Business Cycle

Three Types of Business Cycle Business Cycle Phases Business Cycles as shifts in AD and AS Business Cycle Theories

Business Cycle
The business cycle occurs when economic activity speeds up or slows down. A business cycle is a swing in total national output, income and employment, usually lasting for a period of 2 to 10 years, marked by widespread expansion or contraction in many sectors of the economy.

Business Cycle
Q Potential output Business cycles are the irregular expansions and contractions in economic activity.

Actual output

t (in years)

Three Types of Business Cycle

Economic theory define three types of business cycle:
Short-term (Kitchin) cycle: from 2 to 4 years, it results from the changes in business inventories. Medium-term (Jouglar) cycle: from 7 to 11 years, it refers to new business investment. Long-term (Kondratiev) cycle: from 30 to 50 years, it results from the technological innovation.

Business Cycle
A business cycle can be divided into four major phases:
Recession the downturn of a business cycle. This is a period in which real GDP declines for at least 2 consecutive quarter-years. Through the lowest point of real GDP at the end of a recession.

Business Cycle
Expansion (boom) is a period in which output increases and approaches potential GDP or perhaps even overshoots it. Peak the point at which recession begins, the highest point in real GDP before a recession.

Business Cycles as Shifts in AD

Business cycle generally occurs as a result of shifts in the AD. Decline in the AD lowers output and as a result of downward shift in the AD curve, the gap between actual and potential GDP becomes greater during a recession.

Business Cycles as Shifts in AD

P QP AD AD1 AS Characteristics of the recession: Consumers purchases decline and businesses react by holding back production. Real GDP falls. Businesses investment also falls. The demand for labor falls. The prices of many commodities fall. Wages are less likely to decline, but they tend rise less rapidly. Business profit fall, because the demand for credit falls, interest rates generally also falls.

E P P1 0 E1 Q1 Q

Business Cycles as Shifts in AD

P QP AD1 AD P1 E P E1 AS The case of a boom is, naturally, just the opposite of recession.

Q Q1

Business Cycles as Shifts in AS

P AS1 QP AS

AD E1 E

P1 P

Q1 Q

Business Cycle Theories

Although the main interpretation of business cycles looks to changes in AD, we may classify the different theories into two categories:
The external theories find the root of the business cycles in the fluctuations of something outside the economic system (wars, revolutions, elections, economic policy, migrations, discoveries of new lands and resources). The internal theories look for mechanism within the economic system itself (selfgenerating business cycles).

Business Cycle Theories

Some of the most important business cycle theories are:
Neoclassical theories attribute the business cycle to the expansion and contraction of money and credit. Keynesian theories attribute fluctuations to the economic system itself. They think that the macro economy is prone to extended business cycles, with high levels of unemployed resources for long period of time. They further hold that the government can stimulate the economy.

Business Cycle Theories

Political theories of business cycle attribute fluctuations to politicians who manipulate fiscal and monetary policies in order to be reelected.