eco 561 week 5

Topics: Economics, Macroeconomics, Business cycle Pages: 6 (1596 words) Published: March 3, 2014
The Business Cycle

The long-run trend of the U.S. economy is one of economic growth. But growth has been interrupted by periods of economic instability usually associated with business cycles. Business cycles are alternating rises and declines in the level of economic activity, sometime over several years. Individual cycles (one “up” followed by one “down”) vary substantially in duration and intensity.

Origin of the Idea

O 26.1

Business cycles

Phases of the Business Cycle

Figure 26.1 shows the four phases of a generalized business cycle:

At a peak, such as the middle peak shown in Figure 26.1, business activity has reached a temporary maximum. Here the economy is near or at full employment and the level of real output is at or very close to the economy’s capacity. The price level is likely to rise during this phase. Figure 26.1 The business cycle.

The Business Cycle

The long-run trend of the U.S. economy is one of economic growth. But growth has been interrupted by periods of economic instability usually associated with business cycles. Business cycles are alternating rises and declines in the level of economic activity, sometime over several years. Individual cycles (one “up” followed by one “down”) vary substantially in duration and intensity.

Origin of the Idea

O 26.1

Business cycles

Phases of the Business Cycle

Figure 26.1 shows the four phases of a generalized business cycle:

At a peak, such as the middle peak shown in Figure 26.1, business activity has reached a temporary maximum. Here the economy is near or at full employment and the level of real output is at or very close to the economy’s capacity. The price level is likely to rise during this phase. Economists distinguish four phases of the business cycle; the duration and strength of each phase may vary.

A recession is a period of decline in total output, income, and employment. This downturn, which lasts 6 months or more, is marked by the widespread contraction of business activity in many sectors of the economy. Along with declines in real GDP, significant increases in unemployment occur. Table 26.1 documents the 9 recessions in the United States since 1950. In the trough of the recession or depression, output and employment “bottom out” at their lowest levels. The trough phase may be either short-lived or quite long. A recession is usually followed by a recovery and expansion, a period in which real GDP, income, and employment rise. At some point, the economy again approaches full employment. If spending then expands more rapidly than does production capacity, prices of nearly all goods and services will rise. In other words, inflation will occur. Table 26.1 U.S. Recessions since 1950

Although business cycles all pass through the same phases, they vary greatly in duration and intensity. Many economists prefer to talk of business “fluctuations” rather than cycles because cycles imply regularity while fluctuations do not. The Great Depression of the 1930s resulted in a 27 percent decline in real GDP over a 3-year period in the United States and seriously impaired business activity for a decade. By comparison, the more recent U.S. recessions detailed in Table 26.1 were relatively mild in both intensity and duration.

Recessions, of course, occur in other countries, too. At one time or another during the past 10 years, Argentina, Brazil, Colombia, Japan, Indonesia, Mexico, Germany, and South Korea experienced recessions.

Causation: A First Glance

The long-run trend of the U.S. economy is expansion and growth. That is why the business cycles in Figure 26.1 are drawn against a trend of economic growth. A key issue in macroeconomics is why the economy sees business cycle fluctuations rather than slow, smooth growth. In terms of Figure 26.1, why does output move up and down rather than just staying on the smooth growth trend line?

Economists have come up with several theories. But before turning to them,...
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