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Unit 8
The Business Cycle, Economic Growth and Development
Objectives
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Identify the four phases of a business cycle.
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Discuss the causes of a business cycle.
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Distinguish between economic growth and economic development.
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Explain how economic growth can be measured.
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Explain how economic development can be measured.
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Explain how economic development can be measured.
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Identify the major sources of economic growth.
1.
The Business Cycle
Definition:
The business cycle can be defined as the rise and fall of economic activity that occurs around the growth trend.
It is the upward and downward movement of production (GDP), employment and inflation.
The growth trend is the direction in which the economy moves over a long period of time such as 20 to 30 years.
The business cycle
Four phases of the business cycle
Peak
A peak is the highest level of economic activity in a particular cycle. The economy is doing great and real GDP is high
and employment and profits are usually good. A very high peak is sometimes called a boom.
Downswing (contraction)
A downswing occurs when the level of business activity or real GDP decreases noticeably.
When real GDP decreases for two consecutive quarters (6 months) economists say the economy is in recession. A
depression is a very large recession. It lasts longer and is more severe than a recession.
Trough
A trough is the lowest level of real GDP. Unemployment and idle productive capacity are at their highest level.
Upswing (expansion)
An upswing is the expansionary phase during which real GDP rises. Output expands, profits usually increase and the
employment situation improves.
Measuring business cycles
Economists have developed a set of indicators to give us an idea of when a recession is about to occur or when the
economy is in one. They give an indication of what is likely to happen 12 to 15 months from now.
Leading indicators:
1.
The number of new cars sold
2.
The number of new companies registered
3.
Exports
These indicators are combined into an index that economists use to make forecasts about the economy.
Causes of business cycles
Many forces are responsible for the changes in the level of business activity in a country. But the following factors
may have an influence on the economy:
1.
Consumption: If households decide to buy more or less it will affect the economy.
2.
Weather: Changes in the weather will influence the level of agricultural output; this in turn will influence
business activities.
3.
Money supply: Changes in the business cycle may be caused by a change in the money supply. Too much
money in circulation may trigger inflation while too little money may cause a contraction and unemployment.
4.
Capital investment: Changes in capital investment may cause upward or downward changes in total
production.
5.
Government expenditure and taxes: Government purchases may have a contractionary or expansionary effect
on the economy. Taxes affect the ability of the household and business sectors to buy production.
6.
Resource supply: Changes in resource supply such as energy prices, technology and wages may cause
expansions or contractions.
In general we can say that business cycles are caused by shifts in aggregate demand and aggregate supply.
Monetary and fiscal policies can be used to modify the duration and intensity of these fluctuations.
2.
Economic Growth
Definition
Economic growth refers to an increase in a country’s real GDP during a period of one year.
In simple terms economic growth means an increase in the quantity of goods and services produced in a country
during a period of one year.
Graphically it is shown by an outward shift of the country’s production possibilities curve. It is caused by increased
productive capabilities that are made possible by either an increase in inputs (production factors) such as labour,
capital or technological innovations.
To make comparisons over time when prices are increasing, we must adjust the nominal GDP so that it reflects only
changes in production and not price changes. In other words, we have to convert the nominal GDP into real GDP.
Nominal GDP is the GDP measured at current prices.
Real GDP is the GDP adjusted for inflation – it is measured at constant prices.
Formula:
Nominal GDP
Real GDP = ------------------- x 100
Price index
Example:
Nominal GDP 2006 = N$482 120 million
CPI 2006 = 130.7
Nominal GDP 2007 = N$549 100 million
Consumer price index 2007 = 136.5
N$482 120
Real GDP 2006 =--------------- x 100
130.7
= N$368 875 million
N$549 100
Real GDP 2007 = --------------- x 100
136.5
= N$402 271 million
The economic growth rate is calculated on a yearly basis.
Formula:
Real GDP last year – Real GDP first year
Growth rate = ---------------------------------------------------------x 100
Real GDP first year
402 271 – 368 875
GDP growth for 2007 = ------------------------- x 100
368 875
= 9%
This example shows that this country’s economy grew by 9% during this period.
Reasons for economic growth
The inputs used by businesses as well as the production methods determine the GDP or output of a country.
Businesses can increase their output by using more inputs or by the more efficient use of the available inputs.
Human capital
The first pillar of economic growth is improvements in human capital. These are the knowledge, skills and experience
of the labour force.
Natural resources
The availability of natural resources in a country.
Physical capital
Increases in physical capital will enable workers to become more productive. Workers can be educated, but they still
need computers, tools and equipment to produce goods and services.
Greater economic efficiency
Greater economic efficiency through technological advancement. Technological advancement requires new
inventions, such as the discovery of a new product or process, as well as technological innovations.
An important determinant of the above factors is the saving and investment decisions that people in the economy
make. Investment in research and development, education, factories and equipment will determine future economic
growth of a country.
3
Economic Development
Definition:
An improvement in the position of the average person, e.g. if the GDP per capita increases.
All countries of the world are classified into different groups. The most general classification is the distinction between
developing and developed countries.
Developing countries:
This includes all countries in Africa, South and Central America, some countries in Asia and eastern European
countries. Namibia is, therefore, a developing country.
Developed countries:
This includes the United States, Britain, Canada, Japan, Australia, New Zealand and most western European
countries.
Features and Problems of Developing Countries
Population growth
The population growth in developing countries is much higher than in developed countries and this creates a number
of problems.
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Many new jobs must be created for the many babies that are born.
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The growing population puts pressure on housing, education and health services. If these services are
inadequate, the result may be a low quality labour force.
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HIV/Aids have a negative impact on the labour force due to the loss of skills and experience and the cost of
treating Aids sufferers.
Natural resources
Some have natural resources and other may not have any, but all of them lack capital goods.
Agricultural practices
A large percentage of the labour force is in agriculture, but farming methods are primitive in many cases and
productivity is low.
Capital
Most developing countries do not have their own manufacturing industries and have to import all capital goods. They
rely on foreign investment.
Infrastructure
Most developing countries have poorly developed infrastructures. Roads are often in a poor condition and there may
be a lack of communication systems, electricity, education, health and housing facilities. This makes it difficult for
businesses to access markets.
What is economic development?
Economic development is associated with developing countries and refers to an improvement in the standard of living
of the population as a whole. It allows everyone in society, on average, to have more.
Economic development should be focused on people:
Development of people: Money should be invested in the education, health and nutrition of the people of a country to
enable them to contribute to economic, political and social structures.
Development by people:
development strategies.
The people of a country should participate in the planning and implementation of
Development for people: Development should meet everyone’s needs and create opportunities for everyone.
Economic growth is a prerequisite for economic development. Economic development occurs after economic growth
has taken place. We can see development in the following:
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More and better health and educational services that will result in a higher life expectancy and higher literacy
rates.
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A larger middle class.
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A fairer distribution of income
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Agricultural development to promote food production.
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Industrialisation to create more jobs and make the country less dependent on imported goods.
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Export growth and diversification, in other words not only agricultural products and raw materials but a variety
of manufactured goods
The measurement of economic development
A yardstick that we can use to compare the standards of living across nations is the GDP per capita.
Economic development occurs if there is an increase in the GDP per capita, in i.e. if the position of the average
person in the community improves.
The GDP per capita is the average amount produced by each member of the population.
Example:
Real GDP 2006
= N$608 703 million
Total population 2006
= 45 million
Real GDP 2007
= N$635 372 million
Total population 2007
= 50 million
608 703
GDP per capita 2006 = ----------45
= N$13 526.73
635 372
GDP per capita 2007 = -----------50
= N$12 707.44
The above example shows that the GDP per capita is lower in 2007 than in 2006. This means that the position of the
average person deteriorated in spite of an increase in the total production.
The reason for the lower GDP per capita is the fact that the population increased by 11% while GDP growth was
about 6% so that the available resources had to be divided among more people.
Shortcomings of GDP per capita
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It does not reflect the unequal distribution of income.
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It does not reflect expenditure on public goods and services.
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It does not reflect the value of leisure time and social advantages.
Since 1990 the UNDP has used another index in their Human Development Report. This index is called the human
development index (HDI). The advantage of this index is that it reflects life expectancy, literacy and the standard of
living
Activity
Consider the following statistics to answer the questions below.
Year
2010
1011
Nominal GDP
= N$28 961 million
Total population
= 1.98 million
Consumer price index
= 128.7
Real GDP
= N$23 134 million
Total population
= 2.01 million
Consumer price index
139.4
Calculate the following:
(a)
The real GDP for 2010.
(b)
The GDP per capita for 2010.
(c)
The GDP growth rate for 2011.
(d)
The inflation rate for 2011.
Feedback
28961
(a)
Real GDP for 2010 = -------- x 100
= N$22 503
128.7
22503
(b)
GDP per capita 2010 = ----------
= N$11 365
1.98
23 134 – 22 503
(c)
Growth rate 2011 = ---------------------- x 100
= 2.8%
22 503
139.4 – 128.7
(d)
Inflation rate = ------------------- x 100
128.7
= 8.3%