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Reading 15: Understanding Business Cycles (Inflation (Inflation indices…

- - - - Early Expansion
        
        Sale grows --> Inventory/ sale ratios decrease
      - Early Contraction
        
        Sale slows --> Inventory/ sales ratios increase
    - - Early Expansion
        
        Labor and Capital are used more intensively
      - Early Contraction
        
        Labor and Capital are use less extensively
    - - Determined by
        
        Mortgage rates: Higher the rate, Lower the activities
        
        Income/ housing cost: More in come, more activities
        
        Speculation: Home purchases based on expected price increases
        
        Demographics Household formations, geographic shifts in population density
    - - Import depend on domestic business cycle
      - Export depend on foreign business cycle
      - Foreign exchange rate
        
        Domestic currency APPRECIATES
        
        Import rises
        
        Export falls
        
        Domestic currency DEPRECIATES
        
        Export rises
        
        Import falls
  - - - Cause of Business cycle: changes in technology.
      - Recommend: allowing wages and prices to adjust
    - - Cause of business cycle: Excessive optimism/ pessimism among business causes Aggregate Demand to change
      - Contractions can persist because downward sticky wages
        
        New Keynesian: other input prices are also downward sticky
      - Recommend: Use fiscal/ monetary policy to restore full employment
    - - Cause of Business cycle: Government intervention in economy
      - Recommended policy: Don't force interest rate to artificially low level
    - - Cause of Business cycle: Rational responses to external shocks, technology changes
      - Recommended Policy: Don't intervene to counteract business cycles
    - - Cause of business cycle: Inappropriate changes in money supply growth rate
      - Recommended Policy: Steady, predictable growth rate of money supply
- - - - Inflation rate
        Annual percent increase in price index
      - Hyperinflation: Out-of-control high inflation
    - - High inflation, slow economic growth and high unemployment
      - As there is no good short-term intervention, economy is left to self-correct
  - - - Consumer Price Index
        
        \( (CPI)=\frac{Cost_{current}}{Cost_{base}}\times 100 \)
        
        Limitation: overstate true rate of inflation
        
        Biases
        
        Consumer substitution of lower-priced products for higher-price ones
        
        New goods replace older, lower-price ones
        
        Price increases due to quality improvement
      - Price index for personal consumption expenditures: Weights based on surveys of businesses instead of surveys of consumers
      - Producer price index: Crude materials, intermediate goods, finished goods prices
  - - - Formula: (for goods C at time t)
        \( P_{Laspeyres}=\frac{\sum (p_{c,t_{n}}\times q_{c,t_{0}})}{\sum (p_{c,t_{0}}\times q_{c,t_{0}})}\)
      - Cons: new goods, quality improvements, and consumer's substitution of lower-price goods for higher-price goods overtime cause bias upward.
    - - Formula: \( P_{Paasche}= \frac{\sum (p_{c,t_{n}}\times q_{c,t_{n}})}{\sum (p_{c,t_{0}}\times q_{c,t_{n}})}\)
    - - \( P_{Fisher}= \sqrt{P_{Laspeyres}\times P_{Paasche}}\)
  - - - Increase in wages or other producer input prices --> Decrease short-run aggregate supply (SRAS moves to left) --> Stagflation (higher price but lower output) --> Government intervenes --> increase aggregate demand (AD moves to right)--> move output back to previous level but with higher increased price level
    - - Money supply or government spending increases --> Aggregate Demand increase (AD moves to right), causing higher price and higher output level --> higher wage (may due to higher price) --> Short-run supply decreases (SRAS moves to left) --> output back to normal but at even higher price