202-T&C-1(1) - Econ 202 Terms and Concepts 1 BUSINESS...

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Econ 202: Terms and Concepts 1: BUSINESS CYCLES and GDP What causes capitalized (industrialized) economies to have cycles of boom and bust? Agricultural economies can hit bad times, but genuine cycling of the economy does not emerge until the Industrial Revolution. When cycles began to appear, the first apparent symptom of a downturn was an oversupply of goods and services to the product market. This event was called “ a general glut and economists looked for the cause on the supply side of the market: why do businesses overproduce? In 1913, Wesley Claire Mitchell published the results of a longitudinal study into the behavior of prices and quantities over the course of business cycles. Together with the later work of Simon Kuznets on economic growth and the macroeconomic theory of John Maynard Keynes, Mitchell’s ideas helped create the foundation for our modern understanding of how industrialized economies behave, what economic activities we should measure, and how to measure them. Our modern view of the business cycle is that it begins and ends in the capital goods sector, where the physical capital intensity of industrial production provides a lot of employment, but only during periods of growth. The limit to growth is full employment and full production in the economy as a whole. As soon as an economy approaches full employment and can grow no further, the demand for more physical capital falls off because what is already there is enough and it will last a long time. The resulting unemployment in the capital goods sector is what provokes a downturn. But many interim effects are also important to our understanding of recessions. Phases of a Business Cycle Upturn output, employment, investment and borrowing, and prices in the product market and factor market are all rising. Let’s recall first a few things we learned in microeconomics: Law of Diminishing Returns – there is a limit to growth for individual firms once their scale of operation is established and their physical capital is fixed. But in the long run, all resources are variable so there is no limit to growth, right? But … how big can an economy get? Are there no limits anywhere? And how long is the long run anyway? • “England,” wrote Adam Smith, “is a nation of shopkeepers.” The shopkeepers of 1776 lived above their shops and ‘investment’ took the form of entrepreneurial labor. Capital investment after the industrial revolution meant pooling the financial resource of many people. Industrial capital is expensive, it is complex (the supply chain is long), and once produced it lasts a long time. 1
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Peak all of the above have reached their maximum; the upper boundary is determined by the size of the civilian labor force at full employment, the loanable funds that banks are able to offer, and the amount of physical capital available to the economy. At the peak, because no further growth is possible, those employed in the production of new capital become unemployed, and this sends the economy into the next phase.
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