Goals:

• Describe the four phases of the business cycle
• Explain causes of inflation and deflation
• Identify the importance of interest rates

Key Terms:

• business cycle
• prosperity
• rescession
• depression
• recovery
• inflation
• price index
• deflation

Lesson 2-2    Economic Conditions Change

• Economists have observed that economic activity tends to move in cycles.
• Business Cycle – the movement of the economy from one condition to another and back again.
• Four Phases of the Business Cycle:
• Prosperity – a period in which most people who want to work are working, businesses produce goods and services in record numbers, wages are good, the rate of GDP growth increases.
• Demand is high
• This period is usually the high point in the business cycle
• The economy usually cools off and activity slows down
• Recession – a period in which demand begins to decrease, businesses lower production, unemployment begins to rise, and GDP growth slows for two or more quarters of the calendar year.
• This phase may not be too serious or last very long
• Often it signals trouble for workers in related businesses, this is called the ripple effect.
• Eventually, production weakens throughout the economy
• Total output declines
• Some recessions last for long periods as fewer factors of production are used and total demand falls
• If a recession deepens and spreads throughout the entire economy, the nation may move into the third phase.

Depression – a phase marked by a prolonged period of high unemployment, weak consumer sales, and business failures.

• GDP falls rapidly in a depression.
• The U.S. has not had a depression since the Great Depression of 1930 – 1940.
• Economic downturns do not go on forever. A welcome phase of the business cycle, known as the recovery, begins to appear.

Recovery – the phase in which unemployment begins to decrease, demand for goods and services increase and GDP begins to rise again.

• People gain employment.
• Consumers regain confidence about their futures and begin buying again.
• Recovery may be slow or fast
• As it continues, the nation moves back to prosperity.
• Consumer Prices
• Inflation –an increase in the general level of prices.
• Buying power of the dollar decreases
• Most harmful to people on fixed incomes
• Inflation may cause those whose incomes are fixed to be able to afford fewer goods and services
• Causes of Inflation
  • When demand for goods and services is greater than the supply
  • Even though wages tend to increase during inflationary times, the prices of goods and services usually rise faster than wages increase – the wage earner seems to never catch up.
  • Most people think inflation is harmful.
  • Consumers pay higher prices
  • Workers have to earn more money to maintain the same standard of living
  • Producers may receive higher prices for the goods and services the sell
  • If wages go up faster than prices, businesses tend to hire fewer workers
  • Unemployment goes up
  • Measuring Inflation
  • Inflation rates vary
    • U.S., late 1950s and early 1960s - 1% to 3%
    • U.S. Late 1970s and early 1980s – 10% to 12%
  • Mild Inflation (2% to 3%) can actually stimulate economic growth
    • Wages rise more slowly than the price of products
    • Prices of products sold are hih in relation to the cost of labor
    • Producer makes higher profits and tends to expand production and hire more people
    • The newly employed workers increase spending and the total demand in an economy increases.
  • Consumer Price Index – a number that compares prices in one year with prices in some earlier base year
    • There are different types of price indexes
    • CPI is based on a group of selected items
    • People may not buy the exact items used to calculate the index
    • The cost of necessities may increase faster than that of nonessential items
    • Resulting in a reported inflation rate much lower than the actual cost-of-living increase being felt by consumers
• Deflation – a decrease in the general level of prices
• The opposite of inflation
• Usually occurs during periods of recession and depression
• Prices of products are lower, but people have less money to buy them
• Significant deflation occurred is the U.S. during the Great Depression.
  • From 1929 to 1933 prices declined about 25%
• Deflation may occur for specific products
  • Computers and the electronic products
  •  
• Interest Rates – represents the cost of money  
• Interest rates have a strong influence on business activities
• Companies and governments that borrow money are affecte by interest rates
• Higher interest rates mean higher business costs
• Consumers are affected by interest rates
• The earnings you receive on your savings
• Consumers are also borrowers
• People with poor credit ratings pay a higher interest rate than people with good credit ratings
• Types of Interest Rates – many types of interest rates exist in every economy. They represent the cost of money for different groups in different settings.
• Prime Rate – the rate banks make available to their best business customers, such as large corporations
• Discount Rate – the rate financial institutions are charged to borrow funds from the Federal Reserve banks
• T-bill Rate – is the yield on short-term (13- week) U.S. government debt obligations
• Treasury Bond Rate – the yield on long-term (20 year) U.S. government debt obligations
• Mortgage Rate – the amount individuals pay to borrow for the purchase of a new home
• Corporate Bond Rate – the cost of borrowing for lartge U.S. Corporations
• Certificate of Deposit – the rate for time deposits at a savings institution
• Changing Interest Rates – each day the cost of money (interest) changes because of various factors.           
• The supply and demand for money is the major influence on the level of interest rates
• As amounts saved increase, interest rates tend to decline. This occurs because more funds are available.
• When borrowing by consumers, businesses, and government increases, interest rates are likely to rise.

Assignment - Labor Statistics

Working individually:
The Bureau of Labor Statistics provides data on a variety of economic activities such as wages, consumer spending, inflation, and productivity. Access the web site www.school.cengage.com/business/introtobiz click on the link for Chapter 2 and click on Net Bookmarks. Select one of the data categories. What is the importance of this data? What recent trends have occurred for this data? How might these data trends affect future economic activity?