Business Cycle- Definition: Alternating period of economic growth and contraction, which can be measured by changes in RGDPo 4 phases Expansion Peak Recession Trough- Causeso Shocks in AD Change in wealth Pessimism/optimism about future Change in govt policyo Shocks to AS Sudden change in oil prices Inventions Change in factors of production other than capital/labor (earthquake, drought)o Changes in total expenditures GDP and AD= C+I+G+NX- NBER determines if we are in a recession Challenges- No two business cycles are alike- Real GDP comes out only quarterlyo Must anticipate recessiono Businesses need to anticipate change in demand for their output Indicators- Released more frequently than RGDP- Lead, lag, and coincident - Business cycle indicatorso Leading Stock prices Average weekly hours worked Labor productivity Consumer confidence New orders for plant and equipment and consumer goodso Coincident Employment/Unemployment Consumption Business investments (factories, warehouses, equipment) Industrial production Personal incomeo Lagging InflationThree ingredient recipe for recession (Wessel)- Decrease in home prices- An increase in oil prices- Credit Crunch (Banks decrease lending)Shifts in C vs movement along C- Change in oil prices is movement- Change in home prices is shift b/c a decrease in wealthWhat factors determine I?- Expectations of future profitability- Real interest rateo Rate of profit=expected real return on I- Interest costo If expected return is 3% on new project and cost to borrow is 4%, project isn’t profitable- Business taxeso When t falls, I rises- Cash flowShift in I occurs when any factors except for real interest rate changeShift in I creates a shift in AD because AD=C+I+G+NXNet Exports- Increases during recession and decreases during expansiono Relative price levelso Relative output growtho Relative US dollar strength- If inflation of US>ROW, NX fall- During recession, inflation of US<ROW so US goods are cheaper, so exports increase and imports decrease so NX increase- As US dollar strengthens, US imports increase, exports decreaseo 100Y/$1 -> 100Y/80 cents (less US $ to buy same amount of Yen)- If the growth rate of US GDP is faster than the ROW GDP, the dollar strengthens, so NX decreasesAggregate demand- Shift in ADo When there’s a change in any part of C+I+G+NX except change in PLo Change in income taxes- Consumption factorso Wealtho Interest rateo Expected future income- Investment factorso Expected future profitabilityo Interest rateo Business taxeso Cashflow- Government and Net Exportso Change in relative RGDP to ROWo Relative strength of $- Why does AD have a negative slopeo Wealth effect Wealth=Assets-Liabilities As PL rises, wealth fallso Interest rate effect As PL rises, we need more money to buy goods and services Save more and spend less- Decreases C and I The increase in demand for loans increases the real interest rate on loanso NX effect As PL rises faster in US compared to ROW, X dec M inc NX decQuestions I missed Fiscal policy to prevent or combat recession would be to (reduce taxes) Classical economists believed a prolonged unemployment is impossible because (the economy is self correcting) The Great Depression began in (1929) with the (crash of the stock market) Keynesian Theory is a (macroeconomic theory) Which is not one of the four main categories of spending identified by John Maynard Keynes? (transfer payments) Breakeven income is when Yd=C (C=2+.8Yd, Yd=$10 million) US NX fall when (the growth of the US GDP is faster than ROW) If r increases, consumption will (decrease) and savings will (increase) If US dollar appreciates, imports will (rise) and exports will (fall) Appreciation of US dollar will result in a (decrease) in NX and (decrease) in AD Increase in income taxes will cause (decline in Yd) and (US economy will move down along consumption function graph) If Us economy is heading toward a recession, the Federal Reserve will (lower interest