Chapter 11Business Cycles

These slides supplement the textbook, but should not replace reading the textbook

2

What are the four phases of the

business cycle?• Peak• Recession• Trough• Recovery

3

What causes unemployment?

Excessive inventories

4

What causes inflation?

MV/Q = P

5

What causes stagflation?

A move to the left of the aggregate supply curve

6

Decrease in Aggregate Supply

0Q2 Q1

D

S'

P2

P1

S

7

What can cause a shift to the left of the

aggregate supply curve?

An increase in costs

8

What can cause an increase in costs?

9

• Monetizing the debt• > in the price of oil• > in public union benefits• Detailed laws• Emphasis on green technology• Unfunded liabilities• Interest on national debt• Taxes• Tariffs• Health care

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What can cause deflation?

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• Quantitative easing low interest rates• High corporate taxes• Double taxation on money earned in

foreign countries• Interest earned on reserves held at

the Fed• Large fines paid to Treasury by big

banks• Interest on national debt• Expectation of lower prices• Lengthy and detailed laws

12

What was the Employment Act of 1946?

Mandated the government to:1)Balance the budget2)Favorable balance of payments3)Full employment4)Coordinate monetary and fiscal

policies

13

What isKeynesian Economics?

If we can manage demand we can manage the economy

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What did the 1970s teach us?

A move to the left of the aggregate supply curve can only be solved by supply side remedies

15

What is the largest component of GDP?

Consumption

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What is investment?The purchase of new plants, equipment, buildings, and net additions to inventories

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What is the acceleration principle?

An increase in spending can lead to induced investments

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Why is the investment sector so unstable?

• Expectations can change• Inconsistent accelerator• A change in the rate of

growth determines swings• Govt. policies can cause

economic bubbles

19

What arepro-cyclical

government polices?Policies that can accentuate the swings of the business cycle because of lag effects and emphasis of anti-growth policies

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What is the Helmsman Dilemma?

Brought on by the lag effects of discretionary fiscal policies

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What is the Financial Stability Oversight Council?

As part of the Financial Reform Bill of 2010 (Dodd-Frank Bill) the council decides which nonbank financial institutions might cause instability in the U.S. financial system

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What is the significance of the FSOC?

All banks with assets of more than $50 billion and any other financial businesses deemed large enough will be regulated by the Fed and protected with promise of bailouts if they get into financial trouble

23

What past examples of government protecting

big business?• Fannie Mae and Freddie Mac• Bail out of banks in 2008-09• General Motors and Chrysler

24

What affect does the foreign sector have on

the economy?Can be pro-cyclical or counter-cyclical

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How do we compare real GDP as a percent

from year to year?We take the percent increase from year to year and compare

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What is the percent increase as we go

from 3 to 5?2 / 3 = 67%

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What is the percent decrease as we go

from 5 to 3?2 / 5 = 40%

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What is the circular flow of income and

expenditures?A model that shows the income and expenditures in the economy

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What are leakages?Any diversion of money

from the domestic spending stream

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What are examples of leakages?

Savingtaxes

imports

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What are injections?

Any payment of money into the economic stream

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What are examples of injections?

Investmentgovernment purchasestransfer paymentsexports

33

At what point is equilibrium reached in

the circular flow model?Where planned leakages equal

planned injections

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What are two examples of equilibrium in the

circular flow of money?Internal - banks

External – foreign exchange market

35

What happens when planned borrowing

is greater than planned saving?

Interest rates rise

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What happens when planned saving is

greater than planned borrowing?

Interest rates fall

37

What happens when a country has a

payments surplus?

Its currency appreciates

38

What happens when a country has a

payments deficit?

Its currency depreciates

END