Lesson preview · Growth and the business cycle
Growth and the business cycle
~8 min · Free to read
In 2025, the world produced more than three times as much per person as in 1960, with price rises taken out. That’s economic growth: an economy making more goods and services over time. But the climb wasn’t smooth: world output fell in two years between 1961 and 2025. In 2009, after a global financial crisis, it fell by about 1.3%. In 2020, in the COVID-19 pandemic, it fell by about 2.9% (World Bank figures).
Key Term
Where long-run growth comes from
A country grows over decades when it gets more or better resources, and better ways and rules for using them:
- Capital: more machines, buildings and roads.
- Labour: more people working.
- Skills: education and training, so each worker makes more.
- Technology: better ways of making things.
- Institutions: rules such as fair courts and laws that protect what people own, so people dare to invest and invent.
Growth shifts the whole production possibility curve (the graph of the most a country can make) outward.
Growth also builds on itself. Say output per person grows 2% a year. Next year’s 2% applies to a bigger total, so it adds more than this year’s did. This is compounding.
A shortcut, the rule of 70, tells you how long steady growth takes to double: divide 70 by the growth rate. At 2% a year, living standards double in about 70 ÷ 2 = 35 years.
Use the rate as a plain number: for 2%, divide by 2, not 0.02.
Key Term
The business cycle
GDP (gross domestic product) is the value of all the final goods and services made inside a country in a year. Real GDP takes price rises out. It moves through four phases:
- Expansion: output grows and firms hire. A fast expansion is a boom.
- Peak: the top, where output stops rising.
- Contraction: output falls and firms cut jobs. A significant fall, spread across the economy and lasting more than a few months, is a recession.
- Trough: the bottom, where output stops falling and a new expansion starts.
This is the business cycle. Its phases vary in length and depth, and a shock such as a financial crisis or a pandemic can start a fall.
The rising trend is long-run growth; the wave around it is the business cycle. Above the trend, prices rise faster. Below it, more people are out of work than in normal times.
Key Term
Three goals that can clash
Governments and central banks (the public banks that manage a country’s money) have several aims, including these three:
- Full employment: nobody is out of work because spending is too low. (Some people are always between jobs, or lack the skills employers want.)
- Stable prices: low, steady inflation, the rise in prices across the economy.
- Sustainable growth: growth that can last, without using up what the future needs.
The goals can pull against each other. In a boom, jobs are easy to find. But if spending races ahead of what firms can make, firms compete for scarce workers and materials, and prices rise faster. Slowing spending calms prices, but it also slows growth and can cost jobs.
Central banks faced a version of this clash in 2022. Much of that year’s price rise came from food and energy: gas soared after Russia invaded Ukraine. In October, prices were 11.1% higher than a year earlier in the UK, and 10.6% higher in the euro area. To bring inflation down, central banks in both places raised interest rates. The Bank of England’s went from 0.1% in 2021 to 5.25% by August 2023. Costlier borrowing calms prices but slows growth.
Trap · Common Misconception
"Slower growth means the economy is shrinking"
Say growth falls from 4% to 3%. The economy still makes 3% more than the year before. That’s an expansion slowing down, not a contraction.
Trap · Common Misconception
"Two falling quarters is the official definition"
News reports often call two quarters (three-month periods) of falling real GDP in a row a recession. That’s a rule of thumb, not a universal definition: many economists also check jobs, incomes and spending. The US committee that decides when recessions start and end counts 2001 as one, though real GDP didn’t fall two quarters in a row.
Worked Example
Countries A and B start with 10,000 dollars of real GDP per person. A grows 2% a year, B 4%. Use the rule of 70 to compare them after 70 years.
Practice · 1 / 6
Which of these does most to raise a country’s growth over several decades?
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