ECON 1202 1st Edition Lecture 14 Outline of Last Lecture I. Long-Run Economic Growth (10.1)II. Saving, Investment, and the Financial System (10.2)Outline of Current Lecture I. Business CycleII. Effects of Business Cycle on FirmsIII. Effects of Business Cycle on InflationIV. Effects of Business Cycle on UnemploymentV. Explaining the Great ModerationVI. Common Misconceptions to AvoidCurrent LectureI. Business Cyclea. While real GDP per capita has risen about eight-fold since the start of the 20th century, it has not risen consistently every year.b. The phases of rising are known as expansion; the periods of falling are recessions.c. We refer to the points at which the economy changes from one phase to the other as peaks or troughs, respectively.d. The typical media definition of a recession is “two consecutive quarters of declining real GDP.i. The federal government does not define when a recession starts or ends.ii. However most economists defer to the judgment of the National Bureau of Economic Research:1. “A recession is a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade.”e. Recessions are generally followed by periods of strong economy growthi. Some firms take advantage of the low real interest rates that typically accompany a recession to make investments by expanding productive capacity, effectively betting that the growth will justify their investments.II. Effects of Business Cycles on FirmsThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.a. When a recession hits, workers reduce spending due to expectations about their current and future incomes decreasing.b. But this reduction in spending doesn’t affect all goods equally. Consumers mostlycontinue to buy nondurables like food and clothing. But purchases of durable goods, ones that (by definition) are expected to last three or more years, are more strongly affected.i. This includes goods like furniture, appliances, and automobiles—goods that consumers can continue to use for a little longer when their purchasing power decreases.ii. Hence firms selling durable goods are more likely to be hit hard by a recession.1. i.e. Boeing (aircraft manufacturer)—sales strongly affected by recessionsIII. Effect of Business Cycle on Inflationa. The inflation rate measures the change in the price level from one year to the next.b. During expansions, demand for products is high relative to supply, resulting in prices increasing—high inflation.c. During recessions, demand for products is low relative to supply, resulting in prices increasing more slowly or even decreasing—low inflation or deflation.IV. Effect of Business Cycle on Unemploymenta. As firms see their sales start to fall in a recession, they generally reduce production and lay off workers.b. Unemployment often continues to rise, even after the end of each recession.c. Opposite relationship between unemployment and recession. d. Annual fluctuations in real GDP were typically greater before 1950 than after 1950. Economists refer to this as the “Great Moderation”.i. Is it over? 1. The length and severity of the recession of 2007-2009 has made some economists and policymakers wonder if we would return to the post-1950 pattern of long expansions and short, mild recessions.2. To judge whether this Great Moderation is over, it is useful to consider why has occurred at all, and consider what if anything has fundamentally changed.V. Explaining the Great Moderationa. The increasing importance of servicesi. Manufacturing (especially of durable goods) is more strongly affected by recessions. The economy is based more on services now, decreasing the effect of the business cycle on GDP.b. The establishment of unemployment insurancei. Before the 1930s, unemployment insurance and other government transfer programs like Social Security did not exist. These programs increase the ability of consumers to purchase goods and services during recessions.c. Active federal government stabilization policiesd. Increased stability of the financial systeme. The increasing importance of servicesf. The establishment of unemployment insuranceg. Active federal government stabilization policiesi. Many, though not all, economists believe that active government policies to lengthen expansions and minimize the effects of recessions have had the desired effect. The debate over the role of government in this way became particularly intense during the recession of 2007-2009.h. Increased stability of the financial systemi. The severity of the Great Depression of the 1930s was in part caused by instability in the financial system; similar instability exacerbated the recession of 2007-2009. Returning to macroeconomic stability will requirea stable financial system.VI. Common Misconceptions to Avoida. Economists often have different terms to describe a variable and changes in that variable:i. Real GDP vs. economic growth rateii. Price level vs. inflationb. “Savings” is composed of both private and public savings; it is easy to forget about the latter.c. A “trough” is the end of a recession—the lowest point GDP obtains before beginning to rise again. Don’t confuse “trough” and “recession”.d. Recessions do not affect all firms