Business Cycle
Unit 8 - Lesson 4
Learning outcomes:
● Define all terms in orange bold in section 8.4
● Distinguish between a decrease in GDP and a decrease in GDP growth.
● Explain, using a business cycle diagram, that economies typically go through
a cyclical pattern characterised by the phases of the business cycle.
● Explain the long term growth trend in the business cycle diagram as the
potential output of the economy.
● Explain, using a business cycle diagram, how we can understand the
macroeconomic objectives.
Introduction to Economic Growth
Economic Growth refers to the
quantity of output produced over a
period of time and usually expressed
as:
● A percentage change in Real GDP
or GNI over a period of time.
● A percentage change in Real GDP
or GNI per capita over a period of
time.
Distinguishing between a decrease in GDP and a decrease in GDP growth .
Distinguishing between a decrease
in GDP and a decrease in GDP
growth.
● Decrease in GDP is a result of a
decrease/fall in the value of
output produced.
● Decrease in GDP growth is a
result of decreasing/falling rates
of growth.
○ GDP growth in increasing at
a decreasing rate.
The Business Cycle
Real output in most countries around
the world grows over long periods of
time represented by the straight line
labeled “Long Term Growth Trend”
Over shorter periods of time, Real
output can fluctuate.
The graph to the right illustrates the
Business Cycle.
● Vertical Axis is labeled Real GDP
● The Horizontal Axis is labeled Time
Phases of the Business Cycle
The Business Cycle shows us:
● Expansion
○ Occurs when there is positive
growth in Real GDP.
■ When an economy is
experiencing an
expansion, employment
increases and general
price levels in an economy
increase.
Phases of the Business Cycle
● Peak
○ Represents the cycle’s
maximum Real GDP and is a
sign of the end of the expansion
phase in an economy.
■ Decrease use of resources.
■ General Price Levels
(Inflation) may be rising
more rapidly.
Phases of the Business Cycle
● Contraction
○ After the Peak the economy
begins to experience falling
Real GDP (Negative Growth).
○ If the Contraction lasts for 6
months or longer it is called a
recession.
■ Falling Real GDP
■ Increasing unemployment
of resources.
Phases of the Business Cycle
● Trough
○ Illustrates the minimum level
of Real GDP and the end of
the contraction.
■ May be high levels of
unemployed resources.
■ A trough is usually
followed by a new period
of expansion.
Business Cycle
The term “Business Cycle” suggests that
these periods of expansion and contraction
are regular and predictable.
In fact they are irregular and
unpredictable.
While each cycle can last for several years,
it is not possible to generalize how long
they will last.
For this reason economists call these
cycles, “short-term economic
fluctuations”.
Long term Growth Trend and Potential Output
The straight line represents the long
term growth trend for an economy.
Shows how output grows over time
when the short term cyclical fluctuations
are accounted for.
The output represented by the long
term growth trend is referred to as the
Potential Output.
Actual Output
The short term fluctuations in an economy
are represented by the times of expansion
and contraction.
This is referred to as the actual output an
economy is producing at any given time.
As the economy fluctuates in the short term it
impacts the Macroeconomic objectives of
an economy which are:
1. Low levels of unemployment
2. Low and stable price levels
3. Economic Growth
Inflationary Gap
● When the Actual Output of an economy
is greater than the Potential Output the
economy is experiencing an Inflationary
Gap.
○ Unemployment is less than the
Natural Rate of Unemployment
■ Natural Rate of Unemployment
is the unemployment that occurs
naturally in an economy.
● Structural unemployment
● Frictional unemployment
● Seasonal unemployment
Recessionary Gap
● When the Actual Output of an economy
is less than the Potential Output the
economy is experiencing a
Recessionary Gap.
○ Unemployment is greater than the
Natural Rate of Unemployment
■ Natural Rate of Unemployment
is the unemployment that
occurs naturally in an
economy.
● Structural unemployment
● Frictional unemployment
● Seasonal unemployment
Full Employment
● When the Actual Output of an economy
is equal to the Potential Output the
economy is experiencing Full
Employment.
○ Unemployment is equal to the
Natural Rate of Unemployment
■ Natural Rate of Unemployment
is the unemployment that occurs
naturally in an economy.
● Structural unemployment
● Frictional unemployment
● Seasonal unemployment
Why we study the Business Cycle?
Economies desire to have economic growth over long periods of time
represented by the upward sloping long term growth trend (potential output).
Growth in output allows citizens of that country to experience higher incomes
and improved standards of living.
However, large cyclical fluctuations in the actual output is not desirable for an
economy.
During the upward phases of the business cycle when the economy is
experiencing an inflationary gap price levels may rise rapidly (inflation).
When the economy faces a recessionary gap citizens may experience
increasing levels of unemployment and falling incomes which negatively
impacts the macroeconomic objective of economic growth.
Macroeconomic Objectives
● Reducing the intensity of
expansions and contractions of the
actual output aiming to ensure the
actual output is as close to potential
output as possible.
● In doing so this will lessen the
problems to society that arise from
increasing price level during
inflationary gaps and
unemployment during a
recessionary gap.
Macroeconomic Objectives
● Increasing the steepness of the
long term growth trend (potential
output) of the economy illustrated
on the graph to the right.
● By doing so the economy will
experience more rapid economic
growth over a longer period of
time.
Over the course of Macroeconomics
we will analyse ways that country’s try
to achieve these Macroeconomic
Objectives.
