BUSINESS CYCLE: THEORY, PHASES, CAUSES, TYPES, EXAMPLE - ECONOMY - 2025

The business cycle is the period of time in which there is a natural boom and bust in economic growth. It is a recurring general pattern of periodic oscillations, quite predictable, measured by the gross national product in national economies.

All market economies go through this cycle repeatedly. This period is a useful tool for analyzing the economy and helps to make better financial decisions. It can also be called a business cycle.

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The business cycle is complete when it goes through a boom and recession in sequence. The length of time to complete this sequence is called the business cycle length.

The peak is characterized by a period of rapid economic growth, while the recession is a period of stagnant economic growth. These are measured in terms of real gross domestic product (GDP) growth.

Cycle analysis

Economists inquire at what stage the economy is in in order to anticipate the next transition. In particular, they analyze GDP, which is the sum of the value of all goods and services produced.

They also take into account the unemployment rate, how the stock market is doing, and how the average prices of products and services are changing, which is also called inflation.

Despite numerous attempts to explain the causes of these cycles, no theory is universally accepted or applicable.

Theory of business cycles

Political theories

Some economists think that political leaders push for easing monetary policy before an election, as a means of fostering prosperity.

Even the imposition of a tax or an import restriction can have some dynamic effect on the economy.

Psychological theories

People are highly influenced by the statements of the groups to which they belong. At certain times the general mood is optimistic and at others it is pessimistic.

This is a factor in the ups and downs of the stock market, in financial booms and busts, and in investor behavior.

Low power theories

When an economy is expanding, production grows faster than consumption. This disparity results from unequal income distribution.

This imbalance between production and consumption indicates that the business cycle is caused by either overproduction or underconsumption.

Technological theories

Cycles of rapid growth and technological adjustment have been taking place, such as the development of petroleum-based energy sources, the harnessing of electrical energy, the invention of the computer and the creation of the Internet.

If a rhythm could be found in these waves of change, that rhythm could be responsible for corresponding movements in the economy.

Monetary theories

Changes in the money supply do not always adjust to underlying economic changes.

The banking system, with its ability to expand the supply of credit in an economic expansion and contract the supply of credit in times of recession, can amplify small economic fluctuations in cycles of prosperity and depression.

Investment theories

Savings accumulate when there are no new investment opportunities. In good times, these savings are invested in new industrial projects and a wave of investment occurs.

Bank credit spreads, thus beginning an incongruity between consumption and production. These imbalances lead to a new period of stagnation and depression.

Phases

Expansion

In this phase the economy is growing. GDP, which measures economic output, is on the rise.

For example, the GDP growth rate can be in the range of 2% to 3%. Inflation is around 2%. The stock market is on the rise. Unemployment reaches a rate of less than 5%. If an economy is well managed it could remain in this phase for years.

When the economy overheats it means that expansion is coming to an end. Investors will find themselves in a state of "irrational exuberance." At this point the asset bubbles are created.

Peak

At this point the expansion passes into the next phase of contraction. The economy reaches a point of satiety. Maximum growth limit is reached.

The economic indicators do not grow any more and are at their highest point. Prices are at their peak. Consumers are looking to restructure their budget.

Contraction

In this phase, economic growth weakens. GDP growth stands at less than 2% and turning negative is what economists call a recession.

Companies don't hire new staff until they make sure the recession has stopped. Stocks enter a declining market when investors start selling.

Depression

In this phase is when the economy bottoms out as low as it can go. It is the negative satiety point for an economy. There is a great depletion in national income and expenditure.

Recovery

In this phase the economy changes and begins to recover from the negative growth rate.

Again, the demand begins to increase thanks to the lower prices and the supply begins to react. The economy shows a better attitude towards employment and investment.

Due to the accumulated amounts of cash in the banks, the loans show positive signs generating new investments in the production process. The recovery continues until the economy returns to stable levels of growth.

Causes

Expansion

Consumers are confident because they know they will have future income from better jobs, and they know that home values ​​will be higher and share prices will rise. That's why they buy at the moment

As demand increases, companies will hire new workers, further stimulating demand. This demand can trigger healthy inflation by prompting you to buy before prices rise.

However, a healthy expansion can suddenly turn into a dangerous peak. It happens when there is too much money looking for too little goods. It can cause higher inflation or an asset bubble.

Peak

If demand outstrips supply, then the economy may overheat. Investors and companies compete to win market, taking more risks for an additional return.

This combination of excessive demand and the creation of high-risk derivatives can create dangerous asset bubbles.

Contraction

Three types of events trigger a contraction. These are a rapid rise in interest rates, a financial crisis, or runaway inflation.

Fear and panic replace trust. Investors sell stocks and buy bonds, gold, and hard currencies. Consumers lose their jobs, sell their homes, and stop buying anything but basic necessities. Companies lay off workers.

Depression - Recovery

Consumers must regain confidence before the economy can enter a new phase of expansion.

This often requires government intervention with fiscal or monetary policies.

Types of economic cycle

Minor cycle

This cycle gained popularity in 1923 by the British economist Kitchin. That is why it is also known as the short Kitchin cycle.

This economist after conducting research came to the conclusion that a business cycle occurs approximately every thirty to forty months.

Major cycle

The French economist Jugler stated that periods of bonanza and difficulties commonly occurred within an average span of nine and a half years. It is also known as the long Jugler cycle.

It highlighted that the business cycle is an oscillation of business activity between successive crises.

Very long period cycle

It was proposed in 1925 by the Russian economist Kondratieff. It is also known as the Kondratieff cycle.

He concluded that there are much longer wave cycles, lasting more than fifty years.

Kuznet cycle

This type of business cycle was proposed by the American economist Simon Kuznet.

His approach was that a traditional cycle change generally occurs between 7 to 11 years, and an effect may be shown within that period.

Construction cycles

These cycles are associated with two American economists named Warren and Pearson. They expressed their views in the books "World Prices" and "The Construction Industry" in 1937.

His view was that the business cycle occurs in an average of 18 years and the cost of that cycle has a significant effect on building construction and industrial development.

Example

Economic crisis in the United States

The 2008 recession was very unpleasant, because the economy rapidly contracted 2.3% in the first quarter of 2008. When it recovered 2.1% in the second quarter, everyone thought the recession was over.

However, it contracted another 2.1% in the third quarter, before dropping a whopping 8.4% in the fourth quarter.

The economy took another hit in the first quarter of 2009 when it contracted a brutal 4.4%. The unemployment rate increased from 5% in January to 7.3% in December.

The depression occurred in the second quarter of 2009. GDP contracted 0.6% and unemployment increased to 9.5%.

Start of expansion

The expansion phase started in the third quarter of 2009 when GDP increased by 1.5%. That was thanks to stimulus spending from the US Recovery and Reinvestment Act. However, the unemployment rate continued to worsen, reaching 10% in October.

Four years after the expansion phase, the unemployment rate was still at a peak of 7%. This is because the contraction phase was too hard.

The peak that preceded the 2008 recession occurred in the third quarter of 2007, where GDP growth was 2.2%.

References

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3. Business Dictionary (2019). Economic cycle. Taken from: businessdictionary.com.
4. CFI (2019). What is a Business Cycle? Taken from: corporatefinanceinstitute.com.
5. Henri Guitton (2019). Business cycle. Encyclopaedia Britannica. Taken from: britannica.com.
6. Saqib Shaikh (2019). Business or Trade Cycles in an Economy: Meaning, Definition and Types. Economics Discussion. Taken from: economicsdiscussion.net.