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 Business cycles are the
irregular expansions and
Potential output 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 AS Characteristics of the recession:
QP
•Consumers purchases decline and
businesses react by holding back
AD
production. Real GDP falls.
AD1 Businesses investment also falls.
•The demand for labor falls.
•The prices of many commodities fall.
E
Wages are less likely to decline, but
P
they tend rise less rapidly.
P1 E1 •Business profit fall, because the
demand for credit falls, interest rates
0 generally also falls.
Q1 Q
Business Cycles as Shifts in AD
P AS
QP

AD1 The case of a boom is,

naturally, just the opposite
AD
of recession.

P1 E1
E
P

0 Q Q1 Q
Business Cycles as Shifts in AS
P AS1 AS
QP

AD

E1
P1
P
E

0 Q1 Q 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 (self-
generating 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.