Principles of economics business cycles and inflation

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Business Cycles and Business Cycles and InflationInflation

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Business CyclesBusiness Cycles

The business cycle is the upward and downward movement of economic activity that occurs around the growth trend.

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Business CyclesBusiness Cycles

There are a number of policies regarding business cycles.

Classical economists generally favor laissez-faire or noninterventionist policies.

Keynesians generally favor activist policies.

U. S. Business CyclesU. S. Business Cycles

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Civil War

Recoveryof 1895

World War I

Panicof 1893 Panic

of 1907Great

Depression

Korean War Vietnam War

World War II

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The Phases of the The Phases of the Business CycleBusiness Cycle The peak is the top of the business cycle. A boom is a very high peak, representing

a big jump in output. The downturn is the phenomenon of

economic activity starting to fall from a peak.

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The Phases of the The Phases of the Business CycleBusiness Cycle A recession is a decline in output that

persists for more than two consecutive quarters in a year.

A depression is a large recession. A trough is the bottom of the recession or

depression.

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The Phases of the The Phases of the Business CycleBusiness Cycle An expansion is an upturn that lasts at

least two consecutive quarters of a year.

Expansion ExpansionRecession

The Phases of the The Phases of the Business CycleBusiness Cycle

Boom

Secular growth trend

DownturnUpturn

Trough

Peak

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Why Do Business Cycles Why Do Business Cycles OccurOccur Recessions and expansions are caused

primarily by demand-side of the economy. A debate exists about whether these

fluctuations can and should be reduced.

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Why Do Business Cycles Why Do Business Cycles OccurOccur Most economists believe that potential

depressions should be offset by economic policy.

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Why Do Business Cycles Why Do Business Cycles OccurOccur Since the late 1940s, compared to prior

years: Downturns and panics have generally

been less severe. The duration of business cycles has

increased. The average length of expansions has

increased while the average length of contractions has decreased.

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Why Do Business Cycles Why Do Business Cycles OccurOccur Most economists believe that business

fluctuations have become less severe because of the stronger role of government in the economy.

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InflationInflation

Inflation is a continual rise in the price level. From 1800 until World War II, the U.S.

inflation rate and price level fluctuated. Since World War II, the rate fluctuated,

but the movement of the price level has been consistently upward.

Inflation Since 1900Inflation Since 1900

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Measurement of InflationMeasurement of Inflation

Inflation is measured with changes in price indexes.

Price index – a number that summarizes what happens to a weighted composite of prices of a selection of goods over time.

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The GDP DeflatorThe GDP Deflator

The GDP deflator (gross domestic product deflator) is an index of the price level of aggregate output or the average price of the components in GDP relative to a base year.

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The GDP DeflatorThe GDP Deflator

The GDP deflator is the measure of inflation most economists favor since it includes the widest number of goods.

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Expected and Expected and Unexpected InflationUnexpected Inflation Expected and unexpected inflation affects

behavior differently. Expected inflation is inflation people

expect to occur. Unexpected inflation is inflation that

surprises people.

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Expected and Expected and Unexpected InflationUnexpected Inflation Expectations of inflation play an important

role in the inflation process. Inflationary expectations can accelerate

large inflation.

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Costs of InflationCosts of Inflation

Inflation may not make a nation poorer. It can redistribute income from those who

do not raise their prices to those who do. It can reduce the amount of information

that prices are supposed to convey.

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Costs of InflationCosts of Inflation

Inflation is usually accepted by governments as long as it stays at a low level.

What worries policymakers is hyperinflation.

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Costs of InflationCosts of Inflation

Hyperinflation – exceptionally high levels of inflation of, say, 100 percent or more a year.

The U.S. has not experienced hyperinflation since the Civil War (1861-65).