Chapter 10

the effect of the business cycle on inflation

- Inflation rate measures the change in the price level from one year to the next. - During expansions, demand for products is high relative to supply, resulting in prices increasing, high inflation. - During recessions, demand for products is low relative to supply, resulting in prices increasing more slowly, or even decreasing, low inflation of deflation.

how do we know when the economy is in a recession?

- The typical media definition of a recession is "two consecutive quarters of declining real GDP." - Most economists defer to the judgment of the National Bureau of Economic Research, "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." - during recessions, inflation and employment decrease

what contributes to shorter recessions, longer expansions, and less severe fluctuations in real GDP?

- a service based economy - fiscal policy - unemployment insurance

what is technical progress affected by?

- entrepreneurship - new software developments - private property rights - investment in capital

nondurable good

- food and clothing

stagflation

- increase in both unemployment and inflation

explaining the Great Moderation

- increasing importance of services - establishment of unemployment insurance - active federal government stabilization policies - increased stability of the financial system

how has the real GDP in the US grown since 1900?

- more rapidly than the population

3 key services of the financial system

- risk-sharing: by allowing investors to spend their money over many different assets, investors can reduce their risk while maintaining a high expected return on their investment. - liquidity: the financial system allows savers to quickly convert their investments into cash. - information: the prices of financial securities represent the belief of other investors and financial intermediaries about the future revenue stream form holding those securities.

effect of business cycles on firms

- when a recession hits, workers reduce spending due to expectations about their current and future incomes decreasing. This reduction in spending doesn't affect all goods equally. - firms selling durable goods are more likely to be hit by a recession.

the macroeconomics of saving and investment

closed economy, no exports or imports, GDP= C + I + G I= GDP - C - G

savings

composed of private savings and public savings - total savings = GDP - C - G - Savings = Investments

private savings

equal to all the household income that is not spent; household incomes derive from the payments for factors of production (Y) and transfer payments (TR); households spend money on consumption (C) and taxes (T) - Y + TR - C - T

durable good

expected to last three or more years - this includes goods like furniture, appliances, and automobiles, goods that consumers can continue to use for a little longer when their purchasing power decreases.

financial intermediaries

firms, such as banks, mutual funds, pension funds, and insurance companies, that borrow funds from savers and lend them to borrowers.

economic prosperity

goes hand in hand with health, richer nations can devote more resources to improving the health of their citizens, and healthier citizens are more productive. another good measure is the amount of time we can spend on "leisure", as our lifespan grows, we can spend more time on leisure, and also as we grow more productive, we can devote less time to work, and hence more time to leisure.

technological change

improvements in capital or methods to combine inputs into outputs and allow workers to produce more in a given period of time. The role of entrepreneurs here is critical, in pioneering new ways to bring together the factors of production to produce bette or lower-cost products

what determines the rate of long-run growth?

increases in real GDP per capita rely on increases in labor productivity, the quantity of goods and services that can be produced by one worker or by one hour of work.

capital

manufactured goods that are used to produce other goods and services. the more capital a worker has available to use, the more productive he or she will be.

increasing importance of services

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.

active federal government stabilization policies

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.

financial markets

markets where financial securities, such as stocks and bonds, are bought and sold.

calculating economic growth rate

previous real GDP x (1+g)^t = current real GDP - t= the number of time periods between the previous and current periods. - a useful shortcut is called the Rule of 70, and it can help us to determine how long it will take for an economic variable to double. - number of years to double= (70/growth rate)

potential GDP

refers to the level of real GDP attained when all firms are operating at capacity. Capacity refers to "normal" hours and a "normal" sized workforce. Rises when labor force expands, when a nation acquires more capital stock, or when new technologies are created. - increases over time as technological change occurs - increases over time as the labor force grows

expansion

spending by firms and households is strong. As sales increase, firms increase production and hire more workers. With spending strong, firms find it easier to raise prices. - inflation, production, income, and employment are increasing. -

crowding out

the decline in private expenditure as a result of increases in government purchases. - the effect of government budget deficits and surpluses on the equilibrium interest rate is relatively small.

public savings

the government saves whatever it brings in but does not spend it. When this is zero, the government spends as much as it brings in; this is known as a balanced budget. Negative and positive values for this are known as budget deficits and budget surpluses. - T - G - TR

long-run economic growth

the process by which rising productivity increases the average standard of living. The most commonly used measure of this is real GDP per capita, the amount of production in the economy, per person, adjusted for changes in price level.

increased stability of the financial system

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 require a stable financial system.

financial system

the system of financial markets and financial intermediaries through which firms acquire funds from households.

fluctuations in real GDP

annual fluctuations in real GDP were typically greater before 1950 than after 1950. Economists refer to this as the "Great Moderation".

the effect of the business cycle on unemployment

as firms see their sales start to fall in a recession, they generally reduce production and lay off workers.

establishment of unemployment insurance

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.

the market for loanable funds

a conceptual interaction of borrowers and lenders determining the market interest rate and the quantity of loanable funds exchanged. - firms borrow loanable funds from households, they borrow more when households demand a lower return on their money, a lower real interest rate. - households supply loanable funds to firms. They provide more when firms offer them a greater reward for delaying consumption, a higher real interest rate. - government, through their savings or dissaving, affect the quantity of funds that "pass through" to firms. - technological changes causes investments to become more profitable for firms, so it will increase the demand for loanable funds.

financial security

a document stating the terms under which funds pass from the buyer of the security to the seller

bond

a financial security promising to repay a fixed amount of funds. a bond is essentially a loan from a household to a firm.

stock

a financial security representing partial ownership of a firm.

business cycle

alternating periods of economic expansion and economic recession - real GDP per capita has risen a lot since the start of the 20th century, but it has not risen consistently. The American economy has experienced alternating periods of expanding and contracting economic activity. The phases of rising are known as expansion and the periods of falling are known as recessions.