What Is A Business Cycle

What is a Business Cycle?
A business cycle is a cycle of fluctuations in the Gross Domestic Product (GDP)

around its long-term natural growth rate. It explains the expansion and
contraction in economic activity that an economy experiences over time.
A business cycle is completed when it goes through a single boom and a

single contraction in sequence. The time period to complete this sequence is
called the length of the business cycle. A boom is characterized by a period of
rapid economic growth whereas a period of relatively stagnated economic
growth is a recession. These are measured in terms of the growth of the real
GDP, which is inflation-adjusted.

Stages of the Business Cycle
In the diagram above, the straight line in the middle is the steady growth line.
The business cycle moves about the line. Below is a more detailed description
of each stage in the business cycle:
#1 Expansion
The first stage in the business cycle is expansion. In this stage, there is an
increase in positive economic indicators such as employment, income, output,
wages, profits, demand, and supply of goods and services. Debtors are
generally paying their debts on time, the velocity of the money supply is high,
and investment is high. This process continues as long as economic conditions
are favorable for expansion.
#2 Peak
The economy then reaches a saturation point, or peak, which is the second
stage of the business cycle. The maximum limit of growth is attained. The
economic indicators do not grow further and are at their highest. Prices are at
their peak. This stage marks the reversal point in the trend of economic
growth. Consumers tend to restructure their budgets at this point.
#3 Recession
The recession is the stage that follows the peak phase. The demand for goods
and services starts declining rapidly and steadily in this phase. Producers do
not notice the decrease in demand instantly and go on producing, which
creates a situation of excess supply in the market. Prices tend to fall. All
positive economic indicators such as income, output, wages, etc.,
consequently start to fall.

#4 Depression
There is a commensurate rise in unemployment. The growth in the economy

continues to decline, and as this falls below the steady growth line, the stage
is called depression.
#5 Trough
In the depression stage, the economy’s growth rate becomes negative. There
is further decline until the prices of factors, as well as the demand and supply
of goods and services, reach their lowest point. The economy eventually
reaches the trough. It is the negative saturation point for an economy. There is
extensive depletion of national income and expenditure.
#6 Recovery
After this stage, the economy comes to the stage of recovery. In this phase,
there is a turnaround from the trough and the economy starts recovering from
the negative growth rate. Demand starts to pick up due to the lowest prices
and, consequently, supply starts reacting, too. The economy develops a
positive attitude towards investment and employment and production starts
increasing.
Employment begins to rise and, due to accumulated cash balances with the
bankers, lending also shows positive signals. In this phase, depreciated capital
is replaced by producers, leading to new investments in the production
process.
Recovery continues until the economy returns to steady growth levels. It

completes one full business cycle of boom and contraction. The extreme
points are the peak and the trough.
Key terms
Key term Definition
a model showing the increases and decreases in a nation’s
real GDP over time; this model typically demonstrates an
business increase in real GDP over the long run, combined with
cycle model short-run fluctuations in output.
the total demand for a nation’s output, including household

aggregate consumption, government spending, business investment,
demand and net exports
aggregate the total supply of goods and services produced by a

supply nation’s businesses
expansion the phase of the business cycle during which output is

Key term Definition
increasing
the phase of the business cycle during which output is

recession falling
depression a deep and prolonged recession
the turning point in the business cycle between an

expansion and a contraction; during a peak in the business
cycle, output has stopped increasing and begins to
peak decrease.
the turning point in the business cycle between a recession

and an expansion; during a trough in the business cycle,
output that had been falling during the recession stage of
the business cycle bottoms out and begins to increase
trough again.
when GDP begins to increase following a contraction and a

trough in the business cycle; an economy is considered in
recovery until real GDP returns to its long-run potential
recovery level.
the level of output an economy can achieve when it is

producing at full employment; when an economy is
potential producing at its potential output, it experiences only its
output natural rate of unemployment, no more and no less.
the straight line in the business cycle model, which is

growth usually upward sloping and shows the long-run pattern of
trend change in real GDP over time
Key term Definition
the difference between actual output and potential output
when an economy is producing more than full employment
output; when there is a positive output gap, the rate of
unemployment is less than the natural rate of
positive unemployment and an economy is operating outside of its
output gap PPC.
the difference between actual output and potential output

when an economy is producing less than full employment
output; when there is a negative output gap, the rate of
negative unemployment is greater than the natural rate of
output gap unemployment and an economy is operating inside its PPC.
Key Takeaways
The business cycle

The business cycle model shows how a nation’s real GDP fluctuates over
time, going through phases as aggregate output increases and decreases. Over
the long-run, the business cycle shows a steady increase in potential output in
a growing economy.
Phases and turning points of the business cycle

The typical business cycle has four phases, which progress as follows:
Phase of
cycle Description
When real GDP is increasing and unemployment is
Expansion decreasing
The turning point in the business cycle at which output

Peak stops increasing and starts decreasing
Recession When output is decreasing and unemployment is increasing
The turning point at which a recession ends and output

Trough starts increasing again

What Is A Business Cycle

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What Is A Business Cycle

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What is a Business Cycle?

A business cycle is a cycle of fluctuations in the Gross Domestic Product (GDP)

A business cycle is completed when it goes through a single boom and a

There is a commensurate rise in unemployment. The growth in the economy

Recovery continues until the economy returns to steady growth levels. It

the total demand for a nation’s output, including household

aggregate the total supply of goods and services produced by a

expansion the phase of the business cycle during which output is

the phase of the business cycle during which output is

depression a deep and prolonged recession

the turning point in the business cycle between an

the turning point in the business cycle between a recession

when GDP begins to increase following a contraction and a

the level of output an economy can achieve when it is

the straight line in the business cycle model, which is

the difference between actual output and potential output

The business cycle

Phases and turning points of the business cycle

The turning point in the business cycle at which output

Recession When output is decreasing and unemployment is increasing

The turning point at which a recession ends and output

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