of those who run businesses
- Increase in Aggregate Demand directly through monetary or fiscal policy
New Keynesian Theory
- Keynesian School, plus prices of production inputs other than labor are “downward sticky” presenting additional barriers to reaching full employment.
Monetarist Theory
Aggregate Demand that causes business cycles are caused by rate of growth of Money Supply likely from inappropriate decisions by monetary authorities.
Austrian School Theory
Business cycles are caused by government intervention in the economy
New Classical Theory (Real Business Cycle Theory)
RBC theory emphasizes economic changes likely technological adaptation and external shocks. Not monetary variables.
3 categories of Unemployment
* Unemployed means they are proactively looking for a job
- Frictional
- Structural
- Cyclical
Frictional Unemployment
results from time lag necessary to match employees who seek work with employers need their skills
Structural Unemployment
LR changes in the economy that eliminate jobs and/or add jobs unemployed do not have the skills for.
Cyclical Unemployment
Caused by changes in the general level of economic activity
Unemployment Rate
The percentage of people in the labor force who are unemployed
Labor Force
All people who are either employed or unemployed
Discouraged Workers
Those who are available for work but chose not to get employed and are not seeking a job
Inflation
Persistent increase in price level over time.
Deflation
Associated with deep recessions
Consumer Price Index
CPI represents the purchasing patterns of an urban household.
CPI = [(cost of basket @ current prices) / (cost of basket @ base prices)] * 100
GDP deflator
Also used as an inflation estimator
Producer Price Index (PPI)
Watches for different stages of processing to identify emerging price pressures
Headline Inflation
Refers to price indexes for all goods
Core Inflation
Price indexes that exclude food and energy, because they are more volatile
Laspeyres Index
Uses a constant basket of goods and services to measure inflation
3 factors that cause Laspeyres Index to be biased upwards
- New goods – Old goods replaced by newer, more expensive goods trending the index ^
- Quality Index – If quality of index ^, the price of the index ^. Biasing the index up, when the prices didn’t inflate.
- Substitution – cheaper products that will replace more expensive goods changes.
Hedonic Pricing
Adjusts a price index for product quality
For substitution, Fischer Index is used as a chain-weighted price index.
Fisher Index is a geometric mean of Laspeyres Index and Paasche Index.
Paasche Index uses the current consumption weights, prices from the base period and prices in the current period
PI = current price / (base period)
Cost-push inflation
Results from a decrease in Aggregate Supply, caused by an increase in the real price of an important factor of production, such as wages or energy.
Demand-Pull Inflation
Results from an increase in money supply, increased gov’t spending or any change in Aggregate Demand
Leading Indicators
Change direction before peaks and troughs in business cycles
ex. Average weekly hours,
Stock Prices,
Leading Credit Index
Index of Consumer Expectations
Coincident Indicators
Change direction at roughly the same time as peaks or troughs
ex. Employees on nonagricultural payrolls
Personal Income less transfer payments
Industrial Production
Lagging Indicators
Don’t change directions until after peaks and troughs
ex. Average rate of unemployment
Commerical and Industrial Loans
CPI for services
Labor cost per unti
