Presentation on theme: "ECON2: The National Economy"— Presentation transcript:
1 ECON2: The National Economy 2.2 The Economic CycleWhy does the productive capacity of the economy change over time?How can we tell when or how this is happening?ECON2: The National Economy
2 The concept of the economic cycle 2.2 What you need to knowThe concept of the economic cycleThe different phases of the economic cycleHow to use a range of different economic indicators to identify the various phases of the economic cycleThe difference between demand-side and supply-side shocksThe concept of positive and negative output gaps in the economic cycle
3 2.2 You should be able to:Understand and illustrate the concept of the economic cycle on a diagramUse economic indicators such as GDP, the rate of inflation, unemployment and investment to identify the various phases of the economic cycleShow the impact that demand-side and supply-side shocks might have on the economic cycleExplain the likely state of the economy using economic indicators during periods of positive and negative output gaps
4 The Economic Cycle: A Definition “Variations in the level of productive capacity of an economy over time.”Key QuestionsWhat do we mean by ‘variations’?What do we mean by ‘productive capacity’?What do we mean by ‘over time’?Productive capacity (or potential) is the maximum amount of goods and services that we can produce with the resources we have available.
5 Gross Domestic Product: A Definition In order to understand the economic cycle it is important that we understand Gross Domestic Product (GDP). This is defined as: “The value of goods and services produced in the economy over a period of time.”What is GDP?: BBC
6 The Economic Cycle: A Diagram The level of economic activity fluctuates over time, this pattern is referred to as the economic cycleEconomic activity is measured by GDPGDP is the total value of a country’s output in a yearReal GDP takes into account inflation. If GDP growth is 5% and inflation 2% real GDP growth will be 3%.There are four main stages to the Economic Cycle:Trend rate of economic growthBoomBoomReal GDPRecoveryRecoveryRecessionRecessionSlumpSlumpTime6
7 The Economic Cycle: A Diagram GDPTimeActual GDPTrend lineThe Economic Cycle is also known as the Business Cycle or Trade Cycle.Mark on the diagram the following 4 points:a) Boomb) Recessionc) Slumpd) Recovery
8 Economic Cycle - Boom A period of high levels of economic activity Characterised by:High rate of economic growthHigh demandLow unemploymentInflationary pressureLabour skills shortagesHigh confidence in the economyCapital Investment is highOnce you have studied each of the economic variables in turn you may wish to revisit the economic cycle to discuss why some of the characteristics of a boom lead to a recession.8
9 Economic Cycle - Recession The rate of economic growth starts to fall in a downturnIf real GDP falls for 6 months then this is known as a recessionCharacterised by:Demand fallsUnemployment begins to riseSome firms will go out of businessConfidence in the economy is low and most firms willreduce investmentThe worst recession in the Eurozone.1979 saw the start of Britain’s decline into a recession – mirrored in the music of the dayGhost Town The Specials.The Government state that recession is officially two quarters of negative economic growth. However, it is often regarded as a period of low economic growth.9
10 Economic Cycle - SlumpThe bottom of the business cycle which represents a period of serious economic declineCharacterised by:Low or negative growthDemand and inflation are lowUnemployment is highConfidence in the economy is lowHigh rate of bankruptcyWhy is the housing market frequently quoted as a key indicator of economic activity?10
11 Economic Cycle - Recovery When there are signs that economic growth is starting to rise, often referred to as the ‘green shoots of recovery’Economic growth starts to riseDemand increasesUnemployment fallsInflation starts to riseConfidence in the economy increasesCapital Investment increasesWhy is business confidence so important for a recovery?11
12 The Economic Cycle in the UK: Recent History Source:BBC News WebsiteCan you spot a clear economic cycle within the data?What do you think is meant by the term “double-dip recession”?UK double-dip recession revised away.
13 Positive and Negative Output Gaps An output gap is the difference between actual GDP and potential GDP.Actual GDPTrend lineGDP= Positive Output Gap= Negative Output GapWhich is which?Does the UK currently have a positive or negative output gap?Time
14 Economic Indicators over the Cycle What do you think is likely to be happening to the following indicators during a positive and negative output gap?IndicatorPositive Output GapNegative Output GapUnemploymentRising or FallingInflationInvestmentWage RatesConsumptionHouse Prices
15 Demand Side ShocksYou need to be able to identify what might cause unexpected changes in the economic cycleThis can be split into demand-side and supply-sideDemand-Side:This refers to unexpected changes in the economy that directly impact on aggregate demandExample:The Eurozone crisis occurred due to some states e.g. Spain, Italy and Greece borrowing beyond their means when interest rates were cheap. As rates rose these states struggled to pay back their debts. The consequent fall in demand impacted on trading partners such as the UK.
16 Supply Side Shocks Supply-Side: This refers to unexpected changes in the economy that directly impact on aggregate supplyThis will often refer to the size and productivity of the workforce, and firms’ ability to produce goods and servicesExample:Over the years oil prices have seen dramatic increases that have had a short-term impact on the supply of goods and services as many businesses use oil directly or indirectly in the production process. In , 1979 and 1999 substantial oil price increases occurred. These price changes shifted the short-term aggregate supply curve upwards and to the left.
17 For each of the following, decide whether the impact is demand-side or supply-side, AND if the impact might improve or worsen the economic cycleImpactDemand-Side or Supply Side?Improvement or Worsening of Economic Cycle?The Bank of England raise interest ratesLarger budgets given to schools for educationA cut in the main rate of income taxTax given to businesses to encourage investmentAn unexpected 10% increase in the price of oilConsumer confidence rises
18 Multiple Choice 1Which one of the following is most likely to occur in the boom phase of an economic cycle?Rising national income, falling unemployment and a negative output gapRising imports, rising profits and a positive output gapRising consumption and investment expenditure and a negative output gapExcess demand, falling employment and a positive output gapCan you explain your answer?B
19 Multiple Choice 2 In an economy with a positive output gap There is spare capacityActual output is less than potential outputThere is cyclical unemploymentDemand-pull inflationary pressure existsCan you explain your answer?D
20 Multiple Choice 3An economy’s output gap moves from being positive to negative. The most likely reason for this is that?Taxes have increasedInterest rates have been cutUnemployment has fallenTaxes have been cutCan you explain your answer?A
21 Multiple Choice 4Which one of the following is most likely to result in a demand-side shock to the UK economy? A large rise inWorld commodity pricesUK wages due to a wave of strikesUK interest ratesThe price of imported semi-manufactured goodsCan you explain your answer?C
22 Multiple Choice 5 Can you explain your answer? GDPTimeActual GDPTrend lineIf the economy is operating at point A, which one of the following policies is most likely to be employed by the governmentAn increase in unemployment benefitHigher interest ratesA reduction in income taxCutting the education budgetABCan you explain your answer?
23 2.2 You should be able to:Understand and illustrate the concept of the economic cycle on a diagramUse economic indicators such as GDP, the rate of inflation, unemployment and investment to identify the various phases of the economic cycleShow the impact that demand-side and supply-side shocks might have on the economic cycleExplain the likely state of the economy using economic indicators during periods of positive and negative output gaps