Business Cycle: Various Stages (Phases) Of Business Cycle

By: Watsala Shakya

What Is Business Cycle?

Business cycles are the fluctuations found in the entirety of the economic activities of a country. Like the cycle of the seasons, the cycle of the business cycle starts a new every time. Unlike the season, business cycles do not have definite time frames. A phase of the business cycle could last a month, a year or several years. Economic activities of a country is at constant flux; it expands and contracts simultaneously as a number of economic activities occur at the same time.

In other terms business cycles involve cyclical upturns and downturn which are mainly measured in Gross domestic Product (GDP). These flux are caused due to production, trade, employment, income and other economic activities when they persist for a long time. For instance, if employment increases, this would mean more people have income to buy more commodities, this would in turn bring up demands for commodities in an economy to which increase in production would follow. This would increase the GDP of a nation which would indicate the economy is booming and is expanding. On the other hand, if employment rates were down, people would not have income to buy commodities, this would bring down the demands for commodities in an economy due to which in production would fall. This would decrease the GDP of a nation which would indicates that an economy is going through a slump and is contracting.

Business cycles, also known as economic cycles or boom-bust cycles or trade cycles are universal to capitalist economies. In these economies the market dictates in which phase the economy lies in. Understanding in which phase the economy lies in helps investors make financial decisions and the government to make policies. Now that the world is rapidly globalizing many economies can be seen to in the same economic phases, this also means economies are more inter-dependent now that they ever were. Now nations have together as economic blocs such as NAFTA, SARRC, the strings of pearl and ASEAN to name a few. Once one economy hits its peak others economies closely tied with the economy are likely to follow. While if the economy of one nation falls, other nations may sink.

Stages/Phases Of Business Cycle

Business cycles have six distinct phases that an economy passes through:

1. Expansion

Expansion is the first stage in the business cycle. This phase is characterized by increase in positive economic indicators such as employment, income, wages, corporate profits, demand and supply of commodities and services, among others. During this phase, businesses and companies grow steadily, their production and profits increase, the unemployment rates in the economy remain low, and the stock market does well. During this period, consumers are more inclined to spending their incomes rather than saving. Consumers usually buy and invest, this results in increasing demand for goods and services and consequently prices for goods and services rise. This is the most desirable state of economy which countries strive for. The GDP of this phase is increases consistently over the years. In addition, to this inflation is low and the stock market is a bull market.

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2. Peak

Once the economy reaches a saturation point in the expansion phase, the next stage of business cycle begins, the peak. The peak is considered to be the highest point of the business cycle, when an economy is producing at maximum output, the employment rate is full or close to full employment, and inflation are increasing significantly. At this phase, economic indicators cease to grow further as they reach their highest points. Similarly, as inflation are also at their highest in this phase, prices are at their peak. In this phase, the economy is considered to have grown recklessly out and grows out of control. Companies and investors expand recklessly. Companies expand to foreign markets and product lines, while investors are overconfident when buying assets and growing their portfolio. This stage marks the declining point for the economy, there is no place grow for economic indicators.

3. Recession

Recession follows peak in the business cycle. Recessions begins at the peak of the business cycle—when an expansion ends, when all economic indicators have no space to grow. During the recession, the demand for goods and services begins declining rapidly. Consequently prices of goods and services go down. Manufacturers steadily reduce production due to reduced prices. However, producers cannot match reducing their supply with the decline of demand which creates excess demand in the economy. In addition to this, all positive economic indicators such as employment, income, wages corporate profits, demand and supply of commodities and services, among others, start to decline.

4. Depression

Once the economy does not begin to expand again, the economy may be considered to be in a phase of depression. This period is often the result of decline in economic indicators. Since GDP is used to measure business cycle, this phase is characterized by long periods of falling GDP. This stage is a progressive form of recession. It is vicious cycle in which demand for goods and services fall as people do not possess money to spend. Income of people fall as companies go out of business, which caused unemployment and so forth people do not possess money to spend. The growth in the economy continues to decline even further as it falls below the steady growth line.

5. Trough

Trough is the complete opposite of the peak, it is the lowest point of the economy in a business cycle. This stage occurs when depression reaches its lowest point. At this time the market of the economy starts its rebound into an expansion phase. During this phase, the economic growth rate becomes negative as deflation persist and, demand and supply of goods and services reach their lowest. After this phase, the business cycle begins anew and leads the economy towards recovery.

6. Recovery

After the trough, the economy has nowhere to go except up. The business cycle takes the economy to a recovery phase. This marks a turnaround for the economy. During this phase, demand for goods and services starts to increase due to low prices, consequently producers increase their supply to match the demand in the market. As demand rise, business boom, employment rates steadily begin to increase and the people develop a positive attitude towards investment. This also contributes to increasing employment and production. Recovery continues until the economy returns to steady growth levels and eventually reaches the expansionary phase. This completes one full business cycle.

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