Lecture 3 - Business Cycles

Economics for Business I - Lecture 3: Macroeconomics

Business Cycle Measures and Concepts

  • Business cycle: Periodic fluctuations of national output.
  • Periods of rapid output growth are often followed by periods of low growth or decline (e.g., financial crisis of 2008-9 and the Covid-19 pandemic).

Growth Rates in Selected Developed Economies

  • Includes data and forecasts up to 2024 for annual % change in real GDP for:
    • UK
    • France
    • USA
    • Japan
    • Eurozone (20 countries using the euro as of 2024)
  • Source: AMECO Database (European Commission) and World Economic Outlook (IMF, April 2024).

Actual, Potential, and Full-Capacity Output

  • Actual output: Recorded in published statistics.
  • Potential output: Sustainable level of output that could be produced at normal capacity.
  • Full-capacity output: Maximum level of output that could be produced.
  • Potential and full-capacity output are estimated, not observed.

The Output Gap

  • Output gap: The difference between actual and potential output.
    • If actual output > potential output, then output gap is positive à economy is operating above normal capacity utilization.
    • If actual output < potential output, then output gap is negative à economy is operating below normal capacity utilization.
    • If actual output = potential output, then output gap is zero à economy is operating at normal capacity utilization.
  • The output gap allows identifying the current position over the business cycle.

Business Cycle Phases

  1. Upturn:
    • Contracting or stagnant economy begins to recover.
    • Growth in actual output resumes or begins to accelerate.
  2. Expansion:
    • Rapid economic growth; the economy is booming.
    • The gap between actual and potential output narrows.
  3. Peaking out:
    • Growth slows down or even ceases.
  4. Slowdown or recession:
    • Little or no growth or even a decline in output.
    • The economy is operating with a negative output gap.
  • Each cycle is unique in its length and magnitude, despite having common phases.

Output Gaps, 1965–2025

  • Data includes % of potential GDP for:
    • UK
    • USA
    • Germany (West Germany prior to 1992)
    • France
    • Ireland
  • Figures from 2023 are based on forecasts.
  • Source: AMECO database, Table 6.5 (European Commission, DGECFIN, Nov 2023) and various forecasts.

International Business Cycle

  • Business cycles are often synchronized across countries.
  • Globalisation:
    • Increased economic ties including movement of goods and capital.
    • Coordinated economic policies (e.g., lockdowns in response to the Covid-19 pandemic).
  • Business cycles have both a national and a global component.
  • Global economic volatility is often mirrored in national economic volatility.

UK, US, German and Global Economic Growth

  • Data includes the rate of economic growth (%) for:
    • World
    • UK
    • USA
    • Germany (West Germany up to 1991)
  • Data for 2024 onwards are based on forecasts.
  • Source: World Economic Outlook Database (IMF, April 2024).

Aggregate Demand and the Business Cycle

  • Aggregate demand (AD): Total spending on goods and services produced in the economy.
  • AD = C + I + G + X - M
    • C = consumer expenditure
    • I = investment
    • G = government expenditure
    • X = expenditure on exports
    • M = expenditure on foreign goods and services

Fluctuations of Aggregate Demand

  • Periods of rapid growth are associated with periods of rapid expansion of AD.
  • Periods of recession are associated with a decline in AD.

Fluctuations in Private-Sector Expenditure

  • Consumer spending is the largest expenditure component of AD.
  • Growth rates mirror fairly closely those in real household consumption.
  • Investment spending fluctuates significantly more than output.

Annual Growth of UK Consumption, Investment and Output

  • Growth rates are calculated using constant-price data.
  • Investment growth is the growth in gross fixed capital formation.
  • Source: Quarterly National Accounts, series KGZ7, KG7T and IHYR (ONS).

Aggregate Supply and the Business Cycle

  • Aggregate supply: The total amount of output in the economy.
  • Fluctuations in aggregate supply can cause fluctuations in output.
  • Sudden sharp changes to input prices (e.g., oil prices) can be one such cause.
  • Other examples include changes to production methods, the regulatory climate, or the political environment.
  • Some changes affect potential output positively, some negatively.
  • Lockdowns during the COVID-19 pandemic resulted in negative shocks to both the demand- and the supply-side of economies.

Lecture Summary

  1. All economies experience business cycles – periodic fluctuations in output.
  2. The output gap measures the distance between actual and potential output.
  3. As countries become more interconnected, via trade and finance, their business cycles become more synchronised.
  4. Fluctuations in both aggregate demand and aggregate supply may explain business cycles.