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AS Macro Revision
Aspects of the Economic Cycle
Spring 2014
We add new resources / links / articles every day
to our Economics blogs
Follow this link for the AS Macro Blog on Tutor2u...
Identifying Stages of the Economic Cycle
Cycle is when GDP growth fluctuates around the trend (or underlying) growth

Rece...
Explaining the Stages of the Economic Cycle
Boom

A period when the rate of growth of real GDP is fast
and higher than its...
The Output Gap
General
Price Level

LAS
AS

GPL1

AD
Y1

Yp Real GDP

The output gap is the
difference between the
actual ...
Negative and Positive Output Gaps

Negative Output Gap

Positive Output Gap

When actual GDP is less
than potential GDP

A...
Evidence for the Output Gap in the UK Economy

Positive output gap
after several years of
strong growth

Recession

Recess...
Identifying Some Possible Causes of a Recession
External events
• A recession in a trading partner e.g. The European Union...
External Shocks to Aggregate Demand
Many unexpected events cause changes in the level of demand,
output and employment. Th...
UK Economic Growth in Recent Years

Forecast

A long period of strong,
sustained growth with rising
real GDP and incomes

...
We add new resources / links / articles every day
to our Economics blogs
Follow this link for the AS Macro Blog on Tutor2u...
Short Term Economic Effects of a Recession
Effects of recession depend in part on its causes and how long it lasts

Busine...
Longer Term Economic & Social Effects of a Recession
Effects of recession depend in part on its causes and how long it las...
Legacy of Recession: Hysteresis v Creative Destruction
Here are two competing views about the effects of a recession

Hyst...
The Difference between Recession and Depression
• A depression is a prolonged slump where real GDP falls by more
than 10% ...
Why has the UK Economic Recovery been weak?
Domestic demand-side factors:
Weak consumer demand, low business capital
inves...
Problems in Forecasting Real GDP Growth
No macroeconomic model can hope to cope with the volatility of
indicators such as ...
Real Incomes and Economic Activity
Real income measures the purchasing power of a given amount of
nominal (money) income –...
How The Housing Market Affects AD
• The construction sector employs about 10% of the UK
workforce (over 2 million people) ...
Costs & Benefits of High House Prices

Benefits of rising prices

Costs of rising prices

• Increases wealth of
home owner...
Get help on the AS
macroeconomics course
using twitter

#econ2
@tutor2u_econ

www.tutor2u.net
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AS Macro Revision Aspects of the Economic Cycle

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Transcript of "AS Macro Revision Aspects of the Economic Cycle"

  1. 1. AS Macro Revision Aspects of the Economic Cycle Spring 2014
  2. 2. We add new resources / links / articles every day to our Economics blogs Follow this link for the AS Macro Blog on Tutor2u www.tutor2u.net/blog/index.php/economics/categories/C59
  3. 3. Identifying Stages of the Economic Cycle Cycle is when GDP growth fluctuates around the trend (or underlying) growth Recession Slowdown Recovery Boom
  4. 4. Explaining the Stages of the Economic Cycle Boom A period when the rate of growth of real GDP is fast and higher than its long-term trend Slowdown A weakening of the rate of growth, real GDP is still rising but increasing at a slower rate Recession A period of at least six months when an economy suffers a fall in output. Or a broadly-based contraction in output, employment, investment and confidence Recovery A phase of the cycle, after a recession or depression, during which real GDP starts to increase and unemployment begins to fall Depression A prolonged downturn in the economy and where a nation’s GDP falls by at least 10 per cent
  5. 5. The Output Gap General Price Level LAS AS GPL1 AD Y1 Yp Real GDP The output gap is the difference between the actual level of GDP and its (estimated) potential level and is usually expressed as a percentage of the level of potential output. In the example on the left, the equilibrium level of national income (GDP) is less than long run potential output – therefore the output gap is negative
  6. 6. Negative and Positive Output Gaps Negative Output Gap Positive Output Gap When actual GDP is less than potential GDP Actual GDP is greater than potential GDP Some factor resources are under-utilized Some resources working beyond usual capacity (shift work & overtime) Main problem is likely to be higher unemployment Main problem is rising inflationary pressures
  7. 7. Evidence for the Output Gap in the UK Economy Positive output gap after several years of strong growth Recession Recession causes negative output gap
  8. 8. Identifying Some Possible Causes of a Recession External events • A recession in a trading partner e.g. The European Union or the USA • A sharp rise in global commodity prices e.g. Rising oil and gas prices Tightening of macro policy • Higher interest rates leading to more expensive loans • A rise in taxation or a cut in government spending Fall in asset prices or supply of credit • Steep decline in the level of share or house prices • A collapse in the supply of credit (e.g. Global financial crisis) Drop in business and consumer confidence • Lower business confidence cuts investment and may lead to job losses • Declining consumer confidence leads to less spending and more saving
  9. 9. External Shocks to Aggregate Demand Many unexpected events cause changes in the level of demand, output and employment. These events are called “shocks”. Some of the causes of AD shocks are as follows A large rise or fall in the exchange rate A recession or boom in one or more main trading partner countries A slump in the housing market or a change in the level of share prices An event such as the global financial crisis which caused a fall in the supply of credit
  10. 10. UK Economic Growth in Recent Years Forecast A long period of strong, sustained growth with rising real GDP and incomes Two years of recession followed by a slow recovery
  11. 11. We add new resources / links / articles every day to our Economics blogs Follow this link for the AS Macro Blog on Tutor2u www.tutor2u.net/blog/index.php/economics/categories/C59
  12. 12. Short Term Economic Effects of a Recession Effects of recession depend in part on its causes and how long it lasts Business profits and investment • Falling demand can cause more businesses to fail and profits fall • Planned investment declines – hitting industries that make the capital goods Unemployment • The drop in aggregate demand causes a fall in the demand for labour • This causes a contraction in employment and a rise in cyclical unemployment Government finances • Recession causes a decline in tax revenues and more welfare spending • The result is usually an increase in the budget deficit Inflation • Many business offer price discounts to off-load excess stocks • A deep recession risks causing a period of price deflation (negative inflation)
  13. 13. Longer Term Economic & Social Effects of a Recession Effects of recession depend in part on its causes and how long it lasts Long Term Economic Consequences Long Term Social Consequences Rising structural longterm unemployment Falling real wages hits living standards Low investment can reduce the capital stock Widening inequality of income and wealth Persistent budget deficit and rising national debt Social costs from rising relative poverty
  14. 14. Legacy of Recession: Hysteresis v Creative Destruction Here are two competing views about the effects of a recession Hysteresis When an economy is disabled by recession – big risk of permanent loss of national output Creative Destruction Recessions can cast a dark shadow but capitalist economies usually bounce back Loss of productive capacity due to low investment / business closures Recessions prompt emergence of new business models and an increase in start-ups High rates of longterm structural unemployment – shrinking labour force New technologies can act as a catalyst for renewed growth and investment
  15. 15. The Difference between Recession and Depression • A depression is a prolonged slump where real GDP falls by more than 10% from the peak of the cycle to the trough • In Greece, real GDP has fallen in seven successive years and real GDP is more than 25% lower than at the peak of the cycle
  16. 16. Why has the UK Economic Recovery been weak? Domestic demand-side factors: Weak consumer demand, low business capital investment, cuts in real level of government spending Domestic supply-side factors: Low supply of bank credit to businesses, falling labour productivity (output per worker) + high energy prices, External demand-side factors: Weak growth in key overseas markets, hitting UK export sales e.g. Euro Area, too few exports to Asian region External supply-side factors: Rising world food and energy prices, keeping UK inflation high and squeezing real disposable incomes
  17. 17. Problems in Forecasting Real GDP Growth No macroeconomic model can hope to cope with the volatility of indicators such as inflation, exchange rates and global commodity prices. This makes forecasting GDP growth difficult Uncertain business confidence levels Rate of business job creation hard to forecast Uncertain reactions to macro policy changes Forecast growth for UK (source: BoE) Fluctuations in exchange rate External events e.g. volatile oil and gas prices
  18. 18. Real Incomes and Economic Activity Real income measures the purchasing power of a given amount of nominal (money) income – i.e. nominal income adjusted for inflation Year 2008 2009 2010 2011 2012 2013 Earnings Consumer (Wages, Bonuses Price Index and Overtime) % annual % annual change change 4.7 3.0 1.9 2.3 2.1 3.7 0.4 4.5 1.6 3.0 2.2 2.4 Real incomes Rising Falling Falling Falling Falling Falling Year of recession In each of the last five years, the annual growth of earnings for people in work has been less than inflation – causing real incomes to fall
  19. 19. How The Housing Market Affects AD • The construction sector employs about 10% of the UK workforce (over 2 million people) and contributes almost £90 billion to the UK economy each year • The recession of 2008-2010 caused a steep fall in new house building and led to hundreds of thousands of job losses – this was a factor causing unemployment to rise • House-building remains labour intensive so changes in demand and output have quite large multiplier effects • Changes in house prices affect the level of household wealth and this can affect consumer spending and saving decisions • Falling house prices often cause a fall in consumption • Since 2012, house prices have started to rise again but so too have housing rents – housing affordability is a big issue
  20. 20. Costs & Benefits of High House Prices Benefits of rising prices Costs of rising prices • Increases wealth of home owners • Boosts consumer confidence • Stimulates an expansion of new house-building • Increases tax revenues from stamp duty • Improves the financial stability of the banks • Worsens affordability for first time buyers • Increases level of mortgage debt • Increases wealth inequality • Causes an increase in demand for and cost of renting property • Worsens geographical mobility of labour Evaluation Points Effects of rising house prices depends in part on: 1. The scale of the rise in prices 2. The volatility of the housing market 3. The extent to which homebuyers overextend themselves with high mortgages
  21. 21. Get help on the AS macroeconomics course using twitter #econ2 @tutor2u_econ www.tutor2u.net

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