A business cycle is also known as a boom and bust cycle or, as popular, the economic cycle. This cycle entails four parts. The four stages are; expansion, peak, contraction, and trough. Before we get down to all that, what is a business cycle?
A business or economic cycle can be defined as the ups and downs that an economy goes through overtime. It’s evaluated by observing the rate of the GDP (Gross Domestic Product). Economic indicators crucial to economic cycles include the demand and supply of products. The production rate, employment rate, and consumers’ income or wages are also assessed.
These ups and downs are resultant from different factors. These factors could be;
Internal factors- these are factors controllable to a government. These factors are;
- Demand factors – When a consumer’s demand is high, companies increase product supply. This leads to an increased rate of employment. Elevated profits and increased production are as well seen. Yet, high demand may result in inflation in an economy. Contrary, if the demand falls, there are reduced profits. Also, increased unemployment and reduced production. This will lead to a contraction.
- Credit cycle – At a period when the banks can give consumers loans, the economy booms. Increased lending leads to the banks forcing back the money lent. This will be by reducing the availability of credit. It, in turn, decreases growth in the economy.
- Interest rates – Control of interest rates affect the economic cycle in one way or the other. Reduced interest rates attract high borrowing. Hence, enabling high production, leading to expansion. Increased interest rates discourage borrowing and lower economic growth. Additionally, the inflation rate lowers.
- Money supply in the economy – A large supply of money in the economy attracts a boost and leads to inflation. But, a reduced supply leads to a contraction and an economic recession as well.
External factors- these are factors that a government has no control over. Some of these factors include;
- Wars – In times of war, production is low. The unemployment rate is high, and the economy suffers a loss. When the war ends, a nation seeks to reconstruct buildings and roads, among others. This attracts employment and so an increased income. This results in growth in the economy.
- Natural disasters – These are unavoidable circumstances such as floods, earthquakes, and droughts. They negatively affect the economy. This is in terms of reduced production and income as well.
- Increase in population – Larger households do not encourage saving. This is because consumption is usually high. A high population reduces the number of investments. Thus, reduced the growth of the economy. Interestingly, a larger population can also raise economic growth. This is only if their productivity is higher.
- Technological inventions – Efficient technological inventions lead to a boost in the economy. Inventions and innovations that improve infrastructure lead to an economic boost. Those that reduce the cost of production are effective as well.
The National Bureau of Economic Research (NBER) organization handles economic research. It determines the starting and ending dates of different phases in business cycles.
Four Phases of a Business Cycle
As mentioned early, a business or economic cycle has four stages. They are as below.
This is a phase where the economy thrives, and the people enjoy the greatest productivity. At this stage, the output increases, more jobs are also created, and the unemployment rate is meager. This is in the exception of the unemployment types that are either temporary or intended. Other effects of this stage are an increase in profit, sales, and wages. The supply and demand for goods and services also go up. In this stage, there is a good growth rate of the real GDP. In this stage, progress is up until there is a total use of resources.
The consumers enjoy high productivity and an improved living standard as well. The prices may go up, but the consumers are still able to buy. They now spend and borrow more. Now, they buy high valued property, furniture, cars, and other things. If well maintained, this phase can last but, expansions don’t last long as the economy now heads to its peak.
In literal terms, a peak is defined as the highest or best point of a certain stage. The peak in an economic cycle is a stage with the largest flourish. Unfortunately, growth does not extend any further. The output, employment, and sales are at the highest point. But, they start falling at a gradual speed. The gross domestic product also stops going up. It instead starts falling at a slow rate at this stage.
This is the stage where the expansion phase evolves into the contraction stage.
This phase begins at the peak, and the trough is the end of this stage. Business starts going down. The economic factors that were going up like profits, wages, employment, and productivity start falling. The GDP as well starts decreasing at a rapid pace. The economy goes through a recession. At this stage, borrowing and spending and the purchasing power of consumers are also reduced. Demand goes down. Companies reduce the price of services and goods. This is so that these products can move.
Depression is a serious and long-lasting contraction. The distinguishing factor of depression is a significant fall in the gross domestic product. A huge rate of unemployment is as well seen.
The greatest depression in the world was in the year 1929. The precise date recorded is the 24th of October, 1929, marked as ‘Black Thursday.’ The depression lasted up to 10 years. It’s said that the cause was a failure by the banks, drought, debts, and overproduction. The crash of the stock market in that same year was also a factor.
This is the stage that follows and is the final stage of contraction in a business cycle. It is the exact opposite of a peak. It’s realized after the economic indicators that were fallen, they begin rising again. The real GDP well has fallen hugely. It is at its lowest at this point.
The trough marks the beginning of a recovery and the start of another expansion. This stage may sometimes take a longer time. Economists mark troughs by an extremely lowered income, decreased production. A high unemployment rate and low consumer demand are also observed.
These factors tend to change gradually and positively. This change is while the economy seeks to recover. It also attempts to transition to another expansion. During this recovery period, the real GDP has stopped falling and is going up at a slow pace.
Characteristics of a Business Cycle
- Business cycles may have the same factors but are not at all times, similar in unique aspects.
- They are wave-like. The upwards and downwards movement is usually depicted as a wave.
- The times in the phases of the business cycles vary and are dependent on the economic conditions.
- They affect the entire economy. All parts of the economy, i.e., all industries and sectors, are usually affected.
- They are international – Business cycles not only affect a country. They extend to other countries also. A good example is the Great Depression and the Covid-19 current situation.
An economy may experience prolonged growth in the long term. Even so, contractions or recessions are inevitable. The paradox is not why contractions end but why expansions get interrupted. Consumers should enjoy growth by saving up for a bad time. Observing business cycles is a good way for an economy to assess the growth rate. It’s also an effective way to predict changes.