2.5.1 The economic cycle

What is the economic cycle?

The pattern of growth and contraction in an economy over time, including booms and busts.

What happens in a recovery?

Real output rises after a recession; the economy is growing again.

What is a boom?

A period of fast economic growth, which can be inflationary or unsustainable.

What is a recession?

A period of negative economic growth, typically defined as two consecutive quarters of decline.

What might governments do in a recession?

Increase spending (e.g., welfare), cut taxes to stimulate demand.

What happens to government budgets in a boom?

Tax revenue increases; spending on welfare falls.

Characteristics of a boom:

• High economic growth

• Near full capacity/output

• Low unemployment

• Demand-pull inflation

• High consumer and firm confidence → more investment

• Improved government budget

Characteristics of a recession:

• Negative economic growth

• Spare capacity/negative output gaps

• Demand-deficient unemployment

• Low inflation

• Low confidence → less spending and investment

• Worsening government budget

How do economic fluctuations affect firms?

Changes in average income affect demand for products; firms adjust prices, output, and focus on different types of goods.

Which goods see higher demand during growth?

Luxury goods increase; inferior goods decrease in demand.

Which goods see higher demand during recession?

Inferior goods increase; luxury goods decrease in demand.