Economic Growth And The Business Cycle

This assignment will focus on the economic growth and business cycle to answer the question that why would the UK Government want to end “boom and bust” in favour of sustained economic growth. First, this essay will give a complete definition and explanation of economic growth and the business cycle. Then it will continue to talk about this topic in more detail, analyze the four main phases of the business cycle and what is meant by economic growth. Finally this essay will consider about the GDP and economic growth with the real economic environment and answer the questions about UK economy.

As the economics book defined, economic growth is the growing productive potential of the economy. Usually the economic growth is considered as a good thing. Economists use changes in GDP, the value of output, as a proxy measure. In addition, in the short term, GDP fluctuates around the long term rate of growth and these fluctuations are knows as the business cycle (Economics, Alain Anderton, n.d. p. 185).

Business cycle is regular fluctuations in the level of economic activity around the productive potential of the economy. In business cycles, they tend to have four main phases: Boom, Downturn, Recession and Recovery. Moreover, boom and recession are in the top and bottom of the economic cycle (Economics, Alain Anderton, n.d. p. 189).

Today, many developing countries have reached the boom stage of their business cycle. Boom is the period of time when the economy is growing strongly. When the economy is experiencing a boom, GDP is growing particularly fast. Unemployment is likely to be low and spending high. The rate of growth of GDP is likely to be above its long term trend rate. There will be inflationary pressures due to expanding aggregate demand. Firms will increase their investment to cope with demand (Economics, Alain Anderton, n.d. p. 185). For instance, China now is at the boom stage of the business cycle and facing the inflationary pressure.

However, the economy of a country cannot stay in the boom stage for a long time. There are many reasons which can cause the economy to decline. After the economic prosperity, it will go down and then cause a recession. Recession is at the bottom of the business cycle, the rate of growth of GDP may be close to zero or may be negative. The deeper the recession, the larger the fall in the GDP and the longer the recession will last. In a recession, unemployment will be high and possibly still rising. Consumers and firms will be reluctant to take on debt because they fear they will not be able to repay it. Firms cannot increase their investment because the demand is also decreasing. Inflation will be low and could even be negative (Economics, Alain Anderton, n.d. p. 185). For instance, in the 1929, The United States faced the Great Depression which was the longest, the most widespread and the deepest depression in the 20th century (Charles Duhigg, 2008).

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Source: Economics, Alain Anderton, n.d. p. 185

In order to measure how GDP changes in the economy, the economists may use the trend rate. And we usually talk about trend rate of growth which approximates the growth in productive potential of the economy. The trend rate always represents the trend of the economic growth. Furthermore, the actual level of GDP varies around the trend growth line and this fluctuation is the business cycle. When you look at the data in a real economy, you would like to differentiate the actual level of GDP and its estimated long term value at a point in time. This difference is known as the Output Gap (Economics, Alain Anderton, n.d. p. 186).

Output gap has two parts, one is positive output gap and another is negative output gap. When the economy is in recession and there is high unemployment and deflation, the actual level of GDP will be below the trend line. This is called a negative output gap. When it is in an inflationary boom, the actual level of GDP is likely to be above the trend line. This is called a positive output gap (Economics, Alain Anderton, n.d. p. 186).

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Source: Economics (Alain Anderton, n.d. p. 186)

An inflationary gap is defined as occurring when there is a positive output gap, i.e. when the economy is operating at full employment and there is an increase in aggregate demand. On the contrary, a deflationary gap occurs when there is a negative gap, i.e. aggregate demand is below the productive potential of the economy, or the long run aggregate supply level (Economics, Alain Anderton, n.d. p. 186).

Therefore, as we defined, in the business cycle there are four main phases. When the economy is experiencing a boom, the GDP is growing particularly fast and so does the output. The unemployment is lower than before, people are gaining higher wages and the demand will increase. This will lead the firms to increase their investment to cope with the demand. After the economic prosperity, GDP will continue to increase but the economy is slowing down, so that the unemployment will rise because of the downturn of economy. During this period of time, consumer and investment spending will be slowing and inflationary pressures will be falling. If the rate of growth of GDP continues to decrease, this will cause a recession. When the economy is in recession, unemployment will be very high and possibly still rising. The economy is growing slowly, people may lose their jobs for many reasons. For instance, there are four types of unemployment: Frictional unemployment, Seasonal unemployment, Structural unemployment and Cyclical unemployment (Economics, Alain Anderton, n.d. p. 210). Because there exists low unemployment, the consumption will decrease so that the aggregate demand will fall. This means the firms will be reluctant to invest in case they cannot sell the goods produced by the new investment. Because of a recession, countries will come up with many policies to save the economy. So the economy will be at the recovery stage. In a recovery, the rate of growth of GDP begins to pick up again. Consumers and firms begin to regain confidence and spend more so that unemployment will fall.

When we talk about the business cycle, there is no doubt that we should consider the economic growth. Economic growth is the growth in the productive potential of the economy. It is typically measured by growth in real GDP (Economics, Alain Anderton, n.d. p. 189). As GDP increases, national output can be increased if there is an increase in the quantity or quality of the imports to the production process. There are five reasons that will cause the economic growth: Land, Labour, Capital, Technological progress and Efficiency.

Land: Different countries possess different endowments of land. Land in economics is defined as all natural resources. Making the best use of resources will help developing countries lead to economic growth.

Labour: Increasing the size of the labour force can increase output and lead to economic growth.

Capital: If economic growth is to be sustained, the stock of capital in the economy needs to increase over time.

Technological progress: It cuts the average cost of production of a product and creates new products for the market.

Efficiency: Increased efficiency in the use of resources in itself will bring about rises in output. (Economics, Alain Anderton, n.d. pp. 186-7).

In addition, production possibility frontiers (PPFs) can be used to discuss economic growth and the economic recovery. As the graph shows below, when the economy grows, the PPF will move outward. A movement from A to C would be classified as economic growth and a movement from B to C would be classified as economic recovery (Economics, Alain Anderton, n.d. p. 186).

Economic growth can mean many things. This can be used to measure the national economic performance. When a country has economic growth, they may have low unemployment, high consumer spending and output. Many countries treat economic growth as a good thing because it can lead to lower unemployment, higher consumption and more investment. Also, the economic growth is linked to the standard of living. If your country has a good economy, you may have better working conditions, higher wages and enough welfare. These things will all increase people’s standard of living. In other words, the higher the standard of living, the more productivity the employee will create. So the economic growth can make many beneficial changes to the society. In industrialized countries, life expectancy has doubled over the past 300 years and infant mortality rates have plummeted. People have enough to eat and drink. Also, Housing standards have improved immeasurably and nearly everyone can read and write. These showed that their standard of living has increased (Economics, Alain Anderton, n.d. p. 196). For instance, The United States had faced the Great Depression in the 1929. During that period of time, Unemployment was very high, many people could not find a job so this increase the costs of government spending. There was deflationary pressure and this affected many firms, they could not afford to invest more to the market. Therefore, the government spent a lot of time saving the economy and finally it began to recover and then led to economic growth. So the economic growth is very important for the society and government. It is linked to the happiness of people in this country.

In general, we measure the economic growth or output by using GDP. This is called gross domestic product. GDP is a key measure of national income and this is at market price, which means it is a measure of national income that includes the value of indirect taxes like VAT. GDP also includes the value of exports and imports. (Economics, Alain Anderton, n.d. p. 137). Many countries use GDP to measure the national performance. For instance, the UK has a lower GDP than the USA. In 2006, US GDP was $ 13060 compared £ 1300 billion for the UK. GDP is a good measurement of the economy (Economics, Alain Anderton, n.d. p. 140). Also, there are many other measurements. For instance, GNP is different from GDP. GNP is gross national income which is GDP plus income earned abroad on investments and other assets owned overseas minus income paid to foreigners on their investments in the UK. Using GDP as a measurement of the performance of the economy would be a good method, for it is quick and available. When comparing over time and between countries, movements in GDP at market prices are broadly similar to movements in other measures of national income. So it is a good guide to what is happening in the economy and can be used to judge the performance of the economy. (Economics, Alain Anderton, n.d. p. 137).

Consider the reality of UK economy, the UK government would want to end ” boom and bust” in favour of sustained economic growth. During the business cycle, there are four stages where “boom” and “bust” are included. As we discussed before, when an economy is in a boom, the country may have low unemployment and high inflation. When economy is in a recession or a bust, the country will have very high unemployment and low or even negative inflation. These changes will also lead to the changes in the standard of living. However, if a country want sustained economic growth, it is better to not have fluctuations in the economy.

The UK government has come up with many policies like monetary policy and fiscal policy. In 1998, the government announced two new “fiscal rules” and one is the “golden rule” stated by Gordon Brown. The golden rule stated that the government would only borrow money to invest over the whole period of a business cycle. (Economics, Alain Anderton, n.d. p. 236). This is a good thing for the country’s economy. It can help the economy have less fluctuation which may have negative effects on the economy. When a country is in a recession, the government must borrow money to increase the welfare payments or wages, so the living standard of people will not fall a lot. Although in a recession, the economy will have high unemployment and low inflation. Because of the borrowing finance, there will be lower unemployment than before. The government borrows money to invest to the market which needs help so that this will create more working opportunities. On the contrary, when the economy recovers from a recession, the government will repay the debt. Therefore, government spending and taxation could help reduce the size of the fluctuation experienced in a trade cycle be influencing aggregate demand (Economics, Alain Anderton, n.d. p. 236).

To sum up, the business cycle tells us the fluctuations in the economy. Also, it is connected with economic growth. Many countries treat economic growth as a good thing. Furthermore, a quite efficient way of measuring the economic changes is using the rate of GDP or GNP etc. In conclusion, the reasons why UK government want to end “boom and bust” in favour of sustained economic growth are various. Because business cycle has four main phases and they all have different effects on the economy. The changes in the economy will lead to the changes of living standard and economic happiness. People want long-lasted happiness so they will want to have sustained economic growth. A better way to have sustained economic growth is to end “boom and bust” for the UK government.