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Chapter 15. Business Cycles. © 2003 South-Western College Publishing. The Business Cycle. The rise and fall of economic activity relative to the economy’s long-term growth trend. Types and Lengths of Cycles. Minor cycles relatively mild intensity, noticeable but not severe short numerous

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chapter 15

Chapter 15

Business Cycles

© 2003 South-Western College Publishing

the business cycle
The Business Cycle

The rise and fall of economic activity relative to the economy’s long-term growth trend

types and lengths of cycles
Types and Lengths of Cycles
  • Minor cycles
    • relatively mild intensity, noticeable but not severe
    • short
    • numerous
  • Major cycles
    • wide fluctuations, serious contractions or depressions
    • widespread unemployment
    • lower output
    • low profits or net losses
other types of cycles
Other Types of Cycles
  • Long-wave building cycles
  • Commodity price fluctuations
  • Stock market price fluctuations
duration of business cycles since wwii
Duration of Business Cycles since WWII

Number 10

Average duration 56 months

Longest cycle 120 months (1991-2001)

Shortest cycle 28 months (1980-1982)

Average expansion 57 months

Shortest expansion 12 months (1980-1981)

Longest expansion* 120 months (1991 - 2001)

Average recession 11 months

Shortest recession 6 months (1980)

Longest Recession 17 months (1981-1982)

*as of February, 2000

phases of the business cycle
Phases of the Business Cycle

Peak: highest level of economic activity in a particular cycle

Expansion: rising level of economic activity

Real GDP

Contraction: noticeable drop in the level of business activity

Trough: lowest level of business activity in a particular cycle


phases and measurement of cycles
Phases and Measurement of Cycles
  • Trend
    • Directional movement of the economy over an extended time, usually 20-30 years
  • Seasonal Variations
    • Recurring fluctuations in activity in a given period, usually 1 year
  • Random Fluctuations
    • Changes in activity caused by unexpected events
  • Cyclical Fluctuations
    • Changes in activity that occur regardless of trend, seasonal variations, or random forces
patterns of cycles
Patterns of Cycles
  • Two kinds of elements or forces bring about business cycles
    • Internal: elements within the very sphere of business activity itself: production, income, demand, credit, interest rates, inventories
    • External: elements outside the normal scope of business activity: population growth, wars, basic changes in nation’s currency, national economic policies, natural disasters
  • Output
  • Employment
  • Income
  • Price
  • Costs
  • Profits
  • Investment



  • External factors
  • Cost-price relationship
  • Replacement of depleted inventories
  • Low interest rates
  • Investment increases
  • Demand increases
  • Employment and income increase
  • Output
  • Employment
  • Income
  • Price
  • Profits
  • Investment



  • Output, employment, income at peak
  • Consumer demand tapers off
  • Prices level out, inventories increase
  • Costs increase, profit margins diminish
  • Demand slackens, firms reduce excess inventories
  • Output is cut, and so are income and employment
  • Investments discouraged & outlook pessimistic
business cycle indicators
Business Cycle Indicators
  • Leading Indicators
    • Group of 11 indexes whose upward and downward turning points generally precede the peaks and troughs in general business activity
  • Roughly Coincident Indicators
    • Group of 4 indexes whose turning points usually correspond to the peaks and troughs of general business activity
  • Lagging Indicators
    • Group of 7 indexes whose turning points occur after the turning points for the general level of business activity have been reached
leading indicators
Leading Indicators
  • Average work week for production workers in manufacturing
  • Rate of layoffs in manufacturing
  • New orders for consumer goods and materials
  • New business formations
  • Contracts and orders for plant an equipment
  • Vendor performance, measured as a % of companies reporting slower deliveries from suppliers
leading indicators cont
Leading Indicators (cont.)
  • Number of new building permits issued for private housing units
  • Net change in inventories
  • Change in sensitive prices
  • Change in total liquid assets
  • Changes in money supply
coincident indicators
Coincident Indicators
  • Number of employees on nonagricultural payrolls
  • Personal income less transfer payments
  • Industrial production
  • Manufacturing and trade sales volume
lagging indicators
Lagging Indicators
  • Average duration of employment
  • Change in labor cost per unit of output
  • Average prime rate charged by banks
  • Commercial and industrial loans outstanding
  • Ratio of consumer installment loans outstanding to personal income
  • Change in the CPI for services
  • Ratio of manufacturing and trade inventories to sales
real or physical causes of the business cycle
Real or Physical Causes of the Business Cycle
  • Innovation theory
    • Business cycles are caused by breakthroughs in the form of new products, new methods, new machines, or new techniques
  • Agricultural theories
    • Business cycles relate the general level of business activity to the weather
psychological causes of the business cycle
Psychological Causes of the Business Cycle
  • Psychological theory
    • When investors and consumers react according to some belief about future conditions, their actions tend to transform their outlook into reality
  • Rational expectations theory
    • Suggests that individuals and businesses act or react according to what they think is going to happen in the future, after considering all available information
monetary spending saving causes of the business cycle
Monetary, Spending & Saving Causes of the Business Cycle
  • Monetary theory
    • Business cycle is caused by the free and easy expansion of the money supply
  • Spending and saving causes
    • Underconsumption theories:cycles are caused by the failure to spend all national income, resulting in unsold goods, reduced total production, and consequent reductions in employment and income
    • Underinvestment theories:recessions occur because of inadequate investment in the economy
1991 2001 business cycle
1991-2001 Business Cycle
  • Longest cyclical expansion in U.S. history & subsequent recession one of the mildest
  • Causes of expansion
    • Usual ingredients for cyclical recovery
    • Monetary and fiscal policies conducive to economic growth
    • Rapid introductions of new applications of innovations in communication and computer technology, including Internet
1991 2001 business cycle1
1991-2001 Business Cycle
    • Productivity gains
    • Low energy costs
  • Causes of contraction
    • September 11th and its impact on travel related industries
    • Collapse of several major companies such as Enron, WorldCom, etc.
    • Declines in equity markets and their impact on personal wealth