busniess cycle

8/3/2019 Busniess Cycle

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BUSINESS CYCLE

UNIT 7


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BUSINESS CYCLE

The short-term variations in economicactivity are known as BUSINESS CYCLE.

Economic history shows that the economynever grows in a smooth and evenpattern.

Upward and downward movements in

output, inflation, interest rates, andemployment form the Business Cyclesthat characterizes all market economies.


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BUSINESS CYCLE

Business Cycles are the irregularexpansions and contractions ineconomic activity.

Business Cycles are economy-widefluctuations in total National Output, Income, and Employment, usuallylast for a period of 2 to 10 years,

marked by widespread expansion orcontraction in most sectors of theeconomy.


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FEATURES OF THE BUSINESS

CYCLE

Economists divide Business Cycleinto two phases:

1. Recession: The downturn of a businesscycle is calledRecession.

A period of decline in output, income &employment.

Usually lasts from 6 months to a year.


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BUSINESS CYCLE

2. Expansion: Upward turn of BusinessCycle is called Expansion.

A period of rapid growth in output,national income, and employment.

Factories work overtime and earnfabulous profit.


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DEPRESSION

The contraction in business cycle persistsfor a decade and causes widespreadeconomic hardships.


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BUSINESS CYCLE

American History

History of American Capitalism witnessedfabulous boom in 1990s.

Recession begin in March, 2001 andended in November, 2001.

Great Depression in 1930s.


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PEAKS and TROUGHS

Peaks and troughs mark the turning pointsof the cycle.

Peaks turn downward towardscontractions, and

Troughs lead upward towards expansions.


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CHARACTERISICS OF A

RECESSION

Often consumers purchases declinesharply.

Business inventories of automobiles &other durable goods increaseunexpectedly.

Production/Output decline real GDP falls

Business investment in plants &equipments also fall sharply.


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CHARACTERISICS OF A

RECESSION

The demand for labour falls first seen ina drop in the average workweek followedby layoff & higher unemployment.

Inflation slows.

Demand for raw materials decline pricetumble.

Wages & prices of services are unlikely todecline.


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CHARACTERISICS OF A

RECESSION

Business profit falls sharply.

Price of common-stock usually fall as

investors sniff the scent of a business cycledownturn.

Because demand for credit falls interestrates generally fall in recession.


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EXOGENOUS

The exogenous theories find the sources of the BusinessCycle in the fluctuations of factors outside the economicsystem, i.e.

Wars

Revolutions Elections

Change in Oil Prices

Discoveries of gold, land, resources

Scientific breakthroughs

Technological innovations Migration

Climate or weather changes etc.


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INTERNAL CYCLE

Internal cycle theories look for mechanism withinthe economic system itself give rise to self-generating Business Cycles.

In this approach, every expansion breedsrecession and contraction.

And every contraction breeds revival andexpansion repeating chain.

Internal theory of the business cycle shows amechanism, like the motion of pendulum.


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Role of Multiplier-accelerator

Theory in Business-Cycle.

According to this principle, rapid outputgrowth stimulates investment.

High investment in turn stimulates moreoutput growth this process continuesuntil the capacity of economy is reached at this point, economy growth rate slows.

The slower growth rate in turn reducesinvestment spending and inventoryaccumulation, which tend to sendeconomy into a recession.


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Role of Multiplier-accelerator

Theory in Business-Cycle.

The process then work in reverse asreached to trough, and the economy thenstabilizes and turn up again.


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Business Cycle vs Aggregate

Demand

What causesBusiness Cycles/fluctuations?

How can govt. policies reduce their

virulence? Keynes pointed out the importance of the

forces of Aggregate Demand indetermining Business Cycle.


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KEYNESIAN ECONOMICS

SUGGESTS

Changes in Aggregate Demand can have apowerful impact on the overall level of output,employment, and price in the short-run.

Business cycle fluctuations in output,employment and prices are often caused byshift in aggregate demand.

These shifts occur as consumers, businesses

and governments change total spendingrelative to the economys potential productivecapacity.


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FORECASTING BUSINESS

CYCLES

Economists have developed forecastingtools to help them foresee changes in theeconomy.

In an earlier era: economists try to lookat easily available data on items likemoney, boxcar loadings & steel production

If steel production is dropped, it meansbusiness purchases are reduced economy would soon slow down.


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FORECASTING BUSINESS

CYCLES

This process combines with severaldifferent statistics into an index ofleading indicators.

The index does give an early &mechanical warring on whether theeconomy is heading up or down.


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FORECASTING MODELS

For a more detailed look into the future,economists turn to computerizedeconometric forecasting models.

Econometric model is a set of equations,representing the behavior of theeconomy, that has been estimated usinghistorical data.

Pioneers in this area were Jan Tinbergenof Netherlands & Lawrence Klein ofUniversity of Pennsylvania.


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FORECASTING MODELS

Today, there is an entire industry ofeconometricians estimating macroeconomicsmodels & forecasting future of the economy.

Generally, modellers start with an analyticalframework containing equations both aggregatedemand & aggregate supply.

In small models there are one or two dozen

equations. While, large systems forecast from a few

hundred to 10,000 variables.


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FORECASTING MODELS

Using modern techniques, each equationis fitted to the historical data to obtainparameter estimates (MPC, the slop of theinvestment demand function, etc.).

Once the exogenous and policy variablesare specified (population, govt. spending

& tax rates, monetary policy, etc.), thesystem of equations can project importanteconomic variables into the future.


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Aggregate Demand (AD)

Ad is the total or aggregate quantity of outputthat is willingly bought at a given level of price,other things hold constant.

AD is the desired spending in all product

sectors:1. Consumption ( C )2. Private Domestic Investment ( I )3. Govt. Purchases of good & services ( G )

4. Net Exports ( X )AD = C + I + G + X


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Major Components of AD

AD has 4 major components:

1. Consumption ( C )2. Private Domestic Investment ( I )

3. Govt. Purchases of good & services ( G )

4. Net Exports ( X )AD = C + I + G + X


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CONSUMPTION ( C ).

Consumption primarily determined bydisposable income i.e. personal income-taxes.

Other factors affect consumption are:

Long-term trends in income (permanent income)

Household wealth &

Aggregate price level.

AD Analysis focuses on the determinants of realconsumption i.e. nominal or dollarconsumption divided by the price index forconsumption.


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INVESTMENT ( I )

Spending includes purchases of buildings,software, & equipments and accumulation ofinventories.

Major determinants of investment are: Level of output

Cost of capital (as determined by tax policies,interest rates & other financial conditions).

The major channel by which economic policy canaffect investment is monetary policy.


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GOVERNMENT PURCHASES ( G )

Govt. purchases of goods & services.

Purchases of goods like: tanks or road

building equipments. Purchases of services like: services ofjudges & public school teachers.

This component of AD is determined

directly by govt. spending decisions.


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NET EXPORTS

Net exports are equal to the money valueof exports minus money value of imports.

Export value determined by foreignincomes & outputs, by relative prices & byforeign exchange rates.

Net export, then determined by domestic

& foreign income, relative prices andexchange rates.


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Movements along the AD Curve

Holding other things constant, the level ofreal spending declines as the overall pricelevel in the economy rises---AD Curveslopes downward.

The reason of downward slope is that---there are some elements of income or

wealth that do not rise when price levelrises. (i.e. personal income, govt. transfer payments,minimum wages, companys pension etc.).


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When price level goes up, real disposableincome falls---leads to a declined in realconsumption expenditures.

Some elements of wealth may be fixed innominal terms, e.g. saving certificates orbonds purchases on promises to pay a

certain amount for a fixed period---if pricelevel rises, the real wealth declines---leads to lower level of real consumptions.


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A rise in price level with a fixed moneysupply causes a decline in investment &consumption.

The AD curve slopes downward---realspending declines as the price level rises,other things remain constant.

Real spending with a higher price leveldecreases because of the effect of higherprices on real incomes, real wealth & realmoney supply.


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Shift in AD Curve

Macroeconomic policy variables undergovt. control, i.e. monetary policy & fiscalpolicy.

Monetary Policy: Supply of money &interest rates.

Fiscal Policy: Taxes & govt. expenditures

Exogenous variable: wars, revolutions,foreign economic activity.


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Assignment

Find annual data on real GDP for theUnited States for the period of 1948-2003(see the web site of the Bureau of

Economics Analysis, www.bea.gov ) A. define recessions as years in which

real GDP declined. Which years wererecessions?

Calculate the average growth rate of realGDP for the year 1948, 1973, 1988, 1998& 2003.
http://www.bea.gov/http://www.bea.gov/


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Assignment

Collect data of real growth rate (GDP) ofPakistan from Bureau of Statistics ofPakistan, and show recession & expansionin a business cycle through a table andgraph.

Suggest possible measures to reduce the

intensity of the present recession occur inour economy.


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busniess cycle

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