2.5 The economic cycle Flashcards
What does the economic cycle describe?
The fluctuations in the levels and rates of growth of GDP over a period of time
What is a boom in the economic cycle?
A time of rapid growth and expansion in the economy
What is a downturn in the economic cycle?
The boom slows and the rate of growth decreases
What is recovery in the economic cycle?
Positive growth returns, slowly at first, then picking up the pace
Describe the characteristics of a boom (CoR)
Rate of growth of GDP increases, and the level of demand increases
Firms respond to this by increasing output, using more resources, like labour
Unemployment falls - newly employed have more income to spend, further increasing demand
Incomes may also generally increase as firms try to attract more labour
New businesses start up and existing ones expand
As boom progresses, inflation likely to increase as demand begins to exceed economy’s supply (demand-pull inflation)
Policies to reduce inflation - reduce spending
Describe the characteristics of a recession (CoR)
Downturn leads to falling sales and profits
Output falls, firms need fewer resources like labour
Some employees are made redundant and unemployment rises
Real wages may fall
Unemployed have less disposable income, demand falls
Firms reluctant to invest, slows economy further
Inflation no longer a problem as there is no longer upwards pressure on prices
Expansionary policies will be used
What is a recession?
Two consecutive quarters of negative economic growth
What happens in a boom?
GDP, inflation, unemployment, output, incomes
% growth in GDP: rapid
Inflation: high
Unemployment: low
Output: high
Incomes: rising
What happens in a downturn?
GDP, inflation, unemployment, output, incomes
% growth in GDP: Slowing
Inflation: Slowing
Unemployment: Increasing
Output: Increasing
Incomes: Static
What happens in a recession?
GDP, inflation, unemployment, output, incomes
% growth in GDP: Negative
Inflation: Low
Unemployment: High
Output: Falling
Incomes: Falling
What happens in a recovery?
GDP, inflation, unemployment, output, incomes
% growth in GDP: Increasing
Inflation: Low or rising
Unemployment: Falling
Output: Increasing
Incomes: Static
What does how well a business does in different parts of the economic cycle depend on?
The income elasticity of demand for the product
How are businesses affected by the boom period?
Sale of normal goods increases significantly
Output will rise and investment will increase
Unemployment is low and consumers have more to spend
Sale of inferior goods fall as consumers substitute normal goods instead
Price may rise and demand exceeds supply
May be skills shortages - increased costs, increased prices
How are businesses affected by the downturn period?
Sale of income elastic goods begin to fall
Sale of other goods begin to slow
Unemployment begins to rise - less spending
Investment slows as expectations of growth diminish
Output slows
Costs and prices rise more slowly
How are businesses affected by the recession period?
Sale of normal goods falls significantly
Unemployment is high , consumers have less income to spend
Output of normal goods and investment falls
Sale of inferior goods will increase as consumers buy fewer normal goods and replace them with inferior goods
Prices may fall - supply exceeds demand
Costs fall, prices reduce
How are businesses affected by the recovery period?
Sale of normal goods begin to recover
Sales of other goods begin to rise
Consumers feel worst is over so spend more
Unemployment falls
Investment increases as confidence returns
Output begins to rise
What does the circular flow of income model?
The basic working of the economy and the interactions between households, banks, government, abroad and firms
Describe households role in the circular flow of income.
Supply factors of production to firms (labour etc) and in return, they receive income
May not spend all of this income on payment for goods and services, but may put into savings with the bank, which is a leakage from the economy
Describe firms role in the circular flow of income.
Supply goods and services to households - provides sales revenue
Pay business tax etc to government
Describe govts role in circular flow of income..
Spend on public health, infrastructure etc - injections
Describe banks role in circular flow of income.
Provide finance which businesses use to pay for investment - injection into circular flow
What do leakages do?
Reduce the demand for domestically produced goods and services by diverting part of incomes to savings etc
What do injections do?
Increase demand for domestically produced goods and services.
When is the economy in equilibrium?
Total leakages = total injections
How do higher tax rates affect the circular flow of income?
Reduces consumer spending
HOWEVER, govt almost always spend all of their tax revenue
Spending on benefits rises, recipients spend more
Consumer spending may stay the same or rise - different group of consumers spending now - more likely to buy inferior goods and necessities
How do rising exports and imports affect the circular flow of income?
Rising exports stimulate the economy and extra demand creates jobs
Rising imports have opposite effect
What is aggregate demand?
The sum of total demand from all sources in the economy,
What is consumption?
Total household spending on goods and services.
More people save = lower consumption
What is investment?
Spending now on capital assets that will generate income in the future
Can invest in human capital - training etc
What does govt expenditure include?
All kinds of public spending
What is the trade balance?
X - M
What is aggregate supply?
Total output from all sources in the economy
How can full capacity output increase?
New technologies that can increase efficiency
Investment in capital assets
Increase in available resources
What happened to the UK economy between 2011-14?
Disinflation, a decrease in rate of inflation
Annual increase in average price level slowed from previous time period
What is deflation?
Falling prices
Sustained decrease in average price level
Describe price indices
Measures changes in general level of prices
Weighted averages of price changes based on average levels of spending
What are price indices base year?
100
What is CPI?
Consumer Price Index - headline rate and forms the basis for govts inflation target
Excludes mortgage interest payments and housing costs
What is RPI?
Retail Price iNdex - includes housing costs and mortgage interest payments
Used to decide state pensions and benefit levels
What does a real value mean?
Has had the effects of inflation removed
What does a nominal value mean?
Value expressed in current prices
What is Dd-pull inflation?
Economy is overheating in a boom - supply not catching up
AD > AS
Prices rise in response to market pressures
What is cost-push inflation?
Costs of production are rising
Import prices for commodities may rise
Wage rises may also lead to higher costs
So… prices are increased
How does inflation affect businesses?
Leads to uncertainty about future
Disrupts business planning
Can lead to hyper-inflation like in Zimbabwe
How does uncertainty affect businesses?
Inflation makes it harder to predict accurate cash flow, cost and revenue forecasts - constantly changing
Plans to invest and exapnd production become harder to carry out
How does loss of competitveness affect businesses?
Inflation may make exports less competitive if competing economies hav elower inflation rates
How does inflation affect individuals?
Loss of real income - Nominal rate of interest less than inflation: reduces interest payments for savers
People on fixed incomes lose the most - pensioners etc
Savers and borrowers: Money loses its value and people lose confidence in money as real value decreases
Define employment
All those people between aged 16-64 who are in work
Define unemployment
The number of people able and willing to work but not able to find a paying job
Define underemployment
Those who are employed but are in work that does not reflect their qualifications or are forced into full-time employment
What is the claimant count
Official measure based on the number of people claiming unemployment benefits
What is the ILO
International Labour Organisation - measure of unemployment uses the labour force survey to count those who are available and seeking work
What is structural unemployment?
Occurs when people have the wrong skills for the employment of offer
Or are located far away from the job
What i sthe occupational immobility of labour?
Unemployed people do not have the necessary skills to adapt to changing job requirements
What is the geographical immobility of labour?
Labour cannot move to areas where jobs are available
What is technological unemployment?
As technology improves, fewer employees are needed - can be substituted with capital
What is cyclical unemployment?
Caused by a downturn in the economic cycle.
Spending falls, demands falls, output will fall
Firms need fewer workers
