Changes in the business cycle

0:00- [Instructor] So let's talk about Economic Cycles. So let me make a bigger graph here. So on the vertical axis, I'll put GDP, which you might remember stands for Gross Domestic Product. You can imagine that as just a way of accounting for, for adding up all of the productivity of an economy.

0:22And then in the horizontal axis, I will put time. Now you imagine an economy, let's say, we're at time zero or, whatever year that is. Let's say it's over here and the population grows. So it's able to produce more, people become more productive. Maybe they discover resources, all of these inputs that allow them to become more and more productive.

0:48And so you might imagine, that GDP might grow something like this. And you can imagine this line really representing the economic potential of this economy. Or you could even imagine it being the economic reality of that economy in a perfect world. Well, it turns out that the world is not quite this perfect.

1:13This would be very nice. We wouldn't have any ups and downs, so to speak. But it turns out that we do, and that's why we're going to talk about cycles. What typically might happen is, let's say that we are... That the economy is right over here. Let me do this in a different color.

1:29Let's say the economy is right over here and things become more productive and there's a lot of confidence in what's going on. People get more hopeful, more and more people get hired. Those people spend more and more money. So the economy grows even faster than this potential curve.

1:46And then it even overshoots it. And so people keep getting hired. And because there's so many demand for goods and maybe there's more demand, than even what the output can supply so that prices go higher and higher. Maybe the prices go so high, that it, at least it decreased consumer spending.

2:03People start to lose confidence. And so maybe people pull back. People start pulling back on hiring. And people lose even more confidence 'cause they say, "Oh, things are getting bad." So they start maybe saving more, spending less, and then the economy starts to go down below the potential.

2:21Now down here, you have a lot of capacity. The price increases. Maybe you might even have price... The price increase is slow, you might even have price decreases. Maybe the government gets involved and tries to stimulate the economy somehow. Maybe confidence builds for other reason.

2:36And then we go back up and we do that cycle. And then that cycle tends to happen over and over again. And it tends to be in most economies, in cycles of 5, 7, 10 years, depending on what you look at it, of going from peak to peak or trough to trough. It's not always the case, but that's just a general rule of thumb that you have these cycles.

2:57And we generally call this phase right over here, you would call that expansion. When the economy is for sure growing and, in this case, it's actually growing even faster than its economic potential. You would call this phase, right over here, where it's decreasing, you would call that contraction.

3:21Contraction. And then, of course, we have these peaks right over here. So that is a peak. And then something like this, right over there. Over here, that would be a trough. And as I talked about it, as we go through these cycles, when you are expanding, that lead...

3:42Tends to lead to higher prices because you have more and more demand for goods. So, inflation tends to go up. And because people want to produce more and more, they're hiring more and more people. So unemployment... Unemployment. Tends to go down. And then the opposite happens when we are in contractions.

4:11In a contraction, you have inflation... I'll just write "inf" for that. Inflation tends to be lower. You still might have some inflation, but it tends to be lower, not as high. And then unemployment... Unemployment. Tends to go up. And there's oftentimes reasons for this turning one direction to another.

4:35I mentioned inflation as a cause. It could be decreased consumer confidence. It might be the political environment. There might be things in the world that just make people worried up here. And for the most part it might just be unsustainable. And then down here, there might be other things that turn things around.

4:51And sometimes geopolitical events can turn things around. World War II did that. It took us out of The Great Depression, amongst other things. You might have government stimulus, where the government spends money in order to get that economy going. You might have monetary policy where, essentially money is fed into the system to loosen things so that people start spending and start investing again.

5:12But generally speaking, these cycles happen and it's good to know because a lot of times, there's been famous studies where at any given point in the cycle, you ask economists what's likely to happen, and some people just always extrapolate to where we already are.

5:26So if things were going up, people just extrapolate that they'll just keep going up. Or if things are going down, they extrapolate, they'll just keep going down. But history showed us that it tends to be a cycle and you tend to pick up from your low points, so it won't be low forever.

5:39And you tend to not always be in peak conditions, even though that's when people are often at peak confidence. And in a healthy economy, you tend to have this general upward trend of economic expansion, even though you have these cycles around it.