Question

Below is a recommended topic for this discussion. If your instructor chooses a different “Making the Connection” from this weeks’ readings or another alternate discussion topic, his or her chosen topic and any required work in MyEconLab or elsewhere will be in the instructors’ first posting.

Read the Making the Connection short case titled Can a Recession Be a Good Time for a Business to Expand? in Chapter 21 of our textbook, and also be sure to watch the video right under the Making the Connection title (maybe a few times). Then post your posting this week beginning to discuss what you’ve read and watched in the video.

Making the Connection: Can a Recession Be a Good Time for a Business to Expand?

MyEconLab Video

During a recession, business managers have to quickly make many decisions, such as whether to reduce production, cut prices, close stores or other facilities, or lay off workers. In addition to making decisions aimed at dealing with the immediate effects of the recession, managers have to consider how to prepare for the expansion that will follow the recession. Managers know that every recession, even one as severe as the recession of 2007–2009, will be followed by an expansion during which demand for their products is likely to increase. But it can be difficult to commit resources to future expansion when current conditions are bleak and when the end of the recession is difficult to predict.

The payoff to preparing for future growth can be very large, however. For example, at the end of World War II in 1945, many economists and business managers expected that the U.S. economy would enter a severe recession. Sears and Montgomery Ward were the two largest department store chains in the country. Robert Wood, CEO of Sears, expected continuing prosperity and moved to open new stores across the country. Sewell Avery, CEO of Montgomery Ward, expected falling incomes and rising unemployment and refused to authorize any new stores and closed a number of existing ones. As a result, when strong economic growth occurred during the late 1940s, Sears rapidly gained market share at Montgomery Ward’s expense.

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Businesses such as VF viewed the recession of 2007–2009 as an opportunity to expand operations.

Following the September 11, 2001, terrorist attacks in the United States, the managers of many hotels expected a prolonged period of reduced travel. They responded by laying off workers and postponing or canceling new construction. Isadore Sharp, the chairman and CEO of Four Seasons Hotels, decided that although the recession would severely hurt the hotel industry, the effects would be shortlived. He decided to finish construction of 18 hotels and begin construction of 10 more. By his own account: “We maintained or enhanced our market share in most regions, contrary to the predictions of various industry experts.” In a letter to his shareholders in March 2002, he wrote: “We are well positioned for the economic recovery expected later this year.”

During the severe recession of 2007–2009, managers had similar decisions to make. Based in Greensboro, North Carolina, VF Corporation is the largest apparel maker in the world. Among its brands are North Face, Timberland, and Wrangler. While many firms, such as J.Crew, Anne Klein, and Liz Claiborne, were closing stores or postponing opening new ones, Eric Wiseman, CEO of VF, pushed ahead, opening 89 stores in 2008 and 70 in 2009. One retail analyst was quoted as saying: “Unfortunately, many companies pull in the reins in a downturn, but these are often the best opportunities to grow.” Similarly, Intel, the computer chip manufacturer, decided in early 2009 to proceed with a $7 billion expansion of its factories in the United States, while many rival firms were reducing their spending on new factories as computer sales declined. Paul Otellini, CEO of Intel, was quoted as saying: “I thought it was important for a company like Intel to stand up and say we have confidence.” Heavy equipment manufacturer Caterpillar, Inc., announced that it would build several new facilities and expand some existing ones “to meet the expected increase in customer demand.”

By 2013, the recovery from the 2007–2009 recession was well under way, although much slower than a typical recovery. VF’s decision to expand appeared to have been a good one as sales and profits continued to increase. The company continued to open new stores and forecast that its sales would increase 60 percent between 2013 and 2017. The verdict for Caterpillar and Intel was more mixed. Although both firms remained profitable, Intel was suffering more than expected from a worldwide decline in computer sales as more consumers began using tablets. Caterpillar, whose sales have become increasingly dependent on demand in foreign countries, was suffering from a slowdown in growth in China and other countries. As a result, sales of its mining equipment, in particular, had been hurt.

Over the long run, though, for most firms, betting on the future of the U.S. economy has paid off.

Sources: Andria Cheng, “VF Lays Out Ambitious Growth Plan,” Wall Street Journal, June 11, 2013; Robert Sobel, When Giants Stumble, Paramus, NJ: Prentice Hall, 1999; Isadore Sharp, Four Seasons: The Story of a Business Philosophy, New York: Portfolio, 2009; Bob Tita, “Caterpillar to Expand Kansas Plant,” Wall Street Journal, August 18, 2011; Rachel Dodes, “VF Dresses Up Its Operations, Bucking Recession,” Wall Street Journal, March 31, 2009; and Don Clark, “Intel to Spend Heavily on U.S. Plants,” Wall Street Journal, February 10, 2009.

Answer 1

Deflation has negative effect on the economy, and probably more severe than inflation majorly because of the two foolowing reasons:

• Fall in purchasing power of the individuals: As the prices start going down, businesses loose their profitability because their margins start shrinking. It leads to more and more firms reducing their businesses and even shutting out the factories as long as the deflationary tendencies remain in the economy. More and more unemployment sets in and it leads to fall in purchasing power in the economy because people loose jobs. Low jobs reduce income of the consumers and hence demand of goods and services fall. There is less economic activity. There is a fall in economic growth and therefor deflation is not desired.
• Real interest rates rise: We define real interest rate as sum of inflation rate and nominal rate. For a given nominal interest rate, as inflation rate falls, there is an increase in real interest rates (as shown in the given table in the question). The high real interest rate is not healthy for the economy because the firms who borrow from the market to make investments face high cost of borrowing capital from the market (firms have to pay higher interest inreal terms). Firms postpone their investments decisions and there is a fall in investments. Fall in investment decreases the capital stock and the output growth falls.

The evidence of fall in economic growth because of both demand and supply side factors,as mentioned above, has been documented in great depression of 1930's and recent crisis of 2008.