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macro / ch 8

8.4The business cycle

2 min read · 3 sections

the cyclical pattern and phases of the business cycle

  • Expansion
    • occurs when there’s positive growth in real GDP
    • employment of resources increases
    • general price level of the economy(an average over all prices) begins to rise more rapidly, inflation
  • Peak
    • represents the cycle’s maximum real GDP
    • unemployment of resources has fallen substantially
    • the general price level may be rising quite rapidly
    • experiencing inflation
  • Contraction
    • following the peak, the economy begins to experience falling real GDP(negative growth)
    • if the contraction lasts six month(2 quarters) or more, it is termed as recession
    • falling real GDP
    • growing unemployment of resources
    • increases in the price level may slow down a lot, or it is even possible that prices in some sectors may begin to fall
  • Trough
    • represents the cycle’s minimum level of GDP, or the end of contraction
    • widespread unemployment
    • followed by a new period of expansion(also known as recovery)

Cyclical fluctuations, potential output and output gaps

  • there will be an output gap when the actual/real output/gdp is higher/lower than the potential output/gdp

short-term fluctuations and the long-term growth trend or potential output

  • how unemployment relates to actual and potential output
    • real GDP grows in the expansion phase, unemployment falls; real GDP falls in the contraction phase, unemployment rises;
    • in an expansion, real GDP increases because firms produce more ouput. To do this, they hire more labour and other resources, so unemployment falls.
    • in a contraction, real GDP decreases because firms produce less output. They hire less labour(lay off workers) and other resources, so unemployment rises.
    • at every economy, there’s a level of real GDP at which the economy experiences “full employment”
      • this is known as the full employment level of output
      • at full employment, there’s still some unemployment, know as the “natural rate of unemployment”
        • because at any time, there are people who are in between jobs, some who are moving from one geographical are 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
        • therefore, there are always some people who are unemployed
    • potential output(long term growth trend)
      • this is the level of output produced when there is full employment, meaning that the unemployment is equal to the natural rate of unemployment
      • 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 higher than the natural rate