Fluctuation in the economic activities including a real boom or collapse of the economic growth over a period is termed as stages of a business cycle. It is the time of expansion or recession. National Bureau of Economic Research using quarterly GDP growth-rate determines the business cycle. NBER uses many other factors to determine the economic cycle such as real personal income, employment, retail sales, consumer spending and industrial production.
What causes business cycle?
There are different opinions from monetarist where they tie the business cycle with credit cycle. The Keynesian approach suggests volatility in investment, changes in demand are responsible for cycles. Irving Fisher contradicts here by arguing that there not be anything as such in equilibrium which is why business cycle exists.
The business cycle could vary in different ways depending on how long they last but typically business cycle has four phases and each phase is dynamic. Primarily there are two phases in a business cycle- Depression and Prosperity, however, there are four main intermediary steps- Expansion, Peak, Contraction, and Trough. Moreover, they are characterized with recognizable indicators
Expansion- It is considered as the default mode of economy. In this phase, there is an increase in various economic factors. Certain economic indicators including production, wage, profit, demand, and supply of products, employment shows an upward trend. Debtors are in sound financial state and creditors can lend money at the high-interest rate which leads to an increased flow of money.
Peak – Here the expansion slowly transitions into the contraction phase. While the beginning and end of a business cycle are hard to predict. An industry peak is at a stage when the business cycle reaches its maximum limit. Economic production factor including employment, profit, sales, are at the highest level but will not increase any further. Due to the price increase of the input, there is a slow decrease in demand for different products.
Contraction – Economic growth slows down and is the opposite of the expansion phase. Economic factors that went up during development phase will start dropping. All economic factors, production, investment, prices trends down. Initially, this stage is considered as small fluctuation, but over a period producers stop investing in production elements such as labor, furniture, and machinery. This further leads to the reduction in price factor which results from the decrease of output as well as demand for inputs. Employees will start laying off the workers from payrolls.
Trough- During this phase, the economic activities go below the average level, and the growth rate of the economy is negative. National income and expenditure show a rapid decline and possibly the economy is ta the lowest level of shrinkage. While the GDP is down during contraction as compared to expansion or peak cycles- at trough phase it touches the lowest point. Unemployment is high, and people do not invest in stock markets.
Policy makers and economists study business cycles very carefully. If cash is available or interest rate high or low and whether companies and consumers can borrow and spend on good and services affect how businesses react. Knowing about the different phases of business cycles and understanding the patterns of the past helps economist forecast trends in the future.