The business cycle | Aggregate demand and aggregate supply | Macroeconomics | Khan Academy

The business cycle | Aggregate demand and aggregate supply | Macroeconomics | Khan Academy


Let’s make a plot of real GDP as a function of time. This axis right over here is going to be real GDP, so it’s an actual measure, not just nominal GDP. It’s an actual measure
of the goods and services produced by an economy or the productivity of an economy. Over here let’s have time. In our little country or whatever economy we’re studying here, let’s assume that over time its population is growing. Let me write these things down. So, population is growing over time, and this is not an unrealistic assumption, this is true of most countries. Population is growing over time. Also, let’s assume that
productivity is improving. Productivity … Productivity is just essentially how much can each individual person produce? Productivity. Productivity is going up. Productivity goes up due to technology, probably mainly technology, technology Mainly technology, but there could be discoveries of resources. Discovery of resources … Or it could be new business processes. People wouldn’t even consider that maybe technology, so new processes. On a per person basis, they’re able to produce more and more over time. Because of these trends, and these are trends that do take place over long periods of time in
many, many economies, you would expect the real productivity of that economy to increase. If you were to just do the long-term trend just based on these two things, the population growing and
productivity improving, over time, real GDP should have a trend something like that. That is the long-term trend of most properly functioning economies. When you look at it on the short-term, it doesn’t look like a nice, smooth trend line like this. When you study any major
economy in the world, or any economy, any normal economy, instead of going this
nice, smooth trend line, it tends to look something more like this. Real GDP will be going really fast, maybe higher than trend line, and then all of a sudden, it will essentially recede, or it will essentially shrink. Then it’ll start growing again, maybe go above the trend line, then it’ll recede …
Go below the trend line. Then it’ll go above the trend line, it’ll just keep fluxuating around a trend line like that. This fluxuation around this trend line, this is called the business cycle. This right over here
… And you could maybe call one cycle, you could say it’s from one peak to one peak or one trough to one trough, or whatever you want to call it, it’s this idea that the economy isn’t just a nice, steady-as-you-go growth, you have periods of fast growth going maybe above the trend line, and then it recedes, then it expands, then it recedes. This is the business cycle. Business cycle. The term “cycle” is a
little bit misleading. Whenever you think of a cycle, even the way I drew it,
it kind of looks like a nice well-defined pattern and every the same amount of years you’re going up and down, it kind of implies that it’s predictable. The reality is that the business cycle is very unpredictable. And economists more than anyone have trouble predicting
the business cycle. When you think of a cycle, it’s not this nice, sinusoid pattern, it’s much, much more unpredictable. It does fluxuate up and down above a trend, but it’s hard to predict. Hard to predict. In general, you don’t have the same period of time between every peak and every trough. That is why it is so hard to predict. There are different terms for different phases of the business cycle. I kind of used it just in describing what was happening. Over here, where the economy is growing, so the economy is growing
from there to there, from there to there, we would call this phase of the business cycle, I’ll highlight that in green, we would call that expansion because the economy is
literally expanding. There’s more goods and services being produced in that economy. Then when, and we’ll talk about the reasons why this is happening, and then when it starts to shrink, the economy starts to shrink, this right over here, or
you could call it “recedes”, if you think of it in a title analogy, this right over here is
called a “recession”. This right over here is a … So that purple part right over there, is a recession. If a recession is bad enough, it is sometimes categorized
as a “depression”, and there’s different
categories for a depression; there’s the famous joke,’ “When your neighbor loses
his job, it’s a recession. When you lose your job,
it is a depression.” The interesting thing
is we see this pattern happening, whether it’s every 8 years, 7 years, every 10 years, but we don’t fully understand exactly why it’s happening. What we’re going to try to attempt to do in the next few videos is look at models that do attempt to explain it. That’s actually the whole purpose why we’re going to study aggregate demand and aggregate supply. With that said, I want you to view those models with a huge grain of salt because those are, I would argue, overly simplified economic models that don’t take into consideration probably the most important factor in the economic cycle or any type of market cycle, and
that is human emotions. Human emotions. You might notice in most of our studies of economics so far, we haven’t really talked a lot about human emotions or human’s tendencies to extrapolate the recent past, or human’s greed or risk of fear and greed,
and all of these things, that are very real things because in traditional economics, they don’t fit neatly into the models. There are new fields
in behavioral economics and behavioral finance that do try to take into account things
like human emotions, but it’s not going to make its way into the models that we’re going to study in aggregate supply and aggregate demand. The reason why I say human emotions, and because just based on, I spent I think it was six or seven years in markets while I was an analyst at an investment firm, it
was very clear to me that what drove market cycles and economic cycles to a large degree, was based on human emotions. That what you have happening over here is that the longer time, once again, this isn’t what you would classically learn in
your freshman economics class, I’m just going to say this … Before we start studying the classical one, because I think this
does give a better sense of what’s probably happening
in an economic cycle. Right over here when the expansions phase is starting, people
are still skeptical. They’ve just been through this, people were getting laid off over here, people were losing their jobs, people were having
trouble paying the bills, companies had very low profits or maybe no profits at all, bankruptcies were occurring, so even though the economy is starting to expand right over here, people were kind of skeptical. In the recent past, they
remember all of this pain so they don’t want to go out there and start spending money. They don’t want to go out there and start investing. The further and further
they go from that point, and I’m just explaining the emotional aspect of the economic cycle which I think is probably the most powerful one, the further and further
they go away from this, they say maybe this is for real. Maybe this is really happening. Their memories of that pain are more and more distant. Their memories of all the risk, the memories of all the layoffs and the bankruptcies become more and more distant and then they become
more and more confident and more and more eager to invest. They start investing and spending more and more, they start hiring, and because of all of that, they see fewer and fewer bankruptcies, fewer and fewer layoffs, hiring is starting to occur, people are getting more and more and more optimistic, so the economy keeps growing. When you go to points right around here, it’s been a long time since anyone really talked about major
layoffs and bankruptcies, and foreclosures and all the rest. People over here are feeling
super, super confident and they’re probably underplaying risk at this point. They’re investing money, they’re spending money
like there’s no tomorrow because they think there will always be good growth. They’re essentially extrapulating the recent past. They think, and there’s actually even been studies that show
that even economists, when you ask them at this point, what’s the foreseeable future going to look like, they tend to extrapulate the recent past. They say the recent past, we were growing like that, so in the future
we will grow like that. At this point, essentially people are being too bullish, they’re
being too optimistic and they’re probably
misallocating investment. As soon as things don’t grow as people expect, they start getting
a little bit fearful, but they’re still in denial at this point, they get a little bit more fearful, but here they say, “Oh my God, something is going on.” They start panicking,
layoffs start happening, economy recedes and then we have the entire cycle again. To kind of understand
this emotional aspect of it, this is something I redrew. I redrew a graph that always gets kind of chain mailed around or sent around usually during every bubble when people start becoming skeptical of the growth and economy. It traditionally refers
to stock market cycles. Stock market cycles are closely linked to actual economic cycles. I think these words really do capture the emotional sentiment of what’s going on in either during the business cycle or during a stock market cycle. Right when we’re in the
middle of an expansion, people are pretty optimistic. A little bit further into it, people are feeling excitement. They’re saying, “Maybe this
is a new type of thing. Maybe we’re going to be
able to grow forever.” Then there’s a thrill that people, just the last few years, all they do is they remember making money. They say, “I’m going to put all my money in the stock market. I’m going to start buying Pets.com and whatever else.” Then there’s euphoria. They’re just like, “Wow, easy money. I don’t have to work for a living. I can just keep flipping houses or buying stocks of Pets.com,”
or whatever else, day trading. Then all of a sudden, you have some signs that maybe there was some bad investment, that people’s investments weren’t turning out as good as they expected. People get a little
anxious, but then as you still foresee this, they start denying it. Some people say, “Are we
in a recession thing?” “No, no, no, no, we’re not in a recession. It’s been so long since
we were in a recession. Things are different this time. The internet changes everything. Housing never goes down.” But then as it continues, as the recession really does continue, they start to get fearful,
they start saying, “Maybe this is something going on,” then desperate, then panic, and that’s when people really, if you think of a stock market cycle, really start to sell in the case of a regular business cycle, they start to maybe underspend, they start to really hoard things, then capitulation …
This is when they say, ‘ “Things are just bad. They’re never going to get any better,” and then they become despondent and eventually,
you could even say, emotionally people start getting depressed because they say it’s been so long since we’ve felt all of these good emotions right over here. As any good investors will tell you, “This is the best time to invest.” “This is the worst time to invest.” Even though there’s maybe a little bit of growth right over here, it’s been so long since we’ve experienced all of these emotions.
People are depressed, but then as the growth continues, They start to feel
hopeful, a little relieved, they say, “At least we’re not getting worse and worse,” and then you get back to optimism again. So keep this in mind because in my mind, the emotions really are the main factor that are playing in either stock market
cycles or economic cycles. We we study it kind of classically in an economics class, we’re going to take human emotions a bit out of the picture, which is a little bit artificial because they might be the most
important part of the picture.

82 comments

  1. @DackIsBack I only chose ad hominem, because all you said was unfounded claims without substance. If you actually back up your claims, I will respond properly.

  2. Mr. Khan, you seem to be a highly knowledgeable and diligent student of science. I sincerely hope that one day you put down the Keynes, and pick up the Mises. I guarantee you, Mises and praxeology are far more consistent with the true sciences than Keynes and his "animal spirits." Ludwig Von Mises, Human Action. The Ludwig Von Mises Institute is giving it away on their site. It pains me that a man with your credibility and intelligence is living without understanding Human Action.

  3. FiatTubing, you shouldn't downgrade Sal's credibility. From this video alone I can say that he would probably be very interested in the works of Mises, Hayek, Friedman, etc. The Austrian economists offer a lot to the study, and there's nothing more satisfying than a "new" knowledge on old problems. Mr. Khan, I would surely like to recommend any of the major works by the three economists/thinkers mentioned above.

  4. Salman Khan was a hedge fund analyst. I'd venture to say what you perceive to be his economic philosophy is something he has arrived to logically and can authoritatively back up.

  5. it either goes up or down right. so it's a model that really doesn't have much value. but i'll pretend i believe it coz i am taking econ.

  6. I wish people would eat less junk food, everyone would be more productive, and the entire pie would grow, and people, even those who used to make money off junk food, would have more to their name.

  7. yes you are completely right. What is said in this video is wrong. "A recession is a period of 2 consequtive quarters of negative growth." A depression on the other hand is just like a recession but much more severe . Like the great depression of 1929. The recession of 2008-2010 can also be called a depresion because of the severity of it.

  8. A depression is a more severe recession. But recession is still 2 consequtive quarters of negative growth therefore the term recession in the video is wrong. It should be called a slowdown or a contraction. Source of my information is "Essentials of Economics by John Sloman"

  9. Human emotions? But isn't the "human emotions" (to some degree) influenced by the interest rates (which can be manipulated by the central bank) on indicators of whether to make investments or not?

  10. Yep, all the emotion in the world can't create massive real estate, stock, and commodity bubbles without the trillions of dollars in central bank created credit that have always fueled them. When the author blames emotion for the business cycle he confuses cause and effect. The central bank policy fuels the bubble/bust, Keynes' "animal spirits" simply follow.

  11. I say no, because all the emotions in the world can't create trillions of dollars in credit out of thin air. Only the central bank and the fractional reserve multiplier can do that.

    But trillions of dollars in newly created credit can certainly cause asset price increases that fuel the "animal spirits" in businesses and investors. JMHO.

  12. These are great, you explain econ well and are quite fair. Very non ideological. Glad you did mention human emotions (human action??) because an economy is not really a thing, but just us, all of us. There is history, stats, graphs and charts and they DO help but can't view economics as purely mathematical.
    Khan Academy are you ever gunna touch on the Austrian School? I know its controversial and even ridiculed but since the late 80s I think they have some relevancy

  13. There's probably some truth to that. Ultimately they probably just magnify what is already happening. When things are bad people assume they are getting worse and when things are good people assume they'll get better.

  14. It's my understanding that there's no standardized definition of depression. There's even some criticism over basing the definition of recession just on GDP growth.

  15. Let's begin with the very use of GDP as a measurement. Is it a measurement of the health of the economy? Well, not really, because GDP increases with every dollar spent by government at all levels — whether the revenue is acquired via taxation, by actual borrowing from others in credit markets or by issuance of debt in exchange for currency balances created by the Fed out of thin air. (more to follow)

  16. There is no real business cycle. Booms-to-busts occur every 18-20 years linked to property markets. And, these markets are driven by speculation in land; which, in turn, is exacerbated by easy and cheap credit — and, most importantly, the very low effective rate of taxation on the "rent" of land. Hence, in the real economy a leftward leaning supply curve for land, with intensifying stress on uses of residential, commercial and all land forms. See Mason Gaffney's writing for a complete analysis.

  17. Umm…you're confusing real and nominal GDP. None of this has anything to do with real GDP measurement. We could talk about shifting curves through forward looking prices, but that's another story.

  18. As I am sure you are aware, there is even among economists great concern over the reliance on GDP as a measurement of real economic growth. And, more to the point, GDP growth tells us nothing about changes in the distribution of income or wealth in a society, or other factors that contribute to a stable society.

  19. Sure, real GDP is not the final word in economic health — and economists also work with measures of income and wealth distribution. Even most neoclassical economists are careful when making normative statements about growth, talking-head pundits aside. But that's not to say that real GDP is useless as an analysis tool or a benchmark for growth.

  20. Are you familiar with the Genuine Progress Indicator developed by Redefining Progress? Although far from perfect, the GPI is a much more useful tool for evaluation of public policy choices. Even if one is focused just on economic growth I would rather rely on net growth in the stock of capital goods.

  21. I've not heard of it or used it. After a quick glance my immediate reaction is that, while it sounds nice to include many externalities in a single index, I imagine it has some fairly serious identification issues. That's to say, many of the measurements: loss of leisure time, ozone depletion, crime, etc. likely just find themselves in endless debate…or at least they should. It'd be better to get at these things through a model, no?

  22. The real point of constructing the GPI was (and is) to bring to light the shortcomings of measurements long embraced by the economics profession. Similar quality of life measurements have crept their way into the research and writings of environmental economists. The problem is mainstream models is that they arbitrarily treat nature as a produced (i.e., capital) good, rather than the source of goods, capital and consumer.

  23. You guys should check out this EXTRAORDINARY website called FIREPA.COM . You can make money online and start working from home today as I am!

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  24. I wouldn't know. You'd have to tell ME what Central Bank Interest Rate manipulation is.
    I need the remedial guide for Economics for Dummies. I need Economics for Hopeless near-retards.
    That's no insult. I'm just not Mathtastic in any way, shape or form. I want to be better than I am right now, but I don't live in a dreamworld. I know Math is my most difficult subject.
    That and Business Administration.

  25. My friend, the one I used to try to impress, likes Paul Krugman and Bernie Sanders. He has no problem saying so.
    But he also likes Bill Gates in terms of business people.

  26. hi vicki! i would love to explain it to you but i dont have quite enough room here in the comments section. can you add me as a contact please so i can send a private message?

  27. I'm just watching some of these videos for a review for my macro final, so I already have a bit of knowledge of this stuff. So I heard him talk about human emotions and how that isn't taken into account in the GDP models, and I just thought, "Yes!! He's against Keynesianism just as much as I am!!"

  28. Real GDP is actually going to increase exponentially over time. However, economists often graph the natural log of GDP, which is indeed a straight line as you have graphed. But you may want to make that clear in the video.

  29. The problem with this presentation is that GDP is not really a measurement of economic growth, only the amount being spent by all players in an economy. This includes all government spending, whether the revenue is raised via taxation, via borrowing in the credit markets or by monetary expansion orchestrated by the central bank.

    The most important externality is not "human emotion." Rather, the most important variable is systemic: the structure of property law and taxation that (as explained by Joseph Stiglitz) triggers "rent-seeking" (e.g., land and resource speculation) over the production of goods and delivery of value-adding services.

    A much more insightful explanation of business cycles is provided in the March 2015 issue of the American Journal of Economics and Sociology. Papers by Professors Fred Foldvary (San Jose State) and Mason Gaffney (emeritus, University of California) are of particular value because these two professors accurately forecasted the 2008 financial and economic crisis.

  30. One can argue that these "emotions" or "animal spirits" (as Keynes called the same, just to point out which economic school is taught on this channel) are simply the result of a centralized economy. Or to be more specific that centrally set incentives for all economic agents result into aggregate motion in the same direction (either towards expansion or contraction), if these centrally set incentives are successful to some degree.

    This is because in principle the bankruptcy of particular economic agent is the opportunity of a more efficient other agent, because the more efficient is enabled to acquire liquidated resources and / or market shares of the bankrupt agent. From a theoretical standpoint these motions into a different direction cancel each other out, so from the aggregate perspective, the whole problem is that this mechanism doesnt work there resulting into an aggregate motion in one direction, which one can call forced expansion.

  31. You fail to mention productivity improvements due to capital accumulation, which seems like a huge oversight. You don't need to invent new things or discovery new resources to increase productivity. Building new real estate doesn't involve an increase in technology, resource discovery, or business processes, but it does boost economic output per worker by virtue of increasing output without increasing workers.

  32. Thanks a lot for the video! Can anyone recommend papers or textbooks to read up on the influence of human emotions on the business cycles?

  33. Fed fund rate/inter bank lending rate cycles corolates almost perfect and is obviously the reason for the business cycle

  34. can someone explain pls
    what is the difference between business cycles, economic cycles and financial cycles?

  35. can u help me guiz… i have an assignment about HICKS. in subject mark1 need to explain with the suplorted documents…

  36. As someone who teaches aspects of economic theory to college students, I find this lesson very distressing. It strongly suggests that emotion is the primary driver of investment decisions. This is deeply misleading, and it obscures key drivers of the business cycle, especially the effect of the upward the distribution of profits. It has been well-understood for at least a century that the pooling of profits undercuts aggregate demand (we can call this the paradox of thrift, or whatever). Even Henry Ford clearly understood this. Emotions cannot account for the business cycle.

  37. what the hell with these our Department Teachers… they didn't really knows the method of teaching… Thank you for the Video…

  38. Good explanation, although it is not the only one. there are few other theories of business cycles that are worthy of interest. I would like to see an explanation of the Austrian theory, Monetary or even Marxist..

  39. Ok so not only does this guy help me pass my ap biology and calculus tests, but HE CAN HELP ME WITH COLLEGE ECONOMICS NOW???? WHAT A GOD!

  40. Ate my dinner to this instead of reading the textbook; the result? 70% on the midterm! Your handwriting is wonderful by the way. Thanks a million!

  41. What acctually causes points of return? When we are in a recession, how does acctually expansion start and vice verca?
    Good vid, thanks ahead!!

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