The Economic Cycle
- An economic (or business) cycle refers to the changes in real GDP that occur in an economy over time
- This is the actual growth
- This is the actual growth
- The real GDP will fluctuate above and below the long-term trend rate of growth
- The long-term trend rate of growth refers to the average or long-term rate at which an economy expands over time
- It represents the underlying, sustainable rate of growth that an economy can achieve over the long run, after accounting for fluctuations caused by the economic cycle
- There are four recognisable points in the cycle
- Peak/boom; slowdown/downturn; recession, recovery
Diagram: The Economic Cycle
An economic cycle diagram illustrates the fluctuations of real GDP (actual growth) around long-term trend growth
Diagram analysis
- A positive output gap is identified as growth of real GDP that is above the trend
- A negative output gap is identified as 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 will help the economy stay closer to the long term trend
- E.g. Increasing taxes in a boom period or increasing spending in a recession will help the economy stay closer to the long term trend
A Table Explaining the Characteristics of a Boom & Recession
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Exam Tip
You will often be examined on the characteristics of the economic cycle. Remember to demonstrate critical thinking around the assumptions of the model. For example, some firms may thrive during a recession as consumers switch to purchasing inferior goods (Poundland).
Additionally, the components of aggregate demand do not rise/fall at the same rate. For example, during a recovery, consumption may increase well ahead of investment by firms.
An economy may also experience some fundamental restructuring during a prolonged recession, and the composition of real GDP growth may be significantly different to what is was before the recession.