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Task 8 The figure below illustrates nominal in current prices) and real (in prices of previous year) GDP of Latvia in 2005-2015, in billion euro 30 ma Why is nominal and real GDP 25 calculated? What do these variables represent? b) Using the figure above, highlight 4 stages of business cycle and describe each stage c) What the problem was observed in national economy of Latvia in 2008? Prove your answer by calculation. 20 REd) What the problem was observed in national economy of Latvia in 2009- 2010? What should the government and the Central bank do in this situation? In current prices In prices ofprevious year

Answer 1

a. The Gross Domestic product is the final value of all the goods and services produced in an economy in a particular period of time, generally one year.It is of two types, real GDP and nominal GDP.

1. Nominal GDP: It is the final value of all the goods and services produced in an economy in a year using current prices. It is expressed in monetary terms.
2. Real GDP: It is the final value of all the goods and services produced in an economy in a year accounting for inflation.

Both of these measures represent the output of the economy, but the real GDP is considered a more accurate measure. The real value is not influenced by changes in price, but is only impacted by the changes in quantity. The real GDP represents the purchasing power of the economy.

b. In general terms, the four stages of business cycle are boom, recession, depression and recovery. Based on the above data, the economy of Latvia during the given time period can be divided into the aforementioned stages as follows.

• STAGE I: BOOM

Also called Prosperity, prevails when there is an expansion of output in the economy. It is characterized by high employment, effective demand, income; rising interest rates, credit expansion and business optimism.

From the above figure, it can be stated that the Latvian economy experienced prosperity during the years 2005 to 2008. This is indicative of the rising output of the economy during this period. It must be noted that the year 2008 represents the peak. The GDP in this year is the highest account to 24.4 Billion.

• STAGE II: RECESSION

The downswing from prosperity towards depression is termed as recession. As the economy reaches the peak, it has fully employed all its resources. There is no further scope of rising. Thus after a certain point, the demand starts falling. Investment also also reduces. There is a gradual decline in the macro economic variables. Pessimism starts to override, reducing the incentive to save and invest. The aggregate demand and income decline.

In the above figure, year 2009 indicates recession. It generally lasts for a short period of time.

• STAGE III: DEPRESSION

If the economy is unable to recover from recession, this leads to a further downfall, Depression. It is a continuous decrease in income output and employment.In depression, there is under-utilization of resources and fall in Gross National Product. The aggregate economic activity is at its lowest.

In the Latvian economy, the years 2009 and 2010 represent the period of depression.

• STAGE IV: RECOVERY

The upswing from depression to prosperity is termed as recovery. It is also known as the revival phase. There is expansion and rise in economic activity. The demand starts rising leading to increase in production and investment. The businessmen become confident and optimism prevails.

The years 2011 and 2012 are periods of recovery in Latvia.

c.  In the year 2008, Latvia faced the great financial crisis. These were the effects of the Global Financial Crises of 2008-09. The main reason was the easy credit market burst which resulted in mass unemployment. Many of the companies went bankrupt. Based on the bankruptcy facts, the country's credit rating was severely downgraded.

d. In the year 2009, Latvia had the worst economic performance with annual growth rate averaging −18%. The unemployment rate rose to 23% which was the highest in the EU. However, in the year 2010, slight indications of recovery were noted. The central bank played a major role in handling the crisis. Based on the recommendations of the International Monetary Fund, it devalued its currency. This lead to an increase in exports and an improvement in the balance of payments in the country. The production increased leading to employment and income. This lead to increase in effective demand and the onset of recovery.  The economy grew by 5.5% in 2011 and by 5.6% in 2012.