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Business Cycle 1 PDF

A business cycle consists of periods of economic expansion and contraction. It can be measured by fluctuations in gross domestic product around the potential growth rate of the economy. A full business cycle involves six stages: expansion, peak, recession, depression, trough, and recovery. Expansion involves growth in economic indicators until a peak is reached, followed by a recession, depression at the trough, and eventual recovery back to the steady growth rate. Economists offer different explanations for business cycles, with Keynes attributing them to aggregate demand shocks and others citing technology or supply-side factors.

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626 views4 pages

Business Cycle 1 PDF

A business cycle consists of periods of economic expansion and contraction. It can be measured by fluctuations in gross domestic product around the potential growth rate of the economy. A full business cycle involves six stages: expansion, peak, recession, depression, trough, and recovery. Expansion involves growth in economic indicators until a peak is reached, followed by a recession, depression at the trough, and eventual recovery back to the steady growth rate. Economists offer different explanations for business cycles, with Keynes attributing them to aggregate demand shocks and others citing technology or supply-side factors.

Uploaded by

Amina Gul
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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What is a Business Cycle?

A business cycle is a cycle of uctuations 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 in ation 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 rst stage in the business cycle is expansion. In this stage, there is an
increase in positive economic indicators such as employment, income,
output, wages, pro ts, 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
until economic conditions become 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 in the
trend of economic growth. Consumers tend to restructure their budget
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. The economy
eventually reaches the trough. This is the lowest it can go. 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 hence, production starts increasing.

Employment also begins to rise and due to the accumulated cash


balances with the bankers, lending also shows positive signals. In this
phase, depreciated capital is replaced by producers, leading to new
investment 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.


 

Explanations by Economists
John Keynes explains the occurrence of business cycles as a result of
uctuations in aggregate demand, which bring the economy to short-
term equilibriums that are di erent from a full employment equilibrium.
Keynesian models do not necessarily indicate periodic business cycles
but imply cyclical responses to shocks via multipliers. The extent of these
uctuations depends on the levels of investment, for it determines the
level of aggregate output.

On the contrary, economists like Finn E. Kydland and Edward C. Prescott,


who are associated with the Chicago School of Economics, challenge the
Keynesian theories. They consider the uctuations in the growth of an
economy not as a result of monetary shocks, but a result of technology
shocks, such as innovation. It is generally rejected by mainstream 
economists who follow the path of Keynes.

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