Economic Business Cycles

The business cycle or trade cycle is a permanent feature of market economies: gross domestic product (GDP) fluctuates as booms and recessions succeed each other. During a boom, an economy (or at least parts of it) expands to the point where it is working at full capacity, so that production, employment, prices, profits, investment and interest rates all tend to rise. During a recession, the demand for goods and services declines and the economy begins to work at below its potential. Investment, output, employment, profits, commodity and share prices, and interest rates generally fall. A serious, long-lasting recession is called a depression or a slump.

The highest point on the business cycle is called a peak, which is followed by a downturn or downswing or a period of contraction. The lowest point on the business cycle is called a trough, which is followed by a recovery or an upturn or upswing or a period of expansion. Economists sometimes describe contraction as 'negative growth'.

There are various theories as to the cause of the business cycle. Internal (or endogenous) theories consider it to be self-generating, regular, and indefinitely repeating. A peak is reached when (or just before) people begin to consume less, for whatever reason. As far back as the mid-nineteenth century, it was suggested that the business cycle results from people infecting one another with optimistic or pessimistic expectations. When economic times are good or when people feel good about the future, they spend, and run up debts. If interest rates rise too high, a lot of people find themselves paying more than they anticipated on their mortgage or rent, and so have to consume less. If people are worried about the possibility of losing their jobs in the near future they tend to save more. A country's output, investment, unemployment, balance of payments, and so on, all depend on millions of decisions by consumers and industrialists on whether to spend, borrow or save.

Investment is closely linked to consumption, and only takes place when demand and output are growing. Consequently, as soon as demand stops growing at the same rate, even at a very high level, investment will drop, probably leading to a downturn. Another theory is that sooner or later during every period of economic growth - when demand is strong, and prices can easily be put up, and profits are increasing employees will begin to demand higher wages or salaries. As a result, employers will either reduce investment, or start to lay off workers, and a downswing will begin.

External (or exogenous) theories, on the contrary, look for causes outside economic activity: scientific advances, natural disasters, elections or political shocks, demographic changes, and so on. Joseph Schumpeter believed that the business cycle is caused by major technological inventions(the steam engine, railways, automobiles, electricity, microchips, and so on), which lead to periods of ‘creative governments beginning their periods of office with a couple of years of austerity programmes followed by tax cuts and monetary expansion in the two years before the next election.

2. Complete the sentences using the words given below.

1. Recurrent rises and falls in real GDP over a period of years is called the ­­­­­­­­­___________.

2. A (an)________ is officially defined as two consecutive quarters of real GDP decline.

3.________is measured by the annual percentage change in real GDP in a nation.

4. The_________is the difference between full-employment or potential real GDP and actual real GDP.

5. The phase of the business cycle during which real GDP reaches its maximum after rising during a recovery is called a________.

6. A _______ is a phase of the business cycle during which real GDP reaches its minimum after falling during a recession.

7. An upturn in the business cycle during which real GDP rises is called a______.

Words for reference: recovery; peak; trough; economic growth; GDP gap, business cycle; recession.

3. Choose the right answer.

1) The_______phase of the business cycle follows a recession.

a. recovery;

b. recession;

c. peak;

d. tough.

2) The GDP gap is the difference between:

a. frictional unemployment and actual real GDP;

b. unemployment rate and real GDP deflator;

c. full-employment real GDP and actual real GDP;

d. full-employment real GDP and real GGDP deflator.

3) A recession is a business contraction lasting at least:

a. one years;

b. six months;

c. three months;

d. one month.

4) When is the GDP gap largest?

a. During peak periods in the business cycle;

b. During tough periods in thee business cycle;

c. When unemployment rates are relatively low;

d. When cyclical unemployment is close to zero.

4. Answer the questions on the text.

1. What is a business cycle?

2. Which of the various theories of the business cycle mentioned in the text do you find the most convincing?