MacroeconomicsI_working_version (1)

Business Cycles 39
The output gap allows us to measure the extent of the cyclical deviations of output from
potential level of output. However, it should be mentioned that it is difficult to measure the
potential output in real world. Published numbers of potential GDP always refer to some
estimation based on relevant economic models.
5.1. Phases of the Cycle
Peak The highest point called pragmatically “peak” lying on the line of real GDP
relates to the situation at which the enterprising activity reaches its temporary maximum.
Here the level of real output is very close to capacity of the economy. The inputs are used
fully and the rate of unemployment could be temporarily lower than the natural rate of
unemployment. The price level is likely to rise during this phase and sometimes economists
warn against overheating the economy.
Recession The phase of recession (contraction) represents a period of decline in total
real output. This is accompanied by decreased business’ profits, reduced investment and
increased unemployment. The behaviour of the price level is not unambiguous. Contraction
originated from decline in aggregate demand (negative demand shock) is connected with
decline in the price level. Decreased aggregate supply (negative supply shock) implies
rising price-level. High unemployment accompanied by rising price level is called
stagflation.
Trough The lowest level of the contraction phase is called the trough or the bottom.
Very low economic activity in this point is accompanied by high level of unemployment.
This phase of the cycle may last short as well as relatively long time.
Recovery Both real output and employment rise during the recovery (expansion)
phase. We can distinguish between two possible trends in the price-level similarly as in the
phase of contraction. In the case of positive demand shock (rise in aggregate demand) the
price level rises. Positive supply shock (rise in aggregate supply) is connected with decline
in the price level.
5.2. Non-cyclical Fluctuations
It is important to remain that not all changes in economic activity originates from business
cycles. There can be some seasonal variations in economic activity, which could appear as
a business cycle. In these cases in fact GDP does not overreach its potential level. Thus,
they cannot be labelled as business cycles. Pre-Easter and Pre-Christmas buying rushes
causing noteworthy fluctuations in economic activity every year are the typical examples of
such non-cyclical fluctuations.