CA Foundation · Business Economics · Business Cycles
An economy's real GDP index in a year is 100 at the trough. It then rises 4% in each of the next two years. Which statement is correct about the phase and the level of GDP index at the end of the two years?
The economy is in recovery moving into expansion, and the index is about 108.16. Growth compounds: 100 × 1.04 × 1.04 = 108.16. Simply adding 4% twice gives 108, which ignores compounding. Rising output after a trough cannot be contraction.
- ARecovery/expansion phase, index about 108.16Correct
- BRecovery/expansion phase, index about 108.00
- CContraction phase, index about 108.16
- DPeak phase, index about 104.00
Explanation
Rising output after the trough is recovery and then expansion. Compounding: 100 × 1.04 × 1.04 = 108.16. The figure 108.00 is wrong because it adds the growth rates simply instead of compounding. Output is rising so it is not contraction.
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