Y1 18) The Economic Cycle (Business Cycle) - Stages, Characteristics and Causes

Summary

This script delves into the concept of economic growth, contrasting the ideal steady upward trend with the reality of a fluctuating actual growth line influenced by the business cycle. It outlines the four stages of the cycle: boom, recession, trough, and recovery, highlighting the characteristics of each phase, such as high unemployment and low consumer confidence during recessions. The script also discusses output gaps and the unpredictable nature of economic shocks that can trigger these cycles, emphasizing the complexity and unpredictability inherent in economic growth.

Takeaways

• 📈 The macro objective for growth is to achieve strong, sustained, and sustainable economic growth, ideally represented by a smooth upward sloping line on a GDP over time graph.
• 🔍 In reality, economic growth is not smooth but fluctuates, with periods of increase and decrease, reflecting the actual growth line on the graph.
• 📊 The 'trend growth' or 'potential growth' is the smooth line on the graph representing the long-term growth rate, which is synonymous with the macro objective for growth.
• 🔁 The economic cycle, also known as the business cycle, consists of fluctuations in GDP, with the actual growth line rising and falling over time.
• 🌐 The four stages of the economic cycle are boom, slowdown/recession, trough, and recovery, each characterized by specific economic conditions and behaviors.
• 🚀 During a boom, the economy experiences rampant growth, high production, low unemployment, and high consumer and business confidence, often leading to demand-pull inflation.
• 📉 In a recession or at a trough, the economy suffers with negative growth, high unemployment, low confidence, reduced consumer spending, and investment, potentially leading to destocking and discounting.
• 🌱 Recovery is signaled by green shoots such as recovering consumer confidence, increased spending on big-ticket items, business investment, and construction activity.
• 💡 The concept of output gaps is clearly depicted on the GDP graph, with positive output gaps indicating actual growth above potential growth, and negative gaps the opposite.
• 🔮 Fluctuations in actual growth are caused by unforeseen shocks to the economy, which can be on the demand side, such as changes in interest rates or government spending, or on the supply side, like natural disasters or raw material price increases.
• 🛑 The unpredictability of these shocks explains the occurrence of recessions and the fluctuations in GDP that define the business cycle.

Q & A

What does the macro objective for growth aim to achieve?

The macro objective for growth aims to achieve strong, sustained, and sustainable economic growth.

How is economic growth typically represented on a diagram?

Economic growth is typically represented on a diagram with real GDP on the y-axis and time on the x-axis, showing a smooth upward sloping line for ideal growth.

What is the difference between actual growth and trend growth?

Actual growth refers to the real fluctuations in economic growth over time, while trend growth, also known as potential growth, is the smooth upward sloping line that represents the long-term growth rate without fluctuations.

What are the four stages of the economic cycle?

The four stages of the economic cycle are boom, slowdown/recession, trough, and recovery.

How is a recession defined in economic terms?

A recession is defined in economic terms as two successive quarters of negative growth.

What is an output gap and how can it be identified on the economic growth diagram?

An output gap is the difference between actual growth and potential growth. It can be identified on the diagram as the space between the actual growth line and the trend growth line, with a positive output gap indicating actual growth above potential and a negative output gap indicating the opposite.

What are the characteristics of a boom phase in the economic cycle?

In a boom phase, growth is rampant with actual growth likely exceeding potential growth, resulting in a positive output gap, high production, low unemployment, high consumer and business confidence, and high profits.

What are the economic indicators of a recession or a trough?

Indicators of a recession or a trough include declining actual growth below potential growth, a negative output gap, higher unemployment, low consumer and business confidence, reduced consumer spending, less investment, and destocking by firms.

What are the signs of an economic recovery?

Signs of an economic recovery include increasing consumer confidence, willingness to spend on expensive items, business confidence leading to more investment, expansion of businesses, and an increase in construction activity.

What causes fluctuations in actual growth?

Fluctuations in actual growth are caused by shocks, which can be unpredictable events affecting either the demand side or the supply side of the economy.

What are some examples of demand-side shocks that can impact the economy?

Examples of demand-side shocks include sudden increases in interest rates, cuts in government spending, a sudden strengthening of the exchange rate, a housing market crash, or a banking sector crisis.

What are supply-side shocks and how do they affect the economy?

Supply-side shocks are events that affect the long-term or short-term supply capacity of an economy, such as natural disasters, wars, sudden increases in raw material prices, wage increases, or business tax increases, which can lead to a recession by reducing production and economic growth.

Outlines

00:00

📈 Understanding Economic Growth and Cycles

This paragraph introduces the concept of economic growth, aiming for it to be strong, sustained, and sustainable. It uses a diagram to illustrate the ideal smooth upward slope of real GDP over time, contrasting it with the actual, fluctuating growth pattern observed in reality. The paragraph explains the difference between actual growth and trend or potential growth, which are synonymous. It also outlines the four stages of the economic cycle: boom, slowdown/recession, trough, and recovery, detailing the characteristics of each stage. The concept of output gaps, where actual growth may exceed or fall short of potential growth, is also discussed, along with the implications for the economy during boom and recession periods.

05:02

🌪 Shocks and Their Impact on the Economy

The second paragraph delves into the reasons behind the fluctuations in economic growth, attributing them primarily to unforeseen shocks. These shocks can occur on either the demand or supply side of the economy and can lead to recessions. Examples of demand-side shocks include sudden increases in interest rates, cuts in government spending, or a housing market crash, while supply-side shocks might involve natural disasters, wars, or sudden changes in the cost of raw materials. The paragraph emphasizes the unpredictability of these shocks and how they can abruptly shift the economy from growth to recession, thus contributing to the business cycle. It also touches on the policy responses to such downturns, such as lowering interest rates and increasing government spending, aiming to stimulate the economy and prevent further decline.

Keywords

💡Macro Objective

The macro objective refers to the overarching goals set by governments or economic policymakers to guide the economy towards a desired state. In the video, it is specifically about achieving 'strong, sustained, and sustainable growth,' which is the central theme of the economic discussion.

💡Real GDP

Real GDP stands for Gross Domestic Product adjusted for inflation, which measures the total value of goods produced and services provided in an economy over a specific period. The video uses real GDP on the y-axis of the economic growth diagram to illustrate the concept of economic growth over time.

💡Economic Growth

Economic growth is the increase in the production of goods and services in an economy over time. The video script describes the ideal of continuous and smooth upward sloping economic growth, contrasting it with the reality of fluctuating growth patterns.

💡Trend Growth

Trend growth, also synonymous with potential growth in the script, represents the long-term, sustainable rate of increase in an economy's output. It is depicted as a smooth upward line on the growth diagram, indicating the desired path of economic expansion.

💡Actual Growth

Actual growth refers to the real, observed rate of economic expansion, which includes fluctuations and cycles. The script contrasts actual growth with trend growth, showing that while actual growth fluctuates, it still shows an overall upward trend over time.

💡Business Cycle

The business cycle, also known as the economic cycle, represents the periodic fluctuations in economic activity characterized by expansions and contractions. The video describes the phases of the cycle, including boom, recession, trough, and recovery, which are integral to understanding economic dynamics.

💡Boom

A boom is a phase of the business cycle where economic growth is at its peak, with actual growth exceeding the trend or potential growth rate. The script describes a boom as a period of rampant growth, high consumer and business confidence, and positive output gaps.

💡Recession

A recession is defined in the script as two successive quarters of negative growth, indicating a significant downturn in economic activity. It is characterized by a slowdown or decline in growth, leading to negative output gaps and higher unemployment.

💡Trough

The trough of the business cycle is the lowest point of economic activity, representing the end of a recession. The script mentions the trough as the point where the actual growth line reaches its lowest, indicating the worst of the economic downturn.

💡Recovery

Recovery is a phase of the business cycle where the economy begins to improve after a recession or trough. The script describes signs of recovery, such as increasing consumer and business confidence, more investment, and an uptick in construction and manufacturing activities.

💡Output Gaps

Output gaps in the script refer to the difference between actual growth and potential growth. A positive output gap indicates a boom where actual growth exceeds potential, while a negative output gap suggests a recession or trough where actual growth falls short of potential.

💡Demand Pull Inflation

Demand pull inflation occurs when aggregate demand grows faster than the economy's ability to produce, leading to an increase in prices. The script mentions this concept in the context of a boom, where economic growth beyond potential can lead to inflationary pressures.

💡Supply Shocks

Supply shocks are unexpected events that affect the supply side of the economy, such as natural disasters or sudden increases in raw material prices. The script explains how these shocks can negatively impact economic growth and potentially lead to recessions.

💡Macro Policy

Macro policy refers to the actions taken by governments or central banks to influence the overall performance of an economy. The script discusses how loose macro policies, such as lower interest rates and increased government spending, can be used to stimulate the economy during a recession.

Highlights

The macro objective for growth is to be strong, sustained, and sustainable.

Economic growth is ideally represented as a smooth upward sloping line on a diagram with real GDP on the y-axis and time on the x-axis.

Actual economic growth often fluctuates, differing from the ideal smooth upward trend.

The terms 'trend growth' and 'potential growth' are synonymous, representing the smooth growth line on the diagram.

Actual growth line fluctuations represent the economic cycle, or business cycle, with periods of increase and decrease.

The economic cycle consists of four stages: boom, slowdown/recession, trough, and recovery.

A boom is characterized by growth peaking above the trend, indicating a very strong economy.

A recession is officially defined as two successive quarters of negative growth.

A trough represents the lowest point of the actual growth line, indicating the worst of the economic downturn.

Recovery is marked by an improvement in the economy, moving away from the trough.

Output gaps are the differences between actual and potential growth, with positive and negative gaps indicating economic conditions.

In a boom, there is a positive output gap with high production, low unemployment, and high consumer and business confidence.

A recession and trough are characterized by negative output gaps, high unemployment, and low confidence leading to reduced spending and investment.

During recovery, consumer and business confidence begins to rise, signaling an improvement in the economy.

Fluctuations in actual growth are caused by shocks, which can be unpredictable and impact both the demand and supply sides of the economy.

Demand-side shocks can include sudden interest rate increases, government spending cuts, or financial market crashes.

Supply-side shocks may involve natural disasters, wars, or sudden increases in raw material prices or wages.

The unpredictability of shocks explains the occurrence of recessions and fluctuations in GDP, leading to the business cycle.

Transcripts

hi everyone the macro objective for

growth is for growth to be strong

sustained and sustainable if we were to

map that on a diagram it would look

something like this we have real GDP on

the y axis now and we're looking at

growth real GDP over time time on the x

axis and that line there represents

strong and sustained economic growth

continuous economic growth in a lovely

smooth upward sloping manner however

reality differs very much from this in

reality actual growth looks more like

this there are times where it increases

but also times where it falls and

increases and Falls and increases and

Falls

that's what actual growth really looks

like in an economy and we can label

these lines now so this squiggly one is

our actual growth line where is the

smooth upward sloping one is our trend

rate of growth so we can call that our

trend growth but we can also call that

our potential growth the two terms are

synonymous here's a trend growth

potential growth mean exactly the same

thing in this case so we can see that

actual growth is rising and then falling

and then rising again and then falling

it's not smooth an upward sloping as we

would like and that is the economic

cycle also known as the business cycle

fluctuations in GDP but what we can see

is that the actual growth line even

though it's fluctuating up and down up

and down over time it's still rising so

we're still getting increases and growth

over a given period of time just not

nice and smooth and consistent like we

would like we would hope for given our

objective of growth what we can also

show are the four different phases the

four different stages of the economic

cycle using this diagram so when actual

growth is at its peak we can call that a

boom

but that's when growth is rampant very

strong you can see greater than trend

that is a booming economy when growth

starts to fall from a boom we can call

that a slowdown or we can call it a

recession a recession is a technical

term in economics defined as two

successive quarters of negative growth

so break down the year into four

quarters

Reeta March April to June July to

September October to December to

successive quarters of negative growth

shrinking economy is defined as a

recession here okay so that's when

growth is falling is negative when we

hit the worst position from a recession

that's known as the trough so the lowest

points of the actual growth line is a

trough and then when things start to get

better in the economy that's a recovery

an economic recovery so there are the

four different stages of the economic

cycle we can also show on this diagram

is the concept of output gaps we've

learnt output gaps already and it's very

clear to see them on this diagram so an

actual growth is greater than our

potential growth so here for example we

have a positive output gap and when

actual growth is less than potential

growth so for example this territory we

have a negative output gap so now let's

see what the different characteristics

are of these various stages of the

economic cycle in a boom growth is going

to be rampant with actual growth likely

to be beyond potential growth with a

positive output gap in the economy and

with that firms are going to be

producing a lot you can imagine there

being high construction activity high

manufacturing activity firms are

producing a huge amount of goods and

services and selling them easily with

high profits to produce that output they

need to employ worker so unemployment is

likely to be very low consumer

confidence and business confidence will

be high because the economy is doing so

well that's going to drive consumer

spending and businesses is going to

drive them to invest in capital if

consumers are earning high they're going

to be sucking in inputs demanding goods

and services from abroad imports into

the country the government's going to be

doing well with higher tax revenues

coming in from income tax from

corporation tax from v80 from tariffs

all these revenues will be increasing

but there is likely to be the side

effect of demand pull inflation

especially if growth is occurring beyond

potential in a recession and in a trough

the economy's doing really badly

remember the definition of recession two

successive quarters of negative growth

so the economy's doing poorly we're

basically going to see the opposite of

what we get in a boom declining ad

actual growth is going to be lower

then potential growth that's a negative

output gap as the diagram clearly shows

and with that there is going to be

higher unemployment firms getting rid of

workers in order to maintain profit

margins less demand for labor because

there is less demand for goods and

services generally with that there's

going to be a sharp fall in consumer

confidence and in business confidence

and that means less consumer spending it

means less investment with that there's

gonna be less construction going on less

manufacturing sector activity taking

place and there's going to be a fall in

house prices all bad news all ban using

the economy firms though in order to try

and maintain profit margins to try and

maintain high revenues will be

destocking there won't be producing more

they'll be getting rid of their stocks

and trying to sell their stocks and also

they'll be discounting their prices

clear signs that the economy is

struggling and consumers are not

spending already mentioned the fall in

the house prices and construction

activity because of a falling consumer

confidence but also because of a fall in

investment so firms are not expanding

their factories they're not looking to

build skyscrapers we can expect a lower

demand pull inflation naturally as there

is lower demand lower ad in the economy

we can expect loose macro policy things

like lower interest rates things like

maybe higher government spending lower

taxation to try and stimulate the

economy and get ad up try and get out of

the trough get out of the recession but

also because incomes the lower low

demand for imports so essentially the

opposite of what we see in a boom

recovery is interesting when do

economists know when do people know when

the politicians know that the economy is

healing that the economy is getting

better what are the green shoots of

recovery well these are the key things

that we would witness in a recovery

consumer confidence recovering

increasing willingness to spend

especially on expensive items like

houses and cars who see a pickup in

those markets also businesses feeling

more confident and that means we can

expect more investment businesses

expanding a little bit more buying a new

machinery upgrading their machinery

looking to expand their factory that's a

good sign of recovery also an increase

in construction that comes again from

investment but also consumers spending

on renovating their houses expanding

their houses etc but also loose policies

still to try and prevent the economy

going back into recession so these are

some of the key characters

six are the four different phases of the

economic cycle what's maybe more

interesting though is why are there

fluctuations in actual growth well the

simple answer is shocks things can

happen in the economy then nobody can

foresee nobody can predict shocks and

that's why we don't get this lovely

smooth upward sloping growth line we get

this fluctuating actual growth line

shocks things happen in the economy

which are bad no one expects them and

those bad things can happen on the

demand side or they can happen on this

supply side when I say demand side I

mean shocks to aggregate demand factors

that end up reducing ad that nobody can

predict let's look at a few maybe a

sudden increase in interest rates that

suddenly happens no one expected that to

happen and bam recession is the end

result we see growth falling maybe we

see a sudden cut in government spending

right if that happened then BAM that can

take an economy into recession maybe a

sudden strengthening in the exchange

rate which means less net exports but

also maybe a sudden housing market crash

which massively affects consumption

maybe it's a sudden banking sector

crisis or financial market crash like we

saw in 2009 2010 which again can plummet

the economy into recession with less

consumption taking place less investment

taking place so we have a lot of these

demand side factors things that can

suddenly shock the economy what about

taxation rates higher income tax higher

corporation tax suddenly people couldn't

predict that happening again could shock

the economy into a recession but also we

can have shocks on the supply side maybe

shocks that affect LRS like natural

disasters like Wars but also we can see

shocks to SRS factors that can shift SRS

left that people could not predict for

example a sudden increase in the price

of raw materials for example a sudden

increase in wages for example a sudden

increase in business taxes like v80 or

for example a sudden weakening of the

exchange rate which makes imports of raw

materials more expensive those kind of

factors can shock the economy and drive

us into a recession but the key is that

they are shocks they can't be predicted

and when they happen BAM the economy

suffers it dies and that explains why we

get these recessions and why we get

fluctuations in GDP which cause

the economic cycle the business cycle to

occur so there you go that's the

economic cycle for you everything you

need to know fascinating stuff stay

tuned for the next video as we look at

the costs and benefits of growth see you

then guys

[Music]