What is generally expected to happen with consumer spending during an expansion phase of the business cycle?

There are no changes to consumer spending.

Only luxury goods spending increases.

Where would you expect economic investment levels to be during the peak phase of the business cycle?

At their highest due to optimism about future growth potential.

At their lowest since the economy has reached its full capacity.

Remaining stable regardless of the business cycle phase.

Decreasing because economies tend to anticipate upcoming recessions.

If a country experiences depreciation in its exchange rate, what is the most likely immediate effect on its balance of payments?

The country may see an improvement in its current account due to increased competitiveness of exports and reduced demand for imports.

The financial account will deteriorate due to an outflow of short-term capital seeking higher returns elsewhere.

There will be no change in the balance of payments because changes in exchange rate affect only long-term economic trends.

The capital account will improve as depreciation causes an increase in foreign ownership of domestic assets at lower prices.

How might an increase in tariffs on imported goods affect a country's net export component of GDP in the short term?

Net exports may increase as imported goods become more expensive and consumption shifts towards domestic products.

Net exports may decrease due to international retaliation with their own increased tariffs on exported goods.

Net exports remain unchanged as tariffs do not impact consumer or producer behavior significantly in the short term.

Net exports fluctuate unpredictably because tariffs have different effects across various economic sectors.

When analyzing Phillips Curve data showing simultaneous high inflation and high unemployment what conclusion might economists draw about the current state of the economy?

The economy could be experiencing stagflation

The economy is likely undergoing rapid growth

The data indicates a healthy economy with full employment

Traditional Phillips Curve trade-offs are being observed accurately

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2.7 Business Cycles

3 min read•december 19, 2022

Jeanne Stansak

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Measuring Change in the Economy

In unit 2, we've looked at a few major measures of economic activity. Most notably, we discussed Gross Domestic Product, , and . However, we haven't looked at how we actually use these measures in tandem with each other over time to understand where the economy is and what its health is. As we'll discuss in this guide, the economy is cyclical, meaning that fluctuations in economic measures cycle over time. The cyclical pattern of expansion and of the economy over time is called the .

The Parts of the Business Cycle

The can be viewed by graphing real GDP, a measure of productivity, over time:

Let's break down what each of the pieces of one period of the are:

Expansion Peak

The starts with an expansionary phase, where the economy is growing in the short run. During this phase, is typically very low and is rising. This expansionary phase may also be known as an , because of the positive gap between actual output and potential, long-run equilibrium output. The growth trend line represents the natural rate of real GDP growth over time that the economy hopes to maintain. It also represents a natural and healthy rate of over time. At the growth trend line, the economy is experiencing full employment and meeting each of its goals which include promoting , preventing , and limiting (keeping prices stable). Eventually, the growth slows until the economy reaches a peak.

Contraction Trough

After the economy peaks, it begins contracting. A contractionary period is a period in which the economy is shrinking. This is accompanied with high and low . A is defined as a period of two straight fiscal quarters (6 months) of negative GDP growth. A can develop into a , which is a particularly severe and long . For example, a typical may see hover between 7-9%, the Great saw rates of upwards of 25%. Eventually, the economy reaches a and begins expanding again.

The Business Cycle in Real Life

While we've discussed the in a theoretical sense, we can also observe business cycles in real life data. Take a look at this graph of real GDP growth over time in the United States.

Source: FRED (Federal Reserve Economic Data)

In this graph, the grey areas are recessions. As you can see, the economy is relatively cyclical, but the time between recessions is more variable. Here's a similar graph of the rate over time:

This graph similarly shows the cyclical nature of the economy. In recessions, rises, and steadily decreases in expansionary phases.

Key Terms to Review (10)

Business cycle

: The business cycle refers to the fluctuations in economic activity that occur over time, including periods of expansion (economic growth) and contraction (recession).

Contractionary Period

: A contractionary period refers to a phase in the business cycle when there is a decline in economic activity, resulting in reduced production levels, lower employment rates, and decreased consumer spending.

Depression

: Depression refers to a severe and prolonged economic downturn characterized by high unemployment, low production, and a decline in overall economic activity. It is often marked by falling prices, reduced consumer spending, and business failures.

Economic Growth

: Economic growth refers to an increase in an economy's production capacity over time, resulting in higher levels of real GDP (gross domestic product). It is typically measured by the annual percentage change in real GDP.

Gross Domestic Product (GDP)

: Gross Domestic Product (GDP) measures the total value of all final goods and services produced within a country's borders during a specific period (usually annually). It serves as an indicator of economic growth or contraction.

Inflation

: Inflation refers to the sustained increase in the general price level of goods and services in an economy over a period of time. It means that, on average, prices are rising and the purchasing power of money is decreasing.

Inflationary Gap

: An inflationary gap occurs when the actual level of output in an economy exceeds its potential level, leading to rising prices and increased inflation.

Recession

: A recession is an extended period (usually two consecutive quarters) of significant decline in economic activity. It is marked by reduced production levels, increased unemployment rates, and decreased consumer spending.

Trough

: The trough is the lowest point in a business cycle, representing the end of a period of economic contraction and the beginning of an expansion. It marks the bottom of a recession or depression.

Unemployment

: Unemployment refers to the state of being without a job, actively seeking employment, and available to work. It is an important economic indicator that measures the percentage of the labor force that is jobless.