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What Is the Relationship between GDP and the Business Cycle?

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  • Originally Written By: Esther Ejim
  • Revised By: C. Mitchell
  • Edited By: Kaci Lane Hindman
  • Last Modified Date: 10 December 2016
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There are a couple of ways in which a country’s gross domestic product (GDP) and the larger business cycle intersect, but they are most closely related in terms of general economic prosperity or decline. The business cycle is usually thought of in four phases, namely expansion, peak, contraction, and trough; all of these relate to the success or relative failure of business prospects and profit margins within a given period. A country’s GDP is usually calculated based at least in part on the particular phase of a business cycle in which the nation finds itself. The GDP usually rises during both expansion and peak, but shrinks during contraction and trough. There are usually a number of factors that influence these calculations and the process for coming up with fixed numbers can be quite complex. On the most basic level, though, these two factors can be thought of as complementary; they rise and fall with each other, and can be used together to tell some pretty important things about the economics of either entire landscapes or specific sectors.

Understanding Business Cycle and GDP Generally

Business cycles come in four phases, are usually measured in terms of quarters. Each year, of course, has four quarters, but the cycle doesn’t necessarily hit each phase once per year — it’s possible to have a year where every quarter was a contraction, for instance, and the shifts aren’t always easy to predict.

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Each business cycle is hardly ever the same, as consumer spending and other factors contribute to the rise and dip in the final calculation. A back-to-back drop in the GDP in two quarters leads to the conclusion that a country is experiencing a recession. A drop in GDP is usually due to a reduction in different types of economic activities including domestic and international demand for final products.

GDP is basically how much money the country’s businesses and industries are thought to be producing. It is related to the business cycle primarily insofar as it is calculated based on where in the business cycle the country finds itself, as well as how the economy is thought to be doing on a more universal level.

Calculations

In general, the business cycle is derived from calculations of the activities of the GDP, while at the same time the GDP is determined by the present phase of the business cycle. Studying the result of the GDP within a business cycle will give an indication of how the economy of a nation is faring. The GDP of a nation is determined by calculating the demand for the final goods and services produced by a country. The business cycle concerns to the total demand for the finished product within a certain time frame.

How the Figures are Used

Both numbers are used by economists and analysts alike to get a sense of what to expect and how to predict outcomes. Things like sales and profit margins are often thought to be dependent on the relationship between these two concepts, but even things like currency valuation and international trade power can be impacted by rises and falls in the GDP, and the corresponding changes in the national business cycles.

Periods of Expansion and Contraction

Another connection between the GDP and the business cycle can be seen in the periods of expansion and the periods of contraction that occur during a business cycle. The GDP goes through periods when it reaches a peak and then starts to drop. At other times, the GDP maintains at a somewhat steady level with no undue peak periods and no excessive dips. Things like employment or unemployment levels, retail sales, and other factors help contribute to the rise and dip in these levels.

Impact of Personal Income

Levels of personal income can also play a role. If people do not have enough real personal income, which is the money they bring in from employment, entitlements, and any other sources, they typically conserve and don’t spend as much in the marketplace. In practical terms, this means that they aren’t shopping as much and aren’t buying things that are more discretionary. This lack of spending can cause a dip in the GDP since increased spending and demand for finished products are chiefly responsible for a growth in the GDP. This is the reason why one of the indicators of a recession is a consistent drop in retail sales as consumers shy away from spending.

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fify
Post 3

GDP actually starts falling at the peak of the business cycle or right afterward. This is when inflation is very high and high inflation means high prices. People can no longer afford as much and demand falls. Companies and business are left with products and services that consumers are not buying and the economy becomes stagnant.

stoneMason
Post 2

@SarahGen-- Those are very good questions. I'm not an economist. I'm taking a macroeconomics class and we just covered the business cycle in class this week so I can try and answer.

Even though there is such a thing as a business cycle, as far as I know, the cycle doesn't occur regularly. And the amount of time that each stage in the cycle lasts for is not known, it varies.

If GDP is high, we can say that we are experiencing an economic boom. But we can't say that the economy is going to experience a downturn soon. And if monetary policies are used correctly, a downturn can be prevented. So the business cycle is not some

kind of economic fate. It's just a tool that helps us understand how our economy is doing and what we can do further to stabilize it. GDP is an important factor when analyzing the business cycle. That's how I think about the business cycle.
SarahGen
Post 1

So, GDP is determined by demand. And isn't the peak of a business cycle when demand equals supply? Then why is an economic peak followed by an economic downturn and recession?

I guess what I'm wondering is if it's good for GDP to be very high in terms of the business cycle? Or does a very high GDP mean that the economy is very close to experiencing contraction or shrinking?

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