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Exploring the natural fluctuations of the economy through periods of growth and decline.
Imagine the entire country's economy is a giant heart—sometimes it beats fast and strong, and other times it slows down to rest. How do we know when it's about to change pace?
The economy does not grow in a straight line; it moves in waves called the Business Cycle. The first phase is Expansion. During this time, the economy is 'heating up.' Real GDP (the total value of all goods produced, adjusted for price changes) is increasing. Because businesses are producing more, they need more workers, which means unemployment usually drops. People feel confident and spend more money, which further fuels growth. Think of this as the roller coaster climbing the first big hill—energy and excitement are building up!
Quick Check
During an expansion, what typically happens to the unemployment rate?
Answer
The unemployment rate typically decreases because businesses hire more workers to keep up with demand.
Eventually, the climb hits its highest point: the Peak. At the peak, the economy is at maximum production, and employment is very high. However, the economy can't stay at the top forever. After the peak comes a Contraction. This is a period where Real GDP begins to fall. If a contraction lasts for at least two consecutive quarters (which is months), it is officially called a Recession. During a recession, businesses may close, and it becomes harder for people to find jobs.
Let's look at the GDP growth of a fictional country over three quarters: 1. Quarter 1: 2. Quarter 2: 3. Quarter 3:
Because the growth was negative for two quarters in a row (Quarter 2 and Quarter 3), this country is officially in a Recession.
Quick Check
How many months of declining Real GDP are usually required to signal a recession?
Answer
Six months (which equals two consecutive quarters).
The lowest point of the business cycle is called the Trough. This is the 'rock bottom' where the decline stops and the economy prepares to turn around. While a trough represents the lowest level of economic activity, it is also the transition point back into a new Expansion. On a graph, the distance from one peak to the next peak represents one full cycle. Economists track these cycles to help the government decide when to step in with help, such as changing interest rates or taxes.
To draw the business cycle, follow these steps: 1. Draw a vertical -axis labeled Real GDP. 2. Draw a horizontal -axis labeled Time (). 3. Draw a wavy line moving upward and downward. 4. Label the 'mountaintops' as Peaks. 5. Label the 'valleys' as Troughs. 6. Label the upward slopes as Expansion and downward slopes as Contraction.
Suppose an economy hits a peak in January 2020. It enters a contraction until it hits a trough in January 2021. It then expands until it hits its next peak in January 2025. 1. The Recession lasted months. 2. The Expansion lasted months. 3. The total Business Cycle (Peak to Peak) lasted years ( months).
Which phase of the business cycle is characterized by rising Real GDP and falling unemployment?
What is the 'rock bottom' of the business cycle called?
A recession occurs immediately after the economy hits a trough.
Review Tomorrow
In 24 hours, try to sketch the business cycle graph from memory and label all four phases and the axes.
Practice Activity
Look up a news article about the current 'GDP growth' in your country. Based on the numbers, which phase of the business cycle do you think we are in right now?