Definition of 'Business Cycle

The recurring and fluctuating levels of economic activity that an economy experiences over a long period of time. The five stages of the business cycle are growth (expansion), peak, recession (contraction), trough and recovery. At one time, business cycles were thought to be extremely regular, with predictable durations, but today they are widely believed to be irregular, varying in frequency, magnitude and duration.

Four Phases of Business Cycle

Business Cycle (or Trade ycle) is divided into the following four phases !"
1. 2. 3. 4.

Prosperity Phase ! #xpansion or $oom or %pswing of economy. Recession Phase ! from prosperity to recession (upper turning point). Depression Phase ! ontraction or &ownswing of economy. Recovery Phase ! from depression to prosperity (lower turning 'oint).

Diagram of Four Phases of Business Cycle

The four phases of business cycles are shown in the following diagram !"

The business cycle starts from a trough (lower point) and passes through a recovery phase followed by a period of expansion (upper turning point) and prosperity. After the peak point is reached there is a declining phase of recession followed by a depression. Again the business cycle continues similarly with ups and downs.

Explanation of Four Phases of Business Cycle

The four phases of a business cycle are briefly explained as follows !"

1. Prosperity Phase
(hen there is an expansion of output, income, employment, prices and profits, there is also a rise in the standard of living. This period is termed as 'rosperity phase. The features of prosperity are !" ). +. ,. -. /. 1. 3. 5. *igh level of output and trade. *igh level of effective demand. *igh level of income and employment. .ising interest rates. 0nflation. 2arge expansion of bank credit. 4verall business optimism. A high level of 6# (6arginal efficiency of capital) and investment.

&ue to full employment of resources, the level of production is 6aximum and there is a rise in G P (7ross 8ational 'roduct). &ue to a high level of economic activity, it causes a rise in prices and profits. There is an upswing in the economic activity and economy reaches its Pea!. This is also called as a Boom Perio".

#. Recession Phase
The turning point from prosperity to depression is termed as .ecession 'hase. &uring a recession period, the economic activities slow down. (hen demand starts falling, the overproduction and future investment plans are also given up. There is a steady decline in the output, income, employment, prices and profits. The businessmen lose confidence and become pessimistic (8egative). 0t reduces investment. The banks and the people try to get greater liquidity, so credit also contracts. #xpansion of business stops, stock market falls. 4rders are cancelled and people start losing their 9obs. The increase in unemployment causes a sharp decline in income and aggregate demand. 7enerally, recession lasts for a short period.

$. Depression Phase
(hen there is a continuous decrease of output, income, employment, prices and profits, there is a fall in the standard of living and depression sets in. The features of "epression are !" ). +. ,. -. /. 1. 3. 5. :all in volume of output and trade. :all in income and rise in unemployment. &ecline in consumption and demand. :all in interest rate. &eflation. ontraction of bank credit. 4verall business pessimism. :all in 6# (6arginal efficiency of capital) and investment.

0n depression, there is under"utili;ation of resources and fall in 78' (7ross 8ational 'roduct). The aggregate economic activity is at the lowest, causing a decline in prices and profits until the economy reaches its %rough (low point).

&. Recovery Phase

The turning point from depression to expansion is termed as .ecovery or Revival 'hase. &uring the period of revival or recovery, there are expansions and rise in economic activities. (hen demand starts rising, production increases and this causes an increase in investment. There is a steady rise in output, income, employment, prices and profits. The businessmen gain confidence and become optimistic ('ositive). This increases investments. The stimulation of investment brings about the revival or recovery of the economy. The banks expand credit, business expansion takes place and stock markets are activated. There is an increase in employment, production, income and aggregate demand, prices and profits start rising, and business expands. .evival slowly emerges into prosperity, and the business cycle is repeated. Thus we see that, during the expansionary or prosperity phase, there is inflation and during the contraction or depression phase, there is a deflation

%he 'tages of the Business Cycle

There are four stages that describe the business cycle. At any point in time you are in one of these stages! ). ontraction " (hen the economy starts slowing down. 2. Trough " (hen the economy hits bottom, usually in a recession. ,. #xpansion " (hen the economy starts growing again. -. 'eak " (hen the economy is in a state of <irrational exuberance.<

(ho Determines the Business Cycle 'tages)

The 8ational $ureau of #conomic .esearch (8$#.) analy;es economic indicators to determine the phases of the business cycle. The $usiness ycle &ating ommittee uses quarterly 7&' growth rates as the primary indicator of economic activity. The $ureau also uses monthly figures, such as employment, real personal income, industrial production and retail sales.

(hat GDP Can *ou Expect in Each Business Cycle Phase)

0n the ontraction phase, 7&' growth rates usually slow to the )="+= level before actually turning negative. The +>>5 recession was so nasty because the economy immediately shrank ).5= in the first quarter +>>5, grew 9ust ).,= in the second quarter, before falling another ,.?= in the third quarter, and then plummeting a whopping 8.9% in the fourth quarter. The economy received another wallop in the first quarter of +>>?, when the economy contracted a brutal 1.?=. 0n the Trough phase, 7&' growth may still be negative, but it@s not as bad. 0t@s clear that the economy has turned a corner. According to the 8$#., this occurred in the second quarter +>>?, when 7&' contracted a mere .3=. 0n the #xpansion phase, 7&' growth turns positive again. 0n the +>>5 recession, this wasn@t until the third quarter +>>?, when the 7&' grew ).1=. This was thanks to the stimulus spending from the American .ecovery and .einvestment Act. 0n the #xpansion phase of the business cycle, the 7&' growth rate will be in the healthy +" ,= growth range. 0f the economy is managed well, it can stay in the #xpansion phase for years.The expansion phase started in the third quarter +>>?, and is still continuing "" although it is too slow to create enough 9obs to lower the ?= unemployment rate. That@s because the ontraction phase was so harsh. The 'eak phase is when the economy@s expansion slows. 0t@s usually the last healthy growth quarter before the recession starts. Aou usually don@t know you are in a peak until it is too late. *owever, if the 7&' growth rate is -= or higher for two or more quarters in a row, you can bet the peak is not far off. 0n the +>>5 recession, the peak occurred in the fourth quarter +>>3, when the 7&' growth rate was ).?=.

(hat Causes the Business Cycle)

The business cycle is affected by all the forces of supply and demand. (hen consumers are confident, they buy now knowing there will be income in the future from better 9obs, higher homes values and increasing stock prices. #ven a little healthy inflation can trigger demand by spurring shoppers to buy now before prices go up. As demand increases, businesses hire new workers, which further stimulates more demand. This is the #xpansion phase.

0f demand outstrips supply, then the economy can overheat. This created the housing asset bubble in +>>/. 0t@s still the #xpansion phase, but if demand isn@t cooled down with higher taxes (fiscal policy) or higher interest rates (monetary policy), then the 'eak is not far off. 0n the ontraction phase, confidence is replaced by fear or even panic. onsumers sell their homes, and stop buying. $usinesses lay off workers, and hoard cash. onfidence must be restored to before the Trough can be hit, and the economy re"enters a new #xpansion phase. Examples+ The 8ational $ureau of #conomic .esearch (8$#.) is the official arbiter of economic expansions and contractions, or business cycles.