Economic Growth & Business Cycle

Statements which you might have heard or read in newspaper

“British Rate Still at 0.5% As Growth Stays Slow”-New York Times

“Recession started in December 2007” –Reuters “China Forecasts 7.6% Economic Growth in 2013”-Wall

Street Journal “The Great Depression (1929-39) was the deepest and

longest- lasting economic downturn Did you ever wanted to know what does these

statements or the similar types of statements which you might have read or heard mean?

Reasons why does economies go through Business Cycles

It is unusual for economic growth to be achieved at steady, constant rate

Economies tends to grow at different rates These experiences a wide ranging fluctuations in

there trade, and production These experiences upturns and downturns in

real GDP and Economic activities

Business Cycle The Business Cycle is upwards and

downwards movement of the level of Real GDP

Upward movement refers to the expansion(Growth) in the level of economic activity,

Downward movement is the contraction(recession) in the level of economic activity,

Extremes of business cycle include boom/peak and depression

Its is usually drawn on a graph vertical axes of the graph is labelled with

Real GDP/Level of economic activity Horizontal axes is labelled with the time

period

A basic Illustration Of Business Cycles.

It has a cyclical nature One cycle looks concave or like a hill Trough is the minimum turning point of

the graph Maximum turning point is peak

The graph shows the typical business cycle of an economy

Shape and it’s Nature

Stages of Business Cycle

Peak

RecessionDepression

Growth/recovery

History of Business Cycle

The Great Depression of 1930

The Great Recession of 2008

GDP, Real GDP and GNP GDP(Gross Domestic product) is the value

goods and services produced in an economy over the period of one year

Real GDP(GDP Deflator) is when inflation is subtracted from GDP

GNP is GDP minus Net property income from abroad

What the fluctuations in GDP tells us about? A percentage increase in GDP compared to

previous years is economic growth A fall in GDP compared to previous years is

contraction or recession

Include only goods and services purchased by their final users,

Counts only the goods and services produced within the country's borders,

Exclude financial transactions and transfer payments,

Measures both output and income, which are equal.

Ways of Measuring GDP

If we assume that in an economy

All of the output produced within an economy is sold,

Whole of the income earned within an economy is spent.

Then we can conclude,National Income=National output=National

Expenditure The above makes up the circular flow of income

One person’s spending is another’s income

Realistic four-sector economies evolve more complexities……

Injections into the circular flow of income

1. Consumption by private individuals(C)

2. Government expenditure(G)

3. Investment(I)4. Imports (X)

Withdrawals from the circular flow of income

1. Saving2. Taxes3. Imports(M)

Circular flow of Income

The total demand for good and services in an economy, at different price levels, It always for a given time period

This is the demand for GDPAD curve slopes downwards

from left to right Components of the Aggregate

DemandAD=C+I+G+(X-M)

Definition of Aggregate Demand(AD)

Typical Aggregate Demand Curve

measures the volume of goods and services produced within the economy at a given price level

represents the ability of an economy to deliver goods and services to meet demand

It is initially more elastic as more factors are employed

At full employment level of resources it becomes perfectly inelastic as supply cannot be increased

At this point cost of the firms rises compete for resources and this leads to rising prices

Aggregate supply (AS)

Inflationary gap

Aggregate demand exceeds an economy's productive potential

We tend to see rising inflation and a worsening trade situation at these times

This situation occurs when the economy has been growing for some time leading to a build up of inflationary pressure as demand rises.

Deflationary Gap Deflationary gap prevails when ag gregate demand

(AD) is less than aggregate supply (AS) at full employment level of output

Deflationary gap depicts unemployment situa tion attributable to the fact that at full employment level of output, AD <AS

Measured as the difference between AD and AS at full employment

Deflationary gap, and the resultant conditions of unemployment and sluggish economic activity, will persist until a higher level of aggregate demand consistent with full employment is achieved

To Encourage Economic Growth Keep low levels of Inflation To increase the balance of Payments surplus Reduce the levels of unemployment

Four Government Economic Aims

Inflation Refers to the persistent rise in the

general price level of goods and services

Too much money chasing too few goods

Loss of purchasing power of the unit of money

Government aims keep the low or mild levels of inflation

Unemployment Occurs when people are without work

and actively seeking work Unemployment rate is a measure of

the prevalence of unemployment it is calculated as a percentage by

dividing the number of unemployed individuals

Government always tries to lower the Unemployment

Balance of payments Accounting record of all monetary

transactions between a country and the rest of the world

These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers

If the difference between exports and imports is negative then there is BOP deficit

If the difference between exports and imports is positive then there is BOP surplus

Governments usually aims for BOP surplus

Economic growth Increase in the long-term productive

potential of an economy Increase in the value of GDP compared to

previous yearsMeasured by percentage rate of increase

in GDPValue of GDP/population is GDP per capita Increase in GDP per capita is intensive

growth

Demand Side Causes Increase in

Aggregate Demand due to

1. Increased wages2. Increased

government spending

3. Fall in value of currency

4. Rising house prices

Supply side causes Increase in

Aggregate Supply1. Expanding

productive capacity

2. Discovering new natural resources

3. Technological improvements

4. Increase in labour productivity

Causes of Economic Growth

Due to economic growth national output expands

National income increasesCost of production are lowerProfits(𝞹) of all the firms increasesBusiness confidence level risesEmployment level rises in an economyAggregate Demand for goods and services

increases Interest rates are lowers so, Investments in an economy increasesBalance of surplus is increased

Growth Phase of Business Cycle

Potential benefits gained by Economies achieving Growth

Costs of Growth to the Economies

Improvements in living standards

Negative Externalities

Increase in Employment level

Growth that leads to environmental damage

Greater business confidence

Rise in General Price level

Balance of payment Surplus

The depletion of the global resource base

Higher profits of the firms producing goods & services

Impact of global warming

Technical Advancements

Widening of inequalities of income distribution

Growth Rates over the 50 years of United States

Pakistan’s GDP Growth Rates over the last 10 years

Growth to boom

Multiplier Effect 1. It is the number of times a rise in national income

exceeds the rise in injections of demand that caused it

2. It works on the mechanism that one person’s income is another’s expenditure

3. This can lead to a bigger eventual effect on output and employment

4. It shift’s the Aggregate Demand curve to the right hand side

5. Formula of Multiplier

How does the multiplier works ?

Consider a foreign firm invest £300 in the UK by opening up a new plant of a factory in the UK

This may set off a chain reaction of increases in expenditures

Firms which produce capital goods and construction firm will see an increased incomes and profits

If the Marginal propensity of consume is 3/5Then firms and their employees will spends 3/5

of their income which will lead to an increase of £180 in the national income. This is the first round of spending

Affects of Multiplier on aggregate demand

BOOM An economic boom is a period characterized by an

increase in output and rapid economic growth. A period of significant output within a population. The period is marked by;1. productivity increases2. sales increases,3. wage increases and4. rising demand.

 http://www.businessdictionary.com/definition/economic-boom.html#ixzz2so61riBw

Consumer confidence

High demand Output level Investment

Features of Boom

Full Employment level

Profits Business

failure

Features of Boom

During the boom confidence of consumers is high.

Consumer confidence:

HIGH DEMAND:

As the consumer confidence and spending is high during the boom so the demand of production is high.

OUTPUT LEVEL:

Because of the high consumer confidence, high spending and high demand, business have to produce more items to satisfy the demand of consumers, so the output level is high.

Investment:

As the demand of production is high during boom so the business need more capital to produce more items, so the investments and the demand of the bank loan is high, during the boom.

During the boom, because of the high demand of production, business has needed more employs for the purpose of increasing production level so the employment level is high during the boom.

As the everything are high during the boom so the profits are high during the boom.

BUSINESS FAILURE:

As the everything relating to business is beneficial for the business, so during the boom there is very less chances to any business failure.

INFLATION

Although everything in the boom is beneficially for the economy of any country, but the negative

point of boom is

A constant increase in the level of consumer prices or a constant decrease in the purchasing power of money, caused

by an increase in available currency and credit beyond the proportion of available goods and services.

 http://www.answers.com/topic/inflation#ixzz2soGzcvnC

Cost-push inflation is due to wage increases that cause businesses to raise prices to cover higher labor costs, which leads to demand for still higher wages (the wage-price spiral),

Demand-pull inflation results from increasing consumer demand financed by easier availability of credit;

Monetary inflation caused by the expansion in money supply (due to printing of more money by a government to cover its deficits).

SHORT SUMMARY OF B OOM’S FEATURES:

Industrial Production High

Sales Increase

Profits High

Investment High

Employment Increase

S H O R T S U M M A RY O F B O O M ’ S F E AT U R E S :

Bank Loan High Demand

Interest Rate High

Business Failure Zero

Wage High

Cost of Production Increases

Recession phase of Business

Cycle

Downward trend in Business cycle Decline in real GDP Production Employment Fall in trade Falling Incomes Lower prices Business pessimism Falling Business Confidence Lower interest rates and cheaper bank

loans Opportunities for capital investment due

to lower interest rates

Features

CAUSES OF RECESSION Due to Highest level of Demand pull

inflation and high interest rates: 1. Aggregate Demand falls2. Which leads to low levels of

production3. Squeezing profits 4. Redundancies 5. Reverse multiplier effect 6. Trade surplus turning to deficit

And Ultimately booming situation turns into a recession…..

Global Recession of 2008An on-going marked global economic

decline that begun in December 2007crisis started with a financial liquidity crisis

at the interbank lending market and US housing bubble burst

During the Great Recession:1. Jobs were Lost2. Unemployment and underemployment 3. The Job shortage4. Falling incomes , rising poverty 5. Other fallouts

Depression Phase of the Business Cycle

Recession

Depression Prices start rising Wages decrease Demand decreases Production of goods hampered Liquify of stocks Production decreases Labour unemployed

Depression sets in..

DEPRESSION PHASE

Definition of Depression:Periods labeled with depression are marked

by a substantial and sustained shortfall of the ability to purchase goods relative to the amount that could be produced using current resources and technology.

Another proposed definition:Depression is the phase in which there is :A decline in real GDP exceeding 10%,orA recession lasting 2 years or more.

Depression is : Prolonged economic downturn Begins with two consecutive quarters of

negative GNP growth… Bottom phase of BUSINESS CYCLE, and Its length vary depending upon economic

conditions…

FEATURES OF DEPRESSION Fall in volume of output and trade Fall in income and rise in unemployment Decline in consumption and demand Fall in interest rates Deflation Contraction of bank credit Fall in MEC (Marginal efficiency of capital)

and investment

DEPRESSION ---- FROM HISTORY

In history we see A big depression in the world !

That is THE GREAT DEPRESSION 1930’s

GREAT DEPRESSION IS : Best known depression… Started with WALL STREET CRASH OF 1929… Between 1929 and 1933, GNP of US

decreased by 33%, While the rate of unemployment increased to

25% (industrial unemployment alone rising to 35% approx.…)

MAIN CAUSES : Loose money policies of Federal Reserve

during latter 1920’s… Misallocation of capital.. Based on Easy and Inexpensive credit..

GREAT DEPRESSION

After a decade of prosperity US was thrown into despair on….

Black Tuesday October 29,1929

Period: 1929 – early 1940’s

There are five steps that defines THE GREAT DEPRESSION :

Stock market crashed The dust bowls Riding the rails Roosevelt and the New Deal The end of great depression

THE STOCK MARKET Stock prices plummeted Panic struck Masses of stock sellers No buyers for stock Surest way to become rich

became the PATH OF BANKRUPTCY…

Withdrawal of money from banks…

Decreased spending by consumers

Businesses closed Unemployment of workers

THE DUST BOWL Great plains were hit hard by DROUGHT,And horrendous DUST STORMSFarmers without crops Debt on small farmersFamilies of farmers were homeless and

unemployed

RIDING THE RAILS Unemployed travelling for JOBS Vacancy only for some unemployed Jobless people lived in SHANTYTOWN(known as

HOOVERVILLES) Okies and Arkies in CALIFORNIA

ROOSEVELT AND THE NEW DEAL Blames on President HERBERT HOOVER Hoovervilles Hoover Blankets Hoover Flags Hoover Wagons New President FRANKLIN D.ROOSEVELT Programs – New Deal AAA (Agricultural Adjustment

Administration) CCC (Civilian Conservation Crops) WPA (Work Progress Administration)

THE END OF GREAT DEPRESSION

New Deals of Roosevelt Entrance in World War II Crops were grown to send food to overseas Factories started Men were trained to become soldiers…

Adverse Social ,Economic And Political Effects Of Recession & DepressionGDP declines.Unemployment.mental healthCrimesSuicides Consumer spending might go down.Competition could get fierce.Unpredictable business.Falling Standard of LivingBankruptciesPolitical unpopularity

The Other Side Of Recession Or Depression……..

Capital assets become cheaper which opens up the opportunities for Investment

Demand for the firms producing Inferior goods increases

Improved relationships between employers and employees

Closure of Inefficient factories or departments of a firm

Due to Low inflation increase in demand for exports

Type of Producers

Period of Economic Growth

Period of Recession

Producers of luxury goods and services-e.g. cars

• Increase in range of goods and services

• Raise prices to increase profit margins

• Promote exclusivity and style• Increase output

• May not reduce prices for fear of damaging long-term image

• Credit terms to improve affordability

• Offer promotions• Widen product range with lower-

priced models

Producers of normal goods and services-e.g. tinned food

• Add extra value to product-better ingredients/improved packaging

• Brand image may attract exclusive tag

• Do nothing-sales not much affected anyway

• Lower prices • Promotions • Do nothing-sales not much

affected anyway.

Producers of inferior goods and services-e.g. very cheap clothing

• Attempt to move product upmarket

• Add extra value to the product- e.g. higher quality

• More exclusive or better designed products

• promote good value and low prices

• Free consumer tastes • Increase range of distribution

Strategies a business could adopt during the different phases of business cycle

Fiscal Policy Fiscal policy is the use of government revenue

collection (taxation) and expenditure (spending) to influence the economy

Expansionary fiscal policy The expansionary fiscal policy involves the

government attempting to increase aggregate demand, the two main instruments the government use to achieve this is government spending and taxation.

Contractionary fiscal policyContractionary fiscal policy is a government

policy of reducing spending and raising taxes

Policies To Overcome Recession And Depression

Expansionary Fiscal Policy :

Increase in government spending's

Decrease in taxation

Increases aggregate demand and result in

Economic growth

Contractionary Fiscal Policy :

Decrease in government spending's

Increase in taxation

Decreases aggregate

demand and result in lowering the

rates of economic growth

Monetary Policy Process by which the monetary authority of a

country controls the supply of moneyExpansionary monetary policyContractionary monetary policy is a form of

economic policy used to fight inflation which involves decreasing the money supply in order to increase the cost of borrowing which in turn decreases GDP and dampens inflation

Contractionary Monetary Policy Expansionary monetary policy is an increase

in the quantity of money in circulation, with corresponding reductions in interest rates, for the expressed purpose of stimulating the economy to correct or prevent a business-cycle contraction and to address the problem of unemployment.

Expansionary Monetary Policy :

Increase in supply of money

Decrease in interest rate

Contractionary Monetary Policy :

Decrease in money supply

Increase in Interest rate

Trade policies which a Government could use to Avoid

Recession/DepressionProtectionist PolicyProtectionism is the economic policy of

restraining trade between states through methods ;

1. tariffs on imported goods2. restrictive quotas3. Subsidies 4. Custom duties 5. Embargoes

Exchange Control Policy The way an authority manages its currency in relation to other currencies and the foreign exchange market through its managed exchange rate systems

Both of the above policies boost the trading activities within the economy by exporting more and importing lesser quantities

Which ultimately results in flows of income into the economy contributing to the national income