Business Cycles

Business Cycles

Business cycles are the normal fluctuations of the output of a country.

A country's GDP (under normal circumstances) grows over time, but not at a steady rate.

These fluctuations of the GDP around its steady trend growth line are called business cycles

The upswings and down swings of an economy are called business cycles.

Sometimes the pace of economic growth is rapid, called the expansionary phase, and sometimes the economy slows down called the contractionary phase.

From the diagram below we can see the phases of a business cycle

The steady growth line or trend line is the straight line in the middle.

The economy (or any economy) does not grow in that steady fashion.

Rather it grows in spurts, gathers momentum and grows even faster.

Then the reverse happens, and the economy slows down, and now it gathers momentum in the reverse direction, and slows faster and faster.

This is the real way an economy grows over time, not in a steady manner.

So the irregular ups and downs of an economy are called business cycles.

The phases of a business cycle are:
1) Expansionary Phase:

In the business cycle diagram it is the phase when the economy is moving up the cycle of growth, from a trough towards a peak.

During this phase there is growth observed all around the economy.

Every economic sector is growing.

Producers are producing more because people are buying /demanding more goods and services.

To produce more goods and services you need more people, so employment goes up.

These newly employed spend their money on food, clothing housing etc.

Thus the income in those sectors go up too.

As aggregate demand goes up, so do prices and profits.

So more investment is done in the economy.

Thus a positive momentum or a positive domino effect builds up and the economy grows faster and faster.

Income, employment, output all increase.

2) Contractionary Phase:

The reverse of an expansionary phase happens here.

In the business cycle diagram it is the phase when the economy is moving downfrom a peak towards a trough.

During this phase there is contraction in economic activity observed all around the economy.

Every economic sector is reducing its output.

Producers are producing less because people are buying /demanding fewer goods and services.

To produce fewer goods and services you need fewer people, so employment goes down.

These newly unemployed spend less money on food, clothing housing etc.

Thus the income in those sectors go down too.

As aggregate demand goes down, so do prices and profits.

So private investment goes down too.

Thus a negative downward momentum or a negative domino effect builds up and the economy shrinks or contracts faster and faster.

Income, employment, output all tend to decrease.

3) Peak:

This is the highest point an economy can reach.

It is the end of the expansionary phase.

Everything that happens in the expansionary phase, culminates at this point.

Beyond this point, the downturn starts.

4) Trough:

This is the lowest point an economy can reach.

It is the end of the contractionary phase.

Everything that happens in the contractionary phase, culminates at this point.

Beyond this point, the upturn starts.

Length of a business cycle:

A business cycle is measured as the time period between two troughs or two peaks.

Related Concepts:
Recession:

The technical definition is: It is decrease in real GDP over two consecutive quarters.

But if there is a significant contraction in economic activity all around, we generally call it a recession.

A trough in general would indicate a recession.

Depression:

A severe form of recession is a depression.