84 Business Cycles
What you’ll learn to do: explore economic growth
Over time, real GDP increases. Some years it increases faster than average. Some years it increases slower than average. Some years GDP declines. These waves of peaks and troughs are describe as the business cycle.
In this section, we will explore economic growth, which is the increase in economic activity that occurs over the long term. We measure economic growth by real GDP per capita, but growth is a broader collection of social and economic changes, which lead to an increase in the standard of living.
You’ll see why growth happened rapidly following the Industrial Revolution, and why growth remains important today. You will also determine what factors lead to improvements in standards of living.
CALORIES AND ECONOMIC GROWTH
On average, humans need about 2,500 calories a day to survive, depending on height, weight, and gender. The economist Brad DeLong estimates that the average worker in the early 1600s earned wages that could afford him 2,500 food calories. This worker lived in Western Europe. Two hundred years later, that same worker could afford 3,000 food calories. However, between 1800 and 1875, just a time span of just 75 years, economic growth was so rapid that western European workers could purchase 5,000 food calories a day. By 2012, a low skilled worker in an affluent Western European/North American country could afford to purchase 2.4 million food calories per day.
What caused such a rapid rise in living standards between 1800 and 1875 and thereafter? Why is it that many countries, especially those in Western Europe, North America, and parts of East Asia, can feed their populations more than adequately, while others cannot? We will look at these and other questions as we examine long-run economic growth.
Learning Objectives
- Explain business cycles, including recessions, depressions, peaks, and troughs
Tracking Real GDP Over Time
When news reports indicate that “the economy grew 1.2% in the first quarter,” the reports are referring to the percentage change in real GDP. By convention, GDP growth is reported at an annualized rate: whatever the calculated growth in real GDP was for the quarter, it is multiplied by four when it is reported as if the economy were growing at that rate for a full year.
Figure 1 shows the pattern of U.S. real GDP since 1900. The generally upward long-term path of GDP has been regularly interrupted by short-term declines. A significant decline in real GDP is called a recession. Recessions typically last at least six months (or two quarters). An especially lengthy and deep recession is called a depression. The severe drop in GDP that occurred during the Great Depression of the 1930s is clearly visible in the figure, as is the Great Recession of 2008–2009.
Real GDP is important because it is highly correlated with other measures of economic activity, like employment and unemployment. When real GDP rises, so does employment.
The most significant human problem associated with recessions (and their larger, uglier cousins, depressions) is that a slowdown in production means that firms need to lay off or fire some of the workers they have. Losing a job imposes painful financial and personal costs on workers, and often on their extended families as well. In addition, even those who keep their jobs are likely to find that wage raises are scanty at best—they may even be asked to take pay cuts or work reduced hours.
Table 1 lists the pattern of recessions and expansions in the U.S. economy since 1900. The highest point of the economy, before the recession begins, is called the peak; conversely, the lowest point of a recession, before a recovery begins, is called the trough. Thus, a recession lasts from peak to trough, and an economic upswing runs from trough to peak. The movement of the economy from peak to trough and trough to peak is called the business cycle. It is intriguing to notice that the three longest trough-to-peak expansions of the twentieth century have happened since 1960. The most recent recession started in December 2007 and ended formally in June 2009. This was the most severe recession since the Great Depression of the 1930s.
| Table 1. U.S. Business Cycles since 1900 | |||
|---|---|---|---|
| Trough | Peak | Months of Contraction | Months of Expansion |
| December 1900 | September 1902 | 18 | 21 |
| August 1904 | May 1907 | 23 | 33 |
| June 1908 | January 1910 | 13 | 19 |
| January 1912 | January 1913 | 24 | 12 |
| December 1914 | August 1918 | 23 | 44 |
| March 1919 | January 1920 | 7 | 10 |
| July 1921 | May 1923 | 18 | 22 |
| July 1924 | October 1926 | 14 | 27 |
| November 1927 | August 1929 | 23 | 21 |
| March 1933 | May 1937 | 43 | 50 |
| June 1938 | February 1945 | 13 | 80 |
| October 1945 | November 1948 | 8 | 37 |
| October 1949 | July 1953 | 11 | 45 |
| May 1954 | August 1957 | 10 | 39 |
| April 1958 | April 1960 | 8 | 24 |
| February 1961 | December 1969 | 10 | 106 |
| November 1970 | November 1973 | 11 | 36 |
| March 1975 | January 1980 | 16 | 58 |
| July 1980 | July 1981 | 6 | 12 |
| November 1982 | July 1990 | 16 | 92 |
| March 2001 | November 2001 | 8 | 120 |
| December 2007 | June 2009 | 18 | 73 |
A private think tank, the National Bureau of Economic Research, is the official tracker of business cycles for the U.S. economy. However, the effects of a severe recession often linger on after the official ending date assigned by the NBER.
Try It
Watch It
Watch this short video for another explanation of business cycles.
Business Cycle Vocabulary
Other terminology to know in relation to the ebbs and flows of the business cycle include:
- Overheating, which means the economy is picking up speed leading to increased inflation. It occurs when its productive capacity is unable to keep pace with growing aggregate demand. It is generally characterized by an above-trend rate of economic growth, where growth is occurring at an unsustainable rate. Boom periods are often characterized by overheating in the economy.
- Stagflation, which means the simultaneous occurrence of stagnant growth (or recession) and inflation.
It is a situation where the inflation rate is high, the economic growth rate slows down, and unemployment is also high. It raises a dilemma for economic policy since actions designed to lower inflation may exacerbate unemployment, and vice versa.
Glossary
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