This document defines key terms related to business cycles and fluctuations such as recessions, peaks, troughs, expansions, and leading economic indicators. It describes the typical phases of a business cycle as consisting of recession, trough, expansion and peak. It also discusses some common causes of business cycles, including changes in investment and innovation, monetary policy decisions, and external shocks. The document notes that leading economic indicators and composite indexes can be used to forecast changes in GDP and the timing of recessions and recoveries.

1. Chapter 13 –
Economic Instability
Section 1 – Business Cycles and
Fluctuations

2. Vocabulary
O Business cycles – regular ups and downs
of real GDP
O Business fluctuations – rise and fall of real
GDP over time in an irregular manner
O Recession – first phase of business cycle;
period during which real GDP declines for
at least 2 quarters
O Peak- where recession begins; point
where real GDP stops going up

3. Vocabulary
O Trough – where recession ends; the
turnaround point where real GDP stops
going down
O Expansion – second phase of business
cycle; period of recovery from recession
O Trend line – steady growth path that
economy would follow if periods of
recession and expansion did not occur
O Depression – state of the economy with
large numbers of people out of work,
acute shortages, and excess capacity in
manufacturing plants

4. Vocabulary
O Depression scrip – unofficial currency that
towns, chambers of commerce, and other civic
bodies issued
O Leading economic indicator – a statistical series
that normally turns down before the economy turns
down and vice versa
O Composite index of leading economic indicators –
monthly statistical series that uses a combination of
10 individual indicators to forecast changes in real
GDP
O Econometric model – mathematical model that
uses algebraic equations to describe how the
economy behaves

5. Business Cycles:
Characteristics and Causes
O Phases of Business Cycle:
O See illustration
O Most agree the Great Depression of 1930’s
was only US depression in 20th century
O Changes in Investment Banking
O When economy is expanding, businesses
expect future sales to be high, so they
invest heavily in capital goods
O When companies start to cut back, this can
lead to layoffs and recession

6. Business Cycle (con’t)
O Innovation and Imitation
O When a business innovates, it has an edge on
competitors and sales go up
O Other businesses follow and investment
increases
O Once the innovation takes hold, economic
activity may slow down
O Monetary Policy Decisions
O When the Fed lowers interest rates, it becomes
easier for private sector to borrow and invest
O External Shocks
O Wars, increase in oil price, international conflict
(9/11 attacks)

7. Forecasting Business Cycles
O Example of a leading economic indicator: length of
average work week
O If people work fewer hours, this may signal a
recession
O Composite index of leading economic indicators
(LEI) is made up of 10 individual indicators that
forecast change in GDP
O Can predict recessions that never happen
O On average, index turns down 9 months before
recession
O On average, index turns up 4 months before recovery