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CA Foundation · Business Economics · Business Cycles

An economy's real GDP grew at 6% in Year 1, 5% in Year 2, 2% in Year 3, 0.5% in Year 4, and then fell by 1% in Year 5 and by 0.8% in Year 6, before growing at 3% in Year 7. The long-run trend growth rate is 5%. Which of the following interpretations is most consistent with the meaning of a business cycle?

Growth drifting below the 5% trend from Year 3 shows a downswing, actual output declines in Years 5 and 6 mark the contraction, and renewed growth in Year 7 signals recovery. A business cycle is judged by fluctuations around trend, not just by years of negative growth.

  1. AYears 3 to 6 show a contraction in the sense of a slowdown below trend, with absolute decline in output only in Years 5 and 6, and Year 7 marks the start of recoveryCorrect
  2. BOnly Year 5 is part of the cycle because it was the only year of negative growth
  3. CThe economy was in a recession in Year 1 since growth was above trend
  4. DThe economy left the business cycle after Year 4 because growth fell below 1%

Explanation

A cycle is measured by movements around the trend. Growth fell below the 5% trend from Year 3 (slowdown), output actually shrank in Years 5 and 6, and positive growth in Year 7 signals recovery. Limiting the cycle to one negative year ignores Year 6 and the slowdown phase; above-trend growth is expansion, not recession.

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