What is a Business or Economic Cycle?

The Economic Cycle This is a term used to describe the tendency of an economy to move its economic growth away from its trend path This is a term used to describe the tendency of an economy to move its economic growth away from its trend path Real growth rates are often below or above their trend Real growth rates are often below or above their trend All countries experience these to a greater or lesser extent All countries experience these to a greater or lesser extent

China GDP and real GPD growth rate from year : (source

The trend growth rate is what happens on average over the whole economic cycle/long run. So for U.K our trend growth rate is about 2 ½ % whereas China’s is much higher 0ver the last 2-3 decades. The trend growth rate is what happens on average over the whole economic cycle/long run. So for U.K our trend growth rate is about 2 ½ % whereas China’s is much higher 0ver the last 2-3 decades. So why do Some Countries Grow Faster than Others? So why do Some Countries Grow Faster than Others?

Why do Some Countries Grow Faster than Others? Often reflects stage of long-run economic development / maturity- LEDCs can achieve higher growth rates than DCs as they catch up… Often reflects stage of long-run economic development / maturity- LEDCs can achieve higher growth rates than DCs as they catch up… Exploiting natural resources eg oil Exploiting natural resources eg oil Faster growth driven by higher levels of investment Faster growth driven by higher levels of investment Better education system Better education system Better Governance Better Governance

What causes economic cycles? The economy may move away from its trend growth rate for a number of reasons: The economy may move away from its trend growth rate for a number of reasons: »Demand side shocks such as other countries going into a recession, or experiencing a boom, will affect your economy »Asset wealth such as shares and houses can affect economic growth in short term »Political uncertainty »Supply side shocks such as Oil price increases

Why is the cycle an issue? Large fluctuations in output, employment and prices creates uncertainty for businesses and consumers and may reduce the potential for long term economic growth Large fluctuations in output, employment and prices creates uncertainty for businesses and consumers and may reduce the potential for long term economic growth Stability allows for long term planning by businesses and encourages investment. Stability allows for long term planning by businesses and encourages investment.

Characteristics of an Economic Boom Strong and rising level of aggregate demand Strong and rising level of aggregate demand Often driven by fast growth of consumption Often driven by fast growth of consumption Rising employment and real wages Rising employment and real wages High demand for imported goods & services High demand for imported goods & services Government tax revenues will be rising quickly Government tax revenues will be rising quickly Company profits and investment increase Company profits and investment increase Increased utilisation rate of existing resources Increased utilisation rate of existing resources Danger of demand-pull and cost-push inflation if the economy overheats Danger of demand-pull and cost-push inflation if the economy overheats

Characteristics of an Economic Recession Declining aggregate demand for UK output Contracting employment / rising unemployment Sharp fall in business confidence & profits Decrease in fixed capital investment spending De-stocking and heavy price discounting Reduced inflationary pressure Falling demand for imports Increased government borrowing Lower interest rates from central bank

Main Tools of Economic Management Policies used to stabilise economic growth so it does not move too far away from trend rates tend to be Aggregate Demand management policies Monetary Policy Changes to short term interest rates Fiscal Policy Changes to direct and indirect tax rates Changes to tax allowances for individuals and companies Changes to government spending and borrowing levels Exchange rate manipulation to effect demand for imports and exports

However it is generally agreed upon that Supply side policies are the way to achieve greater trend growth rates (increase economic growth in the long run) Policies to increase Aggregate Supply –Investment Incentives –Labour Market reforms –Increased competition

Advantages and disadvantages of Demand side policies Demand management policies cannot achieve everything at once-there will be a trade off. E.g. if you want to reduce inflation by increasing interest rates then this may lead to higher unemployment. Demand management policies cannot achieve everything at once-there will be a trade off. E.g. if you want to reduce inflation by increasing interest rates then this may lead to higher unemployment. It is not an exact science in that we cannot say that a certain reduction in interest rates will lead to a certain increase in economic growth. It is not an exact science in that we cannot say that a certain reduction in interest rates will lead to a certain increase in economic growth.

They are expensive They are expensive They take a long time to work They take a long time to work Advantages and disadvantages of Supply side policies