Business Cycle

Business cycle

an economic model which describes the fluctuations in economic activity over time

• the cycle is characterised by four phases:

  • boom (peak)

  • contraction (downswing)

  • trough

  • expansion (upswing)

recession

a phase of the business cycle defined as two successive falls in quaterly real GDP

why is the business cycle important

• helps predict long term growth trends - forecast economic activity

• allowing companies to plan investment and government to develop policy

• macroeconomic policy is designed to

  • make the long term trend as steep as possible

  • to reduce the size of fluctuations

economic shocks - positive shocks

• a positive economic shock will cuase an increase in economic activity reflected by an increase in production, employment and income

  • example: an increase in China’s growth rate, a sharemarket boom

economic shocks - negative shocks

• a negative economic shock will cause a decrease in economic activity reflected by a decrease in production, employment and income

  • example: a natural disaster, a pandemic, sharemarket crash

expansion / upswing phase

expansion / upswing phase: a period during which real GDP increase

• a phase between the trough and peak of the cycle

• the initial part of the expansion, just after the trough, is often referred to as the recovery phase

• consumer confidence rises after the trough, resulting in higher consumer spending

• business confidence rises after the trough, resulting in higher investment spending

• production rises

• employment rises to meet demand

• unemployment rate falls

• share prices increase as expected profits rise

• real GDP increase - the growth rate is positive

• the rate of inflation rises

peak / boom phase

a period when growth activity is above average - the highest point of expansion before a contraction

• high levels of confidence

• high levels of consumption especially on consumer durables

• high profit levels

• little spare capacity and supply bottlenecks

• low levels of cyclical unemployment

• high levels of labour market participation

• inflationary pressure: demand pull and cost push

• high levels of borrowing

• governments introduce contractionary economic policy to reduce level of activity and inflation in the economic

  • government policy could include rising interest rates (monetary policy) to discourage borrowing and consumer spending, and increasing taxes (fiscal policy) to reduce spending

contraction / downswing phase

level of business activity starts to fall

• returns to investment begins to fall as labour and capacity shortages occur (bottlenecks)

• slower growth in spending, output and income

• rise in uncertaintly

• profits are squeezes by rising costs (as a result of bottlenecks)

• happens more quickly than an upswing

• the downswing may be dramatic if accompanied by other economic headlines such as a stock market crash or falling asset values

• government policity introduced from boom will start to have an effect - fall in investment and consumer spending

• a contraction is a recession if there are 2 or more quaters of consecutive negative economic growth recorded.

trough phase

level of AE is below economy’s potential

• levels of unemployment peak: cyclical unemployment

• lower levels of profits

• inflation and interest rates bottom out

• slow growth rates of consumer spending on durables

• lower levels of consumer and business confience

• reduced pressure on prices

• levels of saving may rise as some people put off consumption decisions (especially if their job is at risk)

• maximum idle capacity (unemployed resources)

• higher savings rates

• lower interest rates

economic indicators

• reviewing economic indicators allows us to understand whether the economic is expanding or contracting

• allows us to understand trends in the economy

• allows firms to make better business decisions and government to formulate more appropriate economic policies

• help to forecast economic events and important input for businesses decision making and planning

pro cyclical indicator

• one that moves in the same direction as the level of economic activity.

  • e.g. GDP rises as economic activity increase

counter cyclical indicator

• moves in opposite direction to the economic

  • e.g. unemployment rate rises as economic activity slows

leading indicators

predict changes in economic activity, changing before a direction becomes evident in the rest of the economy

• leading indicators reflect the expectations of firms and households

leading indicators examples

• building approvals (investment)

• inventory rises (investment)

• new orders (investment)

• consumer expectations (consumption)

• share prices (consumption and investment)

• levels of business confidence (investment)

• new employment opportunities (consumption and investment)

coincident indicators

appear to move in line with the level of economic activity

coincident indicators examples

• manufacturing output

• production of building material

• sales of consumer durables

• retail sales

• interest rates

• GDP growth

• vehicle sales

• job advertisements

• consumer prices

lagging indicators

are not expected to show any change until after trends in the rest of the economy have been confirmed

• react to economic conditions which occurred in the past

lagging indicators examples

• unemployment levels

• savings bank deposits

• consumer debt levels

• consumer price index (inflation rate)