Economies tend to have periodic expansion and contraction {economic cycle}|.
multiplicative effects
Economies cannot expand at optimum moderate rate, because expansion tends to cause more expansion, and contraction tends to cause more contraction. See Figure 1.
multiplicative effects: contraction
If economy starts to contract, people become more pessimistic. They try to save money and spend less. Demand goes down, and economy contracts more. Economic cycle is on downward curve and goes toward recession.
However, lower demand makes prices lower. Lower demand for money makes interest rates lower and money cheaper. People have saved money. Eventually, lower prices make demand increase. Lower interest rate makes saving less attractive. People can no longer postpone buying things that have worn out. People start to save less and spend more. Recession ends. Economic cycle is at downward-curve bottom.
multiplicative effects: expansion
If economy starts to expand, people become more optimistic. They spend more money and save less. Demand goes up, and economy expands more. Economic cycle is on upward curve and goes toward expansion.
However, higher demand makes prices higher. Higher demand for money makes interest rates higher and money more expensive. People have little saved money. Eventually, higher prices make demand decrease. Higher interest rate makes saving more attractive. People already have everything they need and can postpone buying things. People start to spend less and save more. Expansion ends. Economic cycle is at upward-curve top.
cycle period
If expectation changes are rapid, economic-cycle period is short. See Figure 2.
cycle amplitude
If expectation changes are large, economic-cycle amplitude is high. See Figure 3.
efficiency
For maximum efficiency, economy can minimize economic fluctuations and maintain stable business conditions. Demand and supply can balance, so prices reflect real value, not expectations about the future. Efficient economic cycles have long periods and small amplitudes. See Figure 4.
National government can dampen economic-cycle amplitudes and lengthen economic-cycle periods. During expansion, government can tax more and spend less to decrease demand. During contraction, government can tax less and spend more to increase demand. Taxation and spending rates can depend on previous economic cycles.
equilibrium
Economy is in equilibrium {equilibrium, economy} if total spending equals total costs, because prices equal costs. Economy is in equilibrium if personal savings equal business investment, plus government purchases, minus taxes, plus exports, minus imports {national income identity, cycle}, because consumption equals output. Gross national product (GNP) is in equilibrium if planned expenditures equal present output, with no excess demand or supply. Economy can be at equilibrium, but not at full employment, when demand is unequal to output.
In economies or business sectors, small sales-rate changes typically result in large investment-and-inventory changes {acceleration principle}|.
up
GNP changes direction {turning point} and goes up in response to unused production factors, too-low investment, and too-low inventory levels. In recession, unused capacity and labor lead to lower costs and excess supply, both leading to lower prices and increased demand. In recession, low investment leads to low prices and increased demand. In recession, high inventory levels lead to excess supply, and lower prices and increased demand.
down
GNP changes direction and goes down in response to limited production factors, too-high investment, and too-high inventory levels. In expansion, production-factor limitations result in reduced supply and higher costs, both leading to higher prices and reduced demand. In expansion, high investment leads to higher prices and reduced demand. In expansion, low inventory levels lead to reduced supply, and higher prices and less demand.
House or stock prices can rise much beyond reasonable value {bubble, economics}.
If national planned expenditures are too low {deflationary gap}, businesses have unused resources and lower prices {deflation}|.
National economies can have severe recession {depression, economics}|.
In good times {expansion}, employment increases. Business inventories increase. Machinery and equipment expenditures increase. Consumer durable-good expenditures increase. Durable-good production increases. Business profits increase. Tax receipts increase. Interest rates increase.
Economies can have growth but growth is too slow and results in idle capacity and high unemployment {growth recession}.
Price increases {inflation, economics}| stop by reducing demand.
demand
Excess planned business investment, decreased planned saving, and government budget deficit cause excess demand.
government
Raising interest rates decreases planned business investment. Raising interest rates can increase planned savings. Government can tax more or spend less to reduce demand. Government can change price expectations through communication with public and businesses. Higher worker wage demands make higher prices from businesses {wage-price spiral}, but government can block them.
inflation
Government receives political pressure from people with fixed incomes, because inflation reduces money value. Inflation decreases long-term lending, because money value decreases over time, and people do not want repayment with lower-value currency.
Inflation and slower-than-normal growth {stagflation} can happen together. Money supply is high, and job-creation rate is low.
If people save too much and reduce planned expenditures, GNP decreases, resulting in lower savings {thrift paradox}| {paradox of thrift}, because savings rate is lower when GNP is lower.
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Date Modified: 2022.0225