CHAPTER 2Business

Cycles

CHAPTER 2Unit 1

The composition and Features of Business

Cycles

The composition and features ofbusiness cycles

A time series that shows what happens to the value of the domestic output (GDP) of the economy over time.

starts to rise after a long time fallingreaches highest point and then starts to fallclimbingfalling still climbingstarting to rise rising rapidly

falling ‘the sky is the limit’at its lowest rises after a slow start

rising fallingcontinues to rise hits rock bottom

at its lowest rising on all itemsrising, especially on luxury items falls

at its lowest risesrises to highest point falls

rises to its highest point about to go uprises more than previously falls

still climbing starts to fallhits rock bottom rises, but slowly

CHAPTER 2Unit 2

Explanations of the Business Cycle

Explanations of the business cycle

2 schools of thought: ExogenousEndogenous

Exogenous Theory

• Classical Economists – 19th century• market economies are inherently stable• Exogenous factors cause business cycle• William Jevons sunspot theory– business cycle was caused by periodic changes in

solar radiation

Other exogenous variables • changes in the money supply,• government policies• technology– railways 19th century– radio communication in the 1920– Internet in the1990s

Endogenous Theory

• John Maynard Keynes – Keynesian Theory• inherently unstable - caused by endogenous e.g. change in

total spending.

• An increase in total spending • period of expansion

• reinforced by the multiplier• economy reaches its capacity (full employment)

• firms decrease their investment spending• multiplier process goes into reverse• output of the economy to decline

Followers of the endogenous theory believe that gov. SHOULD intervene to minimise effects of cycle.

• Answer Activity 1 - pg 49 Q 1.1 – 1.4• Answer Activity 2 - pg 52 Q 1.1 – 1.3

CHAPTER 2Unit 3

Government Policy

Government Policy SA’s economic system based on Keynesian view so government intervenes.

They apply policies to affect business cycles to ensure that:• economic growth (increase in real GDP) is maintained• inflation and unemployment are as low as possible• periods of expansion last as long as possible• periods of contraction last as short as possible• the troughs and peaks are smoothed out (the economy is

more stable).

Instruments at the gov’s disposal are…

Fiscal policyFiscal policy: how the government’s budget is used to raise and spend money to influence economic activity.

Contractionary Fiscal Policy

Opposite is true for an expansionary fiscal policy

Economy expanding too quickly

increase taxation (leakage)

decrease expenditure (injection)

Consumption & Gov

Spending fall

Decreasing AD slows economy

Monetary policy: policy of central bank regarding money supply and interest rates to influence economic activity.

Supply of money influenced by…• Interest rates• Buying and selling of gov bonds• Increase/decrease cash reserve requirements of

commercial banks• SARB governor can persuade commercial banks to

lend less in booms and more in recessions.

Monetary policy

Expansionary Monetary Policy

SARB decrease

s repo rate -

interest rate

follows

More money is available

Spending increases

Demand increases

Supply increases

Economic activity

increases

Opposite is true for a contractionary monetary policy

CHAPTER 2Unit 4

The New Economic Paradigm

The new Economic Paradigm

New economic paradigm: government focuses less on fine-tuning and more on eliminating uncertainties with regard to fiscal and monetary policy.

WHY???Fine tuning requires precise knowledge at the right time – not always possible.

Instead…• Create ec stability • Encourage high rates of ec growth without

inflation• Combine demand and supply-side policies

Demand-side policies Supply-side policiesMonetary policy Providing infrastructure

Fiscal Policy Decreasing red tape

Subsidies to firms

Decrease corporate tax

Improve quality and mobility of labour force

Free business advisory services

Review competition policy

Answer Activity 3 – pg 56 Q 1.1 – 1.3

CHAPTER 2Unit 5

Features underpinning forecasting with

regard to business cycles

Leading, Lagging and Coincident Indicators

Leading indicators: change before the economy changes.

• Warn of what we can expect in the future - economists use them to forecast.

• Reach peaks/troughs a few months before the business cycle reaches

Examples • volume of mining production• total number of new cars sold• share prices• number of new businesses registered

Lagging indicators: change only after the economy has changed.

• Indicate what has already happened in the economy. • Confirm direction of the economy. • Used to estimate whether individual indicators gave

false signals. • Reach a peak/trough months after the business cycle

Examples…• hours worked in construction• Employment• investment in capital goods

Coincident indicators: change at the same time as the economy.

• Information about the current situation of the economy.• Move simultaneously with the economy. • Reach peak/trough at the same time as the business

cycle • Used to compile business cycle.

Examples …• real GDP• Unemployment• volume of manufacturing• production

Methods of forecastingDone using quantitative or qualitative scientific methods

Quantitative method based on mathematical models, statistics and historical time series data.

Extrapolation and moving averages

By using moving averages (purple line), we can smooth out volatile data (blue line) and identify the trend more easily. This allows for more accurate extrapolation of the trend (red line).

Answer Activity 4 – pg 60 Q 1 – 3