3.1.3 The Business Cycle

• A business cycle refers to the changes in real GDP that occur in an economy over time
  • This is the actual growth
• The real GDP will fluctuate above and below the long-term trend rate of growth
• There are four recognisable points in the cycle
  • Peak/boom; slowdown/downturn; recession, recovery

  

The Business Cycle illustrates the fluctuations of real GDP (actual growth) around long-term trend growth

Diagram Analysis

• A positive output gap is identified as the growth of real GDP that is above the trend
• A negative output gap is identified as the growth of GDP that is below the trend
• There is often a natural flow through the different stages from boom to slowdown to recession to recovery
• This flow of real GDP can be moderated by government intervention
  • E.g. increasing taxes in a boom period or increasing spending in a recession
    
    

The Characteristics of a Boom and Recession

Characteristics of a Recession	Characteristics of a Boom
A recession occurs when there are two or more consecutive quarters (6 months) of negative economic growth	Increasing/high rates of economic growth
Increasing/high unemployment	Decreasing unemployment and increasing job vacancies
Increasing negative output gap and spare production capacity	Reduction of negative output gap or creation of a positive gap. Spare capacity is reduced or eliminated
Low confidence for firms/households	High confidence and more risky decisions taken
Low inflation	Increasing rate of inflation - usually demand pull
Increase in government expenditure perhaps leading to a great budget deficit	An improvement in the government budget as tax revenues rise and expenditure falls

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