Economics Chapter 12: ECONOMIC CHANGES AND CYCLES

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1 Ecnmics Chapter 12: ECONOMIC CHANGES AND CYCLES SECTION 1 Inflatin and Deflatin What Is Inflatin? Inflatin is an in the level, r the average level f prices. Hw D We Measure Inflatin? If the price level increases frm ne year t the next, the ecnmy is experiencing inflatin. One way f determining inflatin is t lk fr in the cnsumer price index ( ). Fr example, if the CPI increases frm 180 in ne year t 187 in the next year, the inflatin rate is 3.89 percent. Between 1960 and 2006, the United States experienced wide fluctuatins in inflatin rates. Apprximately what was the highest rate during thse years? (Answer: percent) Apprximately what was the lwest rate? (Answer: percent) Demand-Side Versus Supply-Side Inflatin Inflatin can riginate n either the demand side f the ecnmy r the supply side f the ecnmy. If aggregate demand (aggregate = the whle ecnmy) and aggregate supply the same, will ccur. Demand-side inflatin ccurs when an in the price level riginates n the demand side f the ecnmy. Demand-side inflatin can be caused by an increase in the. Supply-side inflatin ccurs when an increase in the price level riginates n the supply side f the ecnmy. The Effects f Inflatin Inflatin increases the that peple must n particular gds r services. It can affect peple n fixed incmes, savers, and partners in cntracts. Inflatin reduces the buying pwer f peple n fixed incmes, such as r prceeds. If the inflatin rate is than the interest rate earned n savings accunts, the mney in thse accunts lses. As time ges n, savers will be able t buy fewer gds with the same amunt f mney. Over time, inflatin can eat up the factred int a lng-term cntract. As the csts f supplies and labr increase during the length f the prject, the prfit that was factred int the cntract begins t disappear. T against inflatin is t try t avid r lessen a lss by taking sme cunterbalancing actin. Peple try t figure ut the best against inflatin by investing in items such as gld, real estate, and art.

2 What Is Deflatin? Deflatin is the ppsite f inflatin. Deflatin is a in the price level, r the average level f prices. A dwnward change in the CPI indicates deflatin. Demand-Side Deflatin Versus Supply-Side Deflatin Like inflatin, deflatin can result frm a change in price r a change in supply. Fr example, if aggregate demand and aggregate supply stays the same, will ccur. A Majr Effect f Deflatin When prices fall, they d nt all fall at the time. When prices d nt fall at the same time, deflatin can lead t firms ging ut f and wrkers being. These are cmmn results during times f deflatin. Ecnmics: Applying the Principles Chapter 12: Ecnmic Changes and Cycles In questins 1-4, calculate the percentage change in the CPI and then indicate whether inflatin r deflatin has ccurred. Rund answers t the nearest tenth f a percent. 1. In 1974, the CPI was 46.6, and in 1975, the CPI was In 1949, the CPI was 24.0, and in 1950, the CPI was In 1997, the CPI was 159.1, and in 1998, the CPI was In 1930, the CPI was 17.1, and in 1931, the CPI was Why is deflatin ften destructive t an ecnmy? Answer: As prices fall, s des ttal revenue. This will cause businesses t fail and wrkers will be laid ff.

3 SECTION 2 Business Cycles What Is a Business Cycle? A business cycle includes swings (up and dwn) in real f an ecnmy. Ecnmists usually talk abut five phases f a business cycle. 1.. At the peak f a business cycle, real GDP is at a temprary high. 2.. If real GDP decreases, the ecnmy is said t be in cntractin. A ccurs when real GDP falls fr cnsecutive quarters. 3.. The lw pint in real GDP, just befre GDP turns up, is called the trugh. 4.. The recvery is the perid when real GDP is rising. 5.. The expansin refers t increases in real GDP beynd the recvery. What Causes the Business Cycle? Between 1945 and 2005, the United States went thrugh business cycles. What causes a business cycle? Cause Hw it leads t expansin Hw it leads t cntractin Mney Supply Business investment, residential cnstructin, and gvernment spending Plitics Innvatin Supply shcks An increase in the mney supply means peple buy mre gds and services, leading t an ecnmic expansin. When business r gvernment spending increases, aggregate demand rises. The increase in emplyment leads t further increases in spending. Members f Cngress may pass spending bills t imprve their chances f reelectin. This increase in spending increases aggregate demand, leading t ecnmic expansin. If a cmpany develps a new technlgy r prduct, investment spending increases fr the innvatr s cmpetitrs. The increase in investment spending leads t ecnmic expansin. Supply shcks lead t ecnmic cntractin, nt expansin When the mney supply drps r the grwth rate in the mney supply declines, peple end up buying fewer gds and services, which leads t an ecnmic cntractin. When business and gvernment spending decrease, aggregate demand falls. The resulting decrease in emplyment leads t further decreases in spending. If inflatin becmes a prblem, pliticians may cut spending t lwer aggregate demand, which may lead t an ecnmic cntractin. Eventually, investment spending tends t slw and the ecnmy cntracts. War and shrtages f necessary resurces reduce the prductive capacity f an ecnmy. The ecnmy cntracts, real GDP falls, and the unemplyment rate rises.

4 Frecasting Business Cycles Let s cmpare the ecnmy t yur health: 1. In the first stage, yu feel a little sluggish and tired. These feelings are indicatrs, letting yu knw that smething may be wrng. In an ecnmy, leading indicatrs ecnmic upturns r dwnturns. 2. When yu are ill, yu might have a bad headache r a stuffed-up nse. These are indicatrs, r indicatrs that cincide with yur illness. In an ecnmy, cincident indicatrs will ecnmic upturns r dwnturns. 3. When yu are recvering frm an illness, yu may cntinue t experience a slight headache r a runny nse. These are indicatrs f yur previus cnditin. The same hlds true fr members f an ecnmy: they may ntice indicatrs that lag ecnmic upturns r dwnturns. SECTION 3 Ecnmic Grwth What Is Ecnmic Grwth? Abslute real ecnmic grwth is an increase in GDP frm ne perid t the next. Per capita real ecnmic grwth is an increase in per capita real GDP frm ne perid t the next. Per capita real GDP is real GDP divided by. Per Capita Real GDP Grwth and the Rule f 72 The Rule f 72 states that the amunt f time it wuld take fr any variable t is equal t 72 divided by the variable s percentage rate. Fr example, if a variable is grwing at 10 percent, it will duble in 7.2 years: 72 divided by 10 equals 7.2. Ecnmic Grwth and a Prductin Pssibilities Frntier The prductin pssibilities frntier (PPF) shws us pssible cmbinatins f gds that an ecnmy can prduce in a certain perid f time. Using a PPF, we can shw what ecnmic grwth lks like. An ecnmy can grw frm a pint the PPF because sme resurces in the ecnmy are currently. Mvement frm a pint belw the PPF t a pint n the PPF is f ecnmic grwth. Real GDP is higher at the pint the PPF than it is at the pint the PPF. When an ecnmy already resides n the PPF, the nly way fr it t experience ecnmic grwth is by the frntier t the.

5 What Causes Ecnmic Grwth? Factrs that cause ecnmic grwth include natural resurces, labr, capital, human capital, technlgical advances, and incentives. With mre natural resurces, a cuntry can prduce gds and services. With mre labr, a cuntry can prduce mre. An increase in f existing labr will als cause ecnmic grwth. Capital investment can lead t increases in prductivity and therefre lead t increases in utput r real GDP. Human capital can als affect ecnmic grwth. Human capital is the and that peple use in the prductin f gds and services. Human capital includes hnesty, creativity, and perseverance traits that lend themselves t finding wrk. Technlgical advances can make it pssible t btain mre frm the amunt f resurces. Technlgical advances may result frm new capital gds r new ways f prducing gds. Sme ecnmists argue that ecnmic grwth develps where peple are given the t prduce and innvate. Tw Wrries Abut Future Ecnmic Grwth Grwth can cme at a great cst. Ecnmic grwth may mean mre, mre, and mre cities, alng with increased scial and psychlgical issues. Cntinued ecnmic and ppulatin grwth may bring us t a time when there is n clean air r water, and n land fr peple t live n cmfrtably. Per capita real GDP is ften used as a measure f standard f living. Use the Rule f 72 t answer questins If the annual grwth rate f per capita real GDP is 1%, yur standard f living will duble in years. If the annual grwth rate f per capita real GDP is 2%, yur standard f living will duble in years. If the annual grwth rate f per capita real GDP is 3%, yur standard f living will duble in years. If the annual grwth rate f per capita real GDP is 4%, yur standard f living will duble in years. If yu culd rule the United States fr a day, what changes wuld yu make t ensure future ecnmic grwth?