The Trade Cycle (aka the Economic or Business Cycle)

From last time: Output Gaps Output Gaps -> The economy is expected to run more efficiently without volatile changes in GDP. Avoidance of output gaps should enable low rates of unemployment and inflation AND allow businesses to plan ahead and invest for the future

Economic Growth comes in waves. WHY? Ideal Target

Economic Uncertainty – examples:

Keynesians advocate “fine tuning” of the economy using Fiscal Policy Fiscal Policy: (Govt spending and Taxation) will change AD to push the economy back to YFE (The Full Employment Level of National Output). This is “fine tuning” Negative Output Gap Y YFE Classical Economists would expect the economy to adjust (via falling SRAS, given lower wages etc.) to the YFE in the long term. SRAS1

Higher taxes to reduce AD Fine Tuning using Gov’t Spending and Taxation (Fiscal Policy!) should dampen the Trade Cycle Higher taxes to reduce AD

Learning Objectives this lesson What is the Business / Economic / Trade Cycle? (3 names for the same thing) What are the 4 stages of the Business Cycle What is the UK’s rate of long term economic growth What sort of events cause the productive potential of an economy to fall/increase What is the UK Govt definition of a recession? What are the definition (and examples) of Demand and Supply Side shocks 

The trade cycle The trade or business cycle describes how the economy tends to exhibit recurring trends in economic growth rates. Booms tend to be followed by downturns, which tend to be followed by recession, before the economy moves into the recovery phase, and then back into a boom. Getting technical: “recession” is defined in the UK as 2 consecutive quarters of falling GDP “depression” is a severe and prolonged downturn in economic activity, often defined as an extreme recession that lasts two or more years.

What happens in the different extremes of the Trade Cycle? Feature of Economy Boom Recession Unemployment / Productive Capacity Inflation Consumer and Business Confidence (“Animal Spirits”) Government Budget Deficit / Surplus Housing Starts / Construction activity Demand for Commodities (Oil, Iron Ore for steelmaking)

Causes of the trade cycle Many different reasons why actual growth differs from potential growth to give a trade cycle Generally think of demand-side shocks and supply side shocks, but there may be a natural rhythm (There is a whole economics forecasting industry based on wave theory!) A demand-side shock is any event which leads to a significant change in aggregate demand A supply-side shock is any event or change which has a significant impact on SRAS

Examples Demand and Supply Side shocks Supply side - remember acronym ->