When examining the US Gross Domestic Product over long periods of time, it clearly appears that the US economy has been growing, from about $2 trillion to $18 trillion from the 1950’s to today (Red line in the graph below).
What are the patterns of this growth in the short term? How do we experience it in our daily lives?
The economy does not grow at the same rate every year, in fact some years it does not grow at all and shrinks. In the graph above, the blue line represents the percentage change in the real Gross Domestic Product or annual growth and shows that the growth varies from one year to the next, that most years it is positive (above the green line) but can also be negative (below the green line). The orange line identifies the long run average annual growth rate around which the economy tends to fluctuate.
This pattern of growth, faster than average at times, then lower than average and even negative sometimes is what is described as the business cycle. The phases of this cycle can vary in length, intensity and frequency, and are difficult to predict.
| Expansion: when the economy grows beyond previous levels and /or grows at higher than average rates. Gross Domestic Product rises along with inflation typically while unemployment tends to fall . | Peak: Maximum economic performance for each expansion cycle | Recession: 2 consecutive quarters of negative growth define a recession. Gross Domestic Product falls along with inflation and unemployment tends to rise | Trough: Lowest level of the downward cycle | Recovery: increase in economic activity with growing Gross Domestic Product and reduction in unemployment. |
The instability brought on by the business cycle, expansions that can trigger harmful inflation, recessions that can lead to high unemployment (accompanied by inflation in some cases), is a concern and has been the focus of government economic policies. The government’s mandate as laid out by the Employment Act of 1946 signed by President H. Truman was prompted by the boom and bust cycle of the after war.
The next section of this course will lay out the model of Aggregate supply and demand as a tool to analyze the sources of the instability and phases of the business cycle. This model also allows for the examination of the various economic tools the government can use and evaluate how to best achieve the goals of the Employment Act and government economic policies: Full employment, Price stability and Economic Growth.
