17  Business Cycles

Objectives

  1. Identify the components of the business cycle: the trend and cycle, booms and busts
  2. Know relationship between potential output and output gap
  3. Understand and identify comovement of variables
  4. Identify seasonality
Trend

The long-run movement of the economy.

Cycle

The short-run movement of the economy.

Business Cycle

Short term fluctuations in economic activity

Potential Output

The level of output that occurs when all resources are fully employed (red dashed line).

Output Gap

The difference between actual and potential output, measured as a percentage of potential output

\[ \text{Output Gap} = \frac{\text{Actual Output} - \text{Potential Output}}{\text{Potential Output}} \times 100 \]

Boom

When the economy is operating above its sustainable potential

Bust

When the economy is operating below its sustainable potential

17.1 Parts of the Business Cycle

Term Definition
Peak A high point in economic activity.
Recession A period of falling economic activity.
Trough A low point in economic activity.
Expansion A period of rising activity.

17.2 Comovement and Seasonality

Comovement

The tendency for economic variables to rise and fall together.

Seasonality

Regular and predictable changes that occur over a year.

Seasonal Adjustment

Data stripped of predictable seasonal patterns.

17.3 Conclusion

  • This lecture studies the business cycle: deviations from the long run trend of the economy
    • We split it into four components: peak, recession, trough, expansion
  • We introduce the concept of seasonality