economics business cycle essay grade 12

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2022 DBE Self-study Guides Gr. 12 Economics: Business Cycles

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Economics Business Cycles

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SENIOR CERTIFICATE

SELF STUDY GUIDE

BUSINESS CYCLES

TABLE OF CONTENTS PAGE

HOW TO USE THIS SELF STUDY GUIDE?

2 This Study Guide addresses content and offers strategies to understand the differen aspects of assessing Business Cycles in a step-by-step approach, with consolidation activities to conclude.

2 The explanations and activities are intended to supplement the work you may have covered in class or have gained from textbooks, and it does not replace them.

2 Activities proceed from the low-order, simple focused examples to middle-order with paragraph and graphical construction and interpretation and finally higher-order questions that require application of knowledge that may relate to current issues.

2 It is important to allocate sufficient time to: - Carefully read the explanations provided; underline or highlight key concepts, difficult vocabulary, important data, and relevant data. - Underline key concepts within the question and ensure that correct interpretation is done before attempting the question. - Practice the skill of drawing graphs dealt with in the Business Cycles.

2 Attempt the activities on your own; make constant reference to the explanatory notes but avoid referring to the suggested answers before attempting to answer an activity.

2 Compare your answers to the suggested answers and do your corrections in a different colour-ink pen. Note that you will learn more by discovering your weaknesses (when you get things wrong) and trying to understand why your thinking was out of line with what was expected.

2 The activities provided may not be sufficient to perfect your skills. Always refer to similar questions from past examination papers for this purpose. Repetitive practice is always valuable.

MACRO ECONOMICS BUSINESS CYCLES

• Analysis and explanation of business cycles, and how they are used in forecasting.
• Know the types of business cycles and what happens in the economy over a few years.
• Understanding the different phases of a business cycle can help individuals make lifestyle decisions, investors make financial decisions and government make appropriate policy decisions.

The composition and features of business cycles Key concepts

Term Description

Business Cycle

Successive periods of increasing and decreasing economic activity / a time series showing repeated increasing and decreasing economic activity/ the recurrent (not periodic) pattern of expansion and contraction in the level of economic activity. Business cycle refers to the changes in the economy that produces a cyclical pattern that repeats itself every three to five years. It is also known as the economic cycle.

When GDP begins to increase following a contraction and a trough in the business cycle; an economy is considered in recovery until real GDP returns to its long-run potential level. Prosperity Increased output and excessive economic activities following the recovery / economic growth rate on a year - to -year basis is positive, at an increasing rate. Expansion A period between the trough and peak including both recovery and prosperity.

Recession A negative economic growth for at least two successive quarters/ a decline in economicactivity lasting more than a few months.

Depression Continuous decrease in the production output and economic activities. Contraction A period between the peak and trough including both recession and depression.

Peak The highest point between the end of an economic expansion (end of prosperity) and the start of a contraction (start of recession).

Boom The period immediately before and through the upper turning point is known as the boom.

Trough The lowest point between the end of an economic contraction (end of depression) and the start of a expansion (start of recovery).

Real business cycle

An actual business cycle is obtained when the effects of irregular events, seasons and long-term growth trend are removed from the time series data.

Characteristics of the phases, points and periods of a business cycle

Recovery phase

• Recovery phase is an improvement in economic activity that occurs immediately after a trough.
• An increase in production output occurs.
• Unemployment decreases as consumers gain confidence in economic growth.
• The increased employment leads to rise in income.
• An economy is considered in recovery until real GDP returns to its long-run potential level.

Prosperity phase

• Businesses and consumers have gained confidence in the economy.
• A sustained increase in the production process is evident.
• Employment levels are at highest, wages and salaries rise and spending increases.
• The demand for goods and services rises.
• The high demand of goods and services will cause a rise in the inflation rate.

Recession phase

• A negative economic growth for at least two successive quarters occurs immediately after the peak.
• The high prices hike of goods and services discourage consumer demand.
• Production output will decline due to high interest rate.
• The demand for credit due to increased interest rates will fall.
• Unemployment rate will rise due to retrenchment.
• There is a decline in the economic activity and growth.

Depression phase

• Continuous decrease in the production output and economic activity leading to a shutdown of most economic activities.
• There is negative impact on investment spending.
• It occurs when a sustained decline in economic growth is evident.
• Unemployment rate is extremely high.
• Most businesses become bankrupt and down scale or close.
• A drastic decline in luxury consumer goods and services.
• The period immediately before and through the upper turning point is known as the boom.

Two turning points of business cycle

• Is the highest turning point of the business cycle.
• Production of goods and services are at the highest output level.
• Employment is also at a maximum level.
• The high demand of goods and services cause a price hike.
• An increase in inflation occurs because of increasing prices.
• This is lowest point of the business cycle at the end of the contraction period.
• Income levels are at the lowest due to high job losses.
• Low levels of investments by firms.
• Households use most of their savings to provide necessities.

Periods of business cycle

The expansion periods

• A period that consists of the recovery and prosperity phases (expansion = recovery + prosperity).
• It is the upswing in economic activities from trough to peak.
• Expansion is an upward sustained growth in the economic activities that lead to the increase in the gross domestic product (GDP).
• During this period, the economy experiences sustained growth.

The contraction periods

• depression).
• It is a downswing from peak to trough.
• It shows a rapid decrease in the production activities in the economy.
• There is a decline in employment and decrease in the gross domestic product (GDP).

Real / actual business cycle

• An actual business cycle is obtained when the effects of irregular events (such as the COVID-19 pandemic), seasons and long-term growth trend are removed from the time series data.
• Real business cycles have periods of increasing and decreasing economic activity within business cycles (as you go up, there are some elements of going down).
• This means there are cycles within cycles.
• It is not a smooth rise or decline.
• These periodic fluctuations are not shown in the typical business cycle graph discussed earlier because the curve has been smoothened.

The graph below shows South Africa’s recent real business cycle

Figure 1.2: South Africa’s Real Business Cycle

• Introduction
• How to use this self-study guide
• Topic: Business Cycle
• 3.1 Notes/Summaries/Key concepts
• 3.1 Worked Example (ECON) 6 -
• 3.1 Questions 12-
• 3 Answers 30 -
• Study and Examination Tips (Subject Specific) 43 - 3 Examination guidance (Topic specific)
• References & Acknowledgements
• Adapted from SARB QB December

1 Study the diagram below and answer questions that follow.

1.2 Identify the letter that represent the trend line in the illustration above. (1) 1.2 Which letter represents a trough in the diagram above? (1) 1.2 Briefly describe the term business cycle. (2) 1.2 Explain economic activity during phase EF in the business cycle. (2) 1.2 How can the length of business cycles be used in forecasting? (4) (10) Explanations/causes of business cycles Key concepts

Concepts Description

Exogenous factors

Factors outside the market system of demand and supply that lead to the occurrence of business cycles.

Endogenous factors Factors originating within the market system that lead to the occurrence of business cycles.

Monetarist approach

A school of thought which believes that controlling the supply of money directly influences inflation and that by fighting inflation with the supply of money, they can influence interest rates in the future. Monetarist economics theory was formulated by Milton Friedman. Monetarist economics involves the control of money in the economy.

Keynesian approach

A school of thought which believes the economy is best controlled by manipulating the demand for goods and services. Keynesian economics theory was formulated by John Maynard Keynes The terminology of demand-side economics is synonymous with Keynesian economics.

Two explanations/ causes of a Business Cycle are discussed and compared.

Exogenous / Monetarist explanations Endogenous/Keynesian explanations Originate from outside the free market system/ economy.

Originate from within the market system/ economy. External forces cause expansions and contractions.

Forces within the market system cause expansions and contractions. Examples of external forces; natural disasters, technological innovations, government intervention, random shocks like COVID- global pandemic, wars and fuel price increases, changes in money supply, changes in the contribution of sectors to the economy (structural changes).

Examples of internal (forces within): shortcomings in how markets operate (different markets not working together), price mechanism failing to bring together demand and supply, prices which are difficult to bring down.

Believe that markets are inherently (naturally) stable.

Refer to the graph above: The straight bold line (AB) indicates the natural growth of the economy which is inherently stable. The fluctuations around it are a result of external forces.

Believe that markets are inherently unstable.

Refer to the graph above: The potential growth path is indicated by the straight thin black line. The cyclical bold line around the thin black line indicates the real path of the economy which is unstable.

Believe that the government should not intervene in how markets operate.

Believe that the government should intervene (by using government policies) to smooth out the business cycles.

2 Choose a description from COLUMN B that matches the item in COLUMN A. Write only the letter (A–E) next to the question numbers (2.1 to 2.1) in the ANSWER BOOK

COLUMN A COLUMN B 2.1 Jugler A Last 50 years and longer 2.1 Kondratieff B Also called kinetics 2.1 Kitchin C Last 15 -25 years 2.1 Kuznets D Shortest cycle

E Caused by large investments of businesses and government (4X1) (4) 2 Name any Two types of Business Cycles (2) 2 Explain the Monetarist explanations in business cycles (8) 2 Explain the exogenous causes of business cycles (8)

Government policy Key concepts

Concept Description

Monetary policy The policy of the central bank regarding the money supply and interest rate of a country to influence economic activity. Expansionary monetary policy

Helps speed up the economy/ increase economic growth by cutting interest rates. Contractionary monetary policy

Helps to slow down a growing economy by increasing money supply in the economy. Repurchase rate (repo rate) Interest rate that the Reserve Bank charges financial banks.

Prime lending rate

The interest rate that commercial banks charge their most creditworthy customers, generally large corporations. It is linked to the repo rate.

Fiscal policy

The policy of how the government’s budget is used to raise money(taxation) and spend money(expenditure) to influence economic activity. Expansionary fiscal policy

Increasing government spending and decreasing taxes to stimulate the economy. Contractionary monetary policy

Decreasing government expenditure and increasing taxes to slow down a growing economy. Taxes Compulsory payments made to the government by businesses and households.

Government expenditure

Includes all government consumption, investment, and transfer payments. Inflation The sustained increase in the general price level of goods and services in the economy.

Economic growth An increase in the productive capacity of a country. An increase in the goods and services produced in a country.

• Government applies policies to ensure the economy is more stable.
• The primary aim of government policies with business cycles is to achieve the best possible growth rates.

Monetary and fiscal policies are the main government policies used to achieve possible growth rates.

Monetary policy Monetary policy refers to the actions undertaken by Reserve Bank to control money supply and achieve sustainable economic growth.

• The Reserve Bank regulates the supply of money by influencing its costs.
• The governor of the Reserve Bank implements the monetary policy.
• Five instruments are used.

Instruments used by the Reserve Bank Interest rates

Interest rates are based on the repurchase rate.

The Reserve bank will cut/decrease the interest rate during a recession or depression.

This is referred to as expansionary monetary policy.

This helps to stimulate the economy by making it less expensive to borrow while increasing the money supply.

If the economy is growing too rapidly during prosperity, the Reserve bank can implement a contractionary monetary policy.

Higher interest rates are charged causing people to have less money to spend.

Expenditure and demand will decrease, and the economy will be dampened.

A contractionary/restrictive fiscal policy will be implemented when the economy grows too fast to curb the growing economic activity. - A decrease in government expenditure will decrease aggregate demand. - Taxes can be increased which will decrease disposable income.

The new economic paradigm Key concepts

Economic paradigm

A basic principle that describes how an economy works or should work. A paradigm is a perspective or set of ideas. It is a way of viewing a condition e., the economy New economic paradigm

Refers to government policies designed to ensure a high rate of economic growth without having supply limitations and price inflation.

Unemployment

Occurs when a person who is actively searching for employment is unable to find work. Is often used as a measure of the wealth of the economy. Phillips Curve Illustrates the relationship between unemployment and inflation Demand-side policies

Attempts to increase or decrease aggregate demand to affect output, employment, and inflation. Supply-side policies Policies aimed at increasing aggregate supply (AS).

Aggregate demand (AD)

It is the total spending on goods and services in the economy. AD = C+I+G+(X-M)

Aggregate supply (AS)

Aggregate Supply (AS) is the total quantity of goods and services supplied at every price level. It is the total value of goods and services produced in the economy in a given period.

Government can use monetary and fiscal policies to smooth out the business cycle

The new economic paradigm

• Theories that explain the causes of business cycles are only true under specific circumstances.
• Governments need to apply policies that will prevent peaks ending with inflation or troughs that end with unemployment.
• The new economic paradigm in terms of the smoothing of business cycles encourages achieving stability through sound, long term decisions relating to demand and supply in the economy.
• The new economic paradigm refers to government policies designed to ensure a high rate of economic growth without having supply limitations and price inflation.
• This new way of thinking (new economic paradigm) lies in demand – side and supply side policies.

Demand-side policies

• Monetary and fiscal policies focus on aggregate demand.
• Demand side policy is relying on aggregate demand only.
• The aggregate demand is created by households, businesses, and the government (C + G + I).
• Demand side policy does not render ideal results on its own i. sustained growth without supply limitations and price inflation.
• Growth is often cut short because of all sorts of bottle necks that develop in the economy. Examples of bottlenecks such as, inflation, balance of payment deficits, and shortages of skilled labour, etc.
• Figure 1 shows what happens when only focusing on the demand side policies which rely on aggregate demand
• Multiple Choice

Subject : Economics

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BUSINESS CYCLES AND FORECASTING GRADE 12 NOTES - ECONOMICS STUDY GUIDES

• Key concepts
• The composition and features of business cycles
• Explanations
• Government policy
• The new economic paradigm
• Features underpinning forecasting with regard to business cycles

Business cycles refer to fluctuations in economic activity or production over several months or years. They seem to indicate a long-term trend, typically involving shifts over time between periods of rapid economic growth (expansion or boom), and periods of stagnation or decline (contraction or recession). Forecasting relates to the economic indicators used to forecast the trends in the business cycle. Overview

2.1 Key concepts

These definitions will help you understand the meaning of key Economics concepts that are used in this study guide.

2.2 The composition and features of business cycles

2.2.1 Nature of business cycles

• Changes in economic activity are recurring but never exactly the same or of the same magnitude.
• Different circumstances and expectations cause consumers and producers to respond differently to initiating forces.
• The duration and amplitude of every business cycle will be different.
• Two periods namely contraction and expansion;
• Two turning points namely trough and peak;
• Four phases, namely recovery, prosperity, recession and depression.
• Economic activity is shown by the upward and downward movements of the curve.
• A period where there is a general increase in economic activity is known as an upswing.
• A period of general decline in economic activity is called a downswing.
• The business cycle oscillates between the upper (peak) and lower (trough) turning points along a trend line.
• The length of the business cycle is measured from peak to peak or from trough to trough.
• The entire period from the peak to the trough is known as the downswing.
• The entire period from the trough to the peak is known as the upswing.
• The period immediately before and through the upper turning point of the cycle is called the boom.
• The period immediately before and through the lower turning point is known as the slump.
• The trend line is the long-term average position or pattern.

2.2.3 Real (actual) business cycle

• An actual business cycle is obtained when the effects of irregular events, seasons and long-term growth trend are removed from the time series data.
• Figure 2.2 shows the real GDP of South Africa over a 12 year period displayed in a jagged diagram.
• The length or duration of the cycle is measured from trough to trough or peak to peak.
• The percentage point difference of successive peaks and troughs can be calculated e.g. a + b (3 + 5 = 8) compared to b + c (5 + 1.5 = 6.5).

Exogenous includes, amongst many others, the monetarist view. Endogenous focuses mainly, but not only, on the Keynesian approach

2.3 Explanations

There are numerous theories as to the causes of business cycles. Among these are the monetarist approach and the Keynesian approach. The government uses monetary instruments such as interest rates to mediate these business cycles. 2.3.1 The exogenous explanation Exogenous variables are those independent factors that can influence business cycles and originate outside the economy. Some economists believe that business cycles are caused by exogenous factors such as those described below:

• The monetarists believe markets are inherently stable and disequilibrium is caused by incorrect use of policies, e.g monetary policy.
• Weather conditions and market shocks cause upswings and downswings.
• Governments should not intervene in the market.
• Sunspot theory based on the belief that increased solar radiation causes changes in weather conditions.
• Technological changes.
• This is often called the Keynesian view.
• The Keynesian approach holds the view that markets are inherently unstable and therefore government intervention may be required.
• The price mechanism fails to co-ordinate demand and supply in markets and this gives rise to upswings and downswings.
• Prices are not flexible enough (e.g. wages).
• A business cycle is an inherent feature of a market economy.
• Indirect links or mismatches between demand and supply are normal features of the economy.
• Kitchen cycles: last between 3 to 5 years caused by adapting inventory levels in businesses.
• Jugler cycles: last from 7 to 11 years and are caused by changes in net investments by government and businesses.
• Kuznets cycles: last between 15 to 20 years, caused by changes in activity in the building and construction industry.
• Kondratieff cycles: last longer than 50 years, caused by technological innovations, wars and discoveries of new deposits of resources e.g. gold.

2.4 Government policy

Government can use monetary and/or fiscal instruments to help stabilise business cycles, also called “fine tuning” the economy. 2.4.1 Policy instruments MONETARY POLICY – can be defined as policies used by monetary authorities (SARB and MPC) to change the quantity of money in circulation as well as the interest rates, with the aim to stabilise prices, reach full employment and achieve high economic growth. The size of the M3-money stock is an important determinant of the quantity of money. The following TWO theories explain changes in the quantity of money and its impact on the economy:

• The quantity theory of money shows how an increase in the stock of money can lead to an increase in the inflation rate and a decrease in the buying power of money. Quantity theory-equation: MV = PT Where: M = Total stock of money V = Velocity of money P = Prices of goods and services T = Quantity goods and services When the stock of money (M) increases, prices (P) will rise and because production (T) cannot be increased immediately it will lead to INFLATION, assuming velocity (v) remains constant.
• The second theory links the change in deposits and the cash reserve requirement. If the amount of new deposits increase, the money multiplier kicks in: Tm = ΔD × 1/rd Where: Tm = Total stock of money at the end of the process ΔD = The initial inflow of new money to the banks/new deposits Rd = Minimum cash reserve percentage kept by banks.

It can be seen that a relatively small deposit of R1 000 with a relatively small cash reserve requirement of 5% (0,05) may lead to a relatively large increase in the total stock of money. Tm = 1 000 × 1/0,05 = 1 000 × 20 = R20 000

• Keeping the TWO theories in mind, the central bank can use the following instruments separately or jointly from its arsenal of monetary and related policy instruments in a selective or discretionary manner:
• Open market transactions The SARB can directly increase/decrease the supply of money by buying/selling government securities in the open market.
• Interest rates If banks experience a shortage of funds in the money market, they are accommodated by the SARB, when they are allowed to borrow money through the Repo system (Repurchase tender system) at a rate known as the repo rate. By increasing this rate, money becomes more expensive for commercial banks, who pass on the increase to their clients by increasing interest rates on loans. Loans become more expensive to the consumer and so the demand for money will decrease.
• Cash reserve requirements The SARB is permitted by the Banks Act to occasionally change the minimum cash balances the banks are required to maintain in order to manipulate the money creation activities of the banks. See the money multiplier equation. Change the 5% to 10% and see what the effect would be on the creation of credit/money in the economy.

SARB buys bonds from ABSA → more money flows into the economy so money supply increases. SARB sells bonds to ABSA → money flows out of the economy and money supply decreases.

FISCAL POLICY – Fiscal policy = Is the process of using taxation and public expenditure to even out the swings of the business cycle. Governments, through their fiscal policy have a powerful weapon for stabilising/ironing out/smoothing of cycles, to stop peaks from ending in high inflation and troughs in too high levels of unemployment.

The original equilibrium situation: Accepts that all economic activities are stable and all markets in equilibrium. Assumes the beginning of the following undesired conditions/problems:

• Raising government spending (G) with borrowed money (Budget Deficit). Aggregate expenditure increases and so does demand. The economy is stimulated and employment is likely to increase.
• Decreasing taxes . Consumers and producers have a larger part of their incomes available to spend on goods and services. Aggregate expenditure increases. The economy is stimulated and employment is likely to increase.
• Raising government spending and simultaneously decreasing taxes . This will have a double effect. Government spending increases and consumers and producers also have more to spend. Demand increases substantially. Employment increases.
• Cut down on government spending (G). The unspent money is preserved. Aggregate expenditure is less and demand drops. Inflation is likely to decrease.
• Increasing taxes (T ). Workers pay more tax and this results in consumers having less income to spend and demand dropping. Inflation is likely to decrease.
• Reducing government spending (G) and simultaneously increasing taxes (T) . This will have a double effect. Government spending decreases and consumers and producers also have less to spend. Demand drops substantially. Inflation decreases.

A COMBINATION OF MONETARY AND FISCAL POLICY: The strongest effects are obtained when a government uses these policies in combination with one another to manipulate aggregate demand.

Restrictive policies make the economy slow down. Expansionary policies make the economy go faster (grow).

2.5 The new economic paradigm

The “new economic paradigm” discourages policy makers from using monetary and fiscal policies to fine-tune the economy, but rather encourages achieving stability through sound long-term policy decisions relating to demand and supply in an economy.

2.5.1 Demand-side policies Demand-side policies focus on aggregate demand in the economy. When households, firms and government spend more, demand in the economy increases. This makes the economy grow but can lead to inflation.

• Aggregate demand increases more quickly than aggregate supply and this causes prices to increase.
• If the supply does not react to the increase in demand, prices will increase.
• This will lead to inflation (a sustained and considerable increase in the general price level).
• Demand-side policies are effective in stimulating economic growth.
• Economic growth can lead to an increase in the demand for labour. As a result more people will be employed and unemployment will decrease.
• As unemployment decreases inflation is likely to increase. This relationship between unemployment and inflation is illustrated using the Phillips curve.

2.5.2 Supply-side policies Supply-side policies include:

• Infrastructural services
• Administrative costs
• Cash incentives
• Capital consumption
• Human resources development
• Free advisory services
• Deregulation
• Competition
• Levelling the playing field

2.6 Features underpinning forecasting with regard to business cycles

There are many economic indicators that can be used to forecast business cycles. Some of these are: 2.6.1 Leading indicators

• Leading indicators give consumers, businesses and the state a glimpse of the direction in which the economy might be heading.
• When these indicators rise, the level of economic activities will also rise a few months later.
• Examples of leading indicators are job advertising space; inventory; and sales.

2.6.2 Co-incident indicators

• Co-incident indicators move at the same time as the economy.
• They indicate the actual state of the economy.
• Examples of these indicators are value of retail sales and real GDP.

2.6.3 Lagging indicators

• Lagging indicators won’t change direction until after the business cycle has changed its direction.
• Examples of these indicators are hours worked in construction and total of commercial vehicles sold.

2.6.4 Composite indicators

• It is a grouping of various indicators of the same type into a single value.
• The single figure forms the norm for a country’s economic performance.

2.6.5 Trend

• The trend is the general direction of the economy.
• The trend line that rises gradually will be positively sloped in the long run. This rising line indicates a growing economy.

2.6.6 Length

• Length is measured from peak to peak or from trough to trough.
• Longer cycles show strength and shorter cycles show weakness with regard to economic activities.

2.6.7 Amplitude

• Amplitude refers to the vertical (height) difference between a trough and the next peak of a cycle.
• The larger the amplitude, the more extreme the changes that occur.

2.6.8 Extrapolation

• Extrapolation means to estimate something unknown from facts that are known. For example, extrapolations from known facts are used to predict future share prices.

2.6.9 Moving averages

• Moving avarages are used to analyse the changes in a series of data over a certain period of time.

Leading indicators show us where we’re heading ♪ Lagging indicators won’t change direction Co-incident indicators, moving together

What’s the trend? Show me the way What’s the length? Weak or strong today

Pump up the amplitude to see the difference I need to extrapolate to make my predictions♫

(Create a song to help you remember these seven forecasting features. Singing the words to a catchy tune over and over again will help you.)

• Define the term business cycle. (3)
• Indicate which indicator is represented by T. (2)
• What is measured by the horizontal axis? (2)
• At which point did the economy reach a peak and a trough? (4)
• Identify the four phases into which the business cycle is divided in the above illustration. (8)
• How is the length measured in the above business cycle? (2)
• Explain lagging and coincident indicators used in the forecasting of business cycles. (2 × 4) (8) [29]
• What is the message behind the cartoon? (2)
• Why do you think that unemployment will not lead to an economic lift off? (2)
• To which forecasting indicator does unemployment refer? (2)
• How would you describe the recovery phase of a typical business cycle? (2) [8]

Activity 3 Discuss the monetarist approach as a cause of business cycles. [8]

Activity 4 Discuss the trend line in the forecasting of business cycles. [8]

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