The Business Cycle Flashcards
(21 cards)
What is the Business Cycle?
An economic cycle, also known as a business cycle, refers to the fluctuation of economic activity in an economy over time. It involves alternating periods of expansion and contraction in real economic output, employment, and other key economic indicators.
What are the Stages of the Business Cycle?
- Boom - A period when the percentage rate of growth of real GDP is fast and higher than the long-term trend
- Slowdown - A weakening of the rate of growth, real GDP is still rising but increasing at a slower rate
- Recession - A period of at least six months when an economy suffers a fall in aggregate output, employment, investment and business / consumer confidence
- Recovery - A phase after a recession, during which real GDP starts to increase and unemployment begins to fall
- Depression - A prolonged downturn in the economy and where a nation’s real GDP falls by at least 10 per cent
What is a Boom in relation to the Business Cycle?
- Consumer spending and investment high
- Business will have high demand for goods/services
- Increasing Incomes (increased competition for workers)
- Profits high (high demand for resources = prices rise can lead to inflation)
- Wages rising (potentially)
- High output due to high demand
- Steady economic growth
- Business and consumer confidence high
- High employment
What are the Causes of an Economic Slowdown?
- An economic slowdown happens when the pace of growth drops
- The economy is still growing but at a weaker pace
- A slowdown happens after a boom and often has multiple causes
- E.g. central banks might respond to an increase in inflation by raising interest rates to cool down the economy and prevent excessive inflation. Higher interest rates can slow down consumer spending and business investment, leading to an economic slowdown.
- A slowdown in global economic growth or the emergence of trade tensions can negatively impact a country’s exports and economic prospects.
What is a Recession (downturn/economic slowdown) in relation to the Business Cycle?
- A recession is a significant and prolonged decline in economic activity
- It is characterised by a contraction in various key economic indicators, such as real GDP, employment, consumer spending, business investment, and industrial production.
- A recession is typically marked by two consecutive quarters of negative real GDP growth.
- During a recession, businesses cut back on hiring or lay off workers. This leads to an increase in unemployment rates.
- Typically, business and consumer confidence falls during a recession
What are the Causes of a Recession?
- Recessions can have domestic and external causes
- Some recessions are caused by policy changes such as a significant rise in interest rates (contractionary monetary policy) or the impact of higher taxes and cuts in real government spending (fiscal contraction)
- Recessions often follow a demand or supply-side shock or a combination of both. E.g. A financial crisis that affects the stability of the banking system can lead to a credit crunch, making it difficult for individuals and businesses to access credit. The 2008 financial crisis was characterised by a banking crisis and a severe credit contraction, contributing to a global recession.
- Fall in asset prices – housing
Collapse in the supply of credit – - global financial crisis - Business Confidence drops –> Firms cut back on production –> Lay-offs of some workers –> Fall in incomes of those affected –> Rise in precautionary savings –> Retail spending drops –> Wider decline in demand and output –> Supply-chain businesses are affected –> Economy loses momentum –> Unemployment may start rising –> Housing market feels impact of a downturn –> Decline in net wealth, hurts sentiment
What are the Characteristics of a Recession?
- Falling real GDP: One of the primary indicators of a recession is a sustained decline in a country’s GDP over at least two consecutive quarters (six months). During a recession, economic output shrinks as businesses produce less, consumers spend less, and investment declines.
- Rising Unemployment: During a recession, there is usually a notable increase in the unemployment rate as businesses reduce production and cut back on hiring, leading to job losses and a rise in cyclical unemployment.
- Disinflation: In a recession, falling demand and a weaker labour market often lead – perhaps with a time lag – to a reduction in the rate of price inflation.
- Reduced Business Investment: Businesses tend to scale back their investment during a recession because of weak or falling demand.
What are the Short Term Effects of Recessions?
- Falling demand can cause more businesses to fail and profits fall
- Planned investment declines – hitting industries that make the capital goods
- A steep decline in aggregate demand causes a fall in the demand for labour
This causes a contraction in employment and a rise in cyclical unemployment - Recession causes a decline in tax revenues and more welfare spending
- The result is usually an increase in the budget deficit and a rising national debt
- Many business offer price discounts to off-load excess unsold stocks
- A deep recession risks causing a period of sustained deflation (negative inflation)
What are the Long Term Effects of Recession?
- Rising structural long-term unemployment and regional decline
- Low rates of investment can reduce the size of the capital stock
- Persistent budget (fiscal) deficits and a rising national debt leads to austerity (cut in public services)
What are the Social Effects of Recession?
- Falling real wages hits average living standards and reduces demand
- Widening inequality of income and wealth leading to rising poverty
- Social costs such as loss of social cohesion and threats to democracy
- Fall in confidence - a drop in animal spirits
- Rising cyclical unemployment
- Lower rate of inflation - with risk of deflation
- Rising facial deficit for the government
How is a Depression different from a Recession?
- A depression is a persistent and severe downturn in output and jobs where an economy operates well below its productive potential and where there can be powerful deflationary forces at work.
An economic depression is a more severe and prolonged economic downturn than an economic recession. - It lasts longer than a recession and can persist for several years
- Unemployment rates can reach very high levels and remain elevated for an extended period.
- Long-term unemployment and underemployment are common features of a depression.
Many economic historians say the line between recession and depression is crossed when unemployment rises above 10% of the labour force and stays there for several years - Depressions can include severe banking and financial crises, with widespread bank failures, credit contractions, and disruptions to the financial system.
What is a Slump (Depression) in relation to the Business Cycle?
- High unemployment
- Very weak consumer spending
- Investment low
- A decrease in profits
- Many businesses fail – therefore closures
- Decline in GDP
- Rapidly rising unemployment
- Prices start falling dramatically - deflation
What is Economic Scarring? - Hysteresis
Economic scarring refers to the medium-long term damage done to the economies of one or more countries following a severe economic shock which then leads to a recession.
Scarring can happen for a number of reasons:
- Fall in investment leading to an ageing of the existing capital stock
- Rise in long-term unemployment and economic inactivity
- Increase in business failures
- Shrinkage in the capacity of financial system to lend
What is an Economic Recovery?
An economic recovery is the phase of the business cycle that follows a recession. It may take several years for national output to recover to where it was before a recession.
What are the Causes of an Economic Recovery?
There is no single cause of a recovery. Monetary and fiscal policy decisions are important. So too, economic events in other countries.
Recovery can come from:
- Cuts in interest rates (monetary policy)
- One or more types of fiscal stimulus
- A rebound in business and consumer confidence
What is a Negative Output Gap?
- When the level of actual GDP is less than potential GDP
- Some factor resources are under-utilised e.g. demand-deficient unemployment
- Main problem is likely to be higher unemployment and possible deflation risk
What is a Positive Output Gap?
- Actual GDP is greater than the estimated potential GDP
- Some resources working beyond usual capacity (shift work & overtime)
- Main problem is rising demand-pull and cost-push inflationary pressures
What are the Problems Measuring the Output Gap?
The output gap is a measure of the difference between the actual output of an economy and its potential output.
Estimating the output gap is difficult because we cannot observe directly the supply potential of an economy directly
- Inaccurate data on the labour force for example difficulties in measuring the scale of net inward labour migration
- Problems in accurately measuring productivity
- Surveys of producers about spare capacity may be inaccurate
- Gaps in knowledge about how much businesses are investing and the potential output from new capital e.g. in digital sectors
- Uncertainties about the number of people who may have left the labour market as “discouraged workers”
- Hard to measure the amount of under-employment in the labour market at different stages of the economic cycle
What are Demand and Supply Side Shocks?
Demand-side and supply-side shocks are two different types of economic disturbances that can impact an economy’s equilibrium.
These shocks can lead to changes in various economic indicators such as prices, output, and employment.
An example of a demand-side shock is a financial crisis which reduces consumer and business confidence can lead to a sharp decline in spending, causing a demand-side shock.
An example of a supply-side shock is a sudden, unexpected rise in commodity prices. Rapid increases or decreases in the prices of essential commodities (like oil) can affect production costs and aggregate supply.
What are examples of a Demand-side Shocks?
- Economic downturn in a major trading partner
- Unexpected tax increases or cuts to welfare benefits
- Financial crisis causing bank lending /credit to fall
- Bigger than expected rise in unemployment rates
What are examples of a Supply-side Shocks?
- Steep rise in oil and gas prices or other commodities
- Lock-down due to the coronavirus pandemic
- Natural disasters causing sharp fall in production
- Unexpected breakthroughs in production technology
