Business Cycles and Their Characteristics - Video Tutorials & Practice Problems
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Business Cycle Characteristics
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Alright, let's talk in a little more detail about the business cycle, remember the business cycle? It's where we're tracking, basically, we're tracking GDP and we're seeing how it increases over time, then decreases, increases, decreases, right? It's going through this cycle of increasing and decreasing. So we're representing fluctuations in specifically Real GDP. And remember when we talk about Real GDP that's adjusting for inflation because we want to see without the effect of inflation, how is real GDP uh flowing over time? Right? So we're gonna see periods of increase and decrease. And like we saw on that graph of the business cycle, it's gonna look something like this. So we're going to have a GDP, let me do it in a different color. Let's do GDP here and time on this axis over here. Right? And we saw that the business cycle kind of looks something like this where we're increasing for some time and then we top out start decreasing. Bottom out increase, right? Something like that right? Where it goes up and down, up and down. Um So what we when we talk about we we've mentioned this before, but let's just go through them real quick. We've got the recession right? The recession is when we're going down, right, when we go through a recession, the economic is in a downturn. So we see that GDP is decreasing and when during this period of GDP decreasing. Well what's happening the jobs are going away as well. So we also see that employment is decreasing. So GDP and employment are decreasing during a recession, right? There's less jobs available and less production happening, firms aren't investing as much, and we call these contractions of the economy, right, recession contraction, they mean the same thing, and then eventually we're gonna bottom out, we're gonna hit the bottom in a trough. So this trough is the bottom, and that's the point where the economy turns from this recession into an expansion, right? So we're gonna start growing again and this expansion while it's the opposite of the recession, where in the recession we're decreasing GDP and employment. Well, now GDP and I'm talking about real GDP here, but just for short, will say GDP and employment, they're now increasing again. Alright, And another term for expansion is recovery, right, We're recovering from this uh from this recession, we're recovering again, and we're on the upturn. So that's the expansion, and then eventually we're gonna hit the top, right, we're going to peak, and that's the top of the business cycle. And this is the point where the economy turns now from the expansion back into a recession. So, on our little graph here, let's point out our, our peaks and troughs. So we've got right here, what do we have right here at this point, right here, is that a peak or a trough in our business cycle, That one's a trough, right? It's the very bottom before it turns into an expansion, here's another one right here trough. And on the other side here, these top points are peaks peak, right there and a peak right there. Right, So we're gonna keep seeing that, that's how the business cycle goes, expansion to a peak, through a recession to a trough expansion, right? And it's gonna keep going through that as a cycle. So although each business cycle is different, what we're going to notice is that each one is different, especially in in terms of length. Sometimes the recessions are long, sometimes the recessions are short. The expansions can last a very long time or a very short time in between them. But however, what we see is that there's general characteristics that are the same when we, when we analyze all of our business cycles. So let's go through some of these general characteristics, let's start here um with the expansion phase. So throughout the expansion phase, what we see is that there's an increase in interest rates while firms are investing their spending more and the interest rates continue to increase throughout that expansion. So as those interest rates increase, we also see increases in wages. So the workers are making more money and the price levels are going up as well, so everything's going up increase. Interest rates are up, wages are up. Price levels are up. However, one thing that starts to happen towards the end of the expansion is that these wages increase faster than the price level. So what does that do? Well, the wages to the firm's, this is an expense where the price level, that's the revenue of the firm, right? That's the money they're bringing in, but the expenses are going up faster than the revenue. So it leads to lower profit leads to lower profit for the firms. And this is as the expansion I'll say, um, near end of expansion. This is where this starts to happen because throughout the expansion, those wages are increasing, but the price levels don't keep up with the wages throughout the expansion, which eventually leads us to turn around. So another thing that happens during this expansion phase is there's a lot of spending going on, not only from the firms investing but also from the household spending, uh, the increase wages that they earn, they increase their spending as well. And to, to finance this spending, maybe they're buying new cars, new houses, Well, they take on debt, right? The households and the firm debt increases during the expansion phase, which eventually they're gonna have to pay back. Right? So eventually this increase in debt leads to a reduction in spending because they're gonna have interest to pay back as well as the principal. So that's gonna reduce their spending, um, over time as well, Right? When they have to finally pay that back. So that's what happens during the expansion. We see everything going up, interest, interest rates, wages, prices, everything's going up and then eventually that debt starts to pile up and we have a decrease in spending. So what the first thing that kind of takes when we have a recession is that we see a decrease in spending, specifically on capital goods. So capital goods, remember this is firms investing, right? This is lower output investment. And remember we're talking about economic investment here, I'll put firm firms investment where they're not not building factories, not buying machinery, right there, not looking into the future as much because they're they've had all this spending, they've piled on this debt and they're not able to purchase much more in the capital goods category um as that recession begins, so we start to see lower firm investment and this lower investment, less spending leads to higher unemployment. There's not there's not as much um expansion going on there, they're not growing their business as much and we see that they're not hiring as much leading to more unemployment and then the higher the unemployment. Well now, not only do the firms have less money, but the households have less money, right? If they're not employed, they're not making money. So it further decreases spending, leading to a deeper recession. Right? So towards the beginning of the recession, we see a decrease in capital goods leading to unemployment, leading to further decrease in spending from the households and then the recession, it bottoms out. Finally, there's going to be a turnaround at some point and we basically see this happen, it eventually turns around right at the end of the recession. So what what generally causes that is that these debts are repaid, right? They were taking on a lot of debt and they finally repay the debt that that was owed, which allows an increase in spending again. Right? So a lot of the issue with, with recession, with the business cycle with the recessions is generally a decrease in spending, right? When there's less spending going on. Well, it doesn't allow firms to invest, it doesn't allow firms to hire people. Right? So the spending is a key factor in these uh in these business cycles. So just like we saw during the expansion, interest rates going up well during the recession, interest rates were also declining. And at these lower interest rates, guess what people are able to borrow and spend again. Especially the firms. Again, the focus here on capital goods being the investment firm investment. Mhm. Allowing for the expansion to happen happen again, right. The recession ends, firms are are investing again, allowing for another expansion of the economy. Cool. So, those are some general characteristics that we see during the expansion and the recession. Okay, so what we've got here at the bottom of the page, we've got one more thing to look at and this is just what the recessions have looked like Uh in the past 60 years or so in the US economy. So notice we've got here on the left, we've got the peaks, which is the top and the trough the bottom of the economy here, the bottom of the business cycle and everything in between. Well that is our recession, right? So notice how each recession has been a little different. Some lasted short somewhere eight months, six months. And we've had long ones 10, 12, 11, 16 and 18 months down here. This this last recession on our chart december 2007 through june 2009. Well, this one we term as the great recession that just happened um just a few years ago. And this was when we had the problems in the real estate market that led to more and more problems with with all sorts of debt. And professors love to talk about the great recession. We're gonna have more videos about the great recession throughout throughout these chapters and how it relates to macro economics. Um So it's just good to know that this this one definitely comes up quite a bit in this class just because it was so long and obviously so recent. Cool. So it's paused here and on the next page we'll discuss a few more things about the business cycle. All right, let's do that. Now
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Causes of Business Cycles
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So why do we go through business cycles? Why aren't we just constantly growing? Why is their growth and then recession and then growth? Why doesn't it happen smoothly? Well, it's because events happen rather sporadically, right spontaneously? We get shocks to the standard flow of things that cause unexpected booms in the market and I don't expect it uh bus recessions in the market. Right? So the main idea here is that things happen, we'll say spontaneously, right? So when we have a shock in the market, well, that's going to cause uh, an unexpected growth or uh recession. Right? So the first thing is irregular innovation, there's going to be big inventions that come around. There's going to be revolutionary technologies that cause economic booms, right? Like when we had the railroad, automobiles or most recently the internet, right? When these things were created, there was sudden expansion in our economy economy that was unprecedented, Right? So what happens is after one of these expansions or one of these inventions, there's unprecedented expansion. But eventually our economy is going to absorb this new technology, right? All that expansion that can happen, the railroad gets built and now we have this new growth in the logistics business. Well, that logistics business is going to cap out eventually, Right? The transportation of people from east to west is gonna cap out eventually and it's going to be absorbed by the economy. So that expansion has to end eventually. Right? So the growth is going to slow down from that new technology until a new technology uh, comes through, right? And these ideas, they occur sporadically? it's not like oh, every five years. We have a new revolutionary idea, right? We can't plan on it like that. It's just something that happens all of a sudden. So irregular innovation causes these shocks in the market. Another one, productivity changes. This is similar to irregular innovation. Um, productivity changes, well, changes in productivity. This could be caused by uh technology. Any kind of change in technology could cause increased productivity or maybe availability of resources, right? Or resources. Even human capital, Right. New public education system leads people to have more human capital leading to higher productivity could lead to unexpected booms and busts. So just like a key resource such as oil being more available. If there's a new oil deposit found and the price of oil decreases a lot. Well, it allows a lot more businesses to invest and use the oil to increase the economy. Right? So any kind of shock like that and availability of a key resource can lead to a shock in the economy. Another shock to the economy is monetary factors. So this is more controlled because this is monetary policy by the Federal Reserve. This is controlled and they're usually trying to fix a recession or help the economy in some way when they make some sort of monetary policy change. And we're going to discuss monetary monetary policy in a lot of detail in in other videos. So for now we'll just know that the Fed can have shocks to the economy through their monetary policy, right, printing a bunch of money or buying a bunch of bonds and, um, or selling bonds, right? Whatever it might be. So monetary factors and another one political events. What if there's an unexpected war happens, peace, terrorism, anything like that can, can cause a shock to the economy, a boom in the economy or a bust right from some sort of unexpected political event. And finally, there's financial instability, Um, from a bubble, let's say there's some sort of bubble in the market. Like we saw in 2008, uh, during the recession, there was a huge bubble that was burst and that was in the real estate market, right? We saw a big decrease in real estate prices that caused an unexpected decrease leading into a big recession. Right? So it's paused real quick and we'll talk about one more thing. A little conclusion here about our business cycle. Cool. Let's do it. In the next video
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Key Ideas of the Business Cycle
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All right. One of the key things to remember about the business cycle about our recessions and expansions is the connection to unemployment and inflation. Alright. What we see is that during a recession, unemployment tends to increase, right, and that's that should come logically right, unemployment increases during the recession, there's no jobs available. So there's a lot of unemployment unemployment increases. So what do you think happens during an expansion? Well now businesses are spending, businesses are hiring, right, they're expanding their businesses. So unemployment decreases during an expansion. And the key thing to remember is that they're opposites, unemployment and inflation are opposites. So they kind of go in opposite directions. So during the recession, while unemployment is increasing, well during a recession inflation is decreasing, right? Because there's no uh nobody spending money, those price levels are dropping, trying to sell inventories, trying to get rid of money. We see that price levels start to drop again during a recession. And guess what, what do you think happens during an expansion? Everyone's making more money, wages are going up, everything's going up. We've got an increase in inflation, right, inflation increases during an expansion. Cool. So that's a key thing to remember is this opposite effect of unemployment and inflation. Now I think the easiest thing to remember is that unemployment during a recession, what do you think unemployment during the recession? I think that's very flows very logically unemployment during a recession is going to increase, there's no jobs available. So if you can remember that unemployment during the recession increases? Well you can remember everything else here because everything happens in opposite. Right? So unemployment increasing during during a recession? Well you'll remember that inflation decreases because it's going to be the opposite. Okay, unemployment and inflation they tend to be opposites there. So one more weird term that they like to bring up and this actually happened during the latest recession um is a jobless recovery. So this is where the what seems to happen where we start to have a recovery and expansion. However, so we're going through a period of growth. So we're going through an expansion and this tends to happen right after a recession where we're going through an expansion. However, the unemployment rate Is still rising and that's called a jobless recovery because we're starting to see growth again where we're starting to see production grow again. However, there's still unemployment. Uh the unemployment problem is not getting fixed and this happened during actually each of the last three recessions since 1990. So when you go back up to the chart, there were jobless recoveries after each of the three last recessions since 1990. Alright so that's about it here. These are some key facts to remember about the business cycle. Let's go ahead and move on to the next video
