Download Business Cycles

ECN 1200- Introductory
Macroeconomics
Lecture 2
Lecturer: Mr. Sydney Armstrong
Business Cycles are recurrent fluctuations of
economic activity or real GDP that occurs relative to
the long-term growth trend of the economy.
These cycles vary in duration and intensity however
economists have identified four phases of a business
cycle.
Peak: At this point economic activity is at a temporary
maximum. The economy is at the full employment level
and real output is at or very close to the economy’s
capacity. The price level is likely to rise during this phase.
A peak is followed by a period of recession.
Recession: A period of decline in an economy’s total
output usually lasting at least six months and marked by
contractions in many sectors of the economy. The price
level shows little or no change but if the recession is long
enough – turns into a depression- then prices will start to
fall. A recession is followed by a trough.
Trough: In this phase the recession or depression is at its
lowest level, and can be short-lived or last very long. The
trough is followed by the recovery or expansionary phase.
Recovery (expansion): As the word suggests the
economy is on the road to growth. In this phase output
and employment start to rise, as a result the price level
will start to rise. This phase will continue until it reaches
the plateau or peak and a new cycle will begin.
Potential growth (potential GDP) represents the
maximum sustainable level of output that the economy
can produce. When an economy is operating at its
potential, there are high levels of utilization of the
labour force and the capital stock.
Potential output is determined by the economy’s
productive capacity, which depends upon the inputs
available (capital, labour, land, etc.) and the economy’s
technological efficiency.
By contrast actual growth (actual GDP) or growth that
is realised, is subject to large business cycle swings if
spending pattern change sharply.
The circular flow model, describes the interactions
between the two basic agents in an economy,
consumers and producers. This model shows the flow
of resources, products, income and revenues between
these two basic economic agents.
1. The economy consists of two sectors: households
2.
3.
4.
5.
6.
and firms.
Households spend all of their income on goods
and services or consumption. There is no saving.
All output produced by firms is purchased by
households through their expenditure
There is no financial sector.
There is no government sector.
There is no overseas sector.
The Basic Circular Flow Model
Introduction of the Financial sector
Savings =S
Finance sector
Investment = I
Savings =S
Taxes = T
Finance sector
Govt. sector
Investment = I
Govt. spending = G
Savings =S
Finance sector
Investment = I
Taxes = T
Govt. sector
Govt. spending = G
Imports = M
Overseas sector
Exports = X
S
Withdraws
T
M
Finance sector
Govt. sector
Overseas sector
I
G
X
Injections
Injections: This is an exogenous addition to the income
of firms and households that does not result from current
production.
Injections lead to an expansion of an economy’s income.
The expansions that result from injections is
compounded through the multiplier effect.
Injections consist of three broad areas viz. investment,
government spending and exports. (Putting back into the
economy)
Withdrawals: Any income that is not circulated
currently in the circular flow of income and as such is
not available for the purchasing of currently
produced goods and services.
Withdrawals help to contract the income of on an
economy, and like injections its impact is exacerbated
by the multiplier effect.
Withdrawals consist of three broad categories viz.
savings, taxation and imports. (Taking out of the
economy)