Introduction to the Business Cycle
What is it?
The business cycle is a model that shows the fluctuations of economic activity over time described by phases of boom,, downturns, troughs and upswings.
Boom - the highest level of economic activity at a time, where the economy is operating at or above full employment - there is no potential output gap
Downturn - where the level of economic activity is decreasing - the potential output gap is increasing during this phase
Trough - where the level of economic activity has reached its lowest point - the potential output gap is the largest and economic activity cannot decrease any further
Upswing - where the level of economic activity is increasing - the potential output gap is decreasing
What is Potential Output?
Potential output is the maximum level of economic activity/output that can be achieved with an economy's resources. Think of the economy as a kitchen stove top with four burners. The potential output is the maximum amount that can be used, that is four burners can be used to cook four seperate dishes. However, for most family meals, only a one or two stove tops are ever used, this is the actual output, how much of the resources is currently being used.
Why is it Important?
Economies fluctuate all the time, one time they're in a trough, high levels of unemployment, low inflation and low economic growth such as in the GFC of 2007-08 and in other times, they're bursting with activity, low levels of unemployment, high inflation and high levels of economic activity such as in the mining investment boom of 2011-2012.
Economies change so much that is tends to follow a cycle, known as, you guest it, the business cycle. The rollercoaster of the economy follows a cycle of ups and downs.
Australia's Past GDP (Economic Activity) Performance
(Graph from RBA chart pack 2/11/16)
Notice how the GDP performance is cyclical full of ups and downs, emulating a business cycle. The Year 12 Economics course focuses on contemporary (in the last 10 years) booms and troughs of the business cycle. Some key time periods are:
2007-08 Pre-GFC Boom
2008-09 Global Financial Crisis
2011-12 Mining Investment Boom
2015-16 Post mining boom trough
Wait? We're in a Trough?
The fact is, we still haven't recovered from the mining boom despite the graph showing an upward trend suggesting we're in an upswing. GDP is the main indicator, but we need to consider other indicators when determining our position in the business cycle.
Other indicators that you may need to consider (which will be discussed in more detail on the next page):
Wage Price Index
Gross Domestic Income
What's actually driving GDP growth