Question

4.1 Examine which phase of the business cycle is linked to a contraction in gross domestic product.

Use a diagram to motivate your answer. (9)

4.2 Three consecutive contractions in gross domestic product implies the onset of recession for an economy.

Compile a fiscal policy to take an economy out of this undesirable situation. (11)

Answer 1

Business cycle describes prosperity and depression in an economy.

There are five different phases of business cycle.

Expansion:- A phase of business cycle with constant increase in GDP, price level, and other economic factors in an economy.

Peak:- Continuous expansion in economic growth finally slows down, with stagnant growth in economic factors.

Recession:- A phase of business cycle with gradual decrease in economic factors such as GDP, price level, revenue collection, total sales of goods and services, to normal level.

Trough:- Gradual fall in growth rate of economy and its economic factors to even further below normal level reaching to the lowest level of shrinking.

Recovery:- A phase of economic growth when economy having fallen to the lowest level starts recovery with a general increase in economic factors.

As we can see in the diagram above, the line comes down in the two phases of business cycles- recession and depression.

4.2 Recession is fall in GDP of a nation for considerable period of time, generally for more than an year.

In order for a contraction in GDP to be called as recession, the contraction should take place for at least 3 consecutive quarters.

John Maynard Keynes, a noted economist, advised an expansionary fiscal policy in periods of economic recession to take an economy out of prolonged recession.

An expansionary fiscal policy such as increase in government spending, or a decrease in taxes helps increase aggregate demand in the economy, thereby leading to a higher economic growth.