The Business Cycle

Definition of the business cycle

• Refers to recurrent fluctuations in the level of

aggregate economic activity.
• Measures change in real GDP over time - %
change in real output as measured by real GDP.
• The business cycle attempts to indicate that
economic activity is unstable and volatile.
 The phases of the business cycle

The business cycle has 4 phases:

• Expansionary Phase

• Peak

• Contractionary Phase

• Trough
 A diagrammatic illustration of the
business cycle

% change in Peak
Real GDP

on

Co
nsi

ntr
pa

a
Ex

ctio
n
Trough

Time
 The business cycle

• An economy has experienced a complete

business cycle when the level of economic
activity has fluctuated between Peak and Peak or
Trough and Trough.

• The economy passes through the 4 phases of the

business cycle.
 Business cycles differ in terms of:

1. The intensity of the cycle

The extent of fluctuation in economic activity

2. The duration of the cycle

The period of time in which economic activity
passes through the four phases.
 Australia –
business cycle 1998 to 2002

3 % c ha ng e
re a l GDP

0
1998 1999 2000 2001 2002
Source: RBA 2003
 China –
business cycle 1997 - 2002

10

5
% c ha ng e
re a l GDP
4

1997 1998 1999 2000 2001 2002 Source: World Bank 2001
 Singapore –
business cycle 1997- 2002

10

4
% c ha ng e
2 re a l GDP

0
1997 1998 1999 2000 2001 2002
-2

-4
Source: MAS 2003
 The Expansionary Phase

• The phase in which economic activity increases

from a preceding period of declining or stagnate
economic growth.

• The phase in which growth in real GDP increases.

 Characteristics

• GDP increases at a higher annual rate

• Unemployment tends to decrease and

employment tends to increase

• Inflation tends to increase

• Business and consumer confidence increases and

is reflected by higher consumption and investment
expenditure
 The Expansionary Phase

• Household savings tend to decrease (and

borrowings increase) as consumers display
greater confidence.

• Consumption patterns change as consumers

purchase items of an expensive and durable
nature
• Motor vehicle registrations
• The sales of whitegood products
• Housing loan approvals
 The Expansionary Phase

• The capacity utilisation of industry

increases.

• Capacity utilisation is the level of industry

output as a proportion of industry capacity
(maximum level of output).

• A firm that has a production capacity of 150

units per week and produces 105 is
producing at 70% of capacity.
 The Peak [The Boom]

• The phase in which the economy experiences its

highest level of economic activity. Increase in
real GDP growth is at a maximum.

• The peak is most accurately identified

retrospectively.
 Characteristics

• Low levels of unemployment

• Unfilled employment vacancies

• Increasing inflation (particularly demand–

pull inflation)
• Increasing wage levels
• Reflecting scarcity of labour
 The Peak

• High levels of confidence.

• Consumption and investment expenditure
increases.
• Industry operates at or near full capacity.
• Imports generally increase.
• Domestic industry may not be able to fully satisfy
demand.
 The Contractionary Phase

• The phase in which economic activity declines.

• The growth in real GDP decreases.

 Characteristics

• Increasing (cyclical) unemployment.

• Stabilisation / reduction of inflation.

• Diminished business and consumer

confidence.

• Significant reductions in the level of private

investment expenditure.
 The Contractionary Phase

• Increase in the level of savings.

• A change in the consumption patterns of

consumers.

• Demand for expensive and luxury items tends

to decrease.
 The Trough

• The phase in which the economy experiences

its lowest level of economic activity.
• Real GDP growth is at a minimum. It may be
‘negative’ – a decline in absolute terms.
• Negative growth in real GDP for two
consecutive quarters is termed a ‘recession’.
• The trough is also most accurately identified in
retrospect.
 Characteristics

• Increased business bankruptcies

• High levels of unemployment
• Further reduction / stabilisation of inflation
• Further reduction of imports
• Continuing and worsening decline in consumer
and business confidence
 Singapore –
business cycle 1996 - 2001

10

4
% change
2 real GDP

0
1996 1997 1998 1999 2000 2001
-2
Source: MAS 2003
-4