2.5.3 - Trade (Business Cycle)

Question 1

Name the parts of the trade (business) cycle

Answer 1

. Peak / Boom
. Recession
. Economic Recovery
. Economic Downturn

. Actual Real GDP
. Trend level of Real GDP

Question 2

Define trade cycle

Answer 2

A graph which shows the fluctuations in the level of economic growth around the productive potential of the economy

Question 3

Characteristics of peak / boom

Answer 3

1.) High national income or GDP

2.) Economy is working beyond full employment (productive potential capacity) and therefore overheating of the economy is present.

Overheating is when the economy is growing at an unsustainable rate. It may lead to rising inflation, which could lead to a downturn due to a fall in demand

3.) Consumption and investment expenditure will be high

4.) Tax revenues will be high

5.) Rising wages and profit

6.) Demand - pull inflation increases average price level

7.) Imports will be high due to higher wages and therefore more consumption

Question 4

Characteristics of recession

Answer 4

. Low national income or GDP

. High unemployment so consumption, investment and imports will be low. This also means low tax revenue and higher expenditure on welfare benefits

. There may be few inflationary pressures in the economy due to a lack of demand - pull inflation, which may lead to falling prices (i.e. deflation)

Question 5

Define Boom / Peak

Define Recession

Define Economic Recovery

Define Economic downturn

Answer 5

1.) A peak or boom is when the economy is growing and operating above its productive potential

2.) A recession is economic growth is negative for two successive quarters (i.e. two periods of three months). It is caused by a fall in AD so refer to AD section

3.) Economic recovery is the movement back from where the economy is operating below its productive potential to a point where it is as its productive potential

4.) Economic downturn is when economic growth is falling

Question 6

Causes of the trade cycle

Answer 6

1.) Caused by demand - side shocks (changes in AD)

Examples :

. Increased taxation or cut in government spending

. Interest rate increase to combat inflation

. Housing market bubble may burst. This occurs due when house prices are too high and suddenly there is a collapse in demand and fall in house prices. This erodes consumer confidence, leading to less consumer spending, leading to fewer new house being built, which increases unemployment and decreases economic growth

2.) Caused by supply - side shocks (change in aggregate supply)

Examples :

Refer to short run aggregate supply section

Question 7

Define demand - side shocks

Define supply - side shocks

Answer 7

1.) A sudden change in aggregate demand

2.) A sudden change in aggregate supply