Business Cycles

Business cycles have varying durations and intensities. Why are busi-

nesses so interested in the state of the economy? They want to be able

to predict whether it’s going into a contraction or an expansion. Making

the right prediction can determine whether the business will be profit-

able or not. That’s why a large amount of economists’ activity goes into

trying to predict the future course of the economy.

The top of a cycle is called the peak. A very high peak, representing

a big jump in output, is called a boom. Eventually an expansion peaks.

When the economy starts to fall from that peak, there’s a downturn in

business activity. If that downturn persists for more than two consecu-

tive quarters of the year, that downturn becomes a recession. In a reces-

sion the economy isn’t doing so great; many people are unemployed and

a number of people are depressed.

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A large recession is called a depression. There is no formal line indi-

cating when a recession becomes a depression. In general, a depression

is much longer and more severe than a recession. This ambiguity allows

some economists to joke, “When your neighbor is unemployed, it’s a

recession; when you’re unemployed, it’s a depression.” It is generally

accepted that if unemployment exceeds 12 percent for more than a year,

the economy is in a depression.

The bottom of a recession or depression is called the trough. When

the economy comes out of the trough, economists say it’s in an upturn.

If an upturn lasts two consecutive quarters of the year, it’s called an ex-

pansion, which leads us back up to the peak. And so it goes.

Two measures that economists use to determine where the economy

is on the business cycle are the unemployment rate (the percentage of

people in the labor force who can’t find a job) and the capacity utiliza-

tion rate (the rate at which factories and machines are operating com-

pared to the rate at which they could be used). Generally economists say

that 5-6 percent unemployment and 80-85 percent capacity utilization

are about as much as we should expect from the economy. Therefore,

they use them as targets. Thus the target rate of unemployment is de-

fined as the lowest sustainable rate of unemployment economists believe

is possible under existing conditions.

Economists translate the target unemployment rate and target ca-

pacity utilization rate into the level of output with which those rates will

be associated. That level of output is called potential output (or potential

income, because output creates income). Potential output is the out-

put that would materialize at the target rate of unemployment and the

target level of capacity utilization. Potential output grows at the secular

(long-term) trend rate of 3.5 percent per year. When the economy is in

a downturn or recession, actual output is below potential output. When

the economy is in a boom, actual output is above potential output.

Text 7

Read the text. Divide it into logical parts. Give the title to the text. Make a list of the

economic terms used in the text. Be ready to explain what they mean.

A firm generally measures how busy it is by how much it produces. To

talk about, how well the aggregate economy is doing, national income

accounting uses a corresponding concept, aggregate output, which goes

under the name gross domestic product (GDP). GDP is the total mar-

ket value of all final goods and services produced in an economy in a

one-year period. It’s probably the single most-used economic measure.

When economists, journalists, and other analysts talk about the economy,

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they continually discuss GDP: how much it has increased or decreased,

and what it’s likely to do. In every country the production of goods and

services provides the food, clothing, and shelter that allow its people

to survive and prosper. Some countries produce an abundance of raw

materials such as coal and timber while others produce manufactured

goods like steel and automobiles. Some countries may concentrate on

producing foodstuffs like rice and butter while others produce services—

movies, insurance, or banking. Whatever is not consumed in the country

itself can be sold to other countries as exports. The size of a country’s

economy is determined by the total amount of goods and services that

country produces. As more and more goods and services are produced,

the economy grows—and the best way to measure this growth is to put

a monetary value on everything bought or sold. Although money is not

the only measure of an economy’s size, it is the easiest way to sum up the

value of all the apples and oranges, automobiles and computers, foot-

ball games and college classes that a country produces in the course of a

given year. The monetary value of all these goods and services can then

be added up and compared with that of other countries. Since almost ev-

ery country uses a different currency, the totals from each country have

to be translated—by using currency exchange rates—to compare the size

of one country’s economy to another. For example, the yen value of the

Japanese economy can be converted into U.S. dollars to compare it to

the American economy. The measure of economic activity that includes

all the goods and services bought or sold in a country over the course of

a year is called gross domestic product (GDP). GDP measures a country’s

economic activity. A healthy economy grows steadily, over a period of

months or years. When the international activities of a country’s resi-

dents are added to GDP, a wider more global measure of a country’s

total economic activity is created: gross national product or GNP. Both

measures tell more or less the same story—GDP concentrates on the

purely “domestic” production of goods and services covering only the

economic activity which takes place within the country’s borders, while

GNP includes net international trade and investment, which includes

everything from exports of movies and compact disks to foreign earnings

and travel abroad. GDP and GNP try to measure every legal good and

service that an economy produces. A farmer selling fresh vegetables, an

automobile dealer selling used cars, a poet selling a new book, a hair-

dresser, prize fighter, or lifeguard selling his goods and services all con-

tribute to economic activity, as measured by GDP and GNP. At each

stage of production, every time that monetary value is added, a country’s

GDP and GNP are increased. Government policymakers and business-

people use GNP to forecast trends and to analyze the economy’s per-

formance. Although the measure is well entrenched, many economists

complain that it is sometimes misleading. The value of all shadow econ-

omy, for example, is not reflected in GNP figures. Revenues from illegal

transactions are not included because they are not reported. Besides, the

value of bartering goods and services cannot easily be measured because

money is not used in the transactions.

Look through the text once again and answer the following questions:

1. How does a firm generally measure its activity?

2. What concept is used to measure how well the aggregate economy

is doing?

3. In what does aggregate output differ from GDP?

4. What does a country do with the goods not consumed in the count-

ry itself?

5. How is the size of a country’s economy determined?

6. What is the best way to measure the growth of the economy?

7. The totals from each country have to be translated by using cur-

rency exchange rates. What for?

8. What does GNP measure?

9. What is GNP used to forecast?

10. Why do many economists complain that GNP is sometimes mis-

leading?