PeakPeak

TroughTrough

Recovery

Recovery

Recession

Recession

PeakPeak

The Business Cycle and Economic Activity

1. What is the difference between a decrease in GDP and a decrease in GDP growth?

2. Explain the cyclical pattern of economies using the business cycle diagram

3. Explain the concept of potential output and its relationship to the “output gap”

Remember:

• Economic growth-increases in the quantity of output produced over a period of time (year) and expressed as:– %change in real GDP/GNI over period of time– %change in real GDP/GNI per capita over a period of

time– i.e., real GDP in 2004 was $50bil and increased to

$51bil in 2005, rate of growth is ((new-old/old)*100), so rate of growth was +2%

• Remember, %change representing growth is not always positive value; if real GDP has fallen, it will be negative– real GDP in 2006 was $60bil and decreased to $57bil

in 2007, rate of growth is ((new-old/old)*100), so rate of growth was -5%

Remember…

The same information shown on the business cycle can be shown on a production possibilities curve:– Full employment– Unemployment– Inflation

The shifters of the PPC affect GDP:– Change in

quantity/quality of resources

– Changes in technology– Changes in trade

Why is economic growth the goal of every society?

• Provides better goods and services

• Increases wages and standard of living

• Allows more leisure time

• Economy can better meet wants

Decrease in GDP vs. GDP growth

• Decrease in GDP-fall in the value of output produced, such as ex. #2 on last slide

• Decrease in GDP growth- falling rates of growth, though rates of growth may be positive (see ex )

Year Real GDP ($bil)

Real GDP growth

2007 210.0 ---

2008 215.5 2.6% (increasing GDP)

2009 219.5 1.9% (increasing GDP, falling GDP growth)

2010 223.1 1.6% (increasing GDP, falling GDP growth)

2011 217.0 -2.7% (decreasing GDP, negative GDP growth)

•Real output in most countries grows over long periods of time, but output growth is uneven and irregular

•business cycle -recurrent fluctuations in -recurrent fluctuations in

growth of real output (“ups and downs”) in the growth of real output (“ups and downs”) in the

level of economic activitylevel of economic activity• Alternating periods of Alternating periods of expansion

(increasing real output) and (increasing real output) and contraction

(decreasing real output)(decreasing real output)• Individual business cycles may vary greatly in Individual business cycles may vary greatly in

duration and intensity duration and intensity • All display a set of phasesAll display a set of phases

Business CyclesBusiness Cycles(aka (aka economic fluctuations)economic fluctuations)

THE BUSINESS CYCLETHE BUSINESS CYCLEPhases of the Business CyclePhases of the Business Cycle

Expansion• Expansion occurs

when there is positive growth in real GDP (upward sloping parts of curve)• During these periods:– Employment of

resources increases– General price level

(average overall prices) begins to rise rapidly

– Beginning of inflation

PEAKPEAK

Time

GROWTHGROWTH

TRENDTREND

Peak (prosperity phase): Peak (prosperity phase): •Real output in the economy is at a high Real output in the economy is at a high level (max real GDP)level (max real GDP)

• Marks end of expansionMarks end of expansion• Unemployment is low Unemployment is low • Domestic output may be at Domestic output may be at

capacity (price level increases capacity (price level increases rapidly)rapidly)

• Inflation may be highInflation may be high

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Contraction (recession) phase:Contraction (recession) phase:•Recession Recession – government determinant of two consecutive – government determinant of two consecutive

quarters (6 months) of declining outputquarters (6 months) of declining output • Real output is decreasing (falling real GDP, negative Real output is decreasing (falling real GDP, negative

growth)growth)• If the recession is prolonged, price may decline If the recession is prolonged, price may decline

(deflation) (deflation) • As contraction continues, inflation pressure fadesAs contraction continues, inflation pressure fades

• Unemployment rate is risingUnemployment rate is rising

Lev

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Time

RECESSIONRECESSIONGROWTHGROWTH

TRENDTREND

Lev

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Time

TROUGHTROUGH

GROWTHGROWTH

TRENDTREND

Trough (depression) phase:Trough (depression) phase:• Minimum (lowest) point of real GDP Minimum (lowest) point of real GDP

• end of contractionend of contraction• Widespread unemployment; output at lowest Widespread unemployment; output at lowest

pointpoint• may be short- or long-termmay be short- or long-term• no precise way to tell where decreased no precise way to tell where decreased

output (serious recession) becomes a output (serious recession) becomes a

depressiondepression

PeakPeak

TroughTrough

One cycleOne cycle

Recovery

Recovery

Rea

l GD

PR

eal G

DP

per

yea

rp

er y

ear

Recession

Recession

TimeTime

PeakPeak

Business Cycle-one cycle through 4 phasesBusiness Cycle-one cycle through 4 phasesBusiness Cycle-one cycle through 4 phasesBusiness Cycle-one cycle through 4 phases

Recessions since 1950 show that duration and Recessions since 1950 show that duration and depth are varied:depth are varied:

PeriodPeriod Duration in monthsDuration in months DepthDepth (decline in real GDP)

1953-541953-54 1010 — 3.0%— 3.0%1957-581957-58 88 — 3.5%— 3.5%1960-611960-61 1010 — 1.0%— 1.0%1969-701969-70 1111 — 1.1%— 1.1%1973-751973-75 1616 — 4.3%— 4.3%19801980 6 6 — 3.4%— 3.4%1981-821981-82 1616 — 2.6%— 2.6%1990-911990-91 88 — 2.6%— 2.6%20012001 88 app. —3.3% app. —3.3%

Innovation Innovation

Political eventsPolitical events

Random eventsRandom events

Wars Wars

Level of consumer spendingLevel of consumer spending

Seasonal fluctuationsSeasonal fluctuations

Cyclical Impacts — durable and non durableCyclical Impacts — durable and non durable

Causes of FluctuationsCauses of FluctuationsCauses of FluctuationsCauses of Fluctuations

An Actual Business CycleAn Actual Business Cycle1981 - 1990 ($ billion, 1992 dollars)1981 - 1990 ($ billion, 1992 dollars)

An Actual Business CycleAn Actual Business Cycle1981 - 1990 ($ billion, 1992 dollars)1981 - 1990 ($ billion, 1992 dollars)

Real GDP

PeakPeak

PeakPeak

TroughTrough

One CycleOne Cycle

‘80 ‘85 ‘90

4600

5200

6000

82

Case study (extra info):

The Great Depression

The Great DepressionThe Great Depression

The Great Depression [continued]The Great Depression [continued]

Great Depression StatsGreat Depression Stats

Ave. Unemployment Rate, 1925-1928Ave. Unemployment Rate, 1925-1928

Ave. Unemployment Rate, 1929-1933Ave. Unemployment Rate, 1929-1933

Percent Decrease in Prices, 1929-1932Percent Decrease in Prices, 1929-1932

Global Depression, 1929-1932Global Depression, 1929-1932

Six Million “Rosie the Riveters”Six Million “Rosie the Riveters”

World War II Production of these items brought us out World War II Production of these items brought us out of the Great Depression.of the Great Depression.300,000 warplanes300,000 warplanes124,000 ships124,000 ships289,000 combat vehicles and tanks289,000 combat vehicles and tanks36 billion yards of cotton goods36 billion yards of cotton goods41 billion rounds of ammunition41 billion rounds of ammunition2.4 million military trucks2.4 million military trucks111,527 tank guns and howitzers111,527 tank guns and howitzers

•$288 billion$288 billion was spent on the war, was spent on the war, •$100$100 billion in the first six months. billion in the first six months.

Unemployment hit an all-time low of Unemployment hit an all-time low of 1.2%1.2% and personal savings were 25.5%. and personal savings were 25.5%.