Business Cycles

• The term business cycle refers to

the recurrent ups and downs in the
level of economic activity, which
extend over several years.
• Individual business cycles may
vary greatly in duration and
intensity.
• All display a set of phases.
 THE BUSINESS CYCLE
Phases of the Business Cycle
PEAK
RECESSION TROUGH RECOVERY
Level of business activity

Time
 Level of business activity
PEAK

• Peak or prosperity phase: Time

• Real output in the economy is
at a high level
• Unemployment is low
• Domestic output may be at its
capacity
• Inflation may be high.
 Level of business activity
RECESSION

Time
√ Contraction or recession phase:
Real output is decreasing
Unemployment rate is rising.
As contraction continues, inflation pressure fades.
If the recession is prolonged, price may decline (deflation)
The government determinant for a recession is two consecutive
quarters of declining output.
 TROUGH

Level of business activity

Time
√ Trough or depression phase:
Lowest point of real GDP
Output and unemployment “bottom out”
This phase may be short-lived or prolonged
There is no precise decline in output at which a
serious recession becomes a depression.
 RECOVERY

Level of business activity

Time
√ Expansionary or recovery:
Real output in the economy is increasing
Unemployment rate is declining
The upswing part of the cycle.
 Business Cycle-one cycle through 4 phases
Real GDP

Peak
per year

Peak

Trough

One cycle Time

 How Indicators Monitor the
Four Phases of the Business Cycle
• The Leading Indicator System
… provides a basis for monitoring the tendency
to move from one phase to the next.
…assesses the strengths and weaknesses in the
economy
… gives clues to a quickening or slowing of future
rates of economic growth
… indicates the cyclical turning points in moving
from the upward expansion to the downward recession,
and from the recession to the upward recovery.
Leading indicators anticipate the direction in which the
economy is headed.
The coincident indicators provide information about
the current status of the economy
1) changing as the economy moves from one phase
of the business cycle to the next
2) telling economists that an upturn or downturn in
the economy has arrived.
Lagging indicators change months after a downturn or
upturn in the economy has begun and help economists
predict the duration of economic downturns or upturns.
 Based on the theory that expectations of future profits
are the motivating force in the economy.
Companies may expand production of goods and
services and investment in new structures and
equipment,when business executives believe that their
sales and profits will rise.
When they believe profits will decline, they reduce
production and investment.
These actions generate the four phases of the
business cycle.
Causes of Fluctuations
Innovation
Political events
Random events
Wars
Level of consumer spending
Seasonal fluctuations
Cyclical Impacts — durable and non durable