cyclical instability

cyclical instability

when fluctuations of the economic cycle are exaggerated

recession

negative economic growth for at least two consecutive quarters

AD will be falling, unemployment will rise and price levels will be falling

boom

when the economy is growing quickly

AD will be rising, leading to a fall in unemployment and a rise in inflation

excessive growth in credit and levels of debt

An increase in national income (in a boom) means easier access to borrowing and higher levels of confidence - levels of borrowing and debt will increase creating more AD - during recessions, higher debt and less saving cannot support spending - subsequent recessions are more severe

asset

a store of value over time

bubble

when the price exceeds the actual underlying value

asset price bubbles

increased spending on assets in a boom will lead to an increase in asset prices e.g. housing - positive wealth effect - increase in AD - bigger boom
bubble bursts - asset prices fall - negative wealth effect - leads to lower spending and exaggerates recession

animal spirits or herding (copied behaviour between economic agents)

during a boom period, businesses and people are spending - leads to other people and businesses spending - fuels AD makes the boom bigger

during recessions there is copied behaviour of lower spending and saving - makes recession more severe

examples of demand side shocks

if consumer confidence is boosted e.g. due to house prices rising this will increase consumer spending

if a country’s major trading partners go into a recession, this may significantly reduce demand for the country’s exports

examples of supply side shock

a poor harvest reduces supply of food, increase its price and reduces the economy’s capacity

the discovery of a major new source of raw materials will greatly reduce its price and increase its supply increasing the capacity of the economy