Question

3. Describe the phases and key characteristics of business cycles. Then explain where you think we are in the business cycle right now and why.

Answer 1

The business cycle shows the fluctuations or upward/downward movement in the GDP which shows different phases of the economy. The business cycle is also known as the trade cycle or economic cycle. It consists of one highest and one lowest point and the process continues. There are five phases of the business cycle which are as follow:

1. Expansion: In this phase, the economy undergoes changes which result in an increase in GDP. This shows increased production, consumption, expenditure, employment, etc. People have money and therefore takes loan which boosts capital and thus GDP. People take loans and therefore the interest rate is high but the repayers are at a good position to repay the loan. This phase also experiences growth in the economy. The profits, wage rates, demand and supply, and every economic activity shows growth in this period. This is shown by the upward movement of the economy over a period of time. This is shown in the diagram below which shows all the phases of the cycle.

2. Peak: Once the GPD grows in the expansion phase, it reaches its maximum limit which is known as peak. When there is an increase in capital, employment, wage rate, demand and supply, GDP increases which result in inflation. Prices rise and therefore people reduce their expenditure gradually and start saving. Peak is the phase when the inflation is high, GDP is high and the economy is in a good position but stagnant. At this point people start saving so less demand is created and then the supply exceeds demand. When supply exceeds demand the price level reduces and from this point, a new phase starts which is known as Recession.

3. Recession: This phase is opposite to that of expansion. This phase starts just after peak. When the economy reaches its maximum, its start declining in which the price level or inflation decreases, employment, demand and supply, income, wages, profit and interest rate, etc decreases. There is a decrease in economic activity in the economy which lowers the GDP of the economy. Since the demand reduces, the supply exceeds the demand and thus there is overproduction. It is so because the suppliers are initially not aware that the demand is decreasing and hence they do not stop producing. Once they come to know about it, the over-production is done and then they start cutting cost by laying off the employees, reducing wage rate, investing less in machinery and other factors of production. This period shows downward movement in GDP over a period of time. This lowers the GDP further which brings the economy to Trough phase, which is the next phase.

4. Trough: It is the lowest point to which the economy reaches after the recession which leads to depression. At this stage, it becomes very difficult for the economy to regain its strength as the growth is in negative. The growth not only stops but it becomes negative. In this period the growth rate is slow with a high rate of unemployment, people become insolvent as they do not have money to repay the debts. There is no demand for loan and hence no investment though the interest is decreased, then also people save as unemployment increases. Trough is the lowest point of the economy.

5. Recovery: Once the economy reaches its minimum limit, the economy is boosted by increasing government expenditure through borrowings and other tools so that the economy can recover itself. This will again increase the demand and supply, wage rate, profit, sales, interest rate, demand for loan and employment. Production, investment, consumption, etc start taking place with an increase in expenditure. This results in an increase in price level also. The companies stop laying off and increase their supply and investment in factors of production. This brings prosperity to the economy once again.

Although the phases change the producers enjoys profit in all the phases. It is the consumers who change their rate of consumptions each time. These phases then continue to take place in this order. This can be shown in the diagram below:

The U.S economy is experiencing Expansion phase now as it had recession is 2008 which got recovered and the interest rates are high to which debtor can repay their loans. The economy is in a better position. The economic activities such as production, consumption, investment are increasing. The producers are not laying off and have increased wage rate, investment in machinery and other factors of production. Therefore we can say that the U.S economy is in the expansion phase of the business cycle.