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What Is the Economic Cycle?
- 4 Stages of a Business Cycle
- How to Measure Cycles
Managing Economic Cycles
Economic theory, the bottom line, economic cycle: definition and 4 stages of the business cycle.
Investopedia contributors come from a range of backgrounds, and over 24 years there have been thousands of expert writers and editors who have contributed.
An economic cycle, also known as a business cycle , refers to economic fluctuations between periods of expansion and contraction. Factors such as gross domestic product (GDP) , interest rates , total employment, and consumer spending can help determine the current economic cycle stage.
Understanding the economic period can help investors and businesses determine when to make investments and when to pull their money out, as each cycle impacts stocks and bonds as well as profits and corporate earnings.
- An economic cycle is the overall state of the economy as it goes through four stages in a cyclical pattern: expansion, peak, contraction, and trough.
- Factors such as GDP, interest rates, total employment, and consumer spending can help determine the current stage of the economic cycle.
- The causes of a cycle are highly debated among different schools of economics.
Investopedia / Mira Norian
Stages of the Economic Cycle
An economic cycle is the circular movement of an economy as it moves from expansion to contraction and back again. Economic expansion is characterized by growth and contraction, including recession, a decline in economic activity that can last several months. Four stages characterize the economic cycle or business cycle.
During expansion, the economy experiences relatively rapid growth, interest rates tend to be low, and production increases. The economic indicators associated with growth, such as employment and wages, corporate profits and output, aggregate demand, and the supply of goods and services, tend to show sustained uptrends through the expansionary stage. The flow of money through the economy remains healthy and the cost of money is cheap. However, the increase in the money supply may spur inflation during the economic growth phase.
The peak of a cycle is when growth hits its maximum rate. Prices and economic indicators may stabilize for a short period before reversing to the downside. Peak growth typically creates some imbalances in the economy that need to be corrected. As a result, businesses may start to reevaluate their budgets and spending when they believe that the economic cycle has reached its peak.
A correction occurs when growth slows, employment falls, and prices stagnate. As demand decreases, businesses may not immediately adjust production levels, leading to oversaturated markets with surplus supply and a downward movement in prices. If the contraction continues, the recessionary environment may spiral into a depression .
The trough of the cycle is reached when the economy hits a low point, with supply and demand hitting bottom before recovery. The low point in the cycle represents a painful moment for the economy, with a widespread negative impact from stagnating spending and income. The low point provides an opportunity for individuals and businesses to reconfigure their finances in anticipation of a recovery.
Measuring Economic Cycles
Key metrics determine where the economy is and where it's headed. The National Bureau of Economic Research (NBER) is the definitive source for marking the official dates for U.S. economic cycles. Relying primarily on changes in GDP, NBER measures the length of economic cycles from trough to trough or peak to peak.
Since the 1950s, a U.S. economic cycle, on average, lasted about five and a half years. However, there is wide variation in the length of cycles, ranging from just 18 months during the peak-to-peak cycle in 1981 to 1982 up to the expansion that began in 2009. According to the NBER, two peaks occurred between 2019 and 2020. The first was in the fourth quarter of 2019, a peak in quarterly economic activity. The monthly peak happened in a different quarter, which was noted as taking place in February 2020.
This wide variation in cycle length dispels the myth that economic cycles are a regular natural activity akin to physical waves or swings of a pendulum. But there is debate as to what factors contribute to the length of an economic cycle and what causes them to exist in the first place.
Businesses and investors need to manage their strategy over economic cycles—not so much to control them but to survive them and perhaps profit from them.
Governments, financial institutions, and investors manage the course and effects of economic cycles differently. During a recession, a government may use expansionary fiscal policy and rapid deficit spending . It can also try contractionary fiscal policy by taxing and running a budget surplus to reduce aggregate spending to prevent the economy from overheating during expansion.
Central banks may use monetary policy . When the cycle hits a downturn, a central bank can lower interest rates or implement expansionary monetary policy to boost spending and investment. During expansion, it can employ contractionary monetary policy by raising interest rates and slowing the flow of credit into the economy.
During expansion, investors often find opportunities in the technology, capital goods, and energy sectors. When the economy contracts, investors may purchase companies that thrive during recessions , such as utilities, consumer staples, and healthcare.
Businesses that track the relationship between their performance and business cycles can plan strategically to protect themselves from approaching downturns and position themselves to take maximum advantage of economic expansions. For example, if your business follows the rest of the economy, warning signs of an impending recession may suggest you shouldn't expand. You may be better off building up your cash reserves .
Monetarism suggests that government can achieve economic stability through their money supply's growth rate. It ties the economic cycle to the credit cycle , where changes in interest rates reduce or induce economic activity by making borrowing by households, businesses, and the government more or less expensive.
The Keynesian approach argues that changes in aggregate demand, spurred by inherent instability and volatility in investment demand, are responsible for generating cycles. When business sentiment turns gloomy and investment slows, a self-fulfilling loop of economic malaise can result. Less spending means less demand, which induces businesses to lay off workers. According to Keynesians, unemployment means less consumer spending , and the whole economy sours, with no clear solution other than government intervention and economic stimulus .
What Are the Stages of an Economic Cycle?
An economic cycle, or business cycle, has four stages: expansion, peak, contraction, and trough. The average economic cycle in the U.S. has lasted roughly five and a half years since 1950, although these cycles can vary in length. Factors to indicate the stages include gross domestic product, consumer spending, interest rates, and inflation. The National Bureau of Economic Research (NBER) is a leading source for indicating the length of a cycle.
What Happens in Each Phase of the Economic Cycle?
In the expansionary phase, the economy experiences growth over two or more consecutive quarters. Interest rates are typically lower, employment rates rise, and consumer confidence strengthens. The peak phase occurs when the economy reaches its maximum productive output, signaling the end of the expansion. After that point, employment numbers and housing starts to decline, leading to a contractionary phase. The lowest point in the business cycle is a trough, which is characterized by higher unemployment, lower availability of credit, and falling prices.
What Causes an Economic Cycle?
The causes of an economic cycle are widely debated among different economic schools of thought. Monetarists, for example, link the economic cycle to the credit cycle. Here, interest rates, which intimately affect the price of debt, influence consumer spending and economic activity. On the other hand, a Keynesian approach suggests that the economic cycle is caused by volatility or investment demand, which in turn affects spending and employment.
The economic or business cycle refers to the cyclical pattern experienced by the economy. The economy remains in an expansion phase until it reaches its peak, reversing to the downside and entering a contraction before a trough, and begins to expand once again. GDP, interest rates, employment levels, and consumer spending can help define the economic cycle. Although there are different economic theories to explain what drives the economic cycle , the conditions associated with each stage can impact business and investment decisions.
Congressional Research Service. " Introduction to U.S. Economy: The Business Cycle and Growth ," Page 1.
National Bureau of Economic Research. " Business Cycle Dating ."
National Bureau of Economic Research. " US Business Cycle Expansions and Contractions ."
National Bureau of Economic Research. " NBER Determination of the February 2020 Peak in Economic Activity ."
International Monetary Fund. " Fiscal Policy: Taking and Giving Away ."
International Monetary Fund. " Monetary Policy: Stabilizing Prices and Output ."
International Monetary Fund. " What Is Keynesian Economics? "
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- BUSINESS-CYCLE THEORIES
- Business Fluctuations and the theory of Aggregate Demand
Exogenous vs. ’emollient Mechanisms . Over the years macroeconomics has been energized by vigorous debates about the sources of business fluctuations.What causes aggregate demand to shift suddenly? Why should market economies blow hot” . and cold? There is certainly no end of possible ex-“plantations. but it is useful to classify the different sources into two categories, exogenous and primarily internal. Economists use the term ”’exogenous” to refer to forces operating from outside the system. The exogenous theories find the root of the. business cycle in the fluctuations of factors outside the economic system-in wars. revolutions. and elections; in oil prices, gold discoveries. and migrations; in discoveries of new.lands and resources; in scientific breakthroughs and technological innovations; ‘even’ in sunspots or the ‘weather. The long economic boom of the 1990s was fueled be an investment boom radiating out of the ‘information technologies sector and largely based on fundamental scientific and engineering developments in microprocessors.
By contrast. the internal theories look for mechanisms within the economic system itself that give rise to self-generating business cycles. In this approach, every expansion breeds recession and contraction. and every contraction breeds revival and “expansion-in a quasi-regular, repeating chain.On~ ‘important case is the multiplier-accelerator theory.According to the accelerator principle. rapid output growth stimulates investment. High investment in turn stimulates more output growth; and “the process continues until the capacity of the economy is reached. at-which point the economic growth rate slows. The slower growth in turn reduces investment ;pending and inventory accumulation.which tends to send the economy into a recession. The process’ then works in reverse until the trough is reached, and the economy then stabilizes and turns up again. This internal theory of the business cycle shows a mechanism. like the motion of a pendulum, in.which an exogenous shock , tends to propagate itself throughout the economy in a cyclical fashion. ‘
Demoed-Induced Cycles . One important source of business fluctuations i! shocks to aggregate demand.
A typical case is illustrated in Figure 23-4. which shows bow a decline in aggregate coriander lowers put. Say that the economy begins in short-run Equilibrium at point B. Then, perhaps because of a decline in defense spending or tight money, the” aggregate demand curve shifts leftward to AD’. If there is no change in aggregate supply. the economy will reach a new equilibrium at point C. Note that • output declines from Q to Q’. In addition, prices are lower than they were at the previous equilibrium. and the rate of inflation falls.
The case of a boom is. naturally, just the -opposite. Here. the AD curve shifts to the right. output approaches potential GDP or perhaps even overshoots it. and prices and inflation rise.
Business-cycle fluctuations in output, employment.and prices are often caused by shifts in aggregate demand. These occur as consumers. businesses, or governments change total spending relative to the economy’s productive capacity. When these shifts in aggregate demand lead to sharp business downturns, the convector suffers recessions or even depressions. A sharp upturn in economic activity can lead to inflation.
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You may have heard in the news that some countries' economy is going through a decline. You may have also heard that some country's economy is experiencing a rapid rise or that it is one of the best performing economies in the world. All these things characterize the business cycle. When an economy experiences a rise or decline in economic activity, it is said to be going through a business cycle. However, simply stating this would be an oversimplification. Let's dig deeper into the topic of business cycles. Keep on reading to find out more!
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- Deficits and Debt
- Demand-side Policies
- Economic Growth and Public Policy
- Effective Taxation
- Expansionary and Contractionary Fiscal Policy
- Federal Government Revenue Sources
- Federal Taxes
- Fiscal Multiplier
- Fiscal Policy
- Fiscal Policy Actions in the Short Run
- Government Income and Expenditure
- Government Revenue
- Government Spending
- Implicit Liabilities
- Incidence of Tax
- Inflation Tax
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- Long-Run Consequences of Stabilization Policies
- Long-Run Phillips Curve
- Lump Sum Tax
- Marginal Tax Rate
- Monetary Policy Actions in the Short run
- Money Growth and Inflation
- National Debt
- Phillips Curve
- Principles of Taxation
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- Short-Run Phillips Curve
- Sources of Revenue for Local Government
- Sources of Revenue for State Government
- Stabilization Policy
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- State and Local Tax
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- The Economics Of Taxation
- The Government Budget
- Trade Liberalization
- Types of Fiscal Policy
- Types of Taxes
- 2008 Financial Crisis
- Argentine Great Depression
- Chinese Economy
- Consequences of Brexit
- Cuban Economy
- Dot-com Bubble
- German Economy
- Great Depression
- Impact of Brexit on UK Economy
- Impact of Brexit on the EU Economy
- Indian Economy
- Japan Lost Decades
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- Oil Crisis 1973
- Singapore Economy
- South Korea Economy
- Tulip Mania
- United Kingdom Economy
- World Economies
- BOP Financial account
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- Consumption Function
- Expenditure Approach
- Expenditure Multiplier
- Gross Domestic Product
- Investment Spending
- Measured GDP
- Measures of National Income and Output
- Measuring Domestic Output and National Income
- National Accounts
- Output Expenditure Model
- Real vs Nominal Value
- Tax Multiplier
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Business Cycle Definition
First, we will provide the definition of a business cycle . Business cycles refer to short-term fluctuations in the level of economic activity in a given economy. An economy may experience long-term growth where its national output or GDP increases. However, while this economic growth happens, it is often interrupted momentarily by a series of business cycles where economic activity rises or declines.
Business cycles refer to short-term fluctuations in the level of economic activity in a given economy.
Let's look at it this way. The economy is eventually (in the long run ) going to grow, either negatively or positively. While this growth is being achieved, the economy goes through some ups and downs. We call these ups and downs business cycles. Let's look at a simple example.
Between year 1 and year 2, the economy of a country grows by 5%. However, within this one-year period, this country's economy experienced different downward and upward changes in output, employment, and income.
The downward and upward changes described above characterize the business cycle. It is important not to rely on duration in understanding business cycles; business cycles can be anywhere from 6 months to 10 years. Look at business cycles as periods of fluctuations !
Types of the Business Cycle
The types of business cycles include cycles caused by exogenous factors and those caused by internal factors . These types exist due to the circumstances that lead to fluctuations in economic activity.
There are two types of the business cycle: cycles caused by exogenous factors and those caused by internal factors.
Exogenous factors refer to those factors that are not inherent to the economic system. Examples of such factors include climate change, discoveries of rare resources, wars, and even migrations.
Exogenous factors refer to those factors that are not inherent to the economic system.
These occur outside the economic system in the sense that they are mainly external factors that cause the economic system to respond in a certain way, which then results in a business cycle. Let's look at an example.
The discovery of crude oil in a country results in the creation of oil refineries in that country as it becomes an exporter of oil.
The scenario described above clearly shows a sudden increase in economic activity as a whole new economic activity has been added.
Internal factors, on the other hand, refer to factors that are within the economic system. The simplest example of this is an increase in interest rate, which reduces aggregate demand. This is because an increase in interest rates makes it more expensive to borrow money or get a mortgage, and this makes consumers spend less.
Internal factors refer to factors that are within the economic system.
Business Cycle Stages
Here, we will look at the business cycle stages. There are four stages of a business cycle. These include the peak, recession, trough, and expansion . Let's look at each of these.
The peak refers to the period where economic activity has reached a momentary maximum. At a peak, the economy has achieved or almost achieved full employment, and its actual output is near or equal to its potential output. The economy typically experiences an increase in price level during a peak.
A recession follows a peak . During a recession, there is a rapid decline in the national output, income, and employment . Here, there is a contraction of economic activity. In other words, economic activity shrinks, and certain sectors reduce in size. Recessions are characterized by high levels of unemployment as businesses shrink and cut down their number of employees.
After a recession is a trough , which is when economic activity has reached its lowest . This means that there can only be a rise in economic activity after a trough. If the economic activity goes further down, then it was not a trough, to begin with. Here, national output, income, and employment are at their lowest for the cycle.
An expansion is the next movement of economic activity after the trough. It is a rise in economic activity as the national output, income, and employment all begin to rise towards full employment. In this phase, spending may increase rapidly and outpace the production in the economy. This results in a rapid increase in the price level, which is referred to as Inflation .
Read our article on Inflation for more on this.
Business Cycle Causes
A series of factors are considered to be possible causes of business cycles by economists. These include irregular innovation, changes in productivity, monetary factors, political events, and financial instability . Let's look at these in turn.
- Irregular Innovation - When new technological discoveries are made, new economic activities emerge. Examples of such innovations include the inventions of the computer, the telephone, and the internet, which are all significant advancements in communication. The inventions of the steam engine or airplanes are also factors that are bound to cause a fluctuation in economic activity. For instance, the invention of planes meant that a new business segment had been created in the transportation industry. Such a scenario will lead to an increase in investment and consumption and, with it, cause business cycle fluctuations.
- Changes in Productivity - This refers to an increase in the output per unit of input. Such changes will cause an increase in economic output since the economy is producing more. Changes in productivity may occur as a result of rapid changes in the availability of resources or rapid changes in technology. For instance, if an industry acquires newer, cheaper technology that helps it to increase its output to twice the previous quantity, this change is likely to cause a fluctuation in the business cycle.
- Monetary Factors - This is directly related to the printing of money. As the country's central bank prints more money than expected, inflation occurs as a result. This is because, as more money is printed, households have more money to spend. As the printed money was unexpected, there was not enough supply of goods and services to match this new demand. This will cause businesses to raise the prices of their goods and services. The opposite of all this happens if the central bank suddenly reduces the quantity of money it prints.
- Political Events - Political events, such as wars, or even a change in government following an election, can cause a business cycle. For instance, a change in government could mean a change in policy or approach to government spending. If the new government chooses to unexpectedly print or spend more money than the previous government, then a fluctuation in economic activity occurs.
- Financial Instability - Unexpected or rapid increases and decreases in the prices of assets can result in a loss or increase in the confidence of consumers and businesses. If consumers lose confidence, there will be a significant unexpected decline in the demand for assets, which will cause a fluctuation in economic activity.
Business Cycle Recession
A business cycle recession is one of the two main parts of the business cycle (the other being an expansion). It refers to the period in a business cycle where there is a rapid decline in the national output, income, and employment .
- A recession refers to the period in a business cycle where there is a rapid decline in the national output, income, and employment.
Business activity contracts during this phase. A recession ends at the trough and is followed by an expansion.
Expansion Business Cycle
A business cycle expansion is one of the main parts of the business cycle alongside a recession. During an expansion, there is a rapid increase in the national output, income and, employment . Business activity expands during this phase. For instance, certain sectors employ more workers as there is room to increase production.
- An expansion refers to the period in a business cycle where there is a rapid increase in the national output, income, and employment.
The Business Cycle in Action
Let's see what the business cycle looks like in real life. Here, we use the potential real GDP and actual real GDP of the United States. Take a look at Figure 3 below.
Figure 3 above shows the ups and downs of the United States economy from 2001 to 2020. Reading from left to right, we see that there was a period when actual GDP was above the potential GDP (until 2010). After 2010, the actual GDP remained below the potential GDP through 2020. Where the actual real GDP falls above the potential real GDP line, there is a positive GDP gap . On the other hand, there is a negative GDP gap where the actual real GDP falls below the potential real GDP line.
You have reached the end of this article. You should read our explanations on the Business Cycle Graph and Inflation to understand more about related macroeconomic concepts.
Business Cycle - Key takeaways
- There are two types of business cycles: cycles caused by exogenous factors and those caused by internal factors.
The business cycle diagram is the graphical representation of the phases of the business cycle.
- Congressional Budget Office, Budget and Economic Data, https://www.cbo.gov/system/files/2021-07/51118-2021-07-budgetprojections.xlsx
Frequently Asked Questions about Business Cycle
--> what is a business cycle example.
An example of a business cycle is an economy where the national economic output, income, and employment undergo a series of fluctuations.
--> What affects the business cycle?
The business cycle is caused by irregular innovation, changes in productivity, monetary factors, political events and financial instability.
--> What are the characteristics of the business cycle?
The business cycle has 4 phases. These include the peak, recession, trough, and expansion.
--> What is the purpose of the business cycle?
The business cycle covers the short-term period and shows the fluctuations in economic activity within this period.
--> What is the importance of business cycle?
The business cycle is important because it helps economists study aggregate output in the short-term.
Final Business Cycle Quiz
Business cycle quiz - teste dein wissen.
What is a business cycle?
Business cycles are caused by both exogenous and ___ factors.
What are exogenous factors?
What are internal factors?
What is a peak?
A peak refers to the period where the economic activity has reached a momentary maximum.
A trough is not a phase of the business cycle.
A recession comes after a trough.
What is a recession?
A recession refers to the period in a business cycle where there is a rapid decline in the national output, income and employment.
An expansion comes after a recession.
A recession comes after an expansion.
What is the business cycle diagram?
Changes in productivity can cause a business cycle.
Employment decreases during an expansion.
Political events are not a possible cause of business cycles.
An expansion is likely to be followed by inflation.
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The Business Cycle: Introduction to Macroeconomic Indicators
Students will be able to:
- Define and label the phases of the business cycle.
- Understand and define the general meaning of the terms associated with business cycle.
- Understand that the business cycle is comprised of expansions and contractions of the GDP within the economy.
National Standards in Economics
National Standards in Financial Literacy
Common Core State Standards
In this economic lesson, student will analyze graphs to learn the parts of the business cycle.
Tell students this lesson will help them understand a basic macroeconomic tool called the business cycle. Have students look at either FRED from the St. Louis Fed or project the graph in the link on the board for them to see. Ask students: “How do you think the economy is doing right now?”and give them sufficient time to respond. If they do not respond or need more prompting, ask: “Is the economy growing (going up) or shrinking (going down)?” Follow up by asking: “What factors do you think is causing economic activity to be up (or down)?”
Open the PowerPoint titled The Business Cycle . Slide 2: Explain that these will be the key words used to discuss the business cycle. Tell students that a business cycle is just a period of expansion and contraction of the economy, measured by changes in the real GDP, or Gross Domestic Product. Slide 3: Walk students through the phases of the business cycle, discussing each phase and giving students enough time to copy the slide into the notes. Explain the following: In the expansion part of the cycle, GDP is growing, unemployment is going down, but inflation may be rising. In the contraction part of the cycle, GDP is shrinking, unemployment is growing, and inflation may stall or shrink. Slides 4 and 5 are the vocabulary terms with definitions. Talk about these definitions and give students enough time to copy them. You may also want to go back to slide 3 to discuss them. Slide 6: Have one or more students come to the board to draw and label the business cycle.
Put students in pairs to complete the Business Cycle Activity. Distribute one copy of the cards and answer sheet to each pair of students. Tell students that you will be reading each statement, then giving them one minute to discuss the potential answer with their partner. Once selecting an answer, they should place an X showing their answer and hold up the card corresponding with their answer. Start the activity, stopping to review and discuss student answers after each statement. After completing the activity, ask students if they have any questions about the business cycle.
Distribute a copy of Drawing a Business Cycle activity to each students. Tell students they should review the information and complete the assignment. Debrief the assignment by reviewing student answers. (Answers will vary, but be sure each graph has the four phases of the business cycle. Unemployment should increase during a recession and decrease during a recovery.)
Have students complete the Kahoot! Business Cycle Ticket and see the answers here.
Have students complete the worksheet “ The Great Recession “. The article can be accessed electronically or printed out for students. Tell students to read the article and answer the questions from the reading. Review their answers and answer any questions they may have.
Put students into small groups. Randomly assigned each group a 10-year period (1980-1990, 1970-1980, etc.). Have each group visit The Balance web site to plot the GDP for each year in their ten year cycle. Be sure they label the phases of their business cycle and identify the lowest/highest periods of unemployment. You may choose to have them complete this assignment on the computer or with graph paper. Have the groups present their graphs to the class in sequence, explaining the parts of the business cycle for that 10-year period. You may also want them to post their graphs on the board for a historical perspective of the U.S. economy.
Fred St. Louis Fed
Group Activity Cards
The Business Cycle Group Activity
The Business Cycle Group Activity Answer Key
Drawing a Business Cycle
The Business Cycle Ticket out the Door (Kahoot)
The Great Recession
The Great Recession Answer Key
The Great Recession article
The Balance.com GDP
Women in the US Workforce During WWII - Measuring Unemployment
Economic misery and presidential elections.
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The Potential Impact of the USMCA on US Manufacturing Jobs
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Course: ap®︎/college macroeconomics > unit 2, the business cycle.
- Business cycles and the production possibilities curve
Lesson summary: Business cycles
- Business cycles
Key takeaways, phases and turning points of the business cycle, output gaps in the business cycle, potential output in the business cycle, the production possibilities curve (ppc), common misperceptions.
- An expansion is not necessarily economic growth. When an economy is recovering from a recession, it is in the expansion phase of the business cycle, but it is not experiencing economic growth. Economic growth occurs when the potential and actual output of a nation increases over time. That growth is either shown by the dashed, upward-sloping trend line (the growth trend) in the business cycle model, or by an outward shift of the PPC. [Explain]
- An economy can produce beyond its full employment level of output. Resources can be overutilized, such as workers working very, very long hours. However, as any student who has ever pulled an all-night study session for an exam knows, you can’t sustain that kind of effort for long. [Explain]
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