Business Cycle - LeFonch

Economic Fluctuations

Ideally all countries would have a steadily growing economy with low unemployment and slowly increasing prices (low inflation).
This would lead to the fulfillment of key macroeconomic objectives: economic growth, full employment, and price stability.
However, it is often very difficult to try and fulfill these goals and economies are often unstable.
Economies that use GDP go through variations, where economic activity is increased or decreased over time.
These variation can be described using the business cycle.

Most countries economies grow over long periods of time but generally fluctuate.
Sometimes economic output might be higher whereas other times it might be slower or even decrease.
The business cycle simplifies these changes into 4 distinct phases, the expansion, the peak, the contraction and the trough.

The business cycle can be graphed by putting Real GDP in the y-axis and Time (usually in years) in the x-axis.
The resulting graph appears like an upwards-sloping sine-wave function.
The cycle has 4 stages, those being the trough, expansion, peak, contraction that repeat in that order.

The trough is a low point in the graph and the peak is the high-point in the wave.

The expansion is from the trough to the peak and contraction is from the peak to the trough.
During the expansion there is positive economic growth and during the contraction there is negative economic growth.
Even though there are ups and downs, there is generally an upwards trend. This trend indicates the average economic growth level.

Employment of resources is the use of resources such as materials, people and time.
Employment of resources increased and decreased depending on the stage of the business cycle.
An economy is considered to be in full employment if all readily available resources are used.

The expansion is from the trough to the peak and contraction is from the peak to the trough.
During the expansion there is positive economic growth and during the contraction there is negative economic growth.

A recession is when there are 2 or more consecutive quartiles (6 months) of negative economic growth.

Even though there are ups and downs, there is generally an upwards trend. This trend indicates the average economic growth level.

An expansion occurs when there is positive growth in real GDP, shown by those parts of the curve in that slope upward.
During expansions, employment of resources increases.
The general price level begins to rise due to increased demand (inflation)

Economic growth slows down at the peak.
Unemployment of resources is generally low, although it begins to increase beyond this point.
The economy is likely to experience inflation.

The contraction occurs right after the peak and it is when the economic growth begins to decrease.
The economy begins to experience falling real GDP (negative growth), shown by the downward-sloping parts of the curve.

Demand decreases.
Wages are often decreased.
Prices in some sectors may fall (deflation).
Increased unemployment.
Unused capacity (low economic employment).
If the contraction lasts six months (two quarters) or more, it is termed a recession, characterized by negative economic growth and increased unemployment of resources.
If it the decline in real GDP is more than 10% it is called a depression.

A trough is the lowest point in a contraction.
A trough is followed by a new period of expansion (also known as a recovery), marking the beginning of a new cycle.

The term "business cycle suggests a phenomenon that is regular and predictable, whereas business cycles are in fact both irregular, as they do not occur at regular time intervals, and unpredictable.
For these reasons, many economists prefer to call them 'short-term economic fluctuations.

While each cycle typically lasts several years, it is not possible to generalize, as there is wide variation in how long the cycle lasts, as well as in intensity (how strong the expansion is and how deep the contraction or recession is),
Expansions usually last longer than contractions These are the reasons why the curve in has an irregular shape.

In graphs that show economic fluctuations you can also see a straight line slowly going up.
This shows long term growth.
This represents average growth over long periods of time (many years) and is known as the long-term growth trend.
The long-term growth trend shows how output grows over time when cyclical fluctuations are ironed out.
Real GDP fluctuates around potential GDP.

When real GDP fluctuates, it does so together with other macroeconomic variables.
Such as the employment or unemployment of resources.
One of the most important of these is unemployment of labour, or how many people in the workforce are out of work.
When real GDP grows in the expansion phase, unemployment falls; in the contraction phase when real GDP falls, unemployment increases.
In an expansion, real GDP increases because firms produce more output; to do this, they hire more labour (and other resources) and unemployment falls. -In a contraction, real GDP falls because firms cut back on production; as they lay off workers, unemployment increases.

For every economy, there is a level of real GDP at which the economy experiences 'full employment'.
This is when a state employs the reasonable maximum of employment.
This is known as the full employment level of output, or full employment level of real GDP.
There is still some unemployment during full unemployment, called the natural rate of unemployment.
This is because at any time, there are some people who are in between jobs, some who are moving from one geographical area to another, some people who are training or retraining to be able to get a new or better job, and some people who are temporarily out of work.

Potential output (shown by the long-term growth trend) is the level of output produced when there is 'full employment' meaning that unemployment is equal to the natural rate of unemployment.
But when actual GDP is greater than potential GDP, unemployment is lower than the natural rate; when actual GDP is less than potential GDP, unemployment is greater than the natural rate.

Exercises

Business Cycle Exercise

Sources