Thursday, September 26, 2013

What Causes Business Cycles ?

Business cycles are alternating rises and declines in the level of economic activity, sometime over several years.

Phases of the Business Cycle
  •  Peak The business activity has reached a temporary maximum. the economy is near or at full employment and the level of real output is at or very close to the economy’s capacity. The price level is likely to rise during this phase.
  • Recession is a period of decline in total output,income, and employment. it's normally lasts 6 months or more, is marked by the widespread contraction of business activity in many sectors of the economy. Along with declines in real GDP, significant increases in unemployment occur.
  • Trough  the output and employment “bottom out” at their lowest levels. The trough phase may be either short-lived or quite long.
  • Expansion, a period in which real GDP, income, and employment rise.
Business cycles can be caused by two types of events: changes in aggregate demand or changes in aggregate supply.

Aggregate supply is the total output a country’s firms are willing and able to produce, contingent on the price level.Aggregate supply is based on the cost of production, which varies with the prices and availability of labor and other inputs, and of technology, human capital.any changes in aggregate supply can cause expansions or contractions.
Aggregate Supply Factors
  • Many changes in aggregate supply arise from external shocks, which are uncontrollable events or decisions made in other countries. The results can be negative or positive.for example an earthquake and tsunami hit Japan in 2011, tens of thousands of people were killed, power plants were destroyed, and ports, roads, bridges, and factories shut down.
  • The inflow of capital from China’s 2010 investment in Argentina, Brazil, Chile, and Venezuela provided a positive external shock in Latin America.
  • Weather Changes such as floods and droughts can cause a contraction by destroying crops and  making it more difficult to produce goods that contain those crops.
  • Changes in the Price of Oil , these include increased demand for oil by other countries, decisions by foreign governments to cut oil exports, and disruptions of supplies caused by war or other threats. Higher oil prices cause a decrease in the quantity of output firms will supply at any given price level, so it decrease aggregate supply. The result can be a contraction.
  • Technological Changes increases productivity or output per worker per hour. When labor is more productive, firms find it less costly and more profitable to increase production.When the change is especially rapid, it can lead to a rapid increase in aggregate supply and start the expansion phase

Aggregate demand is the total amount of domestic output purchased by all sectors of a country’s economy, contingent on the price level.
Aggregate demand Factors  
  • Changes in Household Wealth for example, when housing or stock prices rise, the many people who own them are wealthier, so they increase their spending and boost aggregate demand. But when housing or stock prices fall, their owners are less wealthy. They cut back on their spending, and aggregate demand falls.
  • Changes in Confidence when people confidence that the economy is doing well leads people to buy more consumer goods and firms to invest more in preparation for growing sales which increases aggregate demand.
  • Fear about a weak economy weakens the economy and confidence about a strong economy strengthens the economy.
  • Government Policy such as fiscal policy carried out by the government and monetary policy carried out by the central bank.
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