• The term business cycle refers to the recurrent ups and downs in the

level of economic activity, which extend over several years.

• Business cycle is the periodic up and down movements in economic

activities.

• The ups and downs in the economy are reflected by the fluctuations in
economic activities such as total production, investment, employment,
prices wages bank credit etc.

• The upward and downward movements in these economic variables

show different phases of business cycles.

• The business cycle occurs when economic activity speeds up or slows

down.

• A business cycle is a period of macroeconomic expansion followed by a

period of contraction. The economy follows the Business Cycle.
 Business Cycles
• Business Cycles--are fluctuations, or changes, in a
market systems’ economic activity.
– These changes are measured by increases or decreases GDP.
– Characterized by periods of economic growth followed by
periods of economic decline.

EXAMPLE: What does the GDP tell us?

• If the GDP is larger than last year the economy is

expanding (getting bigger)
• If the GDP is smaller, the economy is shrinking (getting
smaller)
• Prosperity Phase: Expansion or Boom or Upswing of
economy- a period of economic growth

• Recession Phase: From prosperity to recession or downward

turn- a period of economic decline

• Depression Phase: Contraction or Downsizing of the

economy.

Trough: the lowest point of the contraction

• Recovery Phase: from depression to prosperity or upward

turn
Four Phases of the Business Cycle
 Phases of Business Cycle
• Steady Growth line: shows the growth of the economy
when there are no business cycles. The various phases
of business cycles are shown by the line of the cycle
which moves up and down the steady growth line.
• The line of the cycle moving above the steady growth
line – marks the beginning of the period of expansion
or prosperity in the economy.

• It is characterised by increase in output, employment,

investment, AD, sales, profit, bank credit, prices,
percapita output and a rise in standard of living.
– However, the growth rate eventually slows down and reaches its
peak. Then the phase of recession begins when the downward
slide in the growth rate becomes rapid and steady.

Output, employment and prices show a rapid decline though the

growth rate may still remain above the steady growth line.

– So long as growth rate exceeds or equals steady growth rate the

economy enjoys the period of prosperity high or low.

– But when growth rate falls below the steady growth rate it marks
beginning of depression.

When depression continues and hits the bottom it marks a period

of trough.

After the period of trough, the economic begins to recover. The

process is continuous.
 Expansion and Peak
• High level of output
• High level of employment and income
• High level of effective demand or AD
• Rising interest rate& Large expansion of bank credit
• Overall business optimism &People are optimistic and
spending money
• A high level of investment
• Wages increase& Low unemployment
• High demand for goods
• Businesses start
• Easy to get a bank loan
• Businesses make profits and stock prices increase

So long as these conditions permit , the expansion continues

following by the multiplier process.
 In the later stage of prosperity:
• Inputs start falling short of their demand
• Additional workers are hard to find
• They can be obtained by bidding a wage rate higher than
prevailing rate
• Same situation appear in other input markets
• Consequently input prices increase rapidly leading to increase in
output and employment.
• Cost of living increases at a relatively higher than increase in HHs
income.
• Hence actual demand stagnates or even decreases
• The first impact falls on the demand for new houses, flats and
apartments
• Following this the demand for cement iron and steel and
construction labour tends to halt. This appears subsequently in
other durable goods industries.
• This marks reaching the peak.
 Peak
– The economy stops growing (reached the top)
– GDP reaches maximum
– Businesses can’t produce any more or hire more people
– Cycle begins to contract
• Economic activity slows down
• Demand starts falling
• Overproduction of goods
• Steady decline in:
 Output
 Income
 Employment
 Prices and profit

• Once the economy reaches peak increase in demand is halted.

Demand even starts decreasing in some sectors for the reason stated
above.

• Producers on the other hand are unaware of this fact.

They continue to maintain their existing level of production and
• As a result discrepancy between output supply and demand arises and so
slow that goes unnoticed for some time. This situation appear in few
industries at first and latter it spreads to other industries. Then producers
feel that they have done over production and over investment.

• Consequently future investment plans are given up. Orders placed on new
equipment, raw materials and other inputs are cancelled. Demand for
labour ceases to increase

• Temporary and causal workser are not hired to bring demand and supply in
balance.

• The cancellation of orders for inputs by the producers of consumer goods

creates a chain reaction in the input market. Producer of capital goods and
raw materials cancel their orders for their input. This is the turning point
and beginning of the recession.

•
• Since the demand for inputs has decreased, input prices such as wage and
interest etc show a gradual decline leading to decline in income of wage
and interest earners. This causes demand recession.

• On the other hand, producers lower their price to meet their financial
obligations. But consumers in turn further expect to fall in prices and hence
postpone their purchases.

• As a result discrepancy between DD and SS continues to grow. When this

process speed it takes the forms of irreversible recession.
• Investment start declining. The decline in investment leads to decline in
income and consumption.
• When investments are reduced, production and employment decline.
• It results in further decline in demand for both capital and consumer
goods.
• Borrowing for investment decreases, bank credit shrinks. Unemployment
increases even there is fall in wage rate.
 Contraction
• During a period of contraction:
– Businesses cut back production and layoff people
– Unemployment increases
– Number of jobs decline
– People are pessimistic (negative) and stop spending money
– Banks stop lending money

• A contraction that lasts for at least six months is called

a recession. Or when the growth rate falls below the
steady growth line the economy enters the phase of
depression.
 During a
period of
contraction,
more people
are unemployed
and fewer goods
and services are
being produced
and sold. Not
all contractions
are equally
severe.
E. Napp
 A particularly severe and long contraction is called a depression. The growth rate
becomes negative. The level of national income and expenditure declines rapidly.
Prices of consumer and capital goods declines steadily. Workers lose their jobs.
Debters find it difficulty to pay off their debts.

• Rise in unemployment
• Decline in consumption and demand
• Fall in interest rates
• Deflation
• Contraction of bank credit
• Overall business pessimism
• Fall in MEC and investment

• Investment becomes less profitable and attractive. At the depth of

depression all economic activities touch the bottom and the phase
of trough is reached. Weaker firms are eliminated from the
industries. At this point the process of depression is complete.
 Trough
• When the economic cycle reaches a trough:
– Economy “bottoms-out” (reaches lowest point)
– High unemployment and low spending
– Stock prices drop

But, when we hit bottom, no where to go but up!

UNLESS….
When the economy hits the bottom and stays
there for some time it marks the end of
pessimism and beginning of optimism. This
reverses the process
• As the recovery starts , some firms plan additional investment, some
undertake renovation programmes and some undertake both. These
activities generate construction activities in both consumer and
capital goods sector.
• Individuals who had postponed their plans to construct houses
undertake this task now. As result more and more employment is
generated.
• Rise in economic activity
• Rise in demand
• Increase in investment and production
• Rise in:
 Output
 Income
 Employment
 Prices
 Profits
 The Great
Depression
was the most
severe economic
contraction in the
history of the
world. It
permanently
changed the way
economists think.
E. Napp
Factors Which Affect the Business Cycle/What
keeps the Business Cycle Going?
• The following four factors can affect the
business cycle/keep the the Business Cycle
Going :
Investment in Businesses
Interest Rates
Consumer Expectations
External Shocks

E. Napp
 The more money people invest in businesses,
the more money businesses have to grow.
Investment affects the business cycle.

Business Investment
When the economy is expanding, sales and profit keep rising, so
companies invest in new plants and equipment, creating new
jobs and more expansion. In contraction, the opposite is true
E. Napp
Interest is the price of borrowed money. When
interest rates are high, people borrow less.
Businesses borrow less too. Interest rates affect
the business cycle.
Interest Rates and Credit
Low interest rates, companies make new investments, adding jobs.
When interest rates climb, investment
E. Napp dries up and less job growth
When people are optimistic about the future,
they spend more money. Optimism affects
the business cycle.

Consumer Expectations
Forecasts of an expanding economy fuels more spending, while
fear of a recession decreases consumer spending
E. Napp
External shocks can be positive or negative.
An earthquake is a negative external shock.
It affects the business cycle.
E. Napp
What keeps the Business Cycle Going?
4. External Shocks
External Shocks, such as disruptions of the oil
supply, wars, or natural disasters greatly
influence the output of the economy

Ex. 1992-2000 was the longest period of expansion

in U.S. history. Early in 2001, signs of contraction
appeared, though the Bush administration
denied it. The Sept. 11th 2001 terrorist attacks
quickly caused the business cycle to shift into a
contraction.
 Who Cares?????
• Why should you care about the business cycle
and economy?

• Lots of reasons!
 “Don’t quit that job!”
• If the economy is going into a contraction,
jobs will become more scarce. If you quit, you
may not find another job!

• But, if the economy is in a period of

expansion, jobs are readily available. It may be
a good time to switch careers.
 “Should I make a big purchase?”
• Only if you know that you won’t lose your job
in a contraction. So, buy your house during an
expansion.
HOWEVER,
• When the economy starts to slow down
(contraction), interest rates will decrease.
Wait to buy a house until the rates drop to a
low point, if you are sure you won’t lose your
job.
 Quick Review!
• What phase of the business cycle do wages go
up?
• Expansion

• What phase of the business cycle do wages go

down?
• Contraction
 Review cont.
• When are wages at their highest?
• Peak

• When are wages at their lowest?

• Trough
 More Review
• When will borrowing decrease?
• Contraction

• When will borrowing increase?

• Expansion

• When will borrowing be at it’s lowest?

• Trough
 Even More Review!
• When will unemployment be at its lowest?
• Peak

• When will business profits be the highest?

• Peak

• When should you look for a new job?

• Expansion
 Questions for Reflection:
• Define the business cycle.
• What are the four phases of the business cycle
and explain each phase?
• What are the four factors that affect the
business cycle and how does each factor affect
the business cycle?
• What is the relationship between Gross
Domestic Product and the four phases of the
business cycle?
E. Napp
 When an economy
is expanding or
growing, many people
have jobs and many
goods and services
are being produced
and sold.

E. Napp