Business Cycle

Business Cycle term used by economists to designate a periodic increase and decrease in an economy’s production and employment.


Ever since the Industrial Revolution of the 1800s, the overall level of production in industrialized capitalist countries has varied from high output and employment to low output and employment. Economists study business cycles because they have a significant impact on all aspects of an economy.

BUSINESS CYCLE CHARACTERISTICS

 

 

A business cycle has a period of expansion and a period of contraction. Although each business cycle has its own unique characteristics, all business cycles share certain similarities. For example, in the expansion phase, production increases while employment, wages, and business profits also rise. During the contraction phase of the business cycle, production, employment, wages, and business profits all fall. These phases sometimes go by different names. Expansions are referred to as recoveries, booms, upturns, periods of prosperity, and upswings. Contractions are variously called recessions, downturns, downswings, and liquidations. The word “depression” also applies to business cycle contractions but is normally reserved for the worst or most severe contractions.

All business cycles also have peaks and troughs, words that economists use for the turning points in a business cycle. A peak marks the end of an expansion and the beginning of a contraction, while a trough marks the end of a contraction and the beginning of an expansion.

In the typical business cycle expansion, business firms will exhibit optimism about the economic outlook. They will express this optimism by investing in facilities, thereby expanding their ability to produce goods and services. The firms will also hire more people to work in their stores, factories, and offices. Consumers will also be optimistic during an expansion. Their optimism leads them to increase their purchases, typically resorting to additional borrowing to finance the acquisition of more goods and services.

As the upswing continues, however, obstacles begin to develop that hinder further expansion. For example, production costs may increase, shortages of raw materials may develop, interest rates will start to rise, and prices will begin to increase, or, if already increasing, will start to rise more rapidly. Consumers react to higher prices and higher interest rates by buying less. As purchases begin to lag behind production, business firms begin to accumulate inventories (the merchandise or goods that a company or store has on hand). Producers begin to cut back on investment in facilities and reduce employment. Despite these adjustments, profits fall and further cutbacks are made. The economy now enters the contraction phase of the business cycle.

Several different factors can trigger a recovery from a contraction, including an increase in consumer demand, the depletion of inventories, or government action to stimulate the economy. Although generally slow and uneven at the start, the recovery soon gathers momentum. Production and employment begin to increase again, putting additional purchasing power into the hands of consumers. Investment expands in industries that make goods or machinery for sale to other businesses, rather than directly to consumers—industries that are known as capital goods industries. Optimism returns, old businesses expand, and new businesses are created. A new cycle has started.

Business cycles are important not just for their economic consequences but also for their broader social consequences. Several studies have shown that declines in economic activity coincide with declines in birth rates and increases in death and divorce rates. The higher unemployment rates caused by recessions are also associated with higher suicide rates and higher crime rates. See also Suicide; Crime.