Hey everyone, I'm Mr. Willis and you will love economics. Okay, so macroeconomics is the study of the aggregate economy as a larger whole, including its interactions with other economies. It's the big picture. Unlike microeconomics, which investigates individual markets, macroeconomics analyzes all firms and all consumer... and every facet of the collective economy.
In essence, macroeconomics was created to measure the health of the economy and then guide policy to help the economy reach optimal performance. In this unit, we're going to focus on reading economic indicators and measurements that help tell us the health of the economy. But there's one graph that shows it all. The business cycle.
You see, every society on Earth has three economic goals they wish to accomplish. Promote long-run economic growth. Prevent excessive unemployment.
and keep prices stable by limiting inflation. Because the business cycle is a visualization of economic conditions, it's a graph that can show us how societies are doing with meeting those goals. And this is the business cycle. Let's start with the basics. First, the business cycle is measured by two components.
Real GDP over time. Real GDP is the total output produced by the economy. And time is usually measured in years.
Okay, whoa, what's up with the roller coaster here? That blue line with up and down fluctuations is the economy's real GDP output over time. In other words, it tells us where we've been and where we currently are. Real GDP can increase over time, meaning the economy is growing and getting bigger. This is called a period of expansion or recovery.
Real GDP will continue to grow until it reaches a peak, which is the highest level of real GDP growth before the economy begins to immediately contract. Real GDP can also decrease over time. meaning the economy is shrinking or getting smaller.
This is called a period of contraction or recession. Real GDP will continue to shrink until it reaches a trough, which is the lowest level of real GDP contraction before the economy begins to immediately expand. These fluctuations continue in an up and down pattern for months, quarters, or even years at a time.
There are two causes of real GDP fluctuation. The first are static effects, which are natural market fluctuations caused by changes in the free market conditions. Changes in consumer behavior or productivity of firms can cause these fluctuations to occur. And these changes are, well, cyclical. Economic fluctuation brought about by static effects means that when the economy expands, it usually is followed by a period of contraction.
And when the economy contracts, it's usually followed by a period of expansion. It's just the way the economy is. The second cause are known as shocks.
Shocks are unpredictable events, like wars or financial panics or natural disasters, that serve as sudden... abnormal catalysts of contraction or expansion in the economy. Events like World War II, the September 11th attacks, or Hurricane Katrina are great examples.
These events can either be positive or negative for the economy and can help drive the economy towards expansion or contraction. Either way, fluctuations that occur due to static effects or shocks that are too big mean the economy is unstable. And if the market does not return to normal on its own, policymakers will attempt to stabilize the economy to prevent excessive unemployment that results from contraction. and limit inflation that results from expansion.
So, how does this graph tell us how we're doing with the economic goals of promoting economic growth, preventing unemployment, and limiting inflation? This red line here? It's called the growth trend line. It's upward sloping because it represents the optimal rate of real GDP growth over time that the economy wants to achieve with the full employment of all available resources. It's used to compare where we are, wherever that might be on that blue real GDP line, compared to where we want to be.
With that growth rate comes an acceptable rate of inflation. It's natural to have inflation over time. It's the reason why we can't get a 15-cent cheeseburger at McDonald's anymore, or a $1 gallon of gas.
When the economy grows at a rate faster than optimal, the economy experiences excessive inflation of prices as the economy overheats. The level of excessive inflation is visualized by the space between the peak and the growth trend line on our business cycle. A peak of any type means the economy is failing to satisfy the goal of limiting inflation.
because inflation is above the acceptable rate at the growth trend line. When the economy contracts, the economy experiences excessive unemployment, as jobs are lost when the economy shrinks. The level of excessive unemployment is visualized as the space between the trough and the growth trend line on our business cycle. A trough of any type means the economy is failing to satisfy the goal of preventing unemployment, because excessive job loss is occurring because the economy is contracting instead of growing.
One business cycle is defined as a peak, Trough, peak. And business cycles will vary in length and severity. Some cycles are short and shallow, while others can be deep and long. The higher the peak, the more excessive the inflation.
The deeper the trough, the more excessive the unemployment. The longer it takes real GDP to return to the growth trend line, the longer the excessive inflation or unemployment persists in the economy. So when peaks and troughs occur, the economy may return back to the growth trend line on its own.
But when it doesn't, Policies will be used by the federal government and the Federal Reserve to limit the peaks and the troughs in order to minimize excessive inflation and unemployment and return the economy to the optimal conditions at the growth trend line. And let's be clear, while economic contraction can be called recession, an economic recession is classified as two straight fiscal quarters or six straight months of real GDP contraction. And a depression? Oh man, it's severe and prolonged recession with incredible unemployment.
and deep real GDP contraction. I'm depressed. And that's the business cycle. Be sure to subscribe to the channel by hitting the red button below so you can receive alerts about new videos when they become available.
If you enjoy the channel or find my videos useful, let me know by liking the video or feel free to leave a comment below. We have full video lectures on every topic in macro and microeconomics, as well as quick macro and micro minute videos for cram sessions and quick reviews. If you'd like to learn more, You can click here for all of my Introduction to Economics videos, or click here for my Gross Domestic Product video. Thank you so much for watching. I'll see you next time on You Will Love Economics.