Course paper in macroeconomics
Riga Technical University
Course paper in macroeconomicsBUSINESS CYCLES
Author: ..............Supervisor: Muhammad Shakeel
Contents PageBusiness
cycles..............................................................011.1Gross
Domestic Product (GDP)....011.2 Micro Vs Macro ....02 2. Phases of
the Business Cycle...02 2.1 Phases of business cycle - expansion
..03 2.2 Phases of business cycle
peak.........................................................................................04
2.3 Phases of business cycle slow down
(contraction).................................................05
2.4 Phases of business cycle recession
(Trough)...........................................................06
3. Recession and Depression.....07 4. Causes of Business
Cycles......08Business Investment..084.2 Interest Rates and
Credit....08 4.3 Consumer Expectations...08 4.4 External
Shocks.08Internal causes in economy ...09 4.6 External causes..09
5. Types Of Business Cycles....10 5.1 Major Cycles....10 5.2 Minor
Cycles....10 5.3 Long wave cycle..10 6. Characteristic of Business
Cycles.....11 6.1 It occurs periodically11 6.2 It is all
embracing...11 6.3 It is wave-like....11 6.4 The process is
cumulative and self-reinforcing.......11 6.5 The cycles will be
similar but not identical.12 7. Business Cycle Forecasting.13-147.1
The Ten Leading Economic Indicators.....15 8. Types of Forecasts
and Its Method to measure........16 8.1 There are three types of
forecast..16 8.2 Types Of Forecasting Methods.....16
9. Business Cycle Theories...............17 9.1Endogenous.....17
9.2 Endogenous theories.....17 9.3 Exogenous....17 9.4 Exogenous
theories........1710.The Austrian School
theory......................................................................................................18
Conclusions and recommendations List of sources Appendices
Business Cycles
1. Introduction:The business cycle is the downward and upward
movement of levels of gross domestic product (GDP) and refers to
the period of expansions and contractions in the level of economic
activities (business fluctuations) around its long-term growth
trend.The economy follows the Business Cycle regularly.
Fig.1 Fig.2
1.1 GDP (Gross Domestic Product) Def. The total value, in
dollars, of all final goods and services produced within the nation
each year Abbreviated as the GDP If the GDP is larger than last
year the economy is expanding (getting bigger) If the GDP is
smaller, the economy is shrinking (getting smaller) Fig 1.1
011.2 Micro Vs Macro Microeconomics: The study of personal or
small finances. Individuals, families or businesses Macroeconomics:
The study of economic systems on a large scale National or Global
economies
2.0 Phases of the Business Cycle.
Expansion (Growing) Peak (Top) Contraction (Shrinking)
Recession/Trough (Bottom)
Fig 2.0 02 2.1 Phases of business cycle - expansion During a
period of expansion: Wages increase Low unemployment People are
optimistic and spending money High demand for goods Fig. 2.1
Businesses start Easy to get a bank loan Businesses make profits
and stock prices increase
In an economic expansion, businesses experience record sales and
profits. They can hardly keep up with demand. In anticipation of a
continued sales growth, inventories are built up and production
facilities are expanded.
This creates demand for suppliers of raw material and equipment.
The equipment takes time to be built and installed. Banks are
willing to lend given the bright predictions of continued cash
flows. A large number of loan applications push banks to raise
interest rates which companies can afford to pay.
Companies find it difficult to hire all the employees they need,
and are forced to pay higher wages, for instance, for overtime
hours. But, that is not a serious problem in light of healthy sales
and profits.
03
2.2 Phases of business cycle peak When the economic cycle
peaks:
The economy stops growing. GDP reaches maximum Fig 2.2
Businesses cant produce any more or hire more people Cycle begins
to contract
Furthermore, a strong consumer demand justifies raising prices
for many products. With higher wages, employees are still able to
buy in spite of higher prices; moreover, anticipation of continued
employment encourages them to use consumer credit if their income
is insufficient.
The overheating of the economy is evident in shortages of
employees, materials, equipment, loan able funds and products.
These shortages imply inflation. Because of difficulties in
obtaining resources, this is no longer a good time to start a
business even if sales appear encouraging. Prices, wages and
interest rates continued rise puts eventually a stop to further
expanding product demand, new hiring and new lending. The economy
has reached its peak.
04
2.3 Phases of business cycle contraction or Recession During a
period of contraction: Unemployment increases Banks stop lending
money Number of jobs decline People are pessimistic (negative) and
stop spending money Fig 2.3 Businesses cut back production and
layoff people Sales are no longer expanding. The economy starts
slowing down. The slowdown is mild at first. As sales stop
increasing, inventories pile up.
Companies can adjust to that by reducing orders for raw
materials, avoiding overtime and resorting to sales promotions.
Suppliers start to feel the pinch and are forced to lay off a
few workers. These lay-offs are seen as a signal of potential hard
times ahead. Employees prefer to set aside some wages, and reduce
their consumption. Sales start to drop as consumer demand shies
away.
Companies are now burdened by the loans they took out to install
new equipment. Their profits shrink with decreasing revenues, still
high employee salaries, and a large overhead.
The hardest hit are the manufacturers of equipment who see their
orders dwindle. Fewer and fewer businesses are started. Often,
plans to open business are cancelled. Some firms go out of
business.052.4 Phases of business cycle Trough
When the economic cycle reaches a trough: Economy bottoms-out
(reaches lowest point) High unemployment and low spending Stock
prices drop Pessimism and hardship are widespread. If the loss of
income is not too severe it is called a recession, otherwise it is
branded a depression. Firms try to survive as they can sell off the
inventory on hand. More bankruptcies are observed, but the number
and the size of the bankrupt firms are bottoming out. All prices,
interest rates and wages are at their lowest. Unemployment is
ubiquitous. The unemployed are ready to take any job. The
contraction has run its course. The economy has reached its
trough.
Fig 2.4
063.0 Recession and Depression
A prolonged contraction is called a recession (contraction for
over 6 months). Recession is a decline in the Gross Domestic
Product (GDP) for two or more consecutive quarters.
Fig 3.1 Fig 3.2 A recession of more than one year is called a
depression. A depression is any economic downturn where real GDP
declines by more than 10 percent. A recession is an economic
downturn that is less severe.
Fig 3.3 Fig 3.4
074.0 Causes of Business Cycles.
4.1 Business InvestmentWhen the economy is expanding, sales and
profit keep rising, so companies invest in new plants and
equipment, creating new jobs and more expansion. In contraction,
the opposite is true
4.2 Interest Rates and CreditLow interest rates, companies make
new investments, adding jobs. When interest rates climb, investment
dries up and less job growth
4.3 Consumer ExpectationsForecasts of an expanding economy fuels
more spending, while fear of a recession decreases consumer
spending
4.4 External ShocksExternal Shocks, such as disruptions of the
oil supply, wars, or natural disasters greatly influence the output
of the economy Ex. 1992-2000 was the longest period of expansion in
U.S. history. Early in 2001, signs of contraction appeared, though
the Bush administration denied it. The Sept. 11th 2001 terrorist
attacks quickly caused the business cycle to shift into a
contraction.
08
Fig Fig.4
Fig.4a Fig.4b4.5 Internal causes in economy changes in
consumption and investments changes in economic policy (monetary
policy and fiscal policy)
4.6 External causes demographic changes political reasons
inventions and innovation095.Types Of Business Cycles.The
capitalist economy has pass through numerous business
cycle.Following are the types of business cycle. Major
Cycles(8-10)Years Minor Cycle(2-3) Years Long wave Cycle
(50-60)Years 5.1 Major Cycles:These are the wide oscillation of
business activity and are characterized by serious depression,
seven different business cycle were seen during 1870-1937.
5.2 Minor Cycles:These are of relatively mild intensity
characterized by downward movement. Between 1947 to 1983 rapid
economic growth was four times interrupted by minor, Mild down
swing.
5.3 Long wave cycle:Long wave business cycle or trade cycles are
50 to 60 years duration. The upswing period of long swing cycle can
contain several minor and even major cycles. The primary element in
long wave business cycle is the price movement
106. Characteristic of Business Cycles.6.1 It occurs
periodicallyThe business cycle occurs periodically in a regular
fashion. This means the prosperity will be occurring
alternatively.
6.2 It is all embracingThe business cycle implies that the
prosperity or depression effect of the phase will be affecting all
industries in the entire economy and also affecting all industries
in the entire economy and Fig.aalso affecting the economies of
other countries. It is international in character. The Great
Depression of 1929 is an example of this.
6.3 It is wave-likeThe business cycle will have a set pattern of
movements which is analogous to waves. Rising prices, production,
employment and prosperity will become the features of upward
movement: Falling prices, employment will become the features of
the downward movement.
6.4 The process is cumulative and self-reinforcingThe upward
movement and downward movement are cumulative in their process.
When once the upward movement starts, it creates further movement
in the same direction by feeding on itself. This momentum will
persist till the forces accumulate to alter the direction it
persists in the same direction leading to the worst depression and
stagnation till it is retrieved to gain an upward movement.
116.5 The cycles will be similar but not identicalDifferent
cycles and waves in the business cycles will be similar in general
feature, but they are not identical in all respects. A typical
cycle constructed by making, as it is where, a composite photograph
of all the recorded cycles would not materially differ in form
varies widely from any one of them. But this typical cycle is not
an exact replica of any individual cycle. The rhythm is rough and
imperfect. All the recorded cycles are members of the same family,
about among them are no twins.
Fig. Characteristics of business cycle
127. Business Cycle ForecastingBUSINESS FORECASTING is an
estimate or prediction of future developments in business such as
sales, expenditures, and profits. Given the wide swings in economic
activity and the drastic effects these fluctuations can have on
profit margins, it is not surprising that business forecasting has
emerged as one of the most important aspects of corporate planning.
Forecasting has become an invaluable tool for businesspeople to
anticipate economic trends and prepare themselves either to benefit
from or to counteract them.
Fig.7
If, for instance, businesspeople envision an economic downturn,
they can cut back on their inventories, production quotas, and
hirings.
If, on the contrary, an economic boom seems probable, those same
businesspeople can take necessary measures to attain the maximum
benefit from it. Good business forecasts can help business owners
and managers adapt to a changing economy.
13The current state of the economy and where it might be headed
in the near future is of utmost concern to entrepreneurs who are
interested in launching new ventures. For example, if the economy
is nearing a recession, it might not be a good time to start a new
company. Cycle forecasting is the process of making predictions
about the future of the economy by analyzing economic data.
Fig. 7a
Fig. 7b 147.1 The Ten Leading Economic Indicators
Average workweek of production workers in manufacturing Average
initial weekly claims for state unemployment insurance New orders
for consumer goods and materials Vendors performance New orders for
capital goods New building permits issued Index of stock prices and
Money supply Spread between rates on 10-year Treasury bonds and
Federal funds Index of consumer expectations Hours of production
workers in manufacturing New claims for unemployment insurance
Value of new orders for consumer goods S&P 500 Composite Stock
Index New orders for plant and equipment Building permits for
private houses Fraction of companies reporting slower deliveries
Index of consumer confidence Change in commodity prices Money
growth rate (M2)
158. Types of Forecasts and Its Method to measure.
8.1 There are three types of forecast,
Economic forecasts
Technological forecasts
Demand forecasts
Fig 8.18.2 Types of Forecasting can be measured by two
methods,
Qualitative method
Quantitative method
Fig 8.2169.Business Cycle Theories
9.1Endogenous Starts from within the model Endo- inside, source
Genous- born9.2 Endogenous theories Innovation theory: innovation
leads to saturation. Psychological theory: alternating optimism and
pessimism Inventory cycle theory: inventory and demand not in sync
Monetary theory: changes in money supply by Federal Reserve Under
consumption theory: or overproduction
9.3 Exogenous From outside of the model Exo- outside Genous-
born, source9.4 Exogenous theories The external demand shock
theory: effect of foreign economies War theory: war stimulates
economy; peace leads to recession The price shock theory:
fluctuations in oil prices
1710.The Austrian School theoryThe Austrian School says that
recessions are caused mainly by central government intervention in
the money supply. Austrian School economists conclude that, if the
interest rate is held artificially low by the government or central
bank, then the demand for loans will be higher than the actual
supply of willing lenders, and if the interest rate is artificially
high, the opposite situation will occur. This pricing
misinformation leads investors to misallocate capital, borrowing
and investing either too much or too little in long-term
projects.
Fig .10.a Fig 10.b
In Austrian theory, depressions and recessions are positive
forces in-so-much that they are the market's natural mechanism of
undoing the misallocation of resources present during the boom or
inflationary phase. Austrian School economists point to the dot-com
investment frenzy and the U.S. housing bubble as modern examples of
artificially abundant credit subsidizing unsustainable mal
investment.
18Conclusions and recommendations Riga 2015 Business
CycleExpansionPeakContractionTroughExpansionPeakContraction
