Economic Growth » The Economic Cycle

What is the economic cycle?

Economies do not grow smoothly. Some years output races ahead. In other years it slows down or even shrinks. This up-and-down pattern repeats over time. This lesson is part of Section 2.1, Government and the Economy, which is examined on Paper 2 (Macroeconomics and the Global Economy).

Key terms:

• Economic cycle: the repeating pattern of ups and downs in a country's economic growth over time.
• Boom: the stage when the economy is growing quickly and output is high.
• Downturn: the stage when growth slows down. GDP may still be rising, but more slowly.
• Recession: the stage when GDP falls. It is often defined as two or more quarters (three-month periods) in a row of negative growth.
• Recovery: the stage when the economy starts to grow again after a recession.

The cycle is also called the business cycle or the trade cycle. Remember that growth is measured by the change in GDP, which you met in the lesson on economic growth and GDP.

Drawing the economic cycle

The cycle is shown as a wavy line. In the exam, draw it like this:

1. Draw the vertical axis and label it Real GDP (or output). Draw the horizontal axis and label it Time.
2. Draw a straight line rising slowly from the bottom left to the top right. This is the long-run trend, the average path of growth over many years.
3. Draw a wavy line that crosses the trend line again and again, like a wave.
4. Label the top of a wave Boom.
5. Label the part of the line where it flattens and starts to turn down after the top Downturn. Growth is slowing here, so GDP may still be rising.
6. Label the part of the line that falls to the bottom of the wave Recession. This is where GDP actually falls, down to the lowest point of the cycle.
7. Label the part of the line going up from the bottom Recovery.

Then the line climbs again towards the next boom, and the pattern repeats. Some students label the lowest point of the wave as a "trough". Your marks come from the four labels boom, downturn, recession and recovery.

The four stages and their effects

Each stage affects three things: economic growth, inflation and unemployment. Learn the pattern for each stage.

Notice the link between the three. When growth is strong, firms need workers, so unemployment is low, and busy shops can raise prices, so inflation rises. When growth is weak or negative, the opposite happens.

Why does each stage happen?

You do not need to explain the causes in detail, but it helps to understand the chain.

• In a boom, people and firms are confident. They spend and invest more, so demand and output grow.
• In a downturn, confidence drops. People spend less and firms cut back on new projects.
• In a recession, spending falls so far that output falls. Firms earn less and may close. People who lose jobs spend even less.
• In a recovery, spending picks up, and firms start to produce and hire more.

Exam-style question

Country Zentra's GDP growth rate over six quarters is shown below.

Quarter	1	2	3	4	5	6
GDP growth rate (%)	+3.0	+1.5	−0.5	−1.2	+0.6	+2.0

(a) Which one of the following is the stage of the economic cycle that comes straight after a recession? [1 mark]
A Boom   B Downturn   C Recovery   D Inflation

(b) Define the term recession. [2 marks]

(c) Using the table, identify the two quarters that show a recession. [1 mark]

(d) Explain how unemployment is likely to change during a recession. [3 marks]

Recap

• The economic cycle is the repeating pattern of ups and downs in growth. It is drawn as a wave around a rising trend, with Real GDP on the vertical axis and Time on the horizontal axis.
• Boom: high growth, rising inflation, low unemployment.
• Downturn: slowing growth, slowing inflation, unemployment starting to rise.
• Recession: negative growth, low or falling inflation, high unemployment.
• Recovery: growth returns, inflation starts to rise, unemployment starts to fall.