Tuesday, November 18, 2014

The Business Cycle

Below is a basic diagram of the business cycle (Figure 1).
Figure 1 adapted from Krugman & Wells, 2013, P. 171

In the diagram, four separate elements of the business cycle can be seen. The first element is the expansion, where growth is positive. The cycle then reaches a peak where the growth turns from positive to negative. The business cycle then enters a period of contraction, which is illustrated in this diagram by the purple bars. During contraction the size of the economy is shrinking. These times of shrinkage are called recessions, which are two or more quarters of consecutive shrinkage. It is possible to have a shorter contraction that is not a recession, but that is not illustrated in the graph. The shrinkage then stops, and then growth begins again. This local minimum on the diagram is known as a business cycle trough. Overall, despite the cyclical nature of the ups and downs in the business cycle, the upward trend is illustrated with the orange line, a mean with which to revert to.
There are certain economic phenomena related with each segment. For periods of growth in the expansionary phase, the biggest worry is that people might have too much money to spend. Though counter-intuitive, when there is too much money in the economy, the risk of inflation rises as there is too much money chasing too few goods, and the price level rose. Conversely, during times of contraction and especially those that are long enough to be called during recessions, the risk of unemployment is present, as companies lay off workers in reaction to less consumption.
Though there are recessions shown on the diagram, there is one final rare business cycle phenomenon that is not shown on the chart. That would be the potential for depression, which is an extended slump such as happened globally in the 1930s. Through the use of both fiscal and monetary policy, governments were able to make sure that the most recent fiscal downturn was just a deep recession instead of another replay of the Great Depression (Krugman & Wells, 2013, p. 168).  


Krugman, P. & Wells, R. (2013). Macroeconomics. New York, NY : Worth Publishers