Topic 10: The business cycle

Question 1

What is a business cycle

Answer 1

The business cycle is referred to as the fluctuations in economic activity around a long-term growth path

Question 2

What is a Recession

Answer 2

Defined as two conservative quarters of negative economic growth

Question 3

Expansion

Answer 3

• The most common phase of the
  business cycle
• Beginning occurs with two
  conservative quarters of real GDP
  growth
• Typically much longer than a
  contraction

Question 4

Expansion Characteristics

Answer 4

• Increase in economic activity -
  increase in output, employment,
  and production
• Increase in consumption and
  investment
• Increase in real income and living
  standards
• Rising share prices and house prices
  household wealth increase

Question 5

Peak (Boom)

Answer 5

• Upper turning point - marks the end
  of expansion and beginning of
  contraction
• At the peak, economic growth has
  slowed because the economy is
  operating at full employment which
  means no more labor resources to
  expand production

Question 6

Peak Characterisation

Answer 6

• High levels of consumption
• High business and household
  confidence
• Low levels of unemployment
• High demand inflation - as excess
  demand for goods and resources
  causes wages to rise and then feeds
  into higher price levels
• RBA will increase interest rates

Question 7

Peaks can’t last forever

Answer 7

• Expansion: Businesses invest in new equipment, expecting higher sales.
• Sales Slow: When sales level off, investment returns drop, increasing risk.
• Lower Investment: Leads to lower output and income.
• Demand Slows: Sales flatten; economy growth slows.
• Bottlenecks: Resource shortages lead to production limits and higher prices (inflation).
• Government Response: To combat inflation, they raise interest rates, increase taxes, and cut spending.

Question 8

Contraction

Answer 8

• Real DP falls or is negative
• Normally short lived

Question 9

Contractions Characteristics

Answer 9

• Sharp fall in business/
  consumer confidence
• Low consumption and
  Investment
• Lower spending = lower
  output, income
  employment
• Decline in share market

Question 10

Trough

Answer 10

Lower turning point - end of recession and beginning of expansion

Question 11

Trough Characteristics

Answer 11

• Low levels of spending
• High cyclical
  unemployment
• Low labour force
  participation rates - people
  less confident about
  finding a job
• Low inflation
• Low consumer/business
  confidence and rise in
  savings

Question 12

Why doesn’t a trough last?

Answer 12

• Rising Investment: Firms replace or update worn-out equipment, boosting spending.
• Lower Interest Rates: Encourage borrowing, anticipating better economic conditions.
• Government Spending: Increases, especially on welfare, boosting overall demand.
• Machinery Replacement: Drives investment as productive equipment needs renewal.
• Innovation: Businesses innovate to stay competitive.

Question 13

Procyclical

Answer 13

Variable increases during expansion and decreases during contraction (inflation)

Question 14

Counter cyclical

Answer 14

Variables that decrease during expansion and increases during contraction (unemployment)

Question 15

Leading

Answer 15

Change before a direction is evident in the rest of the economy - predict trends
Examples: share prices and building approvals, level of inventory held

Question 16

Coincident

Answer 16

Indicators move in line with the level of economic activity - Identify the current state
Examples: GDP and retail sales

Question 17

Lagging

Answer 17

Variables change sometimes after economic activity changes
Examples: Unemployment rate, inflation, interest rates