The document explains the trade (business) cycle, detailing its four phases: boom, recession, slump, and recovery, characterized by fluctuations in real GDP. It outlines the effects of each phase on economic activity, demand, unemployment, and investment, with emphasis on the hysteresis effect during prolonged slumps. Additionally, it discusses the accelerator effect's role in amplifying fluctuations in the cycle based on national income growth rates.

1. Trade (Business)
Cycle
Lower 6th Macro
National Income

2. Intro to the
Trade Cycle
Trade (Business) Cycle
Mr O’Grady

3. Intro to the Trade Cycle
Definition: Variations in the level of economic activity in an economy over time
Economic activity is measured by real GDP
Real GDP Recap: the total value of a country’s output in a year, adjusted for inflation
Useful approximation: If nominal GDP growth is 5% and inflation 2%, real GDP growth is 3%
Diagram:
GDP
Time
Actual GDP
Trend
line
Actual GDP line: shows how the actual level of
output (Y) fluctuates over time
Trend line: shows how the potential output of
our economy is estimated to grow over time
4 Phases:
Boom: GDP above trend and fast growing
Recession: GDP falling – goes below trend
Slump: GDP is below trend and stagnant
Recovery: GDP rising – goes above trend
Output gaps: seen as the vertical distance
between actual GDP and the trend line at a
given point in time
Negative
Output Gap
Positive
Output Gap
Boom
Recession
Slump
Recovery

4. Phases of the
Trade Cycle:
Booms, Recessions,
Slumps, Recoveries
Trade (Business) Cycle
Mr O’Grady

5. Boom: A period of high levels of
economic activity
Actual GDP is above trend
Characteristics of a boom:
• High rate of economic growth
• High demand
• Low unemployment
• Inflationary pressure
• Labour skills shortages
• High confidence in the economy
• Capital Investment is high
Recession: A period of falling economic
activity
Actual GDP falls from above to below trend
Technical definition: Government states that
a recession is officially two quarters of
negative economic growth
Characteristics of a recession:
• Demand falls
• Unemployment begins to rise
• Some firms will go out of business
• Confidence in the economy is low and
most firms will reduce investment
Phases of the Trade Cycle

6. Slump: A period of low levels of economic activity
Actual GDP is well below trend
Characteristics of a Slump:
GDP
Time
Trend
line
• Low or negative
growth
• Demand and inflation
are low
• Unemployment is high
• Confidence in the
economy is low
• High rate of
bankruptcy
• Hysteresis is possible!
Hysteresis effect: a prolonged slump following a deep recession can damage an
economy’s potential growth rate
Lost output maybe unrecoverable, and the trend growth rate may be slower
Reasons for Hysteresis effect:
Capital stock will be replaced less readily, machines age and become less productive.
Workers lose their skills if they are out of work for a sustained period as they don’t practice
when they are unemployed
Natural resources may be untended, meaning they are less productive when they are
brought back into production

7. Recovery: When economic activity and growth are starting to rise
Actual GDP is rising back towards the trend
Characteristics of a recovery:
• Economic growth starts to rise
• Demand increases
• Unemployment falls
• Inflation starts to rise
• Confidence in the economy increases
• Capital Investment increases
The Accelerator Effect: when an increase in GDP results in a proportionately larger
rise in capital investment spending.
I.e. we often see a surge in investment when an economy is growing quite strongly.
Key Question: How does the accelerator effect help to explain the economic cycle?
If national income is growing at an increasing rate then net investment will also grow
but when the rate of growth slows net investment will fall.
There will then be an interaction between the multiplier and the accelerator that may cause
larger fluctuations in the trade cycle.
N.B. The accelerator is at its strongest when the incentive for firms to invest is strong
This could be if spare capacity is low, availability of finance is high, C is growing quickly

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