2.2: the business cycle and the level of economic activity

2.2: the business cycle and the level of economic activity

1. Overview

   • level of economic activity, measured by GDP, fluctuates
     • creates a wave know as the business cycle
   • Business Cycle - wave like ups and downs in a nations level of production or economic activity.
   • business cycle diagram has two key points.
     • 1. has swings in production levels & 2. long term trend line for national input.

2. Short to medium term cyclical swings in economic activity

   • level of economic activity is always changing
   • repeated once completed
   • Main phases of the business cycle
     • 4 main phases
       • 1. Expansion or recovery phase
         • starts at lower levels, than there is an expansion in economic activity
         • slow at first but picks up later
         • employment grows, unemployment falls and inflation increases
       • 2. The peak (sometimes a boom) phase
         • period of expansion where economic activity reaches its peak
         • unemployment is low, inflation high
         • peak occurs then we are at productive capacity and a boom may result
         • growth rates tail off and may not be fast
         • Boom - period of strong spending and above average levels of economic activity, usually associated with rapid demand inflation and very low unemployment.
       • 3. The slowdown or contraction phase
         • normally follow a peak or boom
         • growth in GDP slows. Sever production may fall
         • unemployment rises and inflation eases
       • 4. The trough (sometimes recession) phase
         • lowest point on cycle
         • slight rise in unemployment
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         • GDP falls twice we go into a recession where inflation is negative
         • Long and severe troughs are known as depression.
           • Depressions- large economic downturn in production associated with very high cyclical unemployment and is caused by significant fall in aggregate demand
         • Recession- period of weak spending and is associated with high levels of cyclical unemployment

3. The 'ideal' level of economic activity

   • ideal at domestic economic stability
   • Domestic Economic Activity - desirable level of economic activity where there is low inflation, a solid and sustainable rate of GDP and low unemployment
     • midway b/w extremes of peaks and troughs
       • point on trend line
   • not too rapid or too slow
   • Aus gov uses aggregate demand (AD) management to steer the level of economic activity towards the ideal situation

4. Special situation of 'stagflation'

   • Stagflation - period of slow GDP growth along with high unemployment and rapid inflation
   • experiences a stagnant (no activity) level of production or activity combined with high costs and inflation and structural unemployment

5. Long term trend line or sustainable speed limit for economic activity

   • rises in economic activity outweighs the falls
   • average trend lines slopes upwards
     • trend lines represents a nations average sustainable rate of economic growth that could be achieved. Taken into account is the limited production, the volume of resources and efficient use of resources
   • steeper trend line shows that a countries productive capacity, enabling economic activity to rise and cause serious inflation
   • Productive Capacity - potential level of national production of goods and services dictated by the quantity and efficiency of a nations resources. Determines the sustainable rate of economic growth in the long term