The Business Cycle (Economic Expansions and Contractions) Explained in One Minute

What is it?

Image Created by Mackenzie Angell, Copyright Mackenzie Angell 2022

The business cycle is a model that shows the fluctuations of economic activity over time described by phases of boom, downturns, troughs and upswing. - Boom - the highest level of economic activity at a time, where the economy is operating at or above full employment - there is no potential output gap - Downturn - where the level of economic activity is decreasing - the potential output gap is increasing during this phase - Trough - where the level of economic activity has reached its lowest point - the potential output gap is the largest and economic activity cannot decrease any further - Upswing - where the level of economic activity is increasing - the potential output gap is decreasing.

What is Potential Output?

Potential output is the maximum level of economic activity/output that can be achieved with an economy's resources. Think of the economy as a kitchen stovetop with four burners. The potential output is the maximum amount that can be used, that is four burners can be used to cook four separate dishes. However, for most family meals, only one or two stovetops are ever used, this is the actual output, how much of the resources is currently being used.

Why is it Important?

Economies fluctuate all the time, one time they're in a trough, high levels of unemployment, low inflation and low economic growth such as in the GFC of 2007-08 and in other times, they're bursting with activity, low levels of unemployment, high inflation and high levels of economic activity such as in the mining investment boom of 2011-2012. Economies change so much that it tends to follow a cycle, known as, you guessed it, the business cycle. The rollercoaster of the economy follows a cycle of ups and downs.

Australia's Past GDP (Economic Activity) Performance

Image Source: RBA Chart Pack, September 2021

Notice how the GDP performance is cyclical full of ups and downs, emulating a business cycle. The Year 12 Economics course focuses on contemporary (in the last 10 years) booms and troughs of the business cycle.

Some key time periods are:

• 2007-08 Pre-GFC Boom

• 2008-09 Global Financial Crisis

• 2011-12 Mining Investment Boom

• 2015-16 Post mining boom trough

• 2020-21 COVID pandemic and recovery

  
  

We're in a Boom?

We're slowly recovering from the COVID-19 pandemic, as the economy recovers (supported by high iron ore prices), GDP growth is rising. However, recent lockdowns have made this more difficult.

Other indicators that you may need to consider (which will be discussed in more detail on the next page):

• Unemployment

• Inflation

• Wage Price Index

• Gross Domestic Income - What's actually driving GDP growth