Chapter 4: Inflation, Real GDP, and Business Cycles TEAM 6 - - PowerPoint PPT Presentation

Chapter 4: Inflation, Real GDP, and Business Cycles

TEAM 6 JANUARY 21, 2020

What is inflation?

Consider a basket of goods in 1913 The cost of this basket is $100

What is inflation?

Now consider the same basket a century later in 2013 This same basket of goods costs $2,363 ...THIS IS INFLATION!

What is inflation?

Inflation is a sustained increase in the average price level. Inflation occurs when the percent weighted average of prices increases.

Measuring Inflation

GDP Price Index Consumer Price Index Producer Price Index

Hyperinflation

• Hyperinflation occurs when a nation's price increase

above 50% per month for a sustained period of time Examples:

• Revolutionary War - Continental Congress issued

too many bills of credit to pay for the war

• Post-World War I Germany - It was so bad that

pickpockets would steal tissues rather than money

Example of Countries with Very High Inflation Rates, 1973-2008

Deflation

• Deflation is when national price levels decline
• Occurs when there are increases in the supply of all

goods and services and/or reductions in demand

REAL GDP vs. NOMINAL GDP

GDP=C+I+G+(X−M) Nominal GDP is the market value of all goods and services produced within a country during a given period using that year's prices, known as current prices. Real GDP measures the output of a country by using constant prices rather than the "current prices" used in nominal GDP. This takes away the effect of changes such as inflation and deflation. Adjusting nominal GDP to real GDP uses the GDP price index/GDP deflator as the "base year" prices.

Business Cycles and How They're Measured

• A recession occurs when there is a significant contraction in

economic activity that is spread broadly across the economy and last more than a few months

• An economic expansion occurs when broad-based economic

activity improves significantly and lasts for more than a few months

• The entire business cycle can be measured peak to peak or

trough to trough

• To identify the phases, a nation must measure its real

economic activity → Based on Real GDP

• Business cycles are

recurring, irregular, and unsystematic movements in real economic activity around a long-term trend

• No matter what nations

do to attempt to prevent economic downturn, they have always occurred

Exhibit 4-8: Recessions and Expansions During the Business Cycle

Causes of Business Cycles

• These can be random shocks, that if anticipated and planned

for could prevent dramatic changes in economic activity.

• Production and spending patterns adjust as the economy reacts

to the unexpected movements, and these adjustments work their way through the economy, causing cumulative changes in economic activity that are larger than the initial shock.

• Cash flows, being tied directly to companies’ top-line growth

and costs can be sensitive to economic fluctuations. The cash flows of companies whose sales and or costs are tied closely to the business cycle are typically more volatilethan those that are not.

• A good example of a relatively high-risk industry is the durable

goods (cars, furniture, phones, major appliances, etc.) industry because its sales are tied strongly to the business cycle.

• There is no single cause
• f business cycles.
• Business cycles can be

caused by supply-side or demand-side factors that

• riginate in domestic-based
• r foreign-based real,

financial, political, and social sectors.

Exhibit 4-9

Procyclical, Countercyclical, and ndAcyclical MacroeconomicVariables

• Procyclical variables – move in the same

direction as the business cycle and economic activity

• Countercyclical variables – move in the
• pposite direction
• Acyclical variables – move independently

from the business cycle

Business cycles are very hard to predict

• Because changes in economic activity can be caused by a very broad range and combination of

economic variables.

• Predicting future economic activity, especially turning points, is also difficult because forecasts

are usually extrapolations of historic trends, or they are based on historic interrelationships.

• One way to forecast business cycles movements is by using a nation’s index of leading economic

indicators (LEI), which help predict changes in business cycles and are chosen based on their economic significance, reliability, consistency, timeliness, and conformity to past business cycles.